Trade deficit in May is uncomfortably high; RBI, FinMin better watch out

The trade deficit for the month of May coming coming in at an all-time high of $23.3 billion should ring a warning bell, even if not an alarm bell, in the Reserve Bank of India (RBI) and in the Union Ministry of Finance. At $23 billion a month, the annual merchandise trade deficit will work out to $275 billion; the past-12 month trade deficit works to $212 billion. In contrast, the last five-year average trade deficit is $147 billion.

The internals of the May import-export numbers and recent trends indicate that May trade deficit high of $23 billion is not a one off, and that a monthly trade deficit of $22-25 billion looks more likely. Here’s why:

Imports have grown 56 percent in May including oil, and 44 percent excluding oil.  The oil import bill was averaging $15 billion from September 2021 to  February 2022, i.e. even before the war. With crude prices shooting up by 20 percent since February, the oil bill may average $18 billion a month hereafter.

2. In addition the government is coaxing — even coercing — power generation companies to blend their coal with at least 10 percent imported coal. Global coal prices have trebled in the past year and together, this has led to our coal import bill in May rising by 156 percent year-on-year to $10.2 billion. It’s tough to see this recede much anytime soon.

3. Electronics imports have jumped 56 percent in May to $12.1 billion. At this stage, one doesn’t know which kind of imports these are, but given the unsatiated demand for chips from Indian autos to consumer goods companies, and given the K-shaped recovery leading to demand for imported phones and other consumer goods, electronics imports too are unlikely to see moderation.

4. Gold imports in May have been high at $5.8 billion and even if one takes into account the average of the last 12 months, gold imports work out to $4-5 billion per month. Gold imports normally rise during times of high inflation expectation, so it’s not logical to expect this import item to fall in coming months.

5. On the export side, the performance in May has been less gratifying. The biggest export contributor has been petroleum products. As a rule, India earns back as petroleum exports account for about 35 percent of its crude import bill.

6. Other imports like cotton yarn and rice have fallen or remain flat in May. This could continue , one, because of the active discouragement of food-related exports by the government and two, because a slowdown in some of the export destinations due to macro stress.

Net-net, the import bill may not fall below $58-60 billion per month and the export bill looks unlikely to rise above $38-40 billion a month. Hence this year it is sensible to work with a total trade deficit of $250 billion at least.

Services inflows in the current account have averaged $120 billion over the past five years, with a high of 133 billion in FY19. Even assuming they do better at say $135 billion, India’s current account deficit this year wont go below $120 billion. This means the current account deficit could breach 3.5 percent of the GDP. The RBI’s traditional comfort zone has been a current account deficit of below 2.5 percent of GDP

Capital account surplus has averaged $75 billion net inflows in the past five years. This year, with FPIs in sell mode and the startup oriented inflows also plateauing, it is tough to believe this average can be bettered. Hence, a $60 billion balance of payments deficit is possible.

The foreign exchange market was largely unruffled on Friday, with the rupee ending flat. Dealers see this partly as a reflection of market perception that India’s foreign exchange reserves at around $600 billion are a good counter weight to any attacks on the currency. And indeed in the past year, the RBI has sold close to $100 billion. The RBI may be preventing a rapid depreciation of the rupee because it may want to fight the inflation fire first. But if market forces are kept at bay for too long, the lagged impact may be severe.

Many economists believe India has a current account deficit problem, but it is next year’s problem. RBI and the government may be right to fight inflation first and ignore the twin deficits issue for now, they argue. But one global “hurricane”, as JPMorgan’s Jamie Dimon says, can advance the problem and blow years of growth away. Mint Street and North Block better watch out.