Manage a depreciation

Weak global economy, strong rupee are both hurting India

For a while, it looked like India had brought its trade deficit under control. Draconian controls on the import of gold, combined with an apparent recovery in exports and cheaper oil, provided considerable comfort on the external account. However, that was always too good to last. In new numbers released on Tuesday, it was revealed that the trade deficit for September 2014 was 133 per cent higher than it was in September 2013. Imports skyrocketed, while export growth was disappointing. Merchandise exports grew only 2.7 per cent year on year, much less than was expected. The Reserve Bank of India also said on Tuesday that services export was largely flat in September 2013 when compared to the same month in 2013.

Part of this weakness in exports will have come from a slowing world economy. It turns out that the global recovery is much more fragile than was hoped for. Over the weekend, the International Monetary Fund revised estimates of global growth in 2014 downwards to 3.3 per cent from 3.4 per cent - the third such downward revision this year. Germany, the powerhouse of the European economy for a long time, has produced startlingly weak industrial production and export figures; it might actually be on the brink of recession. Prime Minister Shinzo Abe in Japan has signally failed to fire the "third arrow" he had promised - the politically difficult structural reform that would have complemented a monetary and fiscal expansion and enabled the Japanese economy to grow. Without the reform, Japan's sudden expansion first slowed and has now reversed.

Only Britain, with growth that is particularly sensitive to financial flows from the rest of the world, is looking like an engine of growth. In the United States, the winding up of quantitative easing means that markets are jittery. There is every reason to suppose that aggressive quantitative actions by the European Central Bank will mean that the United States Federal Reserve will want to keep its stance a little flexible - in other words, competition on monetary policy may well replace co-operation. This is not good news for anyone. The United States recovery will also suffer if the American dollar continues to strengthen. Given the general gloom, it would be unwise to continue to expect an uptick in India's exports.

In other words, sharper methods are called for. The rupee should be allowed to depreciate further. Its strengthening on the back of fund flows into India has clearly come in the way of increasing exports. Meanwhile, gold and silver imports have skyrocketed, in advance of the festive season - in spite of continuing physical restrictions on their imports. The scale of the suppressed demand for imports of the metals, which will inevitably find expression in some way, is thus hinted at. Oil prices have actually moderated, and yet imports have increased 26 per cent in dollar terms over the same month last year. The economy is trying to say something: and that is the rupee must be allowed to drift downwards. Post-election confidence in the economy has had many positive outcomes. But its effect on the rupee - and, thus, on the trade deficit - can be dangerous. If not counter-acted through sensible policy, the high rupee together with the anaemic global economy could stall efforts at increasing Indian exports.