India's trade deficit hit $16b a month on average in 2012

Making the country more vulnerable to global shocks.

According to Moody's, last Wednesday, India reported that its merchandise trade deficit widened to $20 billion in January from $17.7 billion in December 2012, a credit negative increase in a trend of higher trade and current account deficits.

India’s trade deficits averaged about $13.5 billion a month in 2011 and $16 billion a month in 2012, up from an average of $9.5 billion a month between 2008 and 2010.

These rising deficits are being financed by increased foreign-currency borrowing, raising India’s vulnerability to international financial volatility. Wider trade deficits can also weaken the currency, raising domestic prices of imported commodities, further fueling India’s already high inflation rate.

Here's more from Moody's:

The increase in India’s trade deficit over the past two years reflects three factors: slowing global growth, which has lowered demand for Indian exports; rising prices of oil and gold, which respectively accounted for about 35% and 10% of India’s merchandise imports as of the third quarter of 2012; and loose fiscal policy, which stimulates domestic demand, and thus demand for imports.

Loose fiscal policy also fuels domestic inflation, which erodes the competitiveness of both export and import-competing sectors, further widening the trade gap.

Trends in the first two factors are unlikely to turn significantly benign in 2013. Therefore, an improvement in India’s trade balance will require a shift to policies to enhance domestic competitiveness.

Since foreign-currency debt plays a larger role than foreign investment in financing India’s trade deficit, the external debt burden has risen to $365 billion as of third-quarter 2012 from $137 billion in third-quarter 2006.

Although external debt rose to $206 billion from $94 billion between 1997 and 2007, there was a fall in India’s ratios of debt/foreign exchange reserves and debt/current account receipts, as the exhibit below shows.

This improvement in indicators of external vulnerability was due largely to an increase in foreign earnings and non-debt inflows.