Trade Deficit

The deficit number could be getting out of control

The total trade deficit for the first 7 months of the current fiscal year came in at a whopping $88 billion. What is worrying about the Indian economy is that this is a full 60% higher than the trade deficit reported for the corresponding period last year. There are 3 key implications of this sharply higher trade deficit. Here is how…

Pressure on ratings

If India is currently celebrating the upgrade by Moody’s it also needs to be cautious about letting its trade deficit slip beyond a point. We have seen a sharp 60% rises in trade deficit and that has been largely accounted for by oil and gold imports. Oil bill is likely to keep rising as the global price of Brent Crude will be kept at an elevated level at least till the Aramco IPO is through. At $60/bbl, the Indian economy is already under stress and any level above $65/bbl will make the trade deficit to rise more rapidly. Interestingly, despite the rising trade deficit the INR continues to be strong on the back of positive FDI flows. Also, domestic investors are compensating for any selling by FIIs. The strong rupee, in turn, is having a negative impact on the exports and in the month of October, the exports have actually fallen by -1.2%. Remember, while Moody’s has upgraded, S&P has chosen to maintain status quo on deficit concerns. That is something that the Indian policymakers will have to be cautious about in the future.

Service sector slippages

For a very long time, the weakness in the trade account was compensated for by the strength of the services account. Around 2 years back the surplus in India’s services account almost compensated for the deficit in the trade account. That was a comfortable neutral situation to have. In recent months the trade deficit has almost risen to 4 times the service surplus. That is leaving a huge net deficit to be negotiated. Service sector exports in India was largely accounted for by software exports.  With the growth in software exports almost stagnant and lower tech spending globally, the services surplus is narrowing. That is a major concern!

Eye on the forex reserves

The one thing to keep in mind is the level of the forex reserves.  Through most of last year, the forex chest was good to cover 13 months trade imports.  That comfort level has now come down to just about 9-10 months. India’s forex reserves are not exactly growing as the RBI is using a chunk of the reserves to defend the currency from bouts of volatility. If the current trade in the imports continues then India’s forex cover may fall to less than 9 months which may make the Indian economy vulnerable in comparison with other BRICS economies, which are mainly exporters of commodities. That is something to really watch out for! ©

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