Vivek Kaul
The current account deficit for the three month period of July to September 2013 has come in at $5.2 billion or 1.2% of the gross domestic product (GDP). This number is so good that it prompted the Reserve Bank of India(RBI) to release the numbers a month earlier than scheduled.
In technical terms, the current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances. Or to put it in simpler terms, it is the difference between outflow (through imports) and inflow (through imports and foreign remittances) of foreign exchange .
The current account deficit for the April to June 2013 period had stood at 4.9% of GDP, whereas for the July to September 2012 period it had stood at 5% of GDP. Also, this is the lowest current account deficit that the country has seen since the period of three months ending June 2009.
A high current account deficit is not deemed to be good for a country primarily because it means that the outflow of foreign exchange is much greater than its inflow. So in India’s case it means that the outflow of dollars is much greater than the inflow of dollars. This means a greater demand for dollars than supply. Hence, those who need dollars sell rupees to buy them. This leads to a situation where the value of the rupee falls against the dollar. This is precisely what happened between May and August 2013, when the rupee went from around 54 to a dollar to almost 69 to a dollar.
When this happened, Indian importers had to pay a significantly higher amount in rupee terms, for what they were importing. India produces very little oil and imports nearly 80% of its requirement. Hence, the oil marketing companies had to pay a higher amount for the oil that was being imported. But these companies are not allowed to sell cooking gas, diesel and kerosene at a price which is greater than the cost price. The government subsidies them for this under-recovery. This adds to the expenditure of the government and hence, leads to the fiscal deficit going up, which has its own set of problems. Fiscal deficit is the difference between what a government spends and what it earns.
There are two ways of controlling the current account deficit. One is to ensure that the country earns more foreign exchange than it was doing in the past. The other is to clamp down on the demand for foreign exchange. For a government it is always easier to clamp down.
Hence, the government went about increasing the import duty on gold. The duty is now at 10% in comparison to 2% earlier. Another rule, which required a gold importer to re-export 20% of all the gold that he imported, was also introduced by the government.
These two significant changes ensured that gold imports came down dramatically. Gold imports during the June to September 2013 period stood at $3.9 billion, down nearly 65% from the same period in 2012, when it had stood at $11.1 billion. In the period of April to June 2013, the gold imports had stood at $16.4 billion.
This dramatic fall in gold imports is a major reason behind this fall in current account deficit. In absolute terms the fall in gold imports has been $12.5 billion($16.4 billion – $3.9 billion) between the three month period ending in June 2013 and the three month period ending in September 2013.
The current account deficit for the April to June 2013 period was $21.8 billion. For the period July to September 2013 period, it has come in at $5.2 billion. The absolute difference is $16.6 billion. Of this nearly $12.5 billion or nearly three fourths of the fall has been because of lower gold imports.
A fall in the value of the rupee has also helped boost exports. Merchandise exports went up by 12% to $81.2 billion during the period in comparison to the same period last year. This was primarily on account of growth in export of textiles, leather and chemical products.
The major fall in current account deficit has been because of a massive fall in gold imports. And this has meant that the demand for dollars to buy gold has gone down dramatically as well. This has been one of the major reasons for the rupee increasing in value from around 69 to a dollar in end August to around 62.4 to a dollar currently.
The current account deficit was around $87 billion last year. With the clamp down on gold imports, the finance minister P Chidambaram has said in the recent past that he expects the current account deficit to be less than $56 billion in the financial year ending March 2014.
Does a fall in gold imports also mean a fall in demand for gold? India produces almost no gold of its own. But things are not as simple as that.
It is worth remembering here that gold imports were banned in India until 1990. At that point of time, gold smuggling was a fairly lucrative operation. As a recent article in The Economist points out “India consumed only 65 tonnes in 1982. Until 1990 imports were all but banned. Bullion had to be smuggled in and its price within India was about 50% higher than outside it.”
And that is precisely what has been happening over the course of this year. A recent report in The Hindustan Times points out “The Mumbai airport customs has seized around 73kg gold worth Rs.19.71 crore between April and October this year, more than double the quantity (31kg gold worth Rs 9.8 crore) it had seized during the same period last year. The spurt in smuggling activities is a result of the widening difference in the yellow metal’s price between the domestic market and Dubai. The price gap has gone up to Rs 5 lakh a kg in the past few months from being Rs 2.5 lakh a kg in June, and only Rs 1 lakh before that.”
Gold smugglers are also using neighbouring countries to get gold into India. A November 17, 2013, report in The Times of India points out “In the past few months, over 50kg of gold worth more than Rs 15 crore has been smuggled across the Indo-Bangladesh border alone. Sources in Directorate of Revenue Intelligence (DRI) said Nepal too has come up on the radar with some recent seizures on the border. Sources said this was only a fraction of what was being smuggled through these borders.”
A similar point is made by Dan Smith and Anubhuti Sahay of Standard Chartered in their September 12, 2013, report titled “Gold – India’s government gets tough.” As they write “There is much anecdotal evidence suggesting that increased amounts of gold are entering India through unofficial channels, which makes the official figures an understatement. Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India.”
A report in the DNA quotes Somasundaram P R, managing director (India), of the World Gold Council as saying “ demand in neighbouring countries such as Thailand has increased and some of this may be because of India demand.”
The World Gold Council in a recent report also makes the following point. “Gold entering the country unofficially through India’s porous borders helped to meet pent-up demand…It is likely that unofficial gold will continue to find its way into the country to satisfy demand. Reports that a good market for ten tola bars is re-emerging,due to the relative ease with which they can be concealed, reinforce this view.”
The point is that a clamp down on gold imports leading to a major fall in gold imports doesn’t necessarily mean a fall in gold demand. These are two difference things. An increase in gold smuggling has huge social implications. It is worth remembering that some of the biggest mafia dons of Mumbai in the seventies and the eighties started as gold smugglers before getting into other illegal activities.
That apart, there are financial implications to this as well. A major reason why Indians buy gold is to protect themselves from inflation. Over the last few years the consumer price inflation(CPI) has been higher than the interest being paid on fixed deposits and other fixed income instruments.
In this environment, gold has looked like a good bet given that it has given positive returns in each of the years between 2002 and 2011. As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a December 2, 2013 note titled India Economics: 2014 Outlook: A Year of Macro Adjustment “Persistently high CPI inflation has kept real interest rates negative since the credit crisis, encouraging households to reduce financial savings and increase allocation to gold and real estate.”
Hence, buying gold was a perfectly rational thing to do at an individual level. The Indian financial system is rigged towards helping the government borrow money at low interest rates (You can read the complete argument here). Given this, it is not surprising that Indians are fascinated by gold at an individual level. Though at an aggregate level it has led to major problems. One of the problems has been the weak deposit growth of banks. As Ahya and Chachra point out “This is reflected in deposit growth, which has stayed weak relative to credit growth now for the last three and a half years, elevating the loan-deposit ratio near full capacity levels (76.5% currently).”
This basically means that deposits have been growing at a much slower pace than loans being given by banks, due to the fact that people have been diverting their savings into gold and real estate, in the hope of beating inflation. And this in turn has led to higher interest rates.
With the government clamping down on gold imports, the hope was that it would lead to people saving more money in bank and other fixed income deposits. But is that really happening? The evidence available suggests it isn’t because the basic problem in India is high inflation and that hasn’t been addressed.
The article originally appeared on www.firstpost.com on December 4, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Gold
Inflation at 8 month high is a sure spoiler to FM’s ‘all is well’ party
Vivek Kaul
All is well, again.
Or so the government of India has been trying to tell us over the last few weeks.
But some spoilers have come in lately.
The wholesale price inflation (WPI) for the month of September 2013 has come in at an eight month high of 6.46%. It was at 6.1% in August and 5.85% in July.
A massive increase in food prices has been a major driver of wholesale price inflation. Onion prices rose by a massive 323% in September in comparison to the same period last year. Vegetable prices went up by 89.37%. Fruits were up at 13.54%. And all in all food prices were up by 18.4% in comparison to the same period last year.
Half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). Given this, the massive rise in food prices, hits what the Congress led UPA calls the aam aadmi, the most.
In this scenario it is more than likely that the aam aadmi has been cutting down on expenditure on non essential items like consumer durables, in order to ensure that he has enough money in his pocket to pay for food.
Hence, it is not surprising the index for industrial production, a measure of the industrial activity in the country, rose by just 0.6% in August 2013, after rising by 2.8% in July.
As Sonal Varma of Nomura writes in a research note dated October 11, 2013 “consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.” Consumer durables output fell by 7.6% in August 2013. This after falling by 8.9% in July.
What this tells us clearly is that as people are spending more money on food, they are postponing other expenditure. This postponement of consumption is reflected in companies not increasing the production of goods, which in turn is reflected in the overall index of industrial production rising at a very slow pace and the consumer durables output falling by a whopping 7.6% in August 2013.
The government of India wants to tackle this by increasing the capital of public sector banks in the hope that they give out loans to people to buy consumer durables and two wheelers at lower interest rates. (Why that is a bad idea is explained here).
But the trouble is that people are not in the mood to buy stuff because they do not feel confident enough of their job prospects in the days to come. As Varma put it in a note dated October 3, 2011 “The job market and income growth – the key drivers of consumption – remain lacklustre.”
Over and above that there is high food inflation to contend with.
One reason that the inflation will continue to remain high is the fact that the government of India has been running a high fiscal deficit. In the first five months of the year (i.e. the period between April-August 2013) the fiscal deficit stood at 8.7% of the GDP. The government is targeting a fiscal deficit of 4.8% of the GDP during the course of the financial year. Fiscal deficit is the difference between what a government earns and what it spends.
As economist Shankar Acharya put it in a recent column in the Business Standard “In the first five months of 2013-14, the Centre’s fiscal deficit ratio has been running at a whopping 8.7 per cent of GDP. Bringing it down to 4.8 per cent in the remaining seven months looks impossibly difficult, without recourse to seriously creative accounting ploys. In any case, it is worth pointing out that a deficit that stays high through most of the year imposes the associated costs of higher inflation, higher interest rates, more crowding out of private investment.”
With the government running a higher fiscal deficit it needs to borrow more money to finance the deficit. This means that the private sector will have lesser money to borrow(i.e. it will be crowded out by the government) and hence, will have to offer higher interest rates to borrow money. Hence, the interest rates will continue to remain high.
Also, a higher fiscal deficit means increased government spending in some areas of the economy. This leads to more money chasing the same amount of goods and services and hence, higher prices i.e. inflation.
When interest rates as well as inflation remain high, people are likely to concentrate on consuming things that they need the most, like food and avoiding other expenditure. This will have an impact on economic growth. Hence, the only way to revive economic growth is to weed out inflation. And that’s easier said than done.
This recent confidence of the government has come from the fact that the rupee which had almost touched 70 to a dollar, is now quoting at around 61.2 to a dollar.
This has happened because the government has taken steps to squeeze out gold import totally. In the month of September the gold imports fell to around $0.8 billion. In August, the gold imports were at $0.65 million.
Gold is bought and sold internationally in dollars. Hence, any gold importer needs dollars to buy gold. To buy these dollars the importer needs to sell rupees. And this pushes the value of the rupee down against the dollar.
But with the government making it very difficult to buy gold, the importers are not buying dollars and selling rupees. And this has helped the rupee to recover partially, given that the demand for dollars in the official foreign exchange market has gone down.
Of course these numbers do not include the gold that is now being smuggled into India. While there is no specific data available for this, there is enough anecdotal evidence going around. As Dan Smith and Anubhuti Sahay of Standard Chartered write in a report titled Gold – India’s government gets tough “Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India. Dubai has seen a steady pick-up in the number of passengers being arrested at airports for smuggling. Nepal has seen an eight-fold rise in smuggling – 69kg of smuggled gold was seized by customs in the first half of this year, versus 18kg for the whole of 2012.”
This does not reflect in the official numbers and there are other social consequences of smuggling. It is worth remembering that Dawood Ibrahim started out primarily as a gold smuggler, until he moved onto other bigger things.
The other factor that has helped control the value of the rupee against the dollar is the fact that oil companies are buying dollars directly from the Reserve Bank of India and not from the market. Hence, the two major buyers of dollars in the foreign exchange market have been taken out of the equation totally. This has skewed the equation in favour of the rupee.
Of course this cannot continue forever. Some demand for gold is likely to return in the months of October and November, because of the marriage season as well as Diwali. The other decision that has helped the rupee is the fact that the Federal Reserve of United States has decided to continue printing money.
While it is widely expected that the Federal Reserve will continue to print money in the months to come, this is something that is not under the control of the Indian government. Also, it is worth remembering that given the high fiscal deficit, the threat of India being downgraded to “junk” status by an international rating agency remains very high. If this were to happen, many investors will exit India in a hurry, putting pressure on the rupee, and undoing all the work that has been done to get it back to a level of 61 against the dollar.
In short, the macroeconomic conditions of India continue to remain weak, despite the government trying to project otherwise.
The article originally appeared on www.firstpost.com on October 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Phata Poster Nikla Zero – Why Rajan hasn't joined the party
Vivek Kaul
Raghuram Govind Rajan, the governor of the Reserve Bank of India, has refused to join the party.
The financial markets were expecting the Rajan led RBI to cut the repo rate in its Mid Quarter Monetary Policy Review. But that has not happened. Instead the repo rate has been raised by 25 basis points(one basis point is equal to one hundredth of a percentage) to 7.5%. Repo rate is the interest rate at which RBI lends to banks. Hence, the BSE Sensex has fallen by more than 500 points after the policy review was announced. As I write this it is down by around 350 points. The rupee is now quoting at 62 to a dollar, having touched 62.6 to a dollar earlier.
So now Rajan is suddenly looking like a villain after having been turned into a hero by the media over the last few weeks. As a Facebook friend quipped Phatta Poster Nikla Zero.
What Rajan has done needs to be analysed in line with the economic philosophy he believes in. A major reason for increasing the interest rate is high inflation. As the Monetary Policy Review points out “What is equally worrisome is that inflation at the retail level, measured by the CPI (consumer price inflation), has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharifharvest will lead to some moderation in CPI inflation, there is no room for complacency.”
This statement is totally in line with Rajan’s thinking on the issue. In fact, Rajan has clearly pointed out in his earlier writings that RBI should simply concentrate on managing inflation instead of trying to do mulitple things at once.
As Rajan wrote in a 2008 article (along with Eswar Prasad) “The RBI already has a medium-term inflation objective of 5 per cent…But the central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
And given this the RBI ends up being neither here nor there. As Rajan put it “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should ‘just’focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation and intervening in currency markets only to limit excessive volatility…an exchange rate that reflects fundamentals tends not to move sharply, and serves the cause of stability.”
Currently, the RBI is trying to control inflation, accelerate economic growth and stabilise the value of the rupee, all at the same time. Something which is not possible. Rajan understands this well enough. “The RBI’s objective could be restated as low inflation, and growth consistent with the economy’s potential. They amount to essentially the same thing! But it would let the RBI off the hook for targeting the exchange rate. And that is the key point,” Rajan wrote in the 2008 article cited earlier. Given this focus on inflation, it isn’t surprising that Rajan has chosen to go against market expectations and raise the repo rate. His belief is that if inflation is brought under control, other things will sort themselves out.
Rajan is also trying to address the high current account deficit by raising the repo rate. Lets try and understand how. As the monetary policy review of the RBI points out “However, inflation is high and household financial saving is lower than desirable.” Lower savings have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website “The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment.”
If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
This is something that Rajan said in an interview to the India Brand Equity Foundation. As he said “Current account deficit (CAD) essentially reflects the fact that you are spending more than you are saving. That’s technically the definition of the CAD, which means that you need to borrow from abroad to finance your investment. Ideally, the way you would reduce your current account deficit is by saving more, which means consuming less, buying fewer goods from abroad and importing less. Or, the other way is by investing less, because that would allow you to bridge the CAD. Now we don’t want to invest less. We have enormous investment needs. So ideally, what we want to do is save more.”
And to achieve this “the first way is for the government to cut its under-saving or its deficit.” “The second way is when the public decides to save more rather than spend. We need to encourage financial saving,” Rajan said in the interview.
The fact of the matter is that India has not been saving enough over the last few years. As the recent RBI financial stability report released in June 2013 points out “Financial savings of households…have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.”
Financial savings are essentially in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore. This has largely been on account of high inflation. Savings have been diverted into real estate and gold in the hope of earnings returns higher than the prevailing inflation.
Also people have been saving lesser as their expenditure has gone up due to high inflation. And the financial savings will only go up, if inflation comes down, pushing up the real returns on various kinds of deposits.
“Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability,” wrote Rajan in a column in April 2013.
Rajan has increased the repo rate hoping that bank’s and other financial institutions increase the interest rates on their deposits. This will encourage people to save more. Also, by trying to control inflation Rajan hopes that the real return on deposits (nominal return minus inflation) will go up. Once this happens, people are likely to stay away from investing in gold. If people stay away from investing in gold, it helps bring down our imports and hence, also the current account deficit. This puts lesser pressure on the rupee. The current account deficit(CAD) can also be expressed as the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
Also, as India saves more the need to borrow from abroad will come down. India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt.
The trouble is that a lot of this external debt needs to be repaid before March 31, 2014. NRI deposits worth nearly $49 billion mature on or before March 31, 2014. Nearly $21 billion of ECBs raised by companies need to be repaid before March 31, 2014.This will mean a demand for dollars and thus further pressure on the rupee. If India’s borrowing from abroad comes down in the coming years that will mean lesser pressure on the rupee, as the demand for dollars to repay these loans will go down. But for that to happen financial savings need to go up. And that can only happen if inflation is brought under control and real returns on fixed income instruments (like deposits, bonds etc) go up.
Of course, raising the repo rate just once by 25 basis points is not enough for all this to be achieved. Hence, chances are Rajan will keep raising the repo rate in the days to come.
The article originally appeared on www.firstpost.com on September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Explainer: Why gold imports will go up over the next few months
Vivek Kaul
The trade deficit or the difference between imports and exports, in August 2013 was at $10.9 billion. This was a significant improvement over August 2012, when it was at $14.17 billion. The deficit was $12.27 billion in July, 2013.
This fall in trade deficit, as I pointed out a couple of days back, was largely on account of lower gold imports. The gold imports stood at 2.5 tonnes, almost down to zero. These imports cost around $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year.
In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion, and the trade deficit was at $17.8 billion. In May 2013, the 162 tonnes of imported gold had cost $8.4 billion, and the trade deficit was at $20.1 billion.
Hence, its safe to say that the major reason for the fall in trade deficit has been a fall in gold imports. As the Indian Express reported a few days back “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.”
Dan Smith and Anubhuti Sahay of Standard Chartered offer a similar reason in their September 12, 2013, report titled “Gold – India’s government gets tough.”As they write “Recent weeks and months have seen aggressive government action to dampen gold demand, owing to its heavy impact on the current account deficit…the…initial lack of clarity on these measures resulted in a dramatic slump in imports in August.”
This confusion has now been sorted out, and gold imports are going to surge in the months to come. “Local traders and sources estimate that we might see an upswing in bullion imports to 35 tonnes in September. This is still modest compared with the official average import level of 59 tonnes/month last year. October is also likely to see relatively firm imports,” write Smith and Sahay.
The Indian demand for gold is seasonal and tends to pick up around the festival time and wedding season. The festival season has started and the wedding season will soon start. As Smith and Sahay point out “Over the past five years, August, September and October have been the strongest months for India‟s gold imports, accounting for 30% of the annual total as the country restocks ahead of a pick-up in demand. Key reasons for buying gold include the marriage season, which normally starts after the monsoon season in mid-September, and Diwali, which is on 3 November this year.”
What will also drive the demand for gold is a good monsoon which is likely to lead to a higher agricultural growth. As the Economic Outlook 2013-14 released today, by the Economic Advisory Council to the Prime Minister, points out “Agriculture projected to grow at 4.8% in 2013-14 as against 1.9% in 2012-13. The early and good monsoon had a huge positive impact on sowing activity.”
This is likely to lead to a higher demand for gold during the current month and the following few months. “This year the monsoon season was good and farmers planted 7% more crops, according to the Agriculture Ministry. This should feed through into higher incomes and gold demand in the weeks ahead,” write Smith and Sahay.
In a country as underbanked as India is, any increase in income ends up being invested in gold, especially in rural areas. As the Economic Survey released before the budget pointed out “Gold has been a combination of investment tool and status symbol in India. With limited access to financial instruments, especially in the rural areas, gold and silver are popular savings instruments.”
It also needs to be mentioned here that even though “official” gold imports have fallen close to zero, gold continues to come into the country through other routes. This is not surprising given that the import duty on gold bullion currently stands at 10%. Hence, for anyone who manages to get gold into the country without paying the duty on it, there is a huge arbitrage opportunity.
Smith and Sahay provide several examples of gold coming into the country through unofficial routes. As they write “There is much anecdotal evidence suggesting that increased amounts of gold are entering India through unofficial channels, which makes the official figures an understatement. Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India. Dubai has seen a steady pick-up in the number of passengers being arrested at airports for smuggling.”
Gold is also coming in from Nepal. “Nepal has seen an eight-fold rise in smuggling – 69kg of smuggled gold was seized by customs in the first half of this year, versus 18kg for the whole of 2012.”
Higher gold imports will obviously cancel out the recovery on the export front. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion. Even if gold imports come in at $2-3 billion on an average, they will cancel out the bounce in exports. Given this, the trade deficit is likely to go up in the months to come.
The article originally appeared on www.firstpost.com on September 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
With gold imports almost zero, trade deficit unlikely to fall further
Vivek Kaul
The trouble with being a one trick pony is that the trick stops yielding dividends after sometime. Something similar seems to have happened to the efforts of the government of India to control the huge trade deficit. Trade deficit is the difference between imports and exports.”
Trade deficit for August 2013 was at $10.9 billion. This is a major improvement in comparison to the trade deficit of $14.17 billion in August 2012. The deficit was $12.27 billion in July, 2013.
This fall in trade deficit has come through the efforts of the government to bring down gold imports by increasing the import duty on it. India imported just 2.5 tonnes of gold in August and this cost $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year.
In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion and the trade deficit was at $17.8 billion. If there had been no gold imports, then the trade deficit for April would have stood at $10.3billion($17.8 billion – $7.5 billion). If the gold imports had been at $650 million (or $0.65 billion) as has been the case in August 2013, then the trade deficit would have stood at $10.95 billion ($17.8 billion – $7.5 billion + $0.65 billion). This number is very close to the trade deficit of $10.9 billion that the country saw in August 2013.
So the point is that the government has been able to control the trade deficit by ensuring that the gold imports are down to almost zero. As the Indian Express reports “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.”
The confusion has now been cleared. Also, with Diwali in early November and the marriage season starting from October, gold imports are likely to pick up in September and October. Even if it doesn’t, the imports are already close to zero. So, any more gains on the trade deficit front by limiting gold imports, is no longer possible. The Indian Express report cited earlier quotes a senior executive of the Bombay Bullion Association as saying “Imports may again rise to around 30 tonne in September, as jewellers usually start building inventory to cater to the requirement during the festival and marriage season.”
At the same time, the government hasn’t been able to do much about oil, which is India’s biggest import. In August 2013, oil imports stood at $15.1 billion, up by 17.9% in comparison to the same period last year. Oil imports formed nearly 40.8% of the total imports of $37.05 billion. There isn’t much the government can do on this front, other than raising prices majorly to cut under-recoveries of oil marketing companies and limit demand for oil products at the same time.
But that may not be a politically prudent thing to do. The commerce minister, Anand Sharma, warned that with the international prices of crude oil rising over the past 10 days, the oil import bill may go up in the months to come. And this may lead to a higher trade deficit.
As Sonal Varma of Nomura Securities wrote in a report dated September 10, 2013, “Looking ahead, a seasonal rise in imports during the festive season and higher oil prices should result in a slightly higher trade deficit in Q4 2013(the period between Oct and Dec 2013), relative to Q3 (the period between July and Sep 2013).”
But imports form just one part of the trade deficit equation. Exports are the other part. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion.
While exports may have gone up by in August due to a significantly weaker rupee, whether they will continue to go up in the months to come is a big question. As Ruchir Sharma, Head of Global Macro and Emerging Markets at Morgan Stanley, and the author of Breakout Nations, told me in a recent interview I did for Forbes India “Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.”
This something that another international fund manager reiterated when I met him recently. As he said “A part of the problem that India has is that the economic model has been based more on the service sector rather than manufacturing. The amount of manufactured products that become cheaper immediately and everyone says that I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient in number to give a sharp rebound immediately.”
The other big problem with Indian exports is that they are heavily dependent on imports. As commerce minister Anand Sharma admitted to “45% of exports have imported contents. I don’t think weak rupee has any impact on positive export results.”
In fact The Economic Times had quoted Anup Pujari, director general of foreign trade(DGFT) on this subject a few months back. As he said “It is a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters. India’s top five exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery — are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised. In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.”
Also, the moment the rupee falls against the dollar, the foreign buyers try to renegotiate earlier deals, Pujari had said. “As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear.”
What all these points tell us is the simple fact that the trade deficit will be higher in the months to come. And given, this the market, like is the case usually, is probably overreacting.
The article originally appeared on www.firstpost.com on September 11, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)