Worrisome trade data

Overvalued Indian rupee needs attention

The data released last Friday revealed that India’s current account deficit in the first quarter of 2017-18 is at its highest level in four years, at 2.4 per cent of gross domestic product (GDP), or $14.3 billion. This was driven by rising imports of gold, which were 69 per cent higher year-on-year. Imports overall rose by over 20 per cent year-on-year in August, while exports rose by only 10 per cent. Thus, the trade deficit in the month increased to $11.64 billion; it was $7.7 billion in the same month last year. Fortunately, there is no immediate threat of a crisis, since foreign exchange reserves crossed $400 billion earlier this month. But the trend is clear and worrying: Exports from India are simply not keeping pace with those from peer countries, and India’s share of world trade does not look like it is increasing appreciably.

Jobs will not be created unless there is a major increase in manufacturing, particularly in labour-intensive sectors. And domestic demand will not be sufficient to ensure that this manufacturing increase happens on the scale required. As such, exports remain necessary. But labour-intensive sectors such as textiles and garments are also frequently cost-sensitive, and Indian exports are simply not competitive enough. On the one hand, it is necessary to ensure that efforts to reduce paperwork and costly over-regulation are continued and intensified. On the other, however, the effect of an over-valued currency on competitiveness should not be denied. On September 8, the rupee dropped again below the 64-to-a-dollar mark. Since January this year, the rupee has gained six per cent against the dollar. This is a reduction in margins or decrease in competitiveness, which exporters can ill afford.

It is part of a longer trend, since the “taper tantrum” period of 2013, in which the rupee has generally been far more expensive than, it appears, India’s trade position would warrant. What is the reason for this? Partly it is that foreign inflows have been so robust. While this fact is generally seen as a triumph of confidence in India, it is worth noting that it has had a problematic effect on the exchange rate. Since January, foreign institutional investors have bought $6.6 billion in Indian equity and $20.3 billion in Indian debt. This will naturally lead to a tendency for the rupee to appreciate. Equity, perhaps, should not be such a concern; such flows can reverse, and indeed they may have already begun to do so. But debt is a different issue. It is worth examining what the caps on foreign investment in debt are currently, and whether they are harming India Inc, by reducing competitiveness via an increase in the rupee’s value, more than they are helping it by allowing companies to access new sources of funds.

The Reserve Bank of India’s actions should also be examined closely. Comfort with record reserves could change under certain circumstances; for example, instability in West Asia could spike oil prices. It is not certain, therefore, whether the RBI has built up enough reserves in this period since 2013, an action which would have also allowed it to fight back the rupee’s tendency to appreciate. Clearly, business-as-usual cannot be allowed to continue, and some hard decisions will have to be taken.