India’s evolving trade dynamics
- India’s exports notched a record high in the last fiscal year
- Few segments might prove resilient, even as overall export pace loses momentum
- Net terms of trade gauge is moderating
- Global demand matters more than the currency to determine exports
- A wide trade deficit will keep the current account north of 3% of GDP this year
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Record goods exports and imports in FY22, pace softening of late
India’s exports had recovered sharply, up 20% from pre-pandemic level as of Jun22, outpacing the domestic engines - consumption and investment growth. The share of exports in growth has also returned to a seven year high of over 21%, playing a bigger supportive role.
Nominal merchandise exports rose to a record high of US$422bn in FY22 (year ending Mar22), up 45%yoy. Comparatively, before Covid, the value of exports had stagnated around $300bn between FY16 to FY20. Last year’s internals reveal that while part of the lift can be put to post-Covid recovery, there are concerted shifts in the product mix which might see some strength sustain. Imports also added up to record high at $613bn in FY22 on a notably larger commodity bill, including crude oil and coal. By extension, the annual trade deficit rose to a record at $191bn, more than double from year before.
In first half (Apr-Sep22) of FY23, exports totalled $224bn, a run-rate that would place full year exports at a record $430bn. Imports stood at $377bn in first six months of FY23, potentially leaving annual purchases at north of $700bn, also a record. If we assume a slower run-rate for exports in 2H on global growth slowdown and imports moderating on softer commodity prices, the trade deficit will register a record of ~$300bn in FY23, double of FY21-FY22 average.
The evolving net terms of trade index, which shows the relative price of exports vs imports, signals that import prices are growing faster than exports as readings slip below 100.
India’s exports product mix has broadened, led by high value products in the past two years compared to the previous five years.
Besides Covid-driven segments (e.g., pharma, services etc.), engineering, project goods, electronics etc. have also increased their footprint. Manufacturing goods which make two-thirds of the total rose 37%yoy in FY22, driven largely by engineering goods, chemicals, pharma, plastic, textiles, and related products. Electronics is a small part of overall shipments (<5%), but jumped 41%yoy last year, punching above its weight.
Petroleum exports, the second key contributor, benefited from higher oil and refined product prices, rising a sharp 161%yoy. In addition to regular imports, private refiners reportedly tapped discounted supplies from Russia and aggressively boosted fuel exports, whilst public sector players were contracted to purchase under the pre-signed annual supply deals.
Put differently, when classified as labour-intensive/ traditional and manufactured sectors, the latter has led the surge export growth in the past two years (see chart), while labour-intensive industries remained relatively flat. Higher presence of finished goods, besides push from Production Linked Scheme (PLI), and commodity price gains contributed to this outperformance.
These segments started FY23 on a strong note, but barring petroleum shipments, others are slowing, pulling down headline exports. Concurrently, demand from key trading partners is also coming under pressure. As of Sep22, purchases by US, EU, Gulf, ASEAN as well as China have either contracted or slowed, compared to double digit growth last year.
The next question that arises is whether the strength in exports can sustain. Several regulatory support as well as shifts in the global trade environment provide opportunities for India to widen its export footprint. While the short-term trend will be beholden to global demand cycles, an emerging better mix of product lines, including electronics, drugs and pharma, speciality chemicals etc., compared to a more traditional basket (gems and jewellery, textiles, plastics, wood, and products etc.) is expected to lend some extent of resilience to the export trend in the medium term. This set against the backdrop of a reorientation towards a larger manufacturing presence (e.g., fiscal incentives like PLI), core push like One District One Product (ODOP), infrastructure focus, global like China + 1 Strategy (success story on certain Apple manufacturing processes), clean energy (solar modules etc.) and groundwork on free trade agreements, bode well for the external sector.
Imports and commodities
Import growth outpaced exports in FY22 and continues its strong stride into FY23. Amongst the top ten segments - Apr-Aug22 (first five months of FY23) purchases were led by 89% yoy increase in petroleum/ oil, followed by 30% increase in electronics, 174% jump in coal, 41% in chemicals and 28% in iron & steel, whilst gold purchases fell 12.5% in the period.
As the chart below highlights, not only oil put also coal has emerged as a high-ticket import. Recent cool-off in global prices will be helpful in moderating demand, albeit idiosyncratic factors like demand for coal due to domestic supply shortages, for instance, are unlikely to moderate in a hurry, thereby boding unfavourably for overall trade balance. Concurrently, trends of non-gold non-oil imports have also proved to be sticky owing to robust domestic demand, reopening boost, and manufacturing push (higher demand for inputs). Part of these trends are also likely to limit the extent of correction in overall imports.
Trade imbalance with China widened to a record high in FY22, at $73bn from $44bn the year before. Much of this gap reflected the 45%yoy jump in imports whilst exports stagnated due to a slowdown in China’s domestic growth. Electronics, electrical machinery, chemicals, plastics, and fertilisers were the amongst the key segments that rose sharply on yoy terms and made 70% of the import basket.
This carries a few takeaways: a) move up to intermediate/ finished goods will initially be import intensive till domestic capabilities are expanded; b) while a slowing trading partner impacts India’s exports, the import demand remained resilient due to India’s post-reopening boost to growth
Global demand and INR
The recent softening in export performance comes at a time when fears of a slowdown in global growth is rising and there is significant pressure on the currency. Of these two factors, while a depreciating currency could contribute to better trade competitiveness, we argue that global demand dynamics will matter more for the direction of India’s exports.
A scatter plot chart of the changes in the rupee real effective exchange and exports show a wide dispersal, with weak to nil correlation. By contrast, exports signal a strong positive correlation with the demand-side driver i.e., global imports. Further we also ran a regression of changes in rupee nominal effective exchange rate basis (NEER) and India’s exports between 2008 and 2021, which reinforces our previous observation. A similar exercise for world’s imports (as a proxy for global demand) and India’s exports over two decades, shows the relationship is significant, with a one-unit change in global imports translating into a 1.4units change in exports.
Admittedly, this argument misses on few nuances, particularly the role and impact of the domestic manufacturing push, supply chain support, logistical facilities, cost of production (final cost), physical and digital infrastructure, which also influence the extent of trade competitiveness.
Pressure, not panic, on external trade balances
Service trade has maintained a strong beat. Exports are up 30% yoy in the first five months of the fiscal year, even as imports rose sharply at 38%. The trade surplus widened to $50bn vs $42.3bn in the comparable period last year, surfacing as a key source of support (full year services surplus $120-130bn) for the external balances, even if overshadowed by a 2x wider goods trade gap. Computer services made up 67.8% of overall exports in FY22, with the US as the key destination (56% share), followed by Europe (31%) and Asia (6.5%).
For the year, current account math is in a soft spot. Factoring in the year-to-date run rate on the trade deficit, the full-year goods trade deficit is expected to add up to ~$300bn vs FY22’s $190bn. Service trade balance has maintained a strong trend and pulling overall invisibles and goods trade balance together, FY23 current account deficit is likely to top US$100bn, taking the balance to -3.7% of GDP from -1.2% year before. This combined with a volatile flows outlook but resilient FDI, will leave the balance of payments in red for the first time in three years. For next year, bringing together our expectation for slower exports and moderation in imports (on a correction in commodity prices), the current account deficit is likely to narrow to -2.7% of GDP
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