The European connection

The latest official output data from Europe reveals a worsening slowdown, with the economy of the 27-country block contracting by 0.3 per cent as a whole during 2012. Moreover, the latest December-ended quarter figure suggests an acceleration of such contraction, with a decline of 0.6 per cent coming on the back of a 0.4 and 0.3 per cent fall in the preceding two quarters, and a mild 0.1 per cent growth posted in the first quarter. The European Central Bank strategy of keeping its key refinancing rate at a record low of 0.75 per cent since July and flooding banks with over one trillion euros of cheap three-year loans may have averted a bank liquidity crisis or even a break-up of the eurozone because of so-called contagion risks from the sovereign debt woes of a few members. But it has done nothing to breathe new life into the economy in terms of boosting output, jobs and overall demand.

That, in turn, has definite implications for India. The European Union is India’s largest export destination, accounting for $ 52.5 billion out of the total $ 305 billion worth of goods shipped out from the country in 2011-12. With the economic recovery in the US also losing steam – industrial output shrunk in January – and the Japanese economy remaining mired in recession, the prospects for India’s exports aren’t particularly bright in the immediate term. This is notwithstanding the January figure showing a mild 0.8 per cent growth, after eight consecutive months of decline. Clearly, the potential benefits of a weak rupee have been more than offset by even weaker external demand, courtesy a tepid global growth. At the same time, imports have continued to grow, reflecting the relative inelasticity of demand, especially for high-value items like oil and gold. While the rupee’s depreciation may help exports in the medium term, the fact of it doing nothing to restrain imports is leading to more serious immediate problem of a widening merchandise deficit. The latter, in 2011-12, amounted to a record $185 billion and looks set to cross $200 billion this fiscal.

From a policymaker’s perspective, if there is nothing much that can be done to push exports given the current external environment, it only leaves the option of addressing the import side. And here, the prime candidates are precisely those imports, where basic inelasticity of demand is compounded by inadequate domestic pass-through of global prices. Gold imports have actually fallen in the last one year because of domestic prices rising and aligning themselves to higher import costs. The absence of such a mechanism for oil or fertilisers has meant creating an artificial demand relative to the one that could be sustained if domestic prices are allowed to align themselves to the actual cost of imports. Considering that oil imports are up by almost 12 per cent in dollar terms in April-January, the Government should allow that to happen and the sooner the better.

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