Policy balance: Higher trade and fiscal deficits can create risks

Source: The post is based on the article “Policy balance: Higher trade and fiscal deficits can create risks” published in the Business Standard on 8^th September 2022.

Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Relevance: falling exports and rising imports.

News: Recent data shows India’s exports declined marginally in August on a year-on-year basis, while it contracted by about 9% sequentially. Indian exporters have also reported a shift in demand for low-value products.

What are the reasons for the falling exports and rising imports?

Falling Exports: a) Global economy is slowing rapidly, which is affecting demand, b) Higher energy prices are upsetting household budgets in many parts of the world, compressing demand for other goods, c) Higher interest rates and tightening financial conditions, particularly in the US Federal Reserve, has also affecting exports from India.

Rising imports: a) Imports have remained sticky, partly because of higher crude oil prices, b) The ongoing recovery in the Indian economy is also pushing up demand for foreign goods.

What are the impacts on the Indian economy due to falling exports and rising imports?

All this resulted in a widening trade deficit and current account deficit (CAD)in India. Most economists expect the current account deficit (CAD) forecasts for the year to 3.5 to 4% of gross domestic product compared to 1.2% in the last fiscal year.

What are the opportunities for the Indian economy?

A rise in Foreign portfolio investors (FPIs): FPIs have returned to Indian capital markets after aggressive selling in recent months. But, their participation is anchored on global conditions.

This is because, a) Sustained rate hikes by large central banks and tightening financial conditions affected FPI flows to risky assets, such as emerging market equities.

Reduction in commodity prices: Slower global growth could soften commodity prices.

What are the challenges for the Indian economy?

Geopolitical factors and rising energy prices: Sustained disruption in gas supply from Russia could again push up energy prices.

Higher “twin deficits”: The government at present have a higher fiscal deficit. Along with the CAD, higher “twin deficits” are always a risk for macro stability. This makes the financing of CAD more difficult.

What should be done to avoid the twin deficits?

The government should use the buoyancy in tax collection to improve the fiscal position, and the RBI can focus on CAD.

Visible adjustments in both fiscal and current account positions will help strengthen macroeconomic stability, support economic activity, and boost investor confidence.