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MACRO-ECONOMICS: PRINCIPLES AND POLICIES


TERM II
FINAL PROJECT

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Amit Jotwani ± 10DM-011


Amrinder Singh ± 10DM-012
Deepti Gupta ± 10DM-041
Abhay Agarwal ± 10IB-003
Anant Agarwal ± 10IB-009
Amit Aggarwal ± 10FN-010


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cIntroduction

cIndia¶s Trade Deficit: Since 2006

cDetailed Trend of the Deficit since 2008

cAnalysis of the Trend

cConclusion

cBibliography



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The  !"#$ (or a  å sometimes symbolized as  ) is the


difference between the monetary value of exports and imports of output in an
economy over a certain period. It is the relationship between a nation's imports and
exports. A positive or favourable balance of trade is known as a $%$&% if it
consists of exporting more than is imported; a negative or unfavourable balance is
referred to as a $#!orå informallyå a trade gap.
The balance of trade forms part of the current accountå which includes other
transactions such as income from the international investment position as well as
international aid. If the current account is in surpluså the country's net international
asset position increases correspondingly. Equallyå a deficit decreases the net
international asset position.
The trade balance is identical to the difference between a country's output and its
domestic demand (the difference between what goods a country produces and how
many goods it buys from abroad; this does not include money re-spent on foreign
stockå nor does it factor in the concept of importing goods to produce for the
domestic market).
India reported a balance of trade deficit equivalent to 9118.0 Millions in September
of 2010. India is leading exporter of gems and jewelryå textileså engineering goodså
chemicalså leather manufactures and services. India is poor in oil resources and is
currently heavily dependent on coal and foreign oil imports for its energy needs.
Other imported products are: machineryå gemså fertilizers and chemicals. Main
trading partners are European Unionå The United Stateså China and UAE.

India has a chronic deficit on current accounts. What bridges the gap between
payments and receipts is mainly external aid (especially non-project assistance)å
tourism earningså and remittances from Indians working abroad. Heavy imports of
food grains and armament purchases caused a decline in India's foreign exchange
reserves in the mid-1960s. An economic recovery from 1968±69å howeverå eased
the problem.

Although export growth remained strongå the current account deficit tripled from
1993±94 to 1995±96. The increase was attributed to a continuing surge in imports
and higher debt service requirements. Howeverå between 1995 and 1998 the
current account deficit shrank to about 1% of GDP due to increased textile exports
and a liberalizing trade regime.
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In the early 2000så India's exports to East and Southeast Asia increasedå including
to Japan and South Korea. High growth rates were registered for textileså
chemicals and related productså engineering goodså and leather and manufactures.


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An analysis of the major components of India¶s Balance of Payments as released


by the RBI in the last five years is presented below:

$!!"   ' ( ) * 
Exports 105.2 128.9 166.2 189 182.2
Imports 157.1 190.7 257.6 307.7 299.5
Trade Balance -51.9 -61.8 -91.4 -118.7 -117.3
Trade Balance as
% of GDP -6.20% -6.50% -7.40% -9.80% -8.90%

All figures are in


USD Billion



 
 
 
 

  

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One notices trade deficit stabilizing at a high 9 per cent to 10 per cent of GDP; it
has doubled in the last four years; export growth slowing down actually it was
negative last year; imports growing at a rate higher than exports and on a larger
base.

Until few years agoå our trade deficit used to be equal to our oil imports - that is
our exports and nonoil imports used to be more or less equal. Thus the trade deficit
was essentially caused by our oil imports. This is no longer true. In the last few
yearså even without taking into account oil importså we have been running a trade
deficit. This will only worsen further as our GDP growth rates climb higher in
coming years.




 mm mm+,

Oil imports are rising without control. They are a function of demand for petro-
products - petrolå keroseneå dieselå LPGå etc. With per capita incomes risingå
demand for all these products are rising. Subsidies on these products further
support the rising demand. Also autos / CV sales are strong. Such a situation keeps
us very vulnerable to rising global oil prices.

May be the Godavari Basin gas discovery will mitigate these adverse trends; but it
is to be proved. Fortunatelyå the 10 per cent trade deficit is reduced considerably
by the invisibles - mainly software services and remittances. Here againå the
disturbing trend is the slowing growth rate in software services - in FY2010å
software exports grew hardly by 10 per cent compared to the historical 20 per cent
plus growth rate. Whether remittances can remain robust in coming years with
fewer Indian students going abroad needs to be seen.
Needless to emphasizeå any slow-down in software exports and remittances will
worsen our current account deficit dramatically as it has happened in FY2009 and
FY2010.
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$!!"   ' ( ) * 
Oil Imports -
Customs 43.8 56.9 79.6 93.7 85.5
Non-Oil Imports -
Customs 105.2 128.8 171.8 210 193.2

All figures are in


USD Billion

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Our Capital account flows - mainly loanså FDI & FII flows - comfortably fund our
current account deficit. As long as India remains a favorite destination for global
investorså we should not face serious problems in funding our current account
deficit. Howeverå this should not deter the policymakers from addressing the
worsening flow of trends in rising trade deficit and slowing invisibles.

Against such a macro backdropå the rupee exchange rate is determined essentially
by capital account flows ± if they are excessive as in 2007-08å rupee will rise
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sharply and if they are inadequate as in 2008-09å rupee will depreciate. There are
no strong trade account and current account fundamentals which can sustain a
rising rupee. At best what we can hope for is a range bound rupee (say Rs. 40 - Rs.
50 to the U.S. dollar).
The major advantage China has over India is her strong trade and current account
surpluses year after year. That's how China has accumulated vast forex reserves
over years which gave her the financial strength to undertake mega infrastructure
investments year after year while our trade and current account deficits restrict us
from confidently planning and implementing such mega infrastructure investments.

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/$ 0   +$ &$ + 0  0 1 & ! "2 !

*  -10362 -8966 -7825 -10420 -11292 -10554 -12930 -13060 -9118

) -5359 -3121 -3681 -6655 -7854 -9407 -7796 -8471 -6707 -8801 -9690 -10147

( -7955 -5688 -6320 -11857 -10757 -9770 -12595 -15764 -15347 -11738 -12325 -6088

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The general noted trend after a detailed study of the data is that while it
has been highly volatile through the momentså the trade deficit is
generally increasing. The question is that is the increasing deficit (as a
percentage of GDP) a cause for worry?

The answer depends on the determinants of the deficit. For an expanding


economy like India that is growing at more than nine percent per yearå a
trade deficit can arise from virtuous forces like heavy demand for raw
material and intermediate imports from a robust domestic industry. This
has indeed been happening in recent yearså with capital goods leading
the import rally. If industrial imports push the deficitå then there is little
cause for concern.

The deficit can also widen due to exchange rate movements. An


appreciation in the value of the Rupee vis-à-vis other major currencies
can make Indian exports dearer and imports cheaper. Depreciation in the
Rupee will have the opposite effects. The eventual impact of exchange
rate movements on the trade balance will depend upon relative price-
sensitivities of Indian exports and imports. Adverse impacts of such
exchange rate movements (if any) in a globalised world are usually
short-lived as market forces tend to impact interest rates and capital
flows in a manner that is self-equilibrating.

Enlarging deficits usually become a cause for concern if they are


produced by chronic structural deficiencies. For developing countrieså
structural trade deficits can be difficult to financeå making them
unsustainable after a point in time. This is because the chronic nature of
the problems leaves little scope for policy intervention. The situation
worsens if the deficiencies are accentuated by adverse circumstances. A
typical example is the dependence on oil imports. The dependence on
crude oil imports is chronic for most industrializing developing
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countries. The problem is also structural as their current resource


utilization pattern does not contain alternatives to imported crude.
Furthermoreå in a situation of unabated rise in oil priceså like nowå the
problem tends to get compounded.

A closer look at the recent BOP numbers reveals the following:

yc India¶s exports increased from US$128.1 billion in 2006-07 to


US$182.2 billion in 2009-10. This year-on-year increase of
US$54.1 billion was superseded by importså which increased by as
much as US$108.8 billion from US$190.7 billion in 2006-07 to
US$299.5 billion in 2009-10. The sharp rise in imports impacted
the final size of the trade deficit.

yc One of the possible reasons behind a progressively-widening trade


deficit could be a decline in exports accompanied by an increase in
imports. But it has not been so in India¶s case. Exports grew by
23.7 percent in 2007-08å which was higher than their growth of
21.8 percent in 2006-07. But the import growth of 29.9 percent in
2007-08 was far higher than the 21.8 percent growth in the
previous year. So the rise in trade deficit can be attributed to a
much faster rise in imports compared with exports.

yc Imports can be divided into two broad groups: oil and non-oil. The
BOP statistics do not disaggregate oil imports as a separate
category. According to the data made available by the Directorate
General of Commercial Intelligence and Statistics of the Ministry
of Commerceå India¶s oil imports during 2007-08 were US$77.04
billion. This represented an increase of 35.3 percent over US$56.9
billion in the previous year. Furtherå the year-on-year growth in oil
imports in 2007-08 was higher than the growth of 30 percent in
2006-07. In sharp contrastå non-oil importså despite growing at a
higher rate of 23.5 percent in 2007-08å compared with 22.2 percent
in 2006-07å show a much lower rate of growth than oil imports.
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There is no doubt that high growth in oil imports has been the main
factor behind the sharp rise in imports.


 
 

 
 
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yc It is common knowledge that global crude prices are rising at an


unprecedented rate. The prices have substantially inflated India¶s
import bill. India¶s crude imports comprise a basket of three
varieties ± Brentå Dubai and Oman. Given the compositionå even if
one among the three experiences sharp increases in priceså the
overall price of the basket does not get affected by the same extent.
But during last yearå all the three crude varieties saw their prices
rising fast. The average price of the Indian basket varied between
US$65.5 and US$99.8 per barrelå yielding an average price of
US$79.5 per barrel for the year. This was a steep jump vis-à-vis
US$62.5 per barrel in 2006-07. Interestinglyå the volume of oil
imports experienced a lower growth of 11.8 percent in 2009-10
vis-à-vis 14.5 percent in 2006-07. Thuså the increase in oil imports
was primarily value-driven and not volume-driven.

yc Excluding gold and silverå among other non-oil importså capital


goods experienced the fastest growth in 2009-10. Edible oilå
fertilizerså iron and steelå chemicalså textile and coal were the other
leading imports. It must be noted that along with crude oilå global
prices of most of these imports too have gone up. Thuså the impact
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of the world commodity price boom has been felt across the board
by Indian imports.

High crude priceså thereforeå have been the main determinants of India¶s
rising trade deficit.
Given India¶s chronic dependence on oil importså with the latter
accounting for almost one-third of the country¶s total importså the Indian
economy¶s import bill and trade balance will continue to remain
sensitive to movements in world oil prices.

Assuming that oil prices will continue to rise in the near futureå will the
trade deficit become unsustainable? This depends on the Indian
economy¶s capacity to finance the deficit. The high trade deficit has
resulted in an increase in the current account deficit as well. From 1.1
percent of GDP in 2006-07å the current account deficit has increased in
2009-10. Howeverå the balance of payments is yet to come under stresså
due to a healthy capital account surplus. The current account deficit in
2009-10 was more than compensated by a capital account surplus. The
result was net addition of more than US$90 billion to India¶s foreign
exchange reserveså which have now risen to more than US$300 billion.


$$ !!"  ,$! 
/$  !
3 1
2006 ($12å950å000å000) -364.45%
2007 ($26å400å000å000) 103.86%
2008 ($12å110å000å000) -54.13%
2009 ($37å510å000å000) 209.74%
2010 ($31å540å000å000) -15.92%




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If capital flows continue to remain as robust as they were in 2009-10å


then despite wideningå the trade deficit will continue to be financed and
is unlikely to create any adverse impact on the BOP. Sustaining the
deficit should not be a problem even if it increases too much higher
levels. The only downside risk that can be perceived is a reversal in the
direction of short term capital flows. India¶s large capital account
surplus in 2009-10 had much to do with heavy portfolio investment
inflows. Howeverå latest trends suggest that the capital market is passing
through a relatively bearish phase and foreign institutional investor (FII)
inflows have significantly moderated. Thiså howeverå might be a
temporary phase with the flows reacting to alignments among global
foreign exchange markets. A more stable outlook following adjustment
of inflationary expectations can very well see resumption in FII
investment.

As of nowå notwithstanding India¶s chronic dependence on oil imports


and the fact that such imports underline a structural deficiency in India¶s
natural resource utilization patternå the economy looks capable of
managing the trade deficit.
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mm.,-/


1. Press Release of Ministry of Commerce and Industryå Department of
Commerce (Economic Division)

2. Report of the Committee on Fuller Capital Account Convertibility by


the RBI.

3. www.isas.nus.edu.sg ± Brief on India¶s Trade Deficit: Increasing Fast
but Still Manageable by Amitendu Palit.

4. Industrial Economist (August 2010) ± Trends in India¶s BOP by M.


Lakshmiram.

5. www.tradingeconomics.com: India Balance of Trade

6. http://en.wikipedia.org/wiki/Balance_of_trade: (Used for


introduction)

7. www.commerce.nic.in