How global headwinds are slowing growth in India

Foreign trade and current account deficits are concerns because financing funds are drying up

PUBLISHED : Thursday, 20 December, 2012, 12:00am
UPDATED : Thursday, 20 December, 2012, 3:19am

India has not been spared the effects of global economic headwinds.

In the 2010-11 fiscal year, India's trade gap with China jumped to US$28 billion, its largest shortfall with a trading partner. The mushrooming foreign trade and current account deficits are serious concerns, because the foreign funds required to finance the shortfalls have largely dried up.

India wants to shift its exports to China to value-added products such as pharmaceuticals from raw materials such as copper and iron ore, which account for about half the total and are heavily dependent on the growth of the Chinese economy.

India's trade deficit in the 2011-12 fiscal year grew 56 per cent from a year earlier to US$185 billion as oil and gold import prices rose.

The trade and current account deficits, about 4 per cent of gross domestic product, are significantly driven by oil imports, and global crude oil prices are likely to remain high. India imports about three-quarters of its petroleum consumption.

New Delhi recently introduced some policy measures that, though they may be politically necessary, discourage domestic and foreign investment.

Early this year, the government proposed taxes, to be applied retroactively, on transactions in which Indian assets were transferred between foreign entities. The proposal would override an Indian Supreme Court decision in January that British mobile-phone company Vodafone was not liable for more than US$2 billion in taxes on a 2007 deal it made to enter the Indian market.

Another proposal would establish an anti-tax-avoidance policy that investors worry would allow the government to tax investments in India conducted from offshore tax havens such as Mauritius. The plan puts the responsibility on investors, many of them foreigners, to prove that they did not structure corporate deals to avoid taxes.

About US$692 million in foreign capital left the Indian stock market in the three days after that proposal was announced.

Another deterrent to foreign direct investment is the recent proposal to extend pharmaceutical price controls to 60 per cent of the 348 drugs that the government considers "essential" from 20 per cent at present.

The price restrictions would extend beyond generics to patented drugs for the first time. This is a response to the government's concern about the two-thirds of Indians who lack health insurance and the fact that Indians pay 70 per cent of their health care costs out of pocket.

Foreign private equity firms poured money into India-oriented funds from 2005 to 2007, when the country's stock market was booming. Now private equity investors are having trouble raising money for India funds because of the fiscal and current account deficits, slowing growth and uncertain outlook for stocks.

Returns on Indian-oriented private equity funds have been poor in recent years, and a decline in initial public offerings makes it difficult for investors to make a profit.

Last year, private equity firms sold stakes worth US$3 billion through share offerings or mergers and acquisitions, down from US$7 billion in 2010.

With the high trade and current account deficits and foreign money abandoning India, it is not surprising that the rupee has lost strength. The weak currency creates difficulties for Indian companies that issued foreign currency bonds, as well as for foreign investors in Indian debt.

The weak rupee does make Indian goods cheaper abroad. The effect is limited, however, because exports account for only 16 per cent of India's GDP, compared with 26 per cent for China. Furthermore, the costs of exporting goods in India are more than twice as high as in China and exceed even those in the US and Britain.

For India, the lack of infrastructure and prevalence of graft increase costs and impede trade.

Bloomberg

 

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