Exports May Not Put India Growth Story Back On Track, Falling FDI Inflows An Added Worry

Though, ironically, the disruptions during the Covid-19 pandemic created a surplus in goods and services trade in 2020-21, for the first time since 2003-04, it quickly retracted into the usual deficit zone in the following years. At best, India’s performance in exports and imports of goods and services over the past decade has been bumpy.

Post-pandemic performance of India’s external trade is characterised by a drastic fall in imports, moderate growth in exports, and a resultant marginal reduction in trade deficits.

The latest trade figures published by the Ministry of Commerce and Industry show that India’s overall exports in goods and services in March 2024 are estimated at US$ 70.2 billion, exhibiting a negative growth of 3.0 per cent over March 2023. Overall imports are estimated at US$ 73.1 billion, showing a negative year-on-year growth rate of 6.1 per cent.

So, the saga of shrinking trade deficit, as a result of a larger drop in imports compared to exports, continues. Notably, rapidly falling imports are not a good sign for an aspiring economy.

Foreign Direct Investment (FDI) inflows could have offered some cushion, but these have been declining too. In 2018-19 and more recently in 2022-23, lower FDI inflows and subsequent lower capital account surplus could not offset the current account deficit, resulting in the depletion of foreign exchange reserves. Deficit in goods (merchandise) trade in India is usually compensated by the surpluses in services trade and capital account.

Recent trends point towards the risk of running these two buffers (services trade and capital account surpluses) thin on the margin, in case of an exports deceleration. Given the current geopolitical tensions following the Iran-Israel conflict, exports dwindling further is a real possibility. There are other factors, such as lack of global demand for IT services that may adversely impact the services exports as well. 

If that happens, then a goods trade deficit may translate into an overall balance of payments deficit, dwindling foreign exchange reserves, and a further weakening of the rupee. That would mean any Indian citizen spending money on any international transactions, like trade, education, tourism, or health, would have to pay more.

BoP Shielded By Services Trade Surplus, Foreign Capital Inflows 

The balance of payments (BoP) shows the difference in total value between payments into and out of a country over a period. It summarises the economic transactions of an economy with the rest of the world. The BoP is broadly categorised under two different heads: current account and capital account.

The country has to pay outside for its imports, and it gets paid for its exports. The difference between these (exports and imports) payments is captured by the trade deficit or surplus, also known as current account deficit (CAD) or surplus. It reflects all the payments made for the country’s international trade in goods and services.

Capital account, on the other hand, records capital transfers in and out of the country, along with money going in and out of the country due to buying and selling of non-produced, non-financial assets like land, property etc. FDI in the economy and Foreign Portfolio Investment (FPI) in the financial markets are important parts of capital account.

Historically, India runs a deficit in goods trade. In other words, India pays more for its import of goods than it gets for its export of goods. But services trade and capital account usually run surpluses, and these two together take care of the merchandise trade deficit. 

Whenever these two cannot offset the goods trade deficit, there is a decrease in the country’s foreign exchange reserves. That is a situation the economy tries to avoid.

Available data for the last 10 years confirm this trend of capital account surplus making up for the current account deficit. However, a US$ 57.9 billion surplus in capital account could not offset the US$ 67.1 billion current account deficit in 2022-23, resulting in a US$ 9.1 billion depletion of foreign exchange reserves.

Foreign exchange reserves also got depleted in 2018-19. A capital account surplus of US$ 53.9 billion failed to compensate for the US$ 57.3 billion current account deficit, which eroded foreign exchange reserves by US$ 3.3 billion. 

During both 2018-19 and 2022-23, CAD as a percentage of GDP either touched or breached the 2.0 per cent limit. The decadal average of CAD as a ratio to GDP stands at 1.2 per cent. It seems the new red line of breach for CAD has become 2.0 per cent of GDP.

However, the latest official data reveals that the deficit in goods trade stood at US$ 240.2 billion, while services trade showed a surplus of US$ 162.1 billion.

The overall trade deficit in goods and services reduced to US$ 78.1 billion in 2023-24 from US$ 121.6 billion in 2022-23, mainly due to a drastic fall in imports. Exports in goods and services increased by US$ 0.3 billion in 2023-24 compared to the previous year, imports dropped by US$ 43.2 billion. 

This may not be a good sign, as India is a net importer of capital goods such as machinery and equipment. Any decrease in imports may be a symptom of a larger slowdown in different sectors of the industry.

FDI Inflows Hard To Come By

Foreign capital comes in via two routes—foreign direct investment (FDI) and foreign portfolio investment (FPI). The latter is extremely volatile (see chart) and cannot be a trusted compensator for any deficiency on the FDI side or the current account side.

Data available from the Department for Promotion of Industry and Internal Trade displays the continuing trend of falling FDI. The amount of FDI inflow in equity during April-December of 2023-24 stood at US$ 32.0 billion, well below the 2022-23 figure of US$ 46.0 billion.

Therefore, all the existing red flags of the last two years still remain. Only a fresh injection of FDI can alter this tricky external situation, but that is not happening currently.

Net FDI, as percentage of GDP, dwindled to 0.7 per cent in 2022-23 from a high of 3.6 per cent in 2014-15. It was high at 3.0 per cent of GDP in 2020-21, but that can be largely attributed to the drastic fall in GDP during the pandemic. 

Otherwise, the economy generally struggled to attract FDI in the last three years or so. As noted, available data for 2023-24 also point towards that continuing declining FDI trend.

Lower Imports Make Forex Cover Look Good So Far

Foreign exchange cover for imports reached 11.3 months in 2016-17 and fell down thereafter, before reaching a high of 17.4 months in the pandemic year of 2020-21. After the economy opened up, the import cover fell down to 9.6 months in 2022-23.

According to the Reserve Bank of India's Half Yearly Report on Management of Foreign Exchange Reserves, at the end of June 2023, foreign exchange reserves cover of imports increased to 10.2 months from 9.6 months at the end of March 2023. But the continuous falling trend in imports definitely has a role to play in this apparent improvement.

A worrying fact is that the ratio of volatile capital flows, including cumulative portfolio inflows and outstanding short-term debt, to reserves remained at 70.3 per cent between the end of March 2023 and June 2023. 

Portfolio inflows are too volatile to be reliable in the medium and long term. FPI inflows are unlikely to be the saviour if a situation arises, where capital account surplus has to balance the current account deficit.

India’s exports and imports moderated after the pandemic years. However, in an increasingly inward-looking global economy keen on protecting domestic economy interests, exports do not appear to be a pivotal driver of economic development for India, at least in the short run.

With weak domestic consumption and private investment as argued earlier by The Secretariat, the Indian economy is holding on to its GDP ride by increasing government capital spending over the last few years. In that context, foreign investment could play an important part in India’s economic story for the next decade. It can either be a growth booster or a crab-like pull-downer.