Opinions have been divided on whether the Indian economy had fully recovered from the Covid-induced downturn by the end of fiscal year 2021-22. Yet, there has been a consensus that the country’s external sector had ended on a high as exports of goods and services were booming.

Since the beginning of calendar year 2021, merchandise exports were on a steep upward curve with both agriculture and manufacturing contributing to the surge. High technology sectors provided the boost to manufacturing exports, promising the much-needed diversification to the export basket. This all-round expansion catapulted exports to a record high of $421 billion.

Services exports, too, touched a record $255 billion during 2021-22. This export growth was driven by sectors that have fashioned India’s emergence as a major exporter of services, including telecommunications, and information services.

Booming exports brought two significant pluses for the economy. First, global markets provided the trigger for the economic recovery during a phase when domestic demand was low. Secondly, in 2021-22, India’s current account deficit (CAD) was just 1.2 per cent of GDP despite imports of both goods and services reaching record levels, of $613 billion and $147 billion, respectively. Even with fiscal deficit staying well above the FRBM target, a reasonably low CAD meant that macroeconomic management was not seriously challenged by the “twin deficit” problem.

However, during first half of FY23, India’s external sector was in less well off, with a 96 per cent year-on-year surge in merchandise trade deficit at $148 billion. Contributing to this high trade imbalance was the slowing of merchandise exports and the consistent rise in imports.

During April-September 2022, merchandise exports increased by 17 per cent and imports by 39 per cent year-on-year. More significantly, in September 2022, export growth had dropped to 5 per cent, while imports had expanded by nearly 9 per cent.

It can be argued that the increase in imports that caused the widening of trade deficit was inevitable due to sharp rise in crude oil prices following Russia’s invasion of Ukraine. However, two factors need be highlighted here. First, besides the rising crude oil import bill, imports of several other commodities, including fertilisers, textile fabrics and coal also saw sizeable expansion.

Second, during the six months (August 2021-Feb 2022) preceding the Russia-Ukraine conflict, the average of three crude oil spot prices, namely, Dated Brent, West Texas Intermediate, and the Dubai Fateh had increased by 33 per cent, but during March-September 2022, prices fell by 19 per cent. Moreover, since the conflict, India has been buying Russian oil at a discounted price, which has provided a cushion to cope with the bull run in the crude oil market.

The accrued benefit could be substantial as can be gleaned from the fact that Russia’s share in India crude oil imports has increased from 6 per cent in April to over 15.6 per cent in September. In other words, concerns about India’s external sector have coincided with relatively lower crude prices.

This implies that higher merchandise imports in recent months reflect the woes of an import-dependent economy. In fact, two of the three top exports from India, — petroleum products and gems and jewellery — have large dependence on imported raw materials.

So is the case of several other export sectors, including pharmaceuticals and electronic goods. Rising imports have, thus, become inevitable due to the structural characteristics that the Indian economy has acquired over the past three decades, during its global economic integration. But while its imports have risen, India’s exports have not responded adequately.

In particular, non-petroleum exports expanded by a mere 6 per cent during April-September 2022, as compared to the overall export growth of 17 per cent. This under-performance of non-petroleum exports is the major malaise afflicting India’s external sector.

As regards services trade, in April-August 2022-23, exports expanded slower than imports a year-on-year basis. Though not an immediate source of concern, persistent slow growth of services exports could hasten India’s rapidly deteriorating balance of goods and services trade. These trends do not augur well for the country’s current account deficit (CAD), which was well within the comfort zone of 1.5 per cent of GDP in Q4 FY22, and had worsened to 2.8 per cent in Q1 FY23. This was within touching distance of 3 per cent of GDP, generally considered as the redline by the RBI. By the end of Q2 FY23, the CAD is likely to worsen further as the deficit of trade in goods and services, its largest component, had increased from $37 billion at the end of Q1 2022-23 to $63 billion within the next two months.

FDI no remedy

It has often been advocated that CAD should ideally be financed by non-debt creating forms of foreign inflows, among which, foreign direct investment (FDI) is the most favourable. However, a closer examination of the dynamics of FDI inflows during 2021-22 gives rise to questions as to whether FDI can be relied on as a medium-term palliative for the CAD.

In 2021-22, while gross FDI inflows into India were $84.8 billion, disinvestment, or repatriation of FDI was $28.6 billion; in other words, net inflows were $56.2 billion. The RBI informs us that during 2021-22, outflows on account of direct investment income, or dividends and other forms of income that foreign direct investors extract from the country, totalled $37 billion.

Furthermore, outflows due to payments for intellectual property, largely on account of the trademarks and patents owned by the foreign companies operating in India, was $9.0 billion. Thus, if these outflows are factored in, foreign direct investors’ contribution to hard currency inflows into India during 2021-22 was a mere $10.2 billion.

Importantly, India’s policymakers have been well aware of the limitations of FDI. For instance, the RBI Annual Report of 2016-17 had remarked, “robust FDI inflows which were at the forefront in financing CAD in the previous three years, entail servicing through higher income payments which could have implications for CAD”. Clearly, the government should work towards an effective solution for the chronic CAD by improving export competitiveness of India’s producers.

Dhar is Professor, JNU; and Rao is Senior Research Fellow, Academy of Business Studies, Delhi