Decoding the imports surge post demonetisation
Indian imports rose by 23.40% year-on-year (y-o-y) for the first eight months of the calendar year 2017, after contracting by 6.80% between April-December 2016. Many economists believe that the sharp reversal in imports could be attributed to broken domestic supply chains, as a consequence of the demonetisation exercise that was conducted in November 2016. Experts also point to low industrial production numbers, which they claim suggest that rising imports are substituting domestic production rather than satisfying increased domestic demand. Is this causal inference correct? We believe that it is not, and we present compelling evidence in this article to support our view.
Even before getting into what leads to an imports surge, it is instructive to analyse the nature of India’s import bill and the drivers of imports growth. For January-August 2017, the three sectors, namely, mineral products, stone and glass, and electrical/machinery (out of 15 according to the Harmonized Classification System), accounted for 64.83% of the import bill. Some of the important commodities within these sectors include petroleum, liquefied natural gas, diamonds, gold and mechanical equipment. But even more importantly, these three sectors explain 81.30% of the rise in imports during January-August 2017 (see chart). Mineral products account for 27% of the growth in imports while the stone and glass sector (which includes jewellery) accounts for a whopping 42%. Hence, the aggregate import number is heavily skewed because of these sectors and masks the trade performance of most other sectors. If one goes beyond these top sectors, imports growth is much more muted. While the total imports bill for the top three sectors grew by 34% y-o-y, it only grew by 7% y-o-y for the other sectors. Hence a 23% surge in imports bill during January-August 2017 is not the result of rising imports across the commodity spectrum.
The second aspect of the imports bill is that it is a nominal imports bill, not the real bill. Nominal imports equal the quantity imported times the import price. Using data from the directorate general of commercial intelligence and statistics, we decompose the total rise in value into price effect and the quantity effect. The entire rise in import value (around 98%) for mineral products and a substantial part of metal imports is due to the firming of prices of petroleum, oil and gas and basic metals. For the other two sectors, namely stone/glass and electrical machinery, the rise in value mainly reflects the rise in quantity imported as the prices of these commodities have not gone up in recent times. For other sectors like wood, rubber, plastics and footwear, it’s a mix of quantity and price effect. Hence it is not entirely a quantity effect that we would have seen had the supply chains been truly broken.
To dig further into the hypothesis of broken supply chains and weak production, we employ two simple tests. The first is that if the domestic supply chains are broken, then it should in general affect export performance too. We find that sectors with larger growth in imports during January-August 2017 also experienced strong growth in exports during the same period. Exports in the three largest sectors (by their share in the import bill) grew by 10% y-o-y overall, in line with aggregate exports growth of 11.2%. Growth in exports was 12.14% for the other sectors. For other sectors also, there is a good positive correlation between imports growth and exports growth. Out of the top 25 commodities by growth in import value, only four registered poor export performance (the bottom 25%) while 18 commodities registered above-average export performance.
The second test exploits the fact that demonetisation hit the informal sectors hardest. Hence, if imports are substituting weak domestic production, we should see a large growth in imports for the commodities produced in the informal sector, especially in terms of their quantities. The mineral products and electrical machinery sectors are not very informal in their operations and supply chains. These two sectors have 26 companies in the NSE 100 Index as on the date of writing, indicating that it’s a formal sector, yet these experienced large import growth. On the other hand, consider metals. The metal sector experienced imports growth of 19.9% while exports grew by 50%. Some of the commodities within metals, like iron and steel, saw experts grow by over 100%, while imports only grew by a mere 3%.
A significant amount of the production process of iron and steel and other metals happens within the informal sector where workers are typically paid cash wages. Hence some of the important commodities produced within the informal sectors did not experience a surge in imports but, in fact, showed good export performance. The same holds true for ash, ores and slag, where growth is 130%, and for vegetable oils which are, in fact, produced within an even more informal industry than iron and steel. The conclusion holds even after extending the analysis beyond larger sectors; imports growth is not concentrated in informal sectors.
Overall, we did not observe the evidence that imports rose because of broken domestic supply chains. However, we don’t claim that the supply chains were unaffected due to demonetisation. What our analysis claims is that the import surge is sort of disconnected from the fact that demonetisation might have broken supply chains to some extent.
Then what explains the rise? The exchange rate has appreciated from around Rs68 in January to Rs63.50 against the US dollar in August 2017. Around 85% of India’s imports are invoiced in dollars and hence, at least in the short run, the rupee/dollar rate is more significant a determinant of imports than bilateral exchange rates. Given the sharp appreciation till August, at least part of the rise in imports is surely explained by the exchange rate movement.
Apoorva Javadekar and Sujan Bandyopadhyay are, respectively, research director and research associate at CAFRAL.
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