With the trade deficit for July hitting a five year high of $18 billion on the back of a $17.1 billion deficit in June, India’s external sector is deteriorating fast. The bad news is that exports are not really picking up despite GST-related problems having been more or less sorted out. The growth in non-oil exports moderated in July to 11.9% y-o-y from 13.4% y-o-y in June; overall exports rose 14.3%, but on a very weak base of 3.9% in July, 2017. Agriculture, engineering, pharmaceuticals, textiles and leather haven’t done as well as expected though overall volumes are seen to have picked up. Imports, on the other hand, jumped 29% y-o-y, led by bigger pre-festive season purchases of gold and electronics as also coal and chemicals. Monthly oil deficits are now at levels seen in 2013.
Although the currency has been depreciating—the rupee has lost some 8% since January—almost all competing currencies have lost value and several of them have fallen much more than the rupee has. To that extent, a weaker currency can’t really make a big difference to exporters’ ability to price their products competitively. Even otherwise, the currency plays a much smaller role in boosting exports and it is other factors, such as poor infrastructure, very high relative wages and rigid labour laws that are the bigger obstacles. Given how global growth could slow and in its wake, global trade, there is little to suggest any big uptick, but easier trade finance from banks should help. On the other side, a weaker rupee could rein in imports as they get costlier. Moreover, since there is no evidence of meaningful capital expenditure and the economic recovery isn’t really fast-paced, imports of plant and machinery could moderate as could the demand for gold, once the demand in the festive and wedding seasons tapers off.
The big worry is how the CAD will be funded since capital flows this year are unlikely to be as strong as they were last year when the current account deficit, at $48.7 billion, was a shade under 2% of GDP. Foreign direct investment (FDI) flows are estimated to be higher by just about 10% this year over last year’s $30.3 billion. As for portfolio flows, in 2017-18, these were a reasonably strong $22 billion with most of the investments flowing into the bond market. Between April and mid-August, foreign portfolio investors have pulled out $5.6 billion from the bond markets and $2.32 billion from the equity markets. To be sure, the trend has reversed and money has moved into the bond market in August. Nonetheless, given interest rates are rising in the US and the risk aversion to emerging markets (EM) remains, flows could stay modest.
Against this backdrop, economists estimate the CAD for 2018-19 could come in at around 2.7% of GDP on the back of a near $200 billion merchandise deficit. Pranjul Bhandari, chief economist at HSBC, estimates the BoP reached a deficit of around $10-15 billion in Q1FY19. The basic BoP—current account plus net FDI—is also estimated to be negative. RBI holds adequate reserves of $400 billion plus, so there is no reason to panic. But the sharp fall in the currency over the past few days—it hit a new low lifetime of 70.30 on Thursday—and the fact that RBI’s inflation forecast for Q1FY20 is well above its target suggests interest rates could be raised again.