India's Trade Deficit and its effect on Rupee

India's trade deficit grew to a record in 2022, attributed to imports of mineral fuels, mineral oils, natural/cultured pearls precious stones, coal and electrical machinery including equipment's from 51.11% in year 2020-21 to 55.28% in the year 2021-22 and 62.48% in the first two month of the current year 2022-23. Widening trade deficit may add further pressure on the rupee, which has hit a lifetime low. The deficit which is gap between exports and imports in which exports are higher than the imports and which is continuing since long. India's trade deficit for the year 2020-21 was 102.63 billion US $ which has increase to 190.71 billion US $. Economist expect the trade deficit to remain elevated through 2022-23 even as global commodity prices have begun easing and is estimated a slow-down in exports going forward due to slowing demand in key economies.

Exports touched the $ 44 billion mark for the first time in March 2022 which has reduced to $ 39.03 billion in May 2022. India's merchandise exports grew 23% year-on-year in May 2022 to $ 39.04 billion while import grew 45.46% to a record of $ 63.25 billion. The trade deficit in May 2022 was $ 24.21 billion. The government has imposed exports tariffs on petrol, diesel and air turbine fuel besides windfall taxes on crude production to improve domestic supplies and cut the need for imports. Government has also hiked the import duty on gold in an attempt to rein the widening current account deficit (CAD) and to control the depreciation of rupee's declined against dollar. These measures have been taken to provide ease the pressure on the trade deficit. Comparative data of export and import on year-on-year basis for the past 14 months are as below.

Values in USD Million

Global Currencies against USD

The rupee has been a sharp correction this year, with the currency reaching at 80 from 74 at the start of year 2022 against the dollar. The currency's fall has been mainly due to a rise in crude oil prices, a strong dollar and persistent foreign capital outflows. Reserve Bank Deputy Governor, Michael D. Patra said the central bank will not allow "jerky movements" of the rupee and stressed that the Indian currency has witnessed least depreciation in recent times. "We will stand for its stability and we are doing it. We are there in the market and we will not allow disorderly movement of the rupee. We have no level in mind, but we will not allow jerky movement. That is for certain," Patra had said. Central Bank in its Financial Stability Report (FSR) released in the month of July 2022, said the rupee has performed relatively better that its peers. Emerging market currencies have been falling against the dollar amid geopolitical tensions in the wake of Russia-Ukraine war, concerns over growth, high global crude prices, sustained inflation and central banks worldwide adopting hawkish monetary policy approach. India is relatively better placed than other global currencies against the greenback. While the Indian rupee has been subjected to bouts of downward pressure, it has emerged among the better performing currencies relative to peers, the 25th FSR report said. The US dollar serves as the world's most dominant currency. Regarded as benchmark currency, the US dollar determines the value of other currencies in the universal market. Since the World War 1, the dollar has been enjoying worldwide attention. In light of this, the Indian currency, like various others is compared against the dollar to determine its value:

US Dollar Historical rates table (1 USD)

According to economists, the RBI's action may not boost the external account immediately, but it may reduce demand for dollars in the medium run. It is estimated that this arrangement of international trade settlement in rupee will potentially reduce outflows to the extent of $ 3 billion per months. India has experience in operating alternate payment mechanisms to settle dues in rupees instead of dollars. Article VI of the 1953 India-Soviet trade agreement had a similar clause. The purpose of this arrangement was not to circumvent any sanction but to conserve foreign exchange and promote exports. The rupee balances in USSR accounts were kept increasing in 1990. The arrangement was finally terminated in 1992, and it took a long time to liquidate the rupee balance. Similarly, India had a Rupee-Rial payment mechanism with Iran when economic sanctions were imposed. Apart from that, the window opens up the possibility for countries such as Iran, Russia and Sri Lanka to engage with India while they either face global economic sanctions or need financial support. Internationalizing the rupee requires expansion of the basket of key currencies to seven or eight. The currencies that form the majority of the world's forex reserves include the dollar, pound, euro and renminbi. Russia has started discussion with India, Iran, Egypt and some other countries ways to remove dollars and Euros from commercial transactions.

Traders have welcomed the new mechanism, which they hope will increase engineering, pharmaceutical and food grain exports to Russia and some other countries by at least few billion dollars this year, while making crude oil imports cheaper. Some commodity traders said they were in touch with buyers in Russia, and expect to use the mechanism in coming days. But government officials said India would move cautiously on internationalizing the local currency given associated risks for the economy, such as high exposure to global shocks, asset bubbles and exchange rate volatility.