Why India's trade deficit is on-course for a significant correction

Export growth surged by 5.8%.

According to DBS, India's November trade numbers added to the evidence that this year’s trade deficit is on-course for a significant correction. Export growth rose 5.8% YoY slowing from the three-month trailing average (3MMA) at 12.3%.

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The scale of decline in imports (especially non-oil imports), however, was a more notable driver for the improvement in the trade balance.

Headline imports fell 18%, slipping away from 3MMA at 11.6%, with similar trends observed on seasonally adjusted basis as well. At the same time, Nov non-oil imports were down 23%,dragged by the sharp drop in the gold/ silver imports (down 81%) as stringent policy curbs have sapped demand.

Non-oil imports have fallen more than 9% YoY in Apr-Nov13, whileoil purchases are up 3%. Alongside gold curbs, subdued private consumption and investment activity have also weighed on import demand.

Hence, doubts remain on the quality and sustainability of the correction in the trade balance and current account metrics. Until the primary drivers for the erstwhile strong demand for gold are not addressed i.e. negative real deposit rates and high inflation, the purchases will only shift out to the informal channels.

Removal of the administrative measures in FY14/15 could re-widen the current account shortfall. At the same time, as and when recovery takes hold, the re-widening in growth differentials with the trading counterparts could pull up the current account deficit in concert.

Nonetheless, in the short-term, stabilisation in the external accounts is likely to be viewed favourably by the financial markets. Rating agencies meanwhile, remain concerned on the developments on the fiscal outlook. Following the poor performance of the ruling Congress party at the state elections, S&P expressed worry over the prospect of an hung parliament at the May elections.

Fitch highlighted the risk that the government might not push through with the aggressive expenditure cuts, required to meet challenging fiscal targets. The rating agencies have given benefit of doubt to the government, though are likely to act at clear risks to fiscal goalposts or unfavourable political developments.