Trade deficit at a five-year high does not augur well for India’s stability

Ballooning trade deficit to five-year-high levels in June 2018 does not augur well for India’s macro-economic stability. If this trend continues, the current account deficit (CAD) will cross the 2.5 per cent mark this fiscal. Higher CAD this fiscal will impact other fundamentals like inflation and prices, fiscal deficit and restrict the government’s flexibility to spend on development projects.

The spike in crude prices, production cuts by the Organization of Petroleum Exporting Countries (OPEC) till recently and concomitant volatility in rupee value vis-à-vis the US dollar have the potential to negatively impact middle class Indians. The raging trade war between the US and China will only inflict more injury on large developing countries like India that aspire to grow in double digits. Unilateral sanctions on Iran imposed by the US have added yet another dimension to managing finances by oil importing countries with India in the lead. A combination of these factors is bound to hit both domestic and foreign investments while leading to lowering of demand for goods and services in South Asia.

Even though India remains a bright spot in terms of growth, the next 12 months will be crucial for prime minister Narendra Modi’s BJP-led NDA that will seek a second term in office. In just one month, June 2018, trade deficit touched $16.61 billion, ringing alarm bells in the corridors of power. A massive 56 per cent increase in crude oil import bill has been cited as the major cause for the widening deficit. About $50 billion trade deficit in just one quarter was too huge even for India to cope with.

But, one cannot dismiss the positive imprint in the entire trade matrix. Over 17.57 per cent growth in exports led by engineering and pharmaceutical goods lent hope for survival in an otherwise dampened economic environment marked by joblessness. Similarly, double-digit growth in non-oil imports for export manufacturing of a dozen products has limited the damage to the economy. Contradictory signals from RBI and government in managing the rupee vis-à-vis the Indian basket of currencies could deal a big blow too. In fact, RBI seems to have given up on leveraging the $425 billion foreign currency reserves to pull the rupee out of the crisis situation.

The RBI’s one-day norm to treat defaults as non-performing assets has placed 13 banks in a delicate situation with no room to make fresh lending for new projects. On the other hand, the five-point lending policy announced by finance minister Piyush Goyal to ease pressure on demand for cost effective resources, goes diagonally opposite this approach. Most interestingly, RBI was not involved in the entire exercise led by a bankers’ panel.

The exit of Arvind Subramanian as chief economic advisor has only put extra pressure on RBI Governor Urjit Patel and his team on currency management. Some top bankers and old-time hawks see a currency crisis staring in the face given the feeling that Patel’s team is ill-equipped to deal with the full blown rupee volatility. They even cite how Raghuram Rajan was drafted into RBI by the then UPA-II as his predecessor Duvvuri Subba Rao had limited success in strategising the currency policy while crude prices hit $120 per barrel. A coordinated policy framework by both RBI, finance and commerce ministries with the PMO taking a leading role may work.