Is the Spike in India’s Trade Deficit a Cause for Concern?

Is the Spike in India’s Trade Deficit a Cause for Concern?

Sub: Eco

Sec: External Sector

Why This in News

India has recently witnessed a significant rise in its trade deficit, reaching a nine-month high in July 2024, followed by a further increase in August. This surge, driven by declining exports and rising imports, has raised concerns about the sustainability of India’s trade dynamics and its impact on the economy. The focus is on understanding the reasons behind this growing trade deficit, key sectors affected, and potential risks for the future.

Recent Trends in India’s Exports and Imports:

Export Decline: India’s goods exports began declining, shrinking by 1.5% in July 2024 to an eight-month low. The contraction deepened to 9.3% in August.

Record Import Bill: Imports, on the other hand, grew by 7.5% in July and 3.3% in August. This led to a record import bill of $64.4 billion in August, translating into a merchandise trade deficit of $29.7 billion, the second-highest after the $29.9 billion gap recorded in October 2023.

Trade Deficit Explained:

Trade deficit or negative balance of trade (BOT) is the gap between exports and imports. 

When money spent on imports exceeds that spent on exports in a country-a trade deficit occurs.

The opposite of a trade deficit is a trade surplus.

India tends to have a trade deficit every year because it imports far more (in terms of value, measured in $) than it exports.

A trade deficit implies that Indians need dollars/forex more than the rest of the world needs rupees for the trades to settle.

A trade deficit puts pressure on the rupee’s exchange rate against the dollar and persistently high trade deficits tend to weaken the rupee’s exchange rate.

It is a part of the Current Account Deficit.

The current account records exports and imports in goods and services and transfer payments. It represents a country’s transactions with the rest of the world and, like the capital account, is a component of a country’s Balance of Payments (BOP).

There is a deficit in Current Account if the value of the goods and services imported exceeds the value of those exported.

Major components are: Goods, Services, and Net earnings on overseas investments (such as interests and dividend) and net transfer of payments over a period of time, such as remittances.

Current Account Balance = Trade gap + Net current transfers + Net income abroad.

Trade gap/Trade deficit = Exports – Imports

Factors Behind the Widening Trade Deficit

Decline in Major Export Sectors

Petroleum Exports: Oil exports fell sharply by 22.2% in July and 37.6% in August.

Gems and Jewellery: This sector saw over 20% decline in both July and August.

Other Sectors: Export growth in pharmaceuticals, electronics, and iron ore has slowed significantly, with the Chinese economic slowdown contributing to reduced demand in these sectors.

Import Growth Driven by Gold

Gold Imports: India’s gold imports surged, more than doubling to $10.1 billion in August, an all-time high, in contrast to the $3-3.4 billion range seen since April.

Factors Driving Gold Import Surge: The reduction in import duty from 15% to 6%, rising gold prices, and stocking by jewellery players ahead of the festive season have fueled this rise.

Long-Term Challenges

Export Targets: The Indian government aims to scale up both services and goods exports to $1 trillion each by 2030. However, this ambitious goal faces hurdles due to the global economic slowdown, increasing trade barriers, and protectionist policies.

New Trade Barriers: The introduction of measures like the European Union’s Carbon Border Adjustment Mechanism and Deforestation Rules adds further complexity to India’s trade prospects.

Why trade deficit bad for a country’s economy?

If the trade deficit increases, a country’s GDP decreases. 

A higher trade deficit can decrease the local currency’s value.

Impact the jobs market and lead to an increase in unemployment. If more mobiles are imported and less produced locally, then there will be fewer local jobs in that sector.

More imports contribute to imported inflation and an increase in the fiscal imbalance, which is damaging to a developing country.

What is Balance of Payments?

Balance of Payments (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.

For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under – Current account, Capital account and Errors and Omissions. It also shows changes in Foreign Exchange Reserves.

Current Account: It shows export and import of visibles (also called merchandise or goods – represent trade balance) and invisibles (also called non-merchandise). Invisibles include services, transfers and income. Thus,

• The balance of trade in goods
• The balance of trade in services.
• Net current income e.g. profit from overseas investment.
• Transfer payments e.g. payments to the EU.

The balance of exports and imports of goods is referred to as the trade balance. Trade Balance is a part of ‘Current Account Balance’.

Capital Account: It shows a capital expenditure and income for a country. It gives a summary of the net flow of both private and public investment into an economy. External Commercial Borrowing (ECB),Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of capital account.

Errors and Omissions: Sometimes the balance of payments does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately.

Changes in Foreign Exchange Reserves: Movements in the reserves comprises changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) balances.

Overall, the BoP account can be a surplus or a deficit. If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account