If the trade lobbies are to be believed, then the unrelenting appreciation of the Indian rupee in the last few months will, if unchecked, be the death knell of Indian exports. However, the latest trade numbers, released by the commerce ministry on Wednesday, suggest that these fears are as yet premature.
Exports continue to grow at double digits. They were 14.05% higher this June than they were a year ago. There has undoubtedly been a steady deceleration in recent months—from 23% in April to 18% in May to 14.05% in June. Growth in the entire quarter averaged 18.11%. However, it is still a bit early to make a call on the effect of the strong rupee on exports. It usually takes a few quarters for an exchange rate appreciation to impact a country’s exports.
The far bigger story is the 52.5% surge in non-oil imports in June. In the first quarter that ended in June, they jumped by 50.36%. Impressive by any measure, and all the more so when compared with the growth of 9.63% recorded in the same period in 2006-07. In contrast to this, oil imports, despite the recent jump in international prices, grew at a modest rate of 4.21% in the first quarter. As a result, overall import growth—oil and non-oil—is substantially lower at 34.30%. In fact, it is this surge in imports, and not a deceleration in export growth, that has led to a near doubling of the country’s quarterly trade deficit to $7.3 billion.
There is every reason to welcome the growing trade gap. Strong import growth is a sign of a booming economy. And, more importantly, it is investment rather than consumption that seems to be driving import growth. These are imports that will build future growth capacities rather than satisfy immediate consumption needs.
Indian industry is in the midst of a splendid investment boom. Infrastructure spending, too, is rising. Several multilateral agencies, including the International Monetary Fund and the Asian Development Bank, have recognized that economic growth in India is now being driven more by investment rather than consumption. The growing trade deficit, driven by the sharp rise in non-oil imports, shows that investment demand continues to be strong.
Capital goods imports rose by 39.5% in 2004-05, 62% in 2005-06 and by 32.4% in April-January of 2006-07. It will be worth seeing whether a large chunk of these imports are coming from China, which already is India’s third most important trading partner. And, since domestic credit was expensive, business has taken recourse to external commercial borrowings (ECBs) to finance these imports—which, also explains the unprecedented surge in ECBs.
If the trade deficit continues to be at these levels for the rest of the year and assuming the appreciating rupee catches up with exports, then the country’s trade deficit will further widen.
Logically, this would mean that the exchange rate would depreciate as there would be a greater demand for dollars than rupees.
However, two factors could come in the way. First, there are the other earnings on the current account—items such as software exports and earnings from foreign tourists. These dollar earnings will almost surely ensure that the current account deficit will be far lower than the trade deficit. And surging inflows of foreign capital will net out the impact of the trade deficit, putting pressure on the rupee to move the other way. Which is what we have seen so far.
So, clearly, while there is cause for cheer in the trade data, there is no reason to be sanguine. While it will be important to watch how export growth performs in the rest of the year, the challenge in the external sector will be to predict the quantum and direction of global capital flows into India. That is the bigger problem right now.