India seeks tremendous opportunity, as China manifests economic slow down

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There is a complex interconnected web between a slowing China, a recovering India, a restless exchange rate, and elusive exports. However, as we parse through these, a single message emerges – structural reforms to strengthen domestic markets may more than offset possible disruptions caused by an economic slowdown in China.

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India’s trade deficit with China has widened from $20 billion in FY10 to $50 billion in FY15, and exports to China have moderated over the last few years. Not surprising, given that the bulk are commodity intensive (copper, chemicals, cotton, petroleum products). As China slows, it requires fewer inputs.

On the other hand, India’s imports from China – an eclectic mix of electronics, fertilizers, iron and steel, and machinery – have increased rapidly. The Indian economy is on a path to recovery, recording higher growth rates by the quarter; as China’s growth softens, the bilateral trade deficit will likely widen further.

But don’t panic yet. So far we have looked only at China’s bilateral trade deficit with India. Let’s take the next step and consider second-round effects. To the extent that a slowing China depresses global commodity prices, India is a net gainer, as it is an overall net importer of commodities. In fact, 70 percent of India’s overall trade deficit is due to commodity imports. This second-round effect may blunt or even fully offset the direct impact of a slowing China on India’s overall trade deficit.

What role does the rupee play in all of this? On a real trade-weighted basis, the rupee has appreciated 9 percent since the start of 2014. Although the pace moderated in 2015, it has still strengthened 3 percent for the year to date. With the yuan adjustment a fortnight ago having weakened the rupee and other EM currencies, India’s export competitiveness has likely been preserved against the backdrop of its previous appreciation (and, at a stretch, has even improved). So there’s nothing to worry about there, as long as the pace of depreciation remains gradual.

An optimist might even claim that the rupee’s depreciation would lift India’s exports, but we think such a conclusion would be premature. Our analysis of India’s exports suggests that the currency explains only a small part (17 percent) of India’s export performance. While there could be many factors, key among them is the rising import content of India’s exports. A weaker rupee may now lead to costlier imports, blunting the net impact of export competitiveness.

We find that the majority of India’s export performance is explained by global demand conditions (33 percent) and, most importantly (and most surprisingly), domestic bottlenecks (50 percent). These bottlenecks range from poor-quality connectivity between factories and ports, to cumbersome regulatory requirements faced by businesses.

So everything points to one direction: undertake important structural reforms to ease domestic bottlenecks. This would not only create stronger domestic markets capable of delivering higher economic growth, but also make exports more competitive in the face of any global slowdown China may cause.

Source:- reuters

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