Tuesday's Talking Points
Services exports help in narrowing Trade Deficit!
India’s trade deficit for the month of February 2023 dipped to US$2.8bn vs US$10.4bn in February 2022. Lower oil and gold imports, coupled with declining commodity prices, contributed to a significant reduction in India's trade deficit. A noteworthy development however, has been the consistent increase in service exports.
Traditionally, volatility in crude oil prices has been the bane of India’s current account deficit position. For example, spike in crude oil prices post the Russia Ukraine War led to an increase in the merchandise trade deficit. Services exports, led by software service exports, has on the other hand been a key support with steady cashflows. Over this financial year, we have seen a very healthy increase of 35% in net services exports to US$125bn in 11 months.
For a glossary of terms used, please refer the table at the end of this note.
Chart 1: Increase in Services exports leading to reduction in net trade deficit
Chart 2: Net services exports composition – computer services contribute almost entirely to services net exports(Figures in US$ bn)
Source: CMIE
Why are services exports doing well?
As per latest data available on the breakup of services exports, the increase till September 2022 (6 months) was led by software service exports and ‘other business services’, which largely consists of R&D and professional and management consultancy services. Media reports and analysts were quick to highlight that other business services could serve as a new leg of growth in case traditional software services exports falter owing to global slowdown, providing a cushion to software exports.
What do analyst forecasts say on the Current account deficit?
India’s current account deficit / surplus has a few key drivers. The Indian state machinery has been hard at work in reducing import dependencies across the board. A key mover remains crude oil prices, which has been continuously dropping since June 2022, and is now below US$74 per barrel. A mix of the above factors could bode well for the overall current account deficit position. Merchandise exports have also shown strength in a weak global environment, with more than US$400bn of exports in the 11 months of FY23 so far, a growth of 8% over the previous year.
As per the professional forecasters survey published by the RBI on February 8 2023, current account deficit is expected to close at US$104bn for FY23, approximately 3.1% of GDP. This is expected to drop to ~2.4% of GDP in FY24. As of February 8, Crude oil prices were hovering above US$80 per barrel, indicating that expectations could be further revised towards lower current account deficit.
Conclusion
Rising services exports by Indian companies on the software and other professional services are a testament to the benefits of availability of human capital, one of the largest English speaking populations in the world. Risks remain in the form of greater ‘onshoring’ by developed economies and new technologies.
Services exports support the current account balance and bode well in building opportunities for India. Falling prices of Crude Oil could act as a fillip for the overall current account and Balance of Payments position.
Glossary of key terms discussed
| Term | Meaning | Importance |
|---|---|---|
| BOP (Balance of Payments) | A statement that summarizes all transactions made between entities in one country and the rest of the world over a defined period, such as a quarter or a year | Helps understand the net position that the country received or pays in the year to the outside world. |
| CAD (Current Account Deficit) | When a country’s total imports of goods, services and transfers are greater than its total export of goods, services and transfers | Indicates the level of dependency on foreign capital and can affect currency exchange rates |
| Net Merchandise Exports / (Imports) | Export of movable goods where ownership changes from residents to non-residents | India typically has a net merchandise import, and this shows the dependency on the rest of the world to fulfil different needs. |
| Net Services Exports | Net trades of services between residents and non-residents, such as software, travel and tourism, royalties, etc. | While Services exports have been positive for a while, significant growth in the net exports is lending support to the CAD |
Sources: Centre for Monitoring Indian Economy (CMIE), Reserve Bank of India, and other publicly available information.
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