Chapter-2 The Global Economic Situation and India s External Sector Introduction Four years after the onset of the global financial crisis, the world economy continues to struggle. Whilst a weak global recovery has seen growth estimates cut across the board, the transfer of economic power from developed to emerging economies is speeding up. A large amount of political and economic turmoil has been witnessed over the past twelve months, from uprisings in the Middle East and North Africa to the tsunami in Japan and the sovereign debt crisis in the Euro Zone. Resulting volatility in commodity prices, disruptions to supply chains and general uncertainty has impacted businesses across the globe, slowing the recovery in both mature and emerging markets. The crisis has produced a wide-ranging yet differentiated impact across the globe which interalia includes deceleration of growth, economic slowdown, contraction in world trade and reduced access to trade finance and negative effects on trade balances and balance of payments. Besides, this has resulted in dwindling levels of FDI, massive reversal of private capital flows, severe damage to the housing market, the banking sector and the financial sector as a whole, and, above all, reduced public confidence in financial institutions. Global Economic Growth The developments in the large industrial nations are not encouraging, leading to a downward revision in the global growth projections from 3.9% in 2011 to 3.2% in 2012 and 3.5% in 2013 as per the IMF World Economic Outlook (WEO), January, 2013. The outlook for growth in world trade has also been 21 downgraded by WTO, from 3.7% in April, 2012, to 2.5% in September, 2012. All these factors have combined to impact Indian export prospects as well. The IMF WEO, January, 2013, also mentions that global growth will strengthen gradually through 2013, averaging 3.5 percent on an annual basis, a moderate increase from 3.2 percent in 2012, but 0.1 percentage point lower than projected in the October 2012, WEO. A further strengthening to 4.1 percent is projected for 2014, assuming recovery takes a firm hold in the euro area economy. Economic conditions improved modestly in the third quarter of 2012, with global growth increasing to about 3 percent. The main sources of acceleration were emerging market economies, where activity picked up broadly as expected, and the United States. Global financial conditions improved further in the fourth quarter of 2012. However, a broad set of indicators for global industrial production and trade suggests that global growth did not strengthen, further. Turning to the updated outlook, growth in the United States is forecast to average 2 percent in 2013, rising above trend in the second half of the year. These forecasts are broadly unchanged from the October 2012 WEO, as underlying economic conditions remain on track. In particular, a supportive financial market environment and the turnaround in the housing market have helped to improve household balance sheets and should underpin firmer consumption growth in 2013. The near-term outlook for the Euro Area has been revised downward, even though progress in national adjustment and a strengthened EU-wide
Annual Report 2012-13 policy response to the Euro Area crisis reduced risks and improved financial conditions for sovereigns in the periphery. Activity is now expected to contract by 0.2 percent in 2013. Growth in emerging market and developing economies is on track to build to 5.5 percent in 2013. Nevertheless, growth is not projected to rebound to the high rates recorded in 2010 11. Supportive policies have underpinned much of the recent acceleration in activity in many economies. But, weakness in advanced economies will weigh on external demand, as well as, on the terms of trade of commodity exports, given the assumption of lower commodity prices in 2013. Most advanced economies face two challenges. First, they need steady and sustained fiscal consolidation. Second, financial sector reform must continue to decrease risks in the financial system. Addressing these challenges will support recovery and reduce downside risks. In China, ensuring sustained rapid growth requires continued progress with market-oriented structural reforms and rebalancing of the economy more toward private consumption. In other emerging market and developing economies, requirements differ. World Trade : Shifting Pattern In the decades following the end of colonial rule, the share of developing economies in world merchandise exports fell from 34 per cent in 1948 to 24 per cent in 1973, as exports of manufactures from the developed world rapidly increased. Thereafter, as many developing countries turned into increasingly important exporters of manufactured goods, their shares in aggregate merchandise exports recovered to 33 per cent in 2003 and further to 44 per cent by 2010. In the sphere of merchandise imports, Asia (excluding Japan), Latin America, Africa and the Middle East together, the share of global merchandise imports increased from 28 to 38 per cent between 1993 and 2010. The share of the developed western economies and Japan dropped from 71 to 59 per cent in the same period. This process is likely to accelerate in the coming decades. The other notable development in the international trade is the increasing regional concentration of merchandise trade. In 2010, the second largest regional trade was located in Asia (excluding Middle East) amounting in value to US $2.5 trillion Table 2.1: World Economic Growth Estimates for 2012 and 2013 (Annual % Change) UN IMF World Bank 2012 2013 2014 2012 2013 2014 2012 2013 2014 World 2.2 2.4 3.2 3.2 3.5 4.1 2.3 2.4 3.1 Developed Countries 1.1 1.1 2 1.3 1.4 2.2 1.3 1.3 2 Euro Zone -0.3 0.6 1.7-0.4-0.2 1-0.4-0.1 0.9 US 2.1 1.7 2.7 2.3 2 3 2.2 1.9 2.8 Japan 1.5 0.6 0.8 2 1.2 0.7 1.9 0.8 1.2 Developing Countries 4.7 5.1 5.6 5.1 5.5 5.9 5.1 5.5 5.7 LAC 3.1 3.9 4.4 3 3.6 3.9 3 3.5 3.9 Brazil 1.3 4 4.4 1 3.5 4 0.9 3.4 4.1 Russia 3.7 3.6 4.2 3.6 3.7 3.8 3.5 3.6 3.9 India 5.5 6.1 6.5 4.5 5.9 6.4 5.1 6.1 6.8 China 7.7 7.9 8 7.8 8.2 8.5 7.9 8.4 8 Source : UN, World Economic Situation and Prospects, 2013; IMF, World Economic Outlook, January 2013; World Bank, Global Economic Prospects, January 2013. 22
CHAPTER-2 The Global Economic Situation and India s External Sector or 62 per cent of the regional trade concentration after Europe which amounted to US $4.0 trillion. The proportion of Asian origin exports to other Asian markets has increased from 47 per cent in 1999 to 53 per cent in 2010. Not only is the developing world as a whole and Asia in particular becoming proportionately more important in international trade, but the trade within the region and potentially with Africa and Latin America hold the promise of further expansion and deepening. South-South trade has multiplied more than 10 times in the last two decades as compared to global trade which grew 4-fold in this period. Trade Slow Down According to WTO Press Release dated 21 st September, 2012, slowing global output growth has led World Trade Organization (WTO) to downgrade its 2012 forecast for world trade expansion to 2.5% in September, 2012 from 3.7% in April, 2012 and to scale back their 2013 estimate to 4.5% from 5.6% for the same period. On the export side, developed economies trade is anticipated to grow at 1.5% increase in (down from 2%) and a 3.5% expansion for developing countries (down from 5.6%) is expected. On the import side, nearly stagnant growth of 0.4% in developed economies (down sharply from 1.9%) is forecast and a more robust 5.4% increase for developing countries (down from 6.2%) is expected. In the Annual Report by the Director General on overview of developments in the international trading environment covering the period October 2011 to October 2012, the slowdown in trade in the first half of 2012 has been attributed to a marked deceleration in imports of developed countries and by a corresponding weakness in the exports of developing economies. The WTO report has also pointed towards a slowdown in the imposition of new trade restrictive measures, though these continue to add to the existing trade restrictions and distortions put in place since the outbreak of the global crisis, most of which remain in effect and those that have existed for a long time. The persistence of the global economic crisis is fuelling the political and economic pressures put on governments to raise trade barriers. On the positive side the report shows that some countries have also adopted measures to streamline customs procedures. Impact of Euro Zone crisis on India s Trade The opening up of the Indian economy has greatly increased the role of trade. In the Eleventh Plan, the total share of merchandise exports and imports as a proportion of GDP rose from 36.4 per cent to 45.6 per cent. However, along with the increased trade integration, the merchandise trade deficit too has risen from 7.8 per cent of GDP in 2007-08 to 10.6 per cent in 2011-12. This high trade deficit was offset by a growing net balance on service trade and a high level of remittances. Following the global financial crisis in 2007-08, India s exports registered a 3.5% decline in 2009-10. The sovereign debt crisis in the Euro Zone periphery in 2011-12 impacted negatively economic growth in and exports from India. Between 2010-11 and 2011-12 India s growth rate declined from 8.4% in 2010-11 to 6.5% in 2011-12 and to 5% during 2012-13. During the same period growth rate of exports declined from 40.5% in 2010-11 to 20.9% in 2011-12.The tight monetary policy has increased the cost of lending affecting domestic investment. In sharp contrast to a rapid expansion witnessed both in India s exports and imports (21.3% and 32.3% respectively) in 2011-12, in 2012-13, exports have fallen month over month, even in absolute terms, since May, 2012. A negative growth in exports was recorded up to 5.5% in the first 9 months of this year, on a cumulative basis. However, since, January, 2013, exports have again started increasing, on a monthly basis. As per DGCIS data, for the period April- January, 2013,as compared to April to January, 2012 23
Annual Report 2012-13 the share of Europe in the entire export basket fell by 6.11% as against a growth of 15.7% for a corresponding period previous year. The deepening of the Euro Area crisis has led to a considerably softer output growth in the major emerging market economies in as compared to a year earlier. The OECD Economic Outlook, 2012, mentions that: as the crisis has deepened, the volume of goods imported from India and South Africa by the Euro Erea declined by 13-14% in the first half of 2012 than a year earlier. The direct impact effect of the export declines over the year to the first half of 2012 corresponds to a hit to GDP growth over this period of around ¼ percentage point in India as per the OECD Economic Outlook, 2012. Besides, it is likely that there would be negative multiplier effects from the hit to exports, especially on investment. Weaker demand in the euro area will also have lowered exports of services to the euro area from these countries, a factor relatively important for India, and may also have had an indirect impact by reducing third-party demand for exports from the country. Financial channels also have a relatively important role in the propagation of shocks. Heightened general risk aversion at times of intensified stress in the Euro Area places downward pressures on global equity prices and widens credit spreads, with negative effects on aggregate financial conditions. There was a sharp contraction in Euro Area banks cross-border credit to emerging market economies in the latter half of 2011, when strains in euro area financial markets were very high, but little further change in the first quarter of 2012. Presently, the euro crisis may now be acting as a relatively more important drag on growth, with further weakness in euro area domestic demand, and hence imports, set to persist into 2013, and macroeconomic policies in the major emerging market economies like India, now easing gradually and becoming less of a drag on growth. Throughout the Eleventh Five Year Plan period Asia including ASEAN have been the most important destination for our exports having a share of around 50.76%, mainly due to high share of ASEAN and WANA. This is followed by Europe (18.96%) and America (16.42%) in April-March 2011-12. Exports to Africa remained stable around 8.1% (average from April-March 2007-08 to April-March 2011-12) with minor fluctuations during the course of the Eleventh Five Year Plan period. During the Eleventh Plan, Europe s share in the export basket fell from 22.86% in 2007-08 to 18.96% in 2011-12. However, despite the global slowdown both in GDP growth and trade volumes, India recorded one of the highest export growths among the major trading nations of the world in 2011. WTO ranked India as the 19th largest merchandise exporter in the world, with a share of 1.7% of the global trade and the 12th largest importer with a share of 2.5% of global imports in 2011. In commercial services trade, India ranked higher: 8th largest exporter (3.3% of world exports) and 7th largest importer of services (3.1% of the global imports). Trade flows within the South has increased substantially. However, the share of India, though increasing rapidly, is still much lower as compared to countries like China and those in South or South East Asia in particular. Thus, there is substantial potential for increasing India s trade with the South and with Latin America, Africa and CIS. India has been pursuing a policy of market diversification directing her export promotion efforts at Asia and ASEAN, Latin America and Africa through Focus Market initiatives and bilateral trade agreements. There are several important implications of the ongoing dynamic of change in the world economy which are relevant for India. 24
CHAPTER-2 The Global Economic Situation and India s External Sector Status of Current Account of Balance of Payments Trade Deficit The Trade deficit in April- January, 2013 was estimated at US $ 167.2 billion which was higher than the deficit of US $ 154.9 billion during April- January, 2012. This, coupled with the trend of falling surplus in services trade over the medium term, is likely to leave the current account deficit (CAD) too wide for comfort. CAD financing pressures can re-emerge in the face of event risks, although the recent policy measures announced by the government have helped boost portfolio inflows for now. Foreign Direct Investment FDI (Foreign Direct Investment) flows to India stood at US$ 22.2 billion during April-December 2012, which is 22.1 per cent lower than US$ 28.5 billion during April-December 2011. Up to December 2012, net FII (Foreign Institutional Investments) flows amounted to at US$ 16.0 billion (US$ 2.7 billion during the corresponding period of 2011-12). FII flows in recent months witnessed improvement, reflecting the impact of various reform measures announced by the Government. Foreign Exchange Reserves India s foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights (SDRs) and reserve tranche position (RTP) in the International Monetary Fund (IMF). The level of foreign exchange reserves is largely the outcome of the Reserve Bank of India (RBI) intervention in the foreign exchange market to smoothen exchange rate volatility and valuation changes due to movement of the US dollar against other major currencies of the world. The foreign exchange reserves stood at US$ 304.8 billion at end March 2011. In the fiscal 2011-12, foreign exchange reserves reached a high of US$ 322.0 billion at end August, 2011. However, it declined thereafter and stood at US$ 294.4 billion at end March, 2012. In the current fiscal 2012-13, the foreign exchange reserves declined by US$ 4.7 billion to US$ 289.7 billion during the first quarter. At end- December 2012, reserves stood at US$ 295.6 billion, indicating a marginal increase of US$ 1.2 billion from US$ 294.4 billion at end-march, 2012. At this level, reserves provided about seven months of import cover. Country-wise details of foreign exchange reserves reveal that India continues to be one of the largest holders of foreign exchange reserves. India is the eighth largest foreign exchange reserves holder in the world, after China, Japan, Russia, Switzerland, Brazil, Republic of Korea and China P R Hong Kong at end December, 2012. Way Ahead The initial shift from a current account surplus to a deficit situation accompanied the transition of the Indian economy s growth to a higher gear and the parallel dramatic rise in the investment rate. A sharp deterioration of the merchandise trade deficit to GDP ratio by over 5 percentage points between 2004-05 and 2011-12 (from 4.3% to 10.6%), as imports grew faster than even fast growing exports, was chiefly responsible. While oil imports did increase during this period, it was imports of manufactured products which were the main driver of the rapid increase in imports before the global crisis erupted. The impact on the current account of the trends in merchandise trade was, however, moderated somewhat by a simultaneous rise in India s invisibles surplus, to which growth of software services exports and private remittances were the principal contributors. However, Indian exports of both goods and services increased substantially faster during the pre-crisis phase of high growth, even if India s merchandise trade deficit eventually worsened on account of rapid growth of imports. The surge in exports also began before growth picked up. This was accompanied by significant changes in both the direction of Indian exports of goods, as well as, in 25
Annual Report 2012-13 its product composition. Indian exports benefited from the generally positive growth scenario of many developing and oil producing countries and the share of these countries in Indian exports increased quite sharply. This process was not driven by the items which traditionally dominated Indian exports, like textiles and gems and jewellery, but newer products. These new products engineering goods (like iron and steel, metal manufactures, and transport equipment), chemical products, and petroleum products involved greater requirements of capital per unit of output than the labour-intensive traditional exports. This and the export surge may have worked in conjunction to trigger the revival of corporate and manufacturing investment growth from 2003-04. Since imports eventually outpaced exports, even in the very same categories of products whose share in Indian exports was rising, if the trend in merchandise trade had been all that was there, the high growth would have been hard to sustain even for the period that it did. The parallel growth of India s services exports as well as the large inflow of remittances, also therefore played an important role. In particular by checking the expansion of the current account deficit, they were critical to maintaining the conditions necessary for the large capital inflows that occurred as part of a worldwide trend. There is now an increasing shift in India s trade from conventional destinations i.e. US and EU to the South Asia, ASEAN, Africa and Latin America. China has become the largest trade partner, however, the accompanying development of trade deficit is worrying. To maintain the trend experienced in the last few years and to increase our competitiveness, policies have to be geared to access new markets in line with the growth projections and continue the quest for achieving higher efficiency and productivity in our production systems. Expansion of trade basket and diversification of our markets will be a priority to improve the balance of trade. Export expansion needs to be accompanied by contraction in some of the high volume high value imports that display inelastic tendencies. Thus, in an increasingly inter-connected world, no country can remain isolated from what happens in the other parts of the world. Seeking new markets is the only realistic option that India has in the present circumstances. The government and the private sector will have to work in tandem to identify the measures that are needed to promote exports. 26