Is
there to be no end to the bad economic news? The latest
balance of payments data from the Reserve Bank of India
(RBI) confirm what many had been suspecting for the
past few months: that the global financial and economic
crisis has already taken a very heavy toll on the Indian
economy. It has been particularly harsh on the external
sector, which was already much more fragile than the
government and its cheerleaders have cared to admit.
According to the RBI, both the current
and capital accounts of the balance
of payments have deteriorated very sharply, to the point
where both accounts are now in deficit!
On a balance of payments basis, India's merchandise
exports recorded a decline of 10.4 per cent in the period
October to December 2008-09 compared to the previous
year, as against the increase of 33 per cent that was
experienced in October-December 2007. This estimate
is based on trade flows recorded by the central bank.
It differs from the customs-based data provided by the
Directorate General of Commercial Intelligence and Statistics
(DGCI&S) because it includes other exports and imports
that do not pass through customs, such as government
imports.
The DGCI&S data show an even more precipitous decline
for the period October-November 2008, with merchandise
exports declining by 16.3 per cent compared to the same
period in the previous year. This reflected a fall in
exports of all commodity groups except engineering goods.
The biggest falls were recorded in the exports of rice,
raw cotton, sugar and molasses, iron ore, iron and steel,
gems and jewellery.
While exports collapsed, imports continued to grow,
although at a much slower rate. The rate of increase
of import values in BoP terms was 9 per cent in October-December
2008, compared to the very high growth rate of 42 per
cent in the same period of the previous year. But this
was mainly because of the decline in oil prices, which
dramatically reduced the value of oil imports. The DGCI&S
data show that some categories of non-oil imports also
declined, such as capital goods, non-ferrous metals,
artificial resins and plastic materials, textile yarn
and medicinal and pharmaceutical products.
As a result of these developments, the trade deficit
expanded by a whopping 40 per cent in these three months
compared to the same period in 2007, to reach $36.3
billion.
Meanwhile, both invisibles payments and receipts declined
marginally, such that the overall invisibles balance
even improved slightly. The one bright spot was in software
services receipts, which continued to increase by 11.8
per cent. However, this is really due to the large weight
of previous contracts that continued into this period,
as industry insiders note that even in this area, exports
are likely to come down soon as previous contracts expire
and are not renewed to the same extent. This is particularly
true for software contracts in the financial industry,
which account for around 40 per cent of software services
exports, but are increasingly threatened as financial
institutions in the US and UK get effectively nationalised.
So the net invisibles surplus financed 60 per cent of
trade deficit, significantly less than before. This
in turn meant that the current account deficit increased
threefold to US$ 14.6 billion in these three months.
This is the highest quarterly deficit in the current
account since 1990. In terms of shares of GDP, these
are truly stark numbers: a trade deficit of 12.6 per
cent of GDP and a current account deficit of 5.1 per
cent of GDP for the third quarter of 2008-09, that is
October-December 2008.
Note that many developing countries, such as South Korea
and Argentina, have experienced severe balance of payments
crises with significantly better numbers in terms of
trade and current account deficits. The difference at
present is that with the global economic downturn, there
are several other countries – both developed and developing
– that are also showing rapidly worsening current account
deficits as global exports nosedive.
But the first signs of incipient crisis are already
there, in that for the first time in a very long time
the capital account has also turned negative. Gross
capital inflows to India in these three months amounted
to $70 billion ($57 billion less than in the same period
of the previous year) as against gross outflows from
India at $73.6 billion. The larger outflows were mainly
due to net outflows under portfolio investment, banking
capital and short-term trade credit. Of course, these
have been negative for some months previously, especially
portfolio investment which reversed around June 2008
as investors booked their profits in India and moved
back to the US and other locations to cover their losses
in markets there. What has made things worse, and allowed
the entire capital account to turn negative, is that
for the first time there was a fall in foreign direct
investment and external commercial borrowings inflows.
Even inflows under short-term trade credit declined.
So the capital account deficit amounted to 1.3 per cent
of GDP, leading to an overall BoP deficit of 6.2 per
cent, the worst such number in more than forty years.
This shows how fragile the previous boom was, based
as it was on a domestic credit-fuelled expansion encouraged
by large inflows of essentially speculative hot money.
As is inevitable, such money departs for many reasons,
some of which may be determined by factors outside the
Indian economy. It can also be influenced by the so-called
“fundamentals” which in the Indian case are looking
none too healthy.
But once such capital starts to depart, it immediately
affects these fundamentals in turn, causing balance
of payments deficits and currency depreciations. If
these are sufficiently sharp and rapid, a crisis ensues,
as many emerging markets have found to their cost. The
sharp devaluations can then cause havoc within the domestic
economy, allowing trade and current account to improve
only through sharp contractions in domestic output combined
with increasing exports.
But all this typically happens in economies when the
global economy is chugging along at approximately the
same rate as before. This is clearly no longer the case.
International organisations are now vying with each
other to provide ever more depressing forecasts about
world trade and output changes in the coming year. For
example, the latest projection from the OECD suggests
that world trade will contract by 15 per cent in 2009.
If this happens, Indian export figures will look even
worse. And not only will protectionism in the developed
world inevitably increase (despite whatever pious statements
the leaders of these countries may make) but even without
it, export markets for India and similar countries will
necessarily shrink. So clearly, worse is to follow.
These are therefore more than just extraordinary times
that call for extraordinary responses. This is a period
in which failure to take decisive economic action can
have effects that last for several years, creating a
major depression internally in India even if the rest
of the global economy recovers.
That is why what may be even more worrying than all
of this bad news is the current central government's
incredible inertia and sense of denial in the face of
the apparent collapse of all the assumptions and conditions
on which it had based its economic strategy. Our policy
makers refuse to accept reality and keep insisting that
the Indian economy is still doing well. Even worse,
they want to intensify the policies that have brought
us to this pass, such as more financial liberalisation.
They also fail to understand that it is pointless to
simply look towards the US and other developed countries
and expect them to solve the problem. Instead, much
more creative and imaginative policy responses are required,
in terms of changing directions of investment and consumption
in the home market to emphasise wage-led growth, diversifying
exports and generally making moves designed to turn
adversity to an advantage.
This is more than simply a lame-duck government, it
is a government that has been crippled by the loss of
its economic paradigm, and appears to be helpless and
without any clue about how to proceed.
The current account balance is the sum of the trade
balance and the balance on invisibles, which include
services exports and other payments like remittances
of income and profits. The current and capital accounts
together make up the overall balance of payments, and
the difference between them (other than errors and omissions)
results in a change in foreign exchange reserves.
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