After a run of good economic data, there was considerable optimism about the state of the Indian economy. But this spate of good news has come to a halt with the release of the trade data for October 2014 by the Union ministry of commerce and industry on Monday. Market participants had already been warned earlier by the government that October's foreign trade data would be a cause for concern. That warning has been borne out in full measure. India's trade deficit widened sharply, to $13.3 billion; it was $10.6 billion in October 2013. This comes at a time when commodity prices have eased considerably - something that was supposed to take the pressure off India's external account. Yet cheaper gold seems to have had an effect on the Indian consumer - gold imports went up by 280 per cent, to $4.2 billion. Whatever was saved on oil - the petroleum import bill went down by nearly 20 per cent - was not sufficient to keep the trade deficit from responding to the demand for gold. Note that the spurt in the import of the yellow metal has taken place in spite of the fact that many restrictions on gold imports, introduced during a period of near-crisis by the last government, continue to be in place. It has been reported that further restrictions are being considered by the new government, a sign of how few ideas are current in New Delhi when it comes to controlling the trade deficit.
Significantly, it was not just imports that exploded; exports, after six months of growth, saw a compression. Exports fell five per cent, with particularly steep falls for the pharmaceutical sector and for engineering goods. Naturally, the continuing weakness of Europe, and the still weak recovery in the United States, have made a difference to the export variable. In general, it is clear that exports have failed to grow and imports have failed to be curbed - a sign that deeper structural reform is still necessary. Going forward, exports will continue to be a challenge - indeed may become a bigger challenge - since India's key export markets may continue to suffer from anaemic growth. A failure to act now could have a spillover adverse effect on to the current account.
But opening up new markets for Indian exports alone will not be enough. It will also require the rupee to be better managed. A persistent external deficit of this nature and an inflation rate that is still higher than that in the United States suggest that the currency is overvalued. This was always tacitly preferred by the Indian government in the past, because it helped to keep the prices of imported "essentials", fuel in particular, low. That was always a mistake. But, even given that logic, the impact of an exchange-rate correction on the import and subsidies bill now will be much more manageable than earlier, given the softening of crude oil prices. This is the best time to make the much-needed adjustment to a better-valued currency. After all, the impact of global liquidity on the rupee should not be ignored - particularly given the fact that few other markets are expected to show growth. Continuing capital inflows keep the rupee from weakening to the value suggested by India's merchandise trade deficit and relative inflation. The Reserve Bank of India should start building up reserves, in such a manner that this imbalance is corrected.
