The trade gap challenge for policymakers

The current account deficit in Q1 of FY23 has increased to 2.8% of GDP ($23.9 billion), up from 1.5% of GDP ($13.4 billion) in Q4 FY22. The deficit is largely due to the widening of the merchandise trade deficit in Q1FY23 to $68.6 billion from $54.5 billion in Q4FY22. However, on the back of rising exports of computer and business services, net services receipts have increased and softened the blow on the current account deficit. April-September 2022 numbers show a further widening of merchandise trade deficit to $149.97 billion from $76.21 billion in the year-ago period; ie, April-September 2021.

What about global trade volume growth?

The World Trade Organization (WTO) last week slashed its estimate of global trade volume growth in 2023 to 1% from its earlier forecast of 3.4%. Tightening monetary policy in advanced economies which could spark a recession; and the Ukraine war which has triggered an energy crisis and supply chain disruptions, are some of the reasons that can be ascribed to the WTO revising its numbers downwards. India, being an open economy with percentage share of exports in GDP being 22.7% in FY22, won’t be spared either, and is also bearing the brunt of global headwinds.

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What are the other factors driving up trade deficit?

The revival in industrial production has driven up demand for crucial imports such as crude oil and commodities. Additionally, continued depreciation of the rupee has increased the landed cost of these products and increased India’s import bill. However, despite the continued depreciation of the rupee, exports have failed to increase at a desirable rate.

Should the widening trade deficit worry us?

Certainly, a widening trade deficit is a drain on foreign exchange reserves, which are a broad indicator of the country’s import capacity. As of 30 September, 2022, India’s foreign exchange reserves were $532.66 billion, enough to cover approximately nine months of imports, as against 16 months of imports at its peak. However, the trend per se need not be an issue of concern as long as increasing imports are mostly crucial inputs for industrial development, which are a must for economic development.

What are the immediate challenges?

As the world economy -- especially India’s major export markets such as US -- is expected to show poor performance at least in the next two years, prospects of exports improving are bleak. The continued quantitative restrictive approach adopted by the US Fed will prompt foreign portfolio investors to continue withdrawing from Indian markets, and there may not be an immediate respite from the depreciation of the rupee in the near future.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH.

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