People's Democracy

INDIA’S BALANCE OF PAYMENTS PUZZLE

C P Chandrashekar

INDIA’S balance of payments position provides the principal source of comfort for India’s policy makers. Large inflows of invisibles in 2001-02 ensured a small current account surplus after many years, so that the large inflows of deposits, debt and investment contributed, in the net, to an accumulation of reserves that have in recent times touched a record level of $60 billion. While remittance, debt and investment flows have played an important role here, there is one other factor that has contributed to create these conditions. This is the fact that barring the 2 years 1998-99 and 1999-2000, India’s trade deficit has been close to or well below the levels it reached at the end of the 1980s.

Official figures indicate that the trade deficit, which was close to $6000 million in 1990-91, came down substantially during the immediate post-reform years till 1993-94, rose subsequently to around $6500 million in 1997-98, shot up to $9170 million and $12,848 million in 1998-99 and 1999-2000, and then fell to the $6000-6600 range in 2000-01 and 2001-02.

VARIATIONS

IN DEFICIT

This experience with the deficit during the 1990s can be broken up into four periods of varying duration.

First, during the years 1991-92 to 1995-96, both exports and imports grew at more or less similar rates, so that the deficit remained low in most years and fluctuated within the $1 billion to $5 billion range.

Second, between 1995-96 and 1998-99, while imports continued to grow, exports stagnated, resulting in a widening of the trade deficit to $9.1 billion by the end of that period.

Third, in 1999-00, while exports recovered, imports surged because of a rise in oil prices, resulting in the widening of the trade deficit to $12.8 billion.

Finally, in 2000-01 and 2001-02, while exports rose initially and then remained at that level, imports stagnated and the trade deficit returned to the levels it had touched in the mid-1990s.

DOWNTURN

IN EXPORTS

One feature of this experience is the sharp deceleration in export growth since 1995-96, despite the fact that the advocates of reform had argued that the new policy regime would infuse dynamism into India’s historical record of sluggish export growth.

While over the six-year period 1989-90 to 1995-96 exports rose by 91 per cent, the increase over the subsequent six years ending in 2001-02 was only 38 per cent.

Further, besides some expansion in earnings from exports of software and IT-enabled services, the structure of India’s exports has not changed very much. Clearly, the dynamism that was expected on the export front in the wake of reform has not been realised. This implies that whatever "gains" have been registered on the trade front has been on account of the containment of imports, which is indeed puzzling given the expected consequences of import liberalisation.

WHY THIS

BEHAVIOUR?

Resolving this puzzle requires a closer look at the performance of different categories of imports. It is known that movements in oil imports, which are influenced by oil prices, have substantially influenced the size and direction of India’s overall import bill. From an examination of movements in India’s non-oil trade balance, the picture that emerges is indeed remarkable:

During the period 1990-91 to 2000-01, in all years excepting one (1998-99), India’s non-oil trade has either been in balance or reflected a surplus of exports over imports. Further, a rise in exports in 2000-01 and a fall in imports had taken that surplus to $7.8 billion. This is remarkable because, barring a couple of years, India’s export growth has not been creditable.

On the other hand, import liberalisation, involving the removal of quantitative restrictions and reductions in tariffs, was expected to result in a surge in non-oil imports. It is clearly because such a surge has not occurred that India’s trade deficit has been contained in most years when oil prices were not ruling high.

However, the evidence tracing the category-wise movements in imports, suggests that it may be premature to arrive at such a judgement. Movements have been quite varied in the principal categories of imports (oil, non-oil bulk, export-related and other imports). While oil imports have fluctuated quite significantly, as is to be expected, and rose to relatively high levels in 1996-97 and 1999-00 to 2000-01, export related imports have shown a low but consistent rate of increase since 1994-95. Non-oil bulk imports on the other hand have stagnated till the mid-1990s, risen by a small amount during 1995-97 and stagnated once again thereafter.

The really striking feature of the experience is the increase in "other imports" between 1991-92 and 1998-99, after which they have stagnated. We must note here that the segment of imports most affected by liberalisation was the large category of "other imports", which includes most manufactured imports directed towards production for or direct sale in the domestic market. The share of that category, which stood at 40 per cent in 1990-91, rose to 47 per cent in 1995-96 and 52 per cent in 1998-99, before falling to 43 per cent in 2000-01.

The point to note is that this increase was not of a magnitude adequate to undermine the gains in terms of import containment registered in other areas. If we look at the shares of different categories of imports in the total, it is clear that while the share of oil imports has fluctuated significantly, rising sharply in periods when the trade deficit has widened, the share of export related imports has varied within a small range and stagnated over time, and that of non-oil bulk imports has declined. This has meant that the rise in the share of other imports did not result in a worsening of the trade deficit to an unsustainable extent.

ROLE OF CAPITAL

GOODS IMPORTS

One reason why the other imports category did not rise even further as a result of the liberalisation was the fact that capital goods imports which rose from $4.2 billion in 1991-92 to $10.3 billion in 1995-96, stagnated thereafter, fluctuating between $9 and $10 billion till 1998-99. This was the period when after a short-term boom between 1993-94 and 1995-96, Indian industry registered a deceleration in its rate of expansion. That this deceleration would have affected capital goods imports through its impact on investment is partly corroborated by the fact that after 1998-99, when industry began its slide into near-recessionary conditions, capital goods imports fell below $9 million in 1999-00 touching $8.8 billion in 2000-01. Since capital goods constitute an important component of other imports, though its share fell from 60.4 per cent in 1995-96 to 40.4 per cent in 2000-01, this trend would have substantially influenced movements in the ‘other imports’ category.

Has any fact other than sluggish demand played a role in influencing the demand for imported capital goods? There is reason to believe that prices have played a role as well. Over a 13-year period starting from 1980-81, the unit value and quantum indices of imports of Machinery and Transport Equipment maintained a consistent rise. However, in 1994-95, the unit value index, representing the price of capital goods, dropped significantly, only to rise sharply over the next four years till 1998-99, and fall marginally thereafter.

PRICE & QUANTITY

CHANGES

These price movements have been partly neutralised by changes in the quantity of imports. The quantum index of imports of Machinery and Transport Equipment shot up in 1994-95 and then fell sharply till 1997-98, before stabilising at that level over the next three years. The explanation of this could be more complex. One consequence of liberalisation has been an increase in the production of a range of "new" import-intensive manufactures based on component imports by production facilities that carry out assembly or penultimate stage production activities. A crucial requirement for these units is the adequate availability of imported intermediates and components to meet demands for the final product. Thus it is not merely an increase in demand for the final product that triggers an increase in imports, but expectations of any increase in demand, since firms should be in a position to ensure delivery in short periods of time and not be strapped by delays created by import procurement.

This would imply that in periods of rising demand, firms would accumulate inventories of imported components and intermediates. Given the fact that components and spares for capital are included in the "capital goods" category in import data, periods of such accumulation of inventories would also be periods in which the imports of "capital goods" would register an increase. The years 1994-95 to 1996-97 were years when as a result of the release of the pent-up demand for import-intensive manufactured goods, there was a "min-boom" in industry, which would have resulted in a sharp increase in capital goods in the forms of components of various kinds. In fact, qualitative evidence suggests that there was not just such an increase, but that the expectations created by the mini-boom resulted in the excess accumulation of such inventories, which firms were hard put to reduce once the market created by a pre-existing pent-up demand was exhausted. Thus the quantum indices of capital goods, which point to a sharp increase in imports in 1994-95, reflect in all probability this tendency rather than the effects of a decline in prices. It is also not surprising, therefore, that once inventories were accumulated and demand for the final good tapered off, such imports fell sharply and stabilised at a low level. The recession rather than price has finally put restraints on the run-away increase in imports of ‘capital goods’.

That this could be a valid explanation is suggested by the experience with Chemicals, where both unit value indices and prices have risen for most years during the 1990s. While the experience in 1989-90, 1995-96 and 2000-01 suggests that the import demand for chemicals is indeed price sensitive, price changes are hardly the explanation for trends in imports, which must come from the demand side.

Import prices could, however, have had an effect on import trends in other commodities, which do not share these characteristics of capital goods or chemical imports. One such group of commodities is Food and Food Articles. The unit value index of Food and Food Articles rose significantly between 1990-91 and 1994-95, fell sharply thereafter till 1999-00 and rose in 2000-01. The quantum of imports on the other hand, fluctuated around a stagnant trend during the first of these periods, rose sharply between 1995-96 and 1998-99 and has fallen quite significantly over the next two years. It appears that imports rose only when prices were low and fell in response to price increases. The reason why the price factor has been so important here is that "sticky" imports, which occur irrespective of the price level, are no more a major component of food imports.

These "sticky" imports are primarily those made by official agencies to counter domestic shortages and the inflation they engender. Two factors have contributed to a decline in the share of such imports.

First, a combination of consecutive normal or good monsoons and a slow growth in demand that has substantially eased the availability of many food items, especially foodgrains, reducing the need for imports to meet shortfalls.

Second, the fact that import liberalisation has contributed to the dampening of upward movements in domestic food prices over the long run, reducing the need for anti-inflationary imports.

To sum up, despite liberalisation and the stagnation or slow growth of India’s exports since the mid-1990s, India’s balance of trade deficit has not worsened because of the sluggishness of aggregate import growth in years when oil prices have been subdued. Two factors seem to have combined to deliver this result. First, the price responsiveness of imported food and food articles and the decline in bulk imports of food articles aimed at controlling domestic price inflation, both of which keep the import bill on this account under control. Second, the sluggishness in the economy in general and the industrial sector in particular after 1995-96, which has resulted in a tapering off and even decline in the demand for a range of manufactured intermediates. This has meant that the trade deficit tends to widen significantly only when oil prices rise, since the demand for oil and oil products is substantially price inelastic.

Thus there appear to be only two circumstances that can lead to a substantial rise in the import bill. First, a recovery and sustained growth in industrial production. And second, a sharp rise in oil prices. If either of these occurs, the trade deficit is bound to widen, unless India is able to make the breakthrough in world markets that the liberalisation was expected to deliver and has not. In the meanwhile, a contained deficit, combined with large inflows of remittances, deposits, debt and investment have created a situation where India’s foreign exchange reserves have increased substantially to touch the record levels at which they stand at present.