After four years of an easy run, the troubles in the economy are finally coming home to roost. It is not strange that the tipping point should be the drop in the rupee, which has fallen 12 per cent against the dollar this year, and touched a new record low of Rs 74.13 (to the dollar) on Friday. The evident reason for this is the sharp rise in petroleum prices. But other contributing factors have been the slowdown in exports, conspicuous consumption and import of luxury items — the easy import of electronic goods like television sets and mobile phones instead of making them here — and an irrational exuberance in stock markets encouraged by the government and heavy use of funds from external commercial borrowing. This, coupled with a weakness in banks, has further weakened the fundamentals.
International oil prices went up to over $110 per barrel in 2013, but the retail price of petrol and diesel was lower than it is now because the taxes on them were reduced. In 2016, the international price of Brent crude had fallen to $29 a barrel, but duties (and the price of petrol and diesel) were not brought down. When oil prices were close to $80 a barrel by mid-September this year, the government did not reduce the duties, leading to a spurt in retail petroleum prices. (However, as international oil prices touched $86 a barrel, a four-year high, the Centre finally announced a Rs 2.50 per litre cut in petrol and diesel prices, including a Rs 1.50 excise duty cut.) At the same time India’s oil imports, which had fallen to $83 billion in 2015-16, rose to touch $109 billion in the financial year ending March 2018, and will be even higher in the current year, pushing up the trade deficit.
But the high current account deficit is not only because of the rising oil prices. The non-oil trade deficit is shooting up. And the reason for is that the rate of growth of exports between 2013-14 and 2017-18, a compound annual growth rate (CAGR) of just 1.36 per cent, is much lower than imports. The reasons for the stagnation are many, including lack of investment.
However, it is important to remember that around 40 per cent of India’s exports are from the small and medium scale sector (mainly in textiles and garments, gems and jewellery, leather products and engineering). This was hit by demonetisation, which forced many people to shut down their businesses for at least a few months. Further, the hurriedly-launched Goods and Services Tax led to some of their working capital getting blocked when the GST refunds did not come in time.
Despite the rising gap between merchandise imports and exports, two of the economic factors which have allowed us to maintain a balance are software and inward remittances from workers abroad. In the last few years, these have plateaued out. For software, this might be a ripening of the market with the astounding growth rates of the past no longer possible. But the stagnation of remittances, mainly from workers in West Asia since 2014, may represent a loss of confidence in their prospects here. Remittances have remained at around $60 billion since 2014 after growing steadily in the earlier decade.
At the same time, imports of electronic items such as television sets and mobiles have grown with the rising demand since there has been no attempt to ensure that these should be “made in India”, and these imports now compete in value with software exports. And the value of the imports of electronic goods rose from 46 per cent of receipts from net exports software in 2009-10 to 58 per cent of software exports in 2016-17, and further to 70 per cent in 2017-18. This indicates that despite the tall talk about “make in India”, the government is not capable of meeting the domestic demand for widely-used consumer products. The economy’s strength that lay in robust software exports of around $70 billion is being rapidly frittered away by the import of electronic goods that should be made here.
The trade deficit means an excess of imports over exports. One obvious indicator of such vulnerability is the growing current account deficit, which has widened from $14.4 billion in 2016-17 to $48.7 billion in 2017-18. This is less than the current account deficit in 2013-14, but if it does not seem manageable it is because investors are moving out of the stock market. The net outflow of foreign portfolio capital amounted to $8.1 billion in the first quarter of 2018-19, as compared to an inflow of $12.5 billion in the corresponding quarter of the earlier year.
In recent months, the outflow has increased. Goldman Sachs, which was optimistic on India since March 2014, has turned cautious about the Indian market in 2018 and has lowered its investment view to market-weight from overweight earlier. In a report it has stated that “Indian equities are the most expensive in Asia and trading at a record 58 per cent premia to the region”. Indian equities, it says, have doubled over the past five years and have outperformed the region by 60 percentage points in dollar terms.
This is already having an effect on domestic mutual funds and foreign investors. Figures issued by the Securities and Exchange Board of India give the total investment in the Indian equity as Rs 33.4 trillion by FIIs and Rs 23.1 trillion by domestic mutual funds. The situation is made more critical by the meltdown of IL&FS, that has now effectively been taken over by the government, and the housing finance companies.
A further fall in stock market prices would lead to FIIs pulling more money out of the country and a further fall in the rupee. A consequence would be that many large companies took huge sums from abroad under external commercial borrowings. They would see their profitability reduce because as much as 38 per cent of the total external debt of $530 billion is through ECBs. As the downward spiral of the rupee continues, its effect will be felt in the government not being able to hold the fiscal deficit, inflation in oil and other imports, the fall of investments made in the stock market and the increased cost to companies in repaying foreign loans.