India's troubles mount because of a sluggish global trading environment and slipping capital flows.
However much India's policymakers may want the external sector to behave the way they want it to, it is clear that the sector's patterns of behaviour are no longer simply the outcome of domestic policies but of the whims and caprices of international trade and finance movements.
That seems to be the case today, more than ever before, when we consider India's balance of payments position in the light of the fluctuating fortunes in India's most important destinations and sources of trade and capital respectively.
Domestic policies work most effectively when the external environment is by and large favourable to trade. When the environment encourages the free flow of goods and services then for policymakers to take a more laid back position may prevent exporters from exploiting the advantages available in the situation. That had been the case when India's capital controls and forex restrictions had not allowed exporters the elbow room needed to evolve strategies for exports. Then it changed for the better and India was able to ride the horse to its advantage because its policies segued into the environment for trade
The end-of-century turnaround in India's exports and balance of payments came because of services exports and specifically IT exports.
India's telecommunication policy changes, that ushered in the most effective changes in communications ever, created the grounds for India's growing IT sector to become global. That event, with the top five Indian companies becoming known names in IT throughout the world, had wide repercussions on the overall organised economy, boosting demand for goods and services of other sectors such as manufacturing. This in turn boosted capacities, encouraging a re-engineering of extant practices to align with global ones.
The period between 2002 and 2008 can be considered India's golden age of global trade when the current account deficit declined to 1.2 per cent of GDP on the back of a surge of exports and capital flows. Needless to say, services exports in particular ITES exports led the way with the latter increasing its share from around four per cent in 1998 to 25 per cent a decade later.
More than domestic policies it was the international environment that favoured India's export surge. Till the crash of 2008 world demand was buoyant and sustained the export drive of most emerging economies including India.
Four years after September 2008 the world has changed – for the worse. India's exports have been slipping ever since as demand dries up in the West what with the US still weak in its recovery and Europe tackling rather ineffectively its slide into recession in many parts of the Euro Zone. Not surprisingly services exports have been slipping and the latest data from the RBI bear this out vividly.
Last fiscal (March end) saw the slowest growth in services exports at four per cent for three quarters with the slide evident after the first quarter when such exports grew at a healthy rate of 25 per cent. The star of services exports – software – also did poorly at 9.4 per cent after sliding from 21 per cent in the first quarter.
The problem was not with services alone. As the RBI notes in its report on India's balance of payments, export growth decelerated in October-December 2011 while imports continued to rise largely due to high international commodity prices and inelastic demand for gold and silver.
Here it is important to remember and the RBI reminds us that the advanced economies of the West still shape India's export-fortunes; so while the Commerce Ministry and commentators may appear innovative in seeking new markets for India's exports, the fact remains that the largest part of export earnings come from the US and Europe and other major western economies.
India's BoP during the third quarter of 2011-12, according to the RBI that releases the data with a lag of one quarter, bears testimony to how the storms and stress of the global economy can affect growth potential and more disconcertingly, the country's capital position.
As the RBI observes, “India's trade deficit widened, while capital inflows fell far short of financing requirement resulting in significant drawdown of foreign exchange reserves.” The trade deficit it notes rose by more than 50 per cent.
Just how dramatic the fall is can be seen from the facts: On a BoP basis, merchandise exports recorded a growth of 7.9 per cent, year-on-year, during Q3 of 2011-12 compared with 39.9 per cent during the corresponding quarter of 2010-11.
Imports, however, expanded 22.0 per cent during Q3 of 2011-12 compared with 24.7 per cent in the corresponding quarter of the preceding year; so the trade deficit widened more because of the great fall in exports than a significant rise in imports.
On other counts too the fall was steep namely in relation to capital flows that could have mitigated the decline in the trade account. As a result, the current account deficit (CAD) widened to $19.6 billion in Q3 of 2011-12 ($10.1 billion in Q3 of 2010-11). At this stage this would work out to 4.3 per cent of GDP compared with 2.3 per cent of GDP in Q3 of 2010-11.
At this point a little history helps. All through the 1980s, India's current account deficit hovered at 3.2 of GDP; given the policy environment at the time it became difficult to finance such a huge deficit and sure enough in 1991 the cumulative result showed in the country having only a billion dollars in reserves.
With a CAD of 4.3 per cent today alarm bells should be ringing; all through the recent growth period India's CAD has not risen above 1.2 per cent of GDP. In its report the RBI notes a huge drawdown on forex reserves: $12.8 billion (excluding valuation) during Q3 of 2011-12 as against an increase of $4.0 billion in the corresponding quarter of 2010-11.
Given the state of the world today, that should be worrying.