An unwanted surplus beckons India, even as exports hold hope of revival

An 11-year low trade deficit is portending a current account surplus for India in FY21. For an emerging economy characterized by a perennial demand constraint, this surplus is unwanted.

What it shows is that demand has collapsed. In the wake of the pandemic, the deep contraction in imports for two months is just another sign of an upcoming recession. Imports shrank 51% in May. Sure, this was led by a 71% drop in the oil bill owing to a crash in global prices, but the 34% contraction in imports excluding oil, gold and silver is a cause for worry. Add the wholesale price index (WPI), which slipped into deflation, and India’s manufacturers are in danger.

So far this year, the markets have focused on the salutary effect of a strong external sector indicator amid the rising odds of a recession. Indeed, a $500 billion forex reserve, along with a current account surplus, looks good, especially when the economy is bracing for a contraction.

To be sure, exports are expected to be a bright spot in an otherwise weak narrative for India’s manufacturing sector.

Exports shrank by a smaller margin of 36% in May compared with a 60% contraction in April. Much of this improvement is attributed to smoothening of supply chain disruptions, as many countries began to ease lockdown measures.

Economists expect exports to recover faster as policy stimulus provided by advanced economies to counter the coronavirus-led crisis has been both large and swift. With markets opening up and logistical disruptions easing, exports are poised to recover more in the coming months.

“Exports are likely to lead recovery and we expect domestic credit cycle to lag. This is because India’s policy response has been underwhelming (versus rest of the world) in terms of reviving demand in the near term and the economy was quite weak even to start with,” said Edelweiss Securities Ltd analysts in a note.

Much like domestic demand, exports too followed the theme of essentials. Agriculture, pharmaceuticals and chemicals showed better performance than the rest. Other segments showed various degrees of recovery, but remained in contraction mode. Labour-intensive sectors were the worst hit.

Analysts at Nomura Financial Advisory and Securities (India) said despite the recovery, exports would still remain weak as the global demand situation is unlikely to improve quickly.

Therefore, Indian manufacturers can look towards exports to salvage businesses even as domestic demand limps back at a glacial pace. The sharper import contraction is raising the odds for a current account surplus this year.

But an emerging market economy such as India can afford a surplus only if it comes from a wave of export growth. However, in the case of the current year, it would largely be due to import contraction.