A cheerless dip in our trade deficit

While headline figure may seem encouraging, deeper details warrant some caution. The fall in trade deficit is largely led by a contraction in imports and the export story is still benign. Merchandise exports contracted for the second straight month, down 6.6% year-on-year (y-o-y) in January. The moderation in exports is broad-based with 16 out of 30 key sectors exhibiting a contraction and most heavy weight export items, such as engineering goods, and gems and jewellery, declining y-o-y.

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Going ahead, any meaningful recovery in exports looks difficult amid the expected slowdown in global growth and weakening momentum in some of India’s major export destinations such as the US, UK and euro area. In its World Economic Outlook update for January, the International Monetary Fund projected global growth to fall to 2.9% in 2023, lower than the estimated 3.4% in 2022, with a recession likely in the UK.

While India’s exports have remained subdued, imports have fared better so far in FY23 as domestic macro fundamentals remained relatively resilient. Merchandise imports saw a much slower pace of contraction at 3.6% y-o-y in January, with much of the fall being driven by a sharp 71% y-o-y contraction in gold imports. Oil imports have been robust, growing at 19% y-o-y.

Notwithstanding the improvement in January, merchandise trade deficit continues to remain elevated this fiscal so far, ballooning to $233 billion in the first 10 months of FY23 from $154 billion in the year-ago period.

Widening trade deficit has culminated into a higher current account deficit, up 3.3% of GDP in the half year ended September, from 0.2% in H1FY22. Thankfully, India’s services trade is strengthening, with the services surplus at an all-time high of $16.5 billion in January as per government estimates. This will help in keeping current account balance under check for the rest of FY23.

Even so, it is worth noting that foreign portfolio investors (FPI) have turned negative in recent months. As per Bloomberg data, FPI inflows in the Indian stock markets have turned negative since December.

Partly, this is a function of a stronger US dollar, which has rebounded in the last few weeks amid increased expectation of more rate hikes by the US Federal Reserve. Note that on a month-on-month basis, inflation measured via the consumer price index rose 0.5% in January in the US, which was higher than expected.

If this trend sustains, given the continued strengthening of the US dollar and the domestic financial market volatility, the Indian rupee could remain on a weak footing. In the first fortnight of February, the rupee has depreciated by around 1% against the US dollar. Remember, in 2022, the rupee was one of the worst-performing Asian currencies, depreciating by 10.2%.

At times like these, there is a cushion in the form of an intervention weapon in the central bank’s armour. The Reserve Bank of India used it wisely in the past. But the ammunition available with the RBI is finite and depleting.

RBI’s total forex reserves have already fallen to $575 billion as of 3 February, from a high of $632 billion a year ago. In the event of limited support from the central bank, the Indian economy’s underlying external sector dynamics, along with muted export growth and subdued FPI inflow could continue to weigh on the rupee.