When people ask me what is the biggest macroeconomic risk to the India markets and the economy my answer today is the rising Trade Deficit which has been growing month on month and year on year over the last several years. The Trade deficit for the month of July 2010 was USD 13 billion and that on an annualized basis is a whopping USD 150 billion plus. This trade deficit has historically been bridged by strong remittances and services export revenues. The capital account in India has normally bridged the gap with inflows in the form of debt, FDI, Equity, Private Equity etc. etc.
However today India needs capital to grow and in a scenario of fear and global risk aversion such a huge trade gap can lead to macroeconomic disruptions at times of capital outflows. Today most of India’s export markets are not doing well and as such export growth is likely to be muted for a long time to come. On top of that we have a domestic economy which is doing exceedingly well and with the investment cycle picking up and project imports for sectors like power, telecom 3 G equipment etc shooting up the risks are that the trade gap will keep on increasing. As the industrial investment cycle also picks up there will be an import of lot of machinery which is not domestically manufactured.
Unfortunately over the years India has not been able to develop new areas of competence on exports and given the demographic profile and low labour costs there could be a large number of labour intensive industries where such capabilities can be developed. There is also no lack of technically skilled workforce in the country. However poor productivity and infrastructural constraints make Indian manufacturing uncompetitive vis a vis other countries.
The current account deficit for the current year is estimated to be in the region of 3.5% of GDP and this is at a time when crude oil prices are at extremely muted levels. Traditional crude imports used to constitute almost entirely the entire trade deficit, however in July 2010 crude imports were USD 7 billion odd and the trade deficit was nearly double of that. This is at a time when the crude oil production of Cairn has come on stream and Reliance Industries is also producing a significant amount of gas which are both import substitutions.
The current environmental issues on mining and setting up of various kinds of manufacturing plants will lead to a further increase in imports of various metal, inputs etc. over the next few years as domestic production will not be able to keep pace with consumption growth. There is a lack on investment in products with value addition in the country which is not good for the long run as various raw materials with value addition get exported where one is just a price taker.
Auto and Auto ancillary segments are a handful where frugal Indian manufacturing has helped companies capture significant market shares in segments like small cars, forgings etc. However such industries are too few in numbers. In some industries like ship building where Indian companies were doing exceedingly well a lack of clarity on government subsidy schemes as well as poor disbursement of subsidy earned along with other policy issues has led to this sector now lagging behind other countries. There has to be a mechanism to identify industries where the country can be competitive and give support to the same in some form or the other. The FDI policies also need to be simplified in order to bring in longer term capital into key infrastructure projects.
Under the current circumstances India becomes increasingly dependant on capital flows to sustain its external balances and also to provide liquidity for the growth of the domestic economy. India cannot be like the US which has the reserve currency and where capital flows have taken care of the current account deficit for decades. This is one of the major reasons why the Indian rupee has underperformed most other emerging market currencies by a wide margin since the beginning of this year.
While other things look positive this is one issue that could be a bother sometime in the future.
Markets seem to be breaking out of a range and in line to meet the target of 20500-21000 by year end.
“To climb steep hills requires slow pace at first” – Shakespeare