India’s trade deficit is one manifestation of its ongoing digital transformation

19th Oct, 2018| Time to Read: 4 Mins

Within the space of a year, India’s economic environment – largely emanating from foreign conditions – has turned volatile.  A combination of events and risks – from rising oil prices, rising interest rates in the US, the threats and realities of trade wars, response through currency wars via competitive devaluation and an emerging sense of risk emanating from a massive buildup of private corporate debt fuelled by a global Quantitative Easing infusion of zero interest funds, which might begin to unravel with rising interest rates. 

India had become an attractive destination of global investors over the past few years, with its strengthening macro indicators buttressed by the deep structural reforms. By far the most fundamental has been the introduction of the Goods and Services Tax (GST), which not only has the potential of curbing tax evasion, but generating enough data to dramatically increase efficiency in targeting government spending. An improvement in transport logistics is already evident. The second major reform was the Insolvency and Bankruptcy Code, which is seeking to revamp the resolution process, a major plank of attempts to improve India’s Ease of Doing Business. Attempts at improving tax certainty through Advance Pricing Agreements, bilateral agreements with offshore tax jurisdictions, etc., have added to a sense of transparency.
Based on this rising business confidence, Foreign Direct Investment (FDI) flows to India has risen sharply. From an average of USD 30 billion over FY12 to FY14, FDI jumped to USD 35 bn in FY15 and has since averaged over USD 40 bn over FY16 to FY18. Over April – July in the current FY19, FDI inflows have been over USD 16 bn. Over and above the flows into the conventional sectors, one reason for the higher FDI inflows has been India’s rising reputation as a fintech and innovation hub, with global PE and VC funds seeking out both the rapidly increasing turnover via e-commerce platforms as well as the expanding reach of electronic marketplaces like Ola, Uber, OYO, and other service aggregators. PE / VC inflows in 2018, January – June were over USD 15 bn, compared to USD 26.3 bn in 2017. 

Ironically, part of the recent increase in India’s (merchandise + services) trade deficit – from a low of USD 45 bn in FY17 to USD 83 bn in FY18 and USD 27 bn in Q1 FY19 – is due to the success of India’s digital transformation. While a large part of the trade gap was due to the rising cost of oil (and coal) imports and to an extent higher imports of gold, a significant part was also due to imports of computing and communications equipment. While the rising imports of smart cellphones is now well known, also significant is increasing imports of computing and internet devices, including high end ones like servers, routers, switches, etc. Dissuading imports of even basic mobile phones might not be a good idea, since these are productivity enhancing tools.

Since early 2018, global investors have begun to take notice of vulnerabilities in certain metrics of India’s macro fundamentals, particularly in its external account. The Rupee, which had outperformed almost all Emerging Markets exchange rates post 2014, has, since early 2018, depreciated more than many of our Asian competitors. This has led to policy challenges, including the need to tighten rates and squeeze market liquidity. This has led to rising cost of funds for borrowers, leading to concerns of stifling a nascent recovery in investment and capex spends.  The Government and RBI, working in tandem, have managed to balance the often conflicting policy response to stabilize the economy, and are likely to engineer a soft landing for India amid the troubled global scenario of the coming months.

This article has been contributed by Saugata Bhattacharya 

Senior Vice President
Business and Economic Research
Axis Bank

Views are personal. Vikram Chhabra contributed to the article.