Fixing India’s CAD

India’s merchandise trade deficit has ballooned following the spike in crude oil prices to over $100 a barrel. Total imports are running at more than $65 billion a month. Exports have averaged $40 billion a month. That leaves an unsustainable trade deficit of $25 billion a month or $300 billion a year.

India imports 83 per cent of its crude oil due to a decades-long failure to find new oil wells to supplement ONGC’s declining output. Gold imports have added to the import burden. Higher commodity prices and a pick-up in India’s manufacturing industry which relies on imported components has exacerbated the trade deficit.

What can be done? First, it’s not all bad news. Services exports are ticking along nicely. The depreciated rupee has helped Indian infotech services companies like TCS, Infosys and Wipro boost exports. The target for services exports in 2022-23 had been set at $300 billion. That is likely to be achieved.

The other two key forex inflows are foreign direct investment (FDI) and remittances from Indians working abroad. Last year, despite Covid-19’s lethal Delta wave, India received $83 billion in FDI. Much of this was due to the slew of FDI deals by Reliance industries but FDI this year promises to be robust as well.

Remittances too are on the rise. In calendar 2021 they totalled $87 billion. The United States recently overtook the United Arab Emirates (UAE) as the largest remitter of foreign exchange from Indians abroad.

In 2022-23, estimated services exports ($300 billion), FDI ($80 billion), and remittances ($90 billion) would together result in $470 billion flowing into India. Imports of services (an estimated $150 billion) need to be deducted from this forex inflow. That leaves us with nett inflows of roughly $320 billion from services exports, FDI and remittances.

This is what constitutes India’s annual balance of payments (BoP). The surplus of $320 billion in services exports, FDI and remittances will wipe out the deficit of $300 billion in merchandise trade of goods. That would leave the BoP at near net zero or marginally positive or negative depending on the final export-import figures that emerge at the end of the year. When examining CAD, which provides a picture of trade in merchandise goods and services, it’s important to keep the overall BoP position in mind.

Wipro Chairman Rishad Premji is bullish about the IT sector’s export performance. He told shareholders at the company’s annual general meeting (AGM) on 19 July: “The technology services industry, at some level, is recession-proof. In good times, clients spend on new initiatives and business transformation and serving customers digitally. They focus on reducing costs when times are not so good. As long as customers are making decisions, the IT services industry is well placed.”

While the Russia-Ukraine war continues to drive up crude oil and commodity prices, Indian policymakers also worry about possible contagion from Sri Lanka. Analysts have warned that high inflation, low forex reserves, debt and corruption led to Sri Lanka’s collapse.

External Affairs Minister S. Jaishankar acknowledged at an all-party meeting on 19 July: “The situation in Sri Lanka is unprecedented in terms of the financial, social and political consequences. It’s our very close neighbour. So, naturally, there’s a level of concern, as well as the worry that there would be spillover to India.”

But Jaishankar added that comparisons with India were false and motivated. India’s forex reserves are $580 billion, among the world’s largest despite a recent decline. Retail inflation is only one per cent above the Reserve Bank of India’s upper tolerance limit of 6 per cent, and the country’s debt-to-GDP ratio is a fraction of China’s and America’s.  

Meanwhile, though, the government isn’t helping India’s battle against inflation by making frequent changes in the Goods and Services Tax (GST) regime. The latest tweak is the most incomprehensible. The GST Council has imposed five per cent GST on pre-packed or pre-labelled cereals, pulses and flour above 25 kg.

The government has defended its move with three arguments. One, that loose items such as pulses, wheat, rice, flour, oats, maize and curd will be exempt from GST. This, it says, will benefit the poor who buy these items lose and non-labelled. Two, the move will help reduce GST revenue leakages. And three, the same rate and policy existed under VAT in the pre-GST era. 

None of these arguments addresses the critical issue: with retail inflation finally easing, why add a potentially inflationary five per cent GST on pre-packed or pre-labelled food ingredients above 25 kg? This rise is bound to percolate down to wholesalers. Prices are likely to rise, edging up both the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). The timing couldn’t be worse.

Finance Minister Nirmala Sitharaman’s defence misses the point: “Is this the first time such food articles are being taxed? No. States were collecting significant revenue from foodgrains in the pre-GST regime.”

While a spike in inflation is a pressing concern, India needs to find a long-term solution to the merchandise trade deficit. The country can’t rely on surpluses from services exports, FDI and foreign remittances to bail it out. The first obvious target is cutting India’s reliance on crude oil imports. In the 1980s when oil rigs at Bombay High were at their productive peak, India depended on only 60 per cent of its oil requirement on imports. Policy inertia on oil exploration has led to the predicament India finds itself in.

Indians’ passion for gold must be cooled with high import duties. Together crude oil and gold account for nearly $20 billion of India’s $65 billion monthly import bill. They make up 80 per cent of India’s monthly merchandise trade deficit of over $25 billion.

In the meantime, the planned rupee-dominated trade with Russia, the United Arab Emirates and an expanded group of countries could help moderate the rupee’s slide against the US dollar.

Interestingly, while the rupee has depreciated against the dollar it has appreciated against the British pound and the euro. The rupee has strengthened from 101 to 95 against the pound as Britain fights soaring inflation and looming recession.

India’s financial policymakers will have to weigh multiple factors as they steer the economy into calmer waters.