One crisis that has not received as much media attention as handling of corruption or fiscal deficit, is India's burgeoning trade deficit that reached a record level of $185 billion in 2011-12.

This is around 9-10 per cent of the India's GDP. Import of oil and petro products ($150 billion) and gold and silver ($60 billion) accounted for more than 40 per cent of India's total imports of $485 billion.

Given the current global economic scenario and overwhelming protectionist sentiments in India's traditional export markets, the high levels of trade deficit are going to create further pressure on rupee and will adversely affect the cost competitiveness of import-dependent exports.

India has a relatively balanced trade with EU-27 and favourable trade with the US. Countries with which India runs high trade deficits can be categorised into two:

Under category I, are countries that primarily supply oil and other natural resources to India.

The relatively inelastic nature of demand, increase in global prices of commodities, and rupee depreciation have raised the import bills with respect to these countries.

There is not much India can do about their import, as its production of these items is far less than the quantity required.

The second category of countries with which India runs substantial trade deficits comprises those such as China, Switzerland, Japan, South Korea, Taiwan and Germany. One major class of imports from these countries is high-tech machinery and equipment, which create productive capacity in India, and are hence desirable.

In the case of Switzerland, gold, silver and medicines are other important imports. Nevertheless, any viable strategy to deal with the problem of India's growing trade deficit will have to focus on increasing the export of goods, services and capital inflows.

Transaction costs

The easiest method to boost exports is through currency depreciation. Sadly, this is not an option we can resort to because of the inelastic nature of demand for crude, edible oil, fertiliser or scarce commodities. Besides, it may lead to cost-push inflation and increased subsidy burden.

It will also hurt import-based exports such as refined petroleum products, gems and jewellery, or items made of copper. Therefore, this option has to be ruled out and alternative measures aimed at improving the cost competitiveness of India's exports have to be devised.

It would be interesting to analyse the factors responsible for keeping Indian businesses relatively uncompetitive vis-à-vis, say, their Chinese counterparts (China is one of top category II countries as shown above).

High transaction costs arising out of poor infrastructural facilities and poorer regulatory regime are one such factor.

The World Bank's latest Ease of Doing Business Report has ranked India at 109 in trade facilitation as compared to China (60) or Sri Lanka (53) or Pakistan (75). Again, India's ranking in terms of enforcing contracts (182) compares badly with China (16) or Sri Lanka (136) or Pakistan (154).

Poor fiscal management leads to high borrowing costs. Besides, India's ever-growing non-Plan expenditure limits its ability to raise public investment in infrastructure, an essential requirement for improving the cost competitiveness of India's exports.

The China factor

However, the above is not the only problem. Manipulation of trade regulations by some of India's trading partners — China, for example — restricts exports from India into its territory. China is one country with which India's runs unsustainable levels of trade deficits year after year.

China is also the biggest competitor to Indian manufactures in domestic as well as export markets, besides being a high potential export market which the Indian businesses are not able to exploit fully.

There is no denying that China enjoys advantages of scale. But there are other factors which create a significant cost advantage for Chinese manufacturing.

These are (i) low real wages and near absence of industrial disputes/lockouts (ii) cross-subsidisation of productive/corporate sector by Chinese households through government-controlled financial institutions (iii) undervalued exchange rate, making its exports cheaper and imports costlier, prompting use of domestically produced inputs (iv) domestic availability of cheaper inputs through use of export quotas, export duties, export licensing and minimum export price requirements (v) availability of government-acquired land, cheap power and looser environmental standards.

China uses several non-tariff trade barriers to restrict access to its domestic market — for example, the use of unique Chinese national standards, despite the existence of well established international standards to restrict imports of automobiles and auto parts, telecom equipment, fertilisers, food items and cosmetics into its territory.

Many of these measures are often in violation of China's commitment to WTO. Tackling these issues will require proactive coordination between Indian government and its businesses so that these issues can be taken up at appropriate forums , including WTO's dispute settlement body, if other options do not work. This coordination is, however, badly lacking.

Export of Services

Trade deficits in goods can be compensated for by trade surpluses in services. However, despite services accounting for 60 per cent of India's GDP and much hype about India's IT exports, the share of services in India's total exports of goods and services is not more than one-third. This must change if India's current account deficit is to be reduced from current levels of 4 per cent of GDP.

That will require fast-tracking the agreement on trade in services under India-ASEAN FTA, getting into comprehensive economic pacts with key ASEAN nations, or including services under trade pacts with Latin American bloc Mercosur, BRICS nations and other trading partners.

Capital Inflows

Short-term capital inflows depend upon interest rate differentials, stock market returns and risk appetite on the part of foreign investors, which is very low at the moment, and will continue to remain so for sometime.

The latest downgrading by S&P will further dent investor confidence in India. Long-term capital inflows, FDI for instance, depend upon the overall attractiveness of India as an investment destination, or risk-weighted return.

Here, policy paralysis (or frequent change in policies as well) and poor infrastructure are not helping the situation, despite the obvious advantage of a growing Indian consumer market.

It is time Indian policymakers and businesses made concerted and coordinated attempts to tackle India's trade imbalances before we are faced with a serious BOP crisis, like the one in 1990-91.

(The author is an expert in international trade for a top corporate house. Views are personal.)

Related Topics