India's Trade Deficit Widening: Anybody Listening

Blame it to the ever-rising oil prices and significant increase in non-oil imports, merchandise trade deficit is widening with every passing day. And if trend continue, without capital inflows being directed to build productive capacities, India is on the verge of facing the next Asian financial crisis.

Foreign Institutional investors (FIIs) is fast emerging as the main drivers of the Indian capital market because of strong fundamentals of the Indian economy and a high expectation on returns. With Sensex climbing up the ladder since April 2003, setting milestones after milestones, there seems to be no stopping them either.

According to the latest trade statistics released by the Directorate-General of Commercial Intelligence and Statistics relating to the first five months of this financial year (April-August), the deficit in India's merchandise trade stood at $17,431.2 million as compared with $9,728.5 million during the corresponding period of the previous year. If this 80 per cent increase in the deficit persists over the rest of the year, the trend could take India's trade deficit to close to $50 billion over the financial year 2005-06.

Indian markets got the first taste of globalization and liberalization, through Mr. P Chidambaram, Mr. Yashwant Sinha, Mr. Jaswant Singh and Mr. Chidambaram who is back in North Block - have rightly chosen not to peg either economic policy or performance to the rise or fall of the Sensex.

India is poised to become one of the hottest contenders among emerging markets. The Indian capital market posted a return of 27.8 percent (BSE) in 2004-05 while in the earlier fiscal this figure stood at 40.1 percent. Since the beginning of this financial year, the index has shown a growth of about 30 percent.

Coming back to merchandise trade deficit, it could be argued that such an increase was bound to happen because of the sharp increase in the international prices of oil that has increase India's oil import bill tremendously. A brief look at the data of the first five months of this financial year clearly shows that oil imports rose in value by close to 37 per cent from $12,002 million to $16,428 million. What’s more, over the same period non-oil imports also rose by a similar 37 per cent from $26,803 million to $37,763 million.

The situation looks more dim when you take into consideration the fact that there is a creditable 23 per cent increase in the dollar value of India's exports during April-August, yet trade deficit has widened.

According to experts, even if the increase in the oil import bill can be termed as ‘temporary’ because oil prices must moderate or as a matter of fact can even fall, but it cannot be said about the non-oil import bill.

If Securities and Exchange Board of India (SEBI) are to be believed, FIIs poured Rs 3,000 crore less into the markets last fiscal as compared to Rs 44,000 crore in 2003-04, they remained by far the main drivers of the capital market. As compared to this, the net investment from mutual funds in the equity market was Rs 448 crores in 2004-05.

Riding on the back of huge liquidity, the Sensex has posted a rally of almost 5,000 points since April 2003. Indeed, the day the Sensex breached the 8,500 mark, market capitalization was pegged at a massive Rs 22,84,860.34 crore.

Other BSE and NSE indices have been following suit. This is quite unlike the past rallies of 1992 and 2001, with the sentiment running across the board. Based on its soaring volumes, the NSE outranked the BSE to be placed a global third. The turnover at NSE during 2004-05 was Rs 11,40,071 crore. That figure for the BSE stood at Rs 5,18,717 crore.

The million-dollar question is whether the stock market boom will continue in the future? Some say the market has the potential to reach the 16,000 mark or more. Mumbai-based Rakesh Jhunjhunwala, India's richest retail investor, has already voiced the opinion that the market will scale the 20,000 peak in the next five years whereas others has predicted that the Sensex could cross 16,000 in the current fiscal, riding on the back of robust economic conditions.

Though all this seems rosy. But what about trade deficit which is widening very quickly. This situation was there even during the previous two financial years but because of significant inflows of foreign exchange on account of remittances and exports of software and IT-enabled services, it was manageable.

According to the Reserve Bank of India, private transfers brought in a net amount of $20.5 billion in 2004-05 and software services exports contributed another $16.6 billion. This net inflow went a long way towards financing India's foreign exchange requirement in that year on account of the merchandise trade deficit .As a result, the deficit on the current account of the balance of payments was relatively small. Since India has also been a net recipient of substantial capital inflows on account of debt and foreign direct and portfolio investment, this led to a huge accumulation of foreign exchange reserves that implied a comfortable balance of payments situation.

But India’s relatively strong current account position is weakening rapidly. Net remittances, which rose from $16.4 billion in 2002-03 to $22.6 billion in 2003-04, were down to $20.5 billion in 2004-05. While net revenues from software services continue to increase, from $8.9 billion in 2002-03 to $11.8 billion in 2003-04 and $16.6 billion in 2004-05, the current account deficit can be expected to widen.

Though Foreign Institutional Investors (FII) investments drive the current stock market boom and create the euphoria that explains the lack of concern about potential external vulnerability to the extent that foreign debt and direct investment inflows are indeed creating new capacities, they are not generating export revenues to finance the rising non-oil and oil import bill. But anybody listening! 


More by :  VipinK. Agnihotri

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