August Trade Gap Is an Early Warning of Currency and Forex Worries

Imports and exports normally have a positive correlation. But strangely, the August data shows a rather wide divergence, with imports growing 37% and exports declining -1.5%. This is certainly unusual.

Listen to this article:

India’s trade data for August shows an unusual distortion.

While imports grew at a high 37% there was negative growth of 1.5% in exports, and the trade deficit for August has widened to about $28.7 billion, from $11.6 billion in August 2021. The trade deficit widening by over two and a half times for August is worrisome because an expanding deficit on trade and current account would weaken the currency and the dwindling forex reserves historically accumulated by the RBI.

This is structurally inexplicable for exports to shrink when the economy is in recovery mode, as reflected in higher imports of capital goods and intermediates. There is always a strong correlation between imports and exports. For instance, during the economic boom of 2003-04 to 2008-09, imports grew at an average of 26% annually, and exports at 22%. Of course, the world economy was in a better shape then and global trade and investment flows were robust.

Then came a period of relative de-globalisation of trade and investment, after the financial crises and world recession. In this longish phase ― from 2011 to 2019 ― trade flows slowed considerably. India saw its imports grow barely 4-5% annually from 2013 to 2019.  Even exports stagnated at low single digits for this entire period.

The point is that imports and exports normally have a positive correlation. But strangely, the August data shows a rather wide divergence, with imports growing 37% and exports declining -1.5%. This is certainly unusual.

This could be because of several reasons. One, proffered by Commerce Secretary BVR Subrahmanyam, is that exports are sluggish because India has put curbs on a large number of export items like diesel, petrol, aviation fuel, wheat, steel and iron pellets. This week, an export tax of 20% has been imposed on non-basmati and non-parboiled rice, which account for over 80% of India’s total rice exports of 21 million tonnes.

Also read: Modi’s Trade Curbs Are Illogical, Unless There’s a Political Reason Behind Them

There may be a political reason for imposing export curbs on wheat and rice. PM Narendra Modi is probably worried that unbridled exports may disrupt the domestic accumulation of food grain stocks, which will be needed in the run-up to the 2024 elections if food prices go out of hand.

Similarly, he may also fear that higher steel prices could increase the cost of committed flagship welfare programmes like the PM Aawas Yojna for low cost housing. While these may be legitimate concerns, the net effect of curbs on exports of a large number of items, including energy, is a distortion in the equation between imports and exports.

Exports have also fallen because other emerging economies in Africa and Latin America which import from India are themselves facing hard currency constraints due to the dollar’s relentless rise after the Ukraine conflict. For instance, India is the biggest exporter of two-wheelers to Africa but this year, exports from Bajaj Auto, Hero Honda and TVS have shrunk by 15-20%.

The emerging global recession is also seriously impacting exports, but our domestically driven infrastructure growth is keeping imports up. In this scenario, India would need to keep a close watch on the growing gap between its rising imports and shrinking exports. It is to be noted that from April to August this year, India has shown a negative export growth of 35% with its largest trade partner, China, even as imports from China continue to grow at 28%. Another telling example of the huge divergence between export and import growth.

While energy imports are unavoidable, India should keep a close watch on imports of capital goods and intermediates used for big industrial and infrastructure projects. These infra-related imports may drain dollar resources without producing immediate export growth to create necessary dollar earnings. This mismatch could create currency instability and undue stress on forex reserves in the short or medium term. Both the Centre and RBI need to be on high alert over the divergence between import and export growth. The August trade data is a warning signal.

This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.