The topic under consideration is “external impulse and India’s foreign trade” that how recent global imbalances (the so-called global financial and economic crisis) has affected India’s foreign trade.
September 2008, the fall of Lehman Brothers, Beginning of the collapse of Global economies, starting from the Housing Sector and finally entering the real sector, De-coupling theories with EMEs failed, the economic theories failed, the crisis spread the world over, the world stunned!!
Contrary to the decoupling hypothesis, India too like other EMEs has been impacted by the crisis-and by much more than it was suspected earlier. Real GDP growth moderated to 7.8 per cent in the first half of 2008-09 as against 9.3 per cent in the first half of 2007-08 .The impact has been pronounced after the Lehman crisis and, as Reserve Bank of India (RBI) Governor D Subbarao (2009) has pointed out, it arises from three channels: the trade channel, the financial channel and the confidence channel. Here on I shall discuss the severity of the crisis on the India’s foreign trade.
Today we are living in the era of Globalization. Undoubtedly there is financial and real integration of the Indian economy with the world economies, particularly after the introduction of the New Economic Policies of 1991. If crisis occurs in one country it will also impact the other economies through many channels. This is what has happened with the ongoing crisis crunch. It originated from the US and Western Europe and reached to most of the countries of the world through contagion effect. More or less, the crisis has affected almost all sectors of the Indian economy. But thanks to the sound financial sector and confident entrepreneurs that fundamentally the Indian economy has only been impacted through the trade channel.
Thus despite the domestic sector resilience slump in the demand from abroad has deteriorated our trade position and finally affecting our economy. Also over the years trade has occupied an important place in the growth momentum of the Indian economy. India's integration into the world economy over the last decade has been remarkably rapid. Integration into the world implies more than just exports. Going by the common measure of globalization, India's two-way trade (merchandize exports plus imports), as a proportion of GDP, increased from 21.2 per cent in 1997-98, the year of the Asian crisis, to 34.7 per cent in 2007-08. Hence we need to lay emphasis what has been the impact of the ongoing crisis on India’s foreign trade?
Throughout this article I have started with how India’s foreign trade has been affected due to slump in the demand from abroad and after what has been the impact of this slump?
ANALYTICAL RATIONAL
The significance of the impact on external trade for the domestic economy arises on three counts. First, with the spectacular increase in both merchandise and services exports lasting for more than a decade, massive investment has been undertaken in export-oriented sectors, including SEZs. A sharp drop in export growth thus not only affects an economic slowdown through the multiplier process, but is also likely to cause debt default, bankruptcies, and severe cutbacks in investments in the pipeline with all their adverse implications encompassing both the financial and the real sectors. Second, given the share of exports at around 22% of GDP, the quantitative impact of a slowdown in exports on domestic demand is far more negligible. Third, crude oil, perhaps the most crucial intermediate input required for sustaining the production process, is the single-most important item of India’s merchandise import, accounting for around one-third of the total. Changes in international oil prices, it is thus no wonder, have major consequences for the Indian economy, remembering that demand for petroleum products is relatively price inelastic in the short run.
Thus in a demand-constrained economy, a rough and ready measure of the growth-debilitating effect of external factors operating through the trade route is the current account deficit, reflecting the net leakage of domestic demand to the rest of the world. Judged by this index, the adverse impact of global developments transmitted through trade is fairly clear; since the fourth quarter of 2006-07 the current account deficit has continued to widen and was as high as 4.3% of GDP in the second quarter of 2008-09 and now it is $12.5 billion. However, the deficit is outcome of all factors, both domestic and external. Hence arises the need to examine the various ways in which global developments since the onset of the US sub-prime turmoil have affected India’s exports and imports of goods and services.
FIRST, the slowdown in global GDP growth has constituted by far the most important factor constraining the country’s exports. Indeed, the extent of deceleration of world income does not fully reflect the seriousness of the problem faced by exporters. The OECD countries account for around 42% of India’s merchandise exports and practically the entire export of services, especially the high-growth ones. With services accounting for 37% of export earnings (including earnings from invisibles) in recent years, the precipitous fall in GDP growth and emergence of strong recessionary tendencies in advanced countries have constituted a major contractionary factor for the Indian economy. This is not to deny the importance of exports to developing countries whose share in merchandize exports jumped from 30.9% in 2001-02 to 42.3% in 2007-08. The important point to note in this connection is that, since the world income elasticity of demand for India’s exports appears to be quite high, the negative impact of a global economic meltdown on the country’s export earnings would tend to be correspondingly large.
SECOND, the surge in international oil price inflation led to an increase in India’s crude import bill from $5.6 billion in August 2008, with the share of oil in total imports rising from 30.5% to 36.6% over this period. The quantitative significance of this doubling of oil imports may be appreciated from the fact that at its height the incremental (monthly) drain from the domestic demand on account of oil imports was about 6% of the country’s income and hence constituted a significant source of GDP deceleration during this period. (by the same logic the declining trend in the oil import bill should ceteris paribus be growth enhancing).
THIRD, the global financial crisis, as already noted, affected exports and imports through a drying up of the supply of trade credit. Its net impact on India’s trade balance was perhaps favourable (though the overall effect of the crisis on aggregate demand, operating through the domestic banking system, was undoubtedly negative).
Mounting difficulties faced by the US and other advanced country financial firms have led to a large-scale withdrawal of foreign funds, especially FIIs, from the Indian (and other EME) capital markets. The resulting depreciation of the rupee has helped limiting the GDP slowdown in two ways;
First; in the initial phase of the crisis, when the global meltdown was mostly in the financial and not so much in the real sector, currency depreciation provided a significant boost to the country’s foreign exchange earnings. Thus between October 2007 and August 2008 the NEER and REER indices declined from 93.3 and 106.1 to 88.6 and 99.6, respectively. During the same period, India’s earnings from merchandise exports in terms of dollars registered a whopping 33.3% (y-0-y) growth. It is only since then that the recessionary forces have become dominant everywhere and export growth plummeted and turned negative from October 2008 onwards.
Depreciation, it is worth noting, also helped in raising the purchasing power of export earnings over domestic consumption and investment. This is so even allowing for the pass through of higher prices of foreign goods (due to depreciation) to domestic prices. Hence arises the importance of focussing on the value exports (or imports) in terms of domestic products for purposes of assessing the effects of exchange rate movements on domestic demand.
When the depreciation is due primarily to the capital outflow, as happened during the earlier phase of the crisis, it would tend to produce a favourable impact on export and domestic demand. However, if it is the rising trade deficit due to declining world income that lies at the root of depreciation, it only moderates, but cannot reverse the contractionary forces transmitted through trade to the domestic sector. With the decline in export earnings due to the global economic downturn playing an increasingly greater role in driving down the value of the rupee, it is no wonder that since September 2008 there has been a significant fall in foreign exchange earnings from merchandise exports. Over January-February 2009, real exports registered an absolute decline, amounting to nearly 3%, even though there was a near 20% (y-o-y) depreciation of the rupee against the dollar during these two months. Indeed, since the demand for service exports are more (OECD-) income elastic, in recent months the (domestic) growth debilitating impact of the crisis operating through trade is much greater than that suggested by the decline in merchandize exports.
To be more precise as demand contracts in the affected economies exports from other countries are adversely impacted. The contraction in demand would stem not only from reduced incomes in the US, EU and Japan but also from the wealth effect arising out of substantial asset deflation currently under way in the US. A substantial proportion of our exports of key merchandise items are to the western economies (and Japan) which are in the grip of a recession-cum-depression situation. If we term these vulnerable exports, then as a proportion of our total exports they constituted nearly 22% in 2007-08. The prognosis for Indian exports in 2009 is rather gloomy because of the expected unabated fall in incomes in the economies of the US, EU and Japan. The IMF WEO estimates imports in advanced economies to decline by 3.1% in 2009, translating into a decline of 0.8% in the total exports of emerging and developing economies. In the Indian context, exports in January 2009 at $12,381 million were lower by 15.9% when compared to the corresponding figure last year. Among the sectors worst affected are gems and jewellery, textiles (and within textiles the handloom sector), leather and leather products, cotton and manmade yarn, tea, oil meals, marine products, carpets and handicrafts. As all these industries are highly labour intensive, the impact on employment is bound to be substantial. About 1.5 million jobs have already been lost or are in jeopardy in these sectors.
The trade impacts are, however, not confined to merchandise trade alone but have split over into the exports of invisibles. As jobs shrink and incomes contract in the US and EU, private transfers and remittances from NRIs (which are shown on the current rather than capital account of the balance of payments in India) are likely to decline. Currently these stand at Rs 1, 63,709 crore for the year 2007-08 or about 3.48% of the GDP and represent a substantially significant item of the balance of payments. Another important category in the invisibles section of the current account is “miscellaneous services” (with software services as the major component followed by communication, financial and business services) accounting for about 3.32% of the GDP. This category is facing the prospect of a huge decline in exports as the major demand for these services (about 60%) is from the US (and especially its financial sector), which is in the vortex of the storm.
If an economy falls into a recession, it will also impact its trading partners as well. A recession would imply less demand for overall products and services including import items. A recession also leads to lower investments and corporate would not be able to export their products and services. The first would affect the incomes of its export partners and second would affect the consumption levels of its importing partners.
TRADE FINANCE; Banks are at the centre of the international trade as they provide trade finance and other financing facilities that facilitate trade. A problem in financial markets will disrupt the international trade as well. WTO and World Bank Chiefs have raised concerns over trade finance at numerous forums. This could undo a number of years of work on international trade. The Baltic Trade Index has already fallen to an all-time low and there are concerns that trade volumes might decline for the first time Hence, there are interlink ages between both the trade and finance channels and this makes the task of policymaker all the more difficult.
CONCLUSION
India’s accelerated trade in the recent past has caught the world’s attention. By any standard, Indian trade performance has greatly improved; export per capita has increased much more rapidly in the post-reform period than in earlier years. Although, with an import substitution policy in place, India took two decades (1950/51 to 1969/70) to cross the US$ 2 billion export mark, with a much more liberal policy the country crossed the US$ 20 billion export milestone after just two years from 1991. Over time, with greatly reduced barriers to international transactions, Indian participation in the international economy has improved rapidly. Today, with a 19 per cent per annum growth rate, India’s exports have passed US$ 169 billion (2008/09), while imports have increased to US$ 288 billion, having grown at about 25 per cent per annum since 2000/01. India’s trade growth rate in the present decade has thus been the highest of all the decades since the 1950s. Higher growth in the post-1991 period helped India not only to enlarge but also to diversify its exports. As India’s share in the world trade has gone up significantly to touch 1.5% share may cross 2% by 2009, despite the global economic turmoil. India’s success story in international trade is thus a well-documented case.
However, the impact on trade has been severe, after registering an export growth of 29.02% and import growth of 35.4% during 2007-08, merchandize export growth fell 15% in dollar terms in October 2008. This is the first time in five-years that exports have actually shown a dip, reflecting the growing adverse impact of the global slowdown. If the present trend continues there is a danger that India will not achieve the export target of $200 billion for the current fiscal.
The current crisis threatens to undo the economic development achieved by many countries and to erode people's faith in an open international trading system. According to the World Trade Organization (WTO) (2009), “the collapse in global demand brought on by the biggest economic downturn in decades will drive exports down by roughly 9 per cent in volume terms in 2009, the biggest such contraction since the Second World War.” With the increasing integration of the Indian economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from the global economic and financial crisis. Nonetheless, if the crisis is prolonged, it will damage India’s trade pattern and production structure, which have been built up over time.
As we know that the crisis originated in the US and spread to the world over. The underlying impact of the US crisis on India has primarily been experienced in the trade sector. In a recent meeting held in New Delhi it was concluded that the US financial crisis may have wreaked havoc in the world’s largest economy but India’s business with it has not been affected much, says a survey by the Indo-American Chamber of Commerce (IACC) released on this 25th November 2009. The IACC in its Indo-US Business Confidence Index (IUBCI) indicated that the US sub-prime mortgage crisis had little effect on the economic cooperation and business and entrepreneurial confidence between the two nations.
In turning the present crisis into opportunities, there is no doubt that India has to unfold another set of reforms as it did in the aftermath of the 1991 crisis in order to enhance its global trade and to strengthen the globalization process. It should be remembered that, India comes much behind other emerging economies such as China in international trade. With a population of more than 1 billion and a US$ 1 trillion economy, India’s trade potential is largely unrealized. It should also be remembered “Behind every dark cloud there is a silver lining”
With the advent of 2009, economists are debating the extent of the impact of global meltdown on the Indian economy in 2009. The predictions range between somewhat optimistic to fairly pessimistic. But the common thread running is that 2009 will be challenging. There is also controversy among the Economists even in India that the dampening of the India’s foreign trade can be accrued purely to the recent global economic turmoil or not? However with the help of data to a considerable extent I have tried to establish the link between slumps in India’s foreign trade and global economic crisis. There is also debate among the experts that the crisis is just over or is it the sign of double-deep recession? Thereby influencing the direction and composition of India’s foreign trade and trade potential scenario significantly!
Source;
Economic Survey (2008-09).
Commerce Ministry website
Reserve Bank of India website
Economic and Political weekly (April 2009)
IMF (world economic outlook)
THANK YOU!!
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