India aims to be the largest exporter of finished goods and service industry in the future. It has propelled various lucrative concessions to the investors around the world with its flagship programme ‘Make in India‘. Prime Minister Narendra Modi made a clarion call to the investors around the world from the decks of the Red Fort in New Delhi to ‘Come, Make in India‘ on India’s 67th Independence Day celebrations. Last month, the Government of India carried out the world’s biggest experiment to wash out black economy of India (considered to be among the top three in the world) by cancelling the legal tender of the top two currency notes and replacing them with the new ones. As we have already discussed the pros and cons of this experiment in the earlier post, let us see what it means for ‘Make in India’ programme.
Demonetization has given short term shocks to the Indian economy across many sectors. One of them is the EXIM (Export-Import) trade of India. The skeptical economists have argued that such a shock therapy to reinvent unaccounted wealth has given a shot in the arm for India’s exports, whereas the imports suffer reduction too, bringing joy for India’s balance of trade. Let us look at the short term effects of the demonetization scheme on Indian exports and imports. We are discussing only the short term effects because the long term effects on the economy are very dynamic and depend on multiple factors which cannot be predicted at this nascent stage.
In the short run, the overall exports may suffer due to lower liquidity in the market. Lower liquidity means lower purchasing capacity of the exporters. An exporter would find it difficult to arrange the factors of production due to liquidity crunch, leading to lower productivity and hence lower volume of exports. All this is happening in the midst of a situation when Indian exports became competitive in the international market due to Chinese slowdown and lower crude oil prices. Exports from the primary sectors of the economy such as agriculture, animal husbandry among others would find it difficult to market and service their production for exports in the international market despite ample steps taken by the Government. Liquidity crunch would force them to sell at below market price in the domestic markets funneling them into an enigma rural distress. The informal middlemen such as traders at the borders who procure the finished goods for export in the international market will find it difficult to procure such goods due to unavailability of liquid cash (an economy that works mostly on black money) and it would be difficult for them to honor their previous commitments, which would further lower the trust on Indian markets. Unavailability of liquid cash in the market will bring the price of rupee into a stable frame due to lower demand of foreign currency in the international market. This would be a boon for Indian exports in the long run, contain inflation in the short run and improve India’s balance of trade in value terms. Lower exports in the short run would enable the competitive economies like Bangladesh, Vietnam to penetrate deep into the international markets and replace Indian exports as a sustainable and committed mode of supply. This might lower down trust in Indian exports. Micro and small industries that thrive on export business would be the worst hit because many of them are isolated from formal banking channels and the liquidity crunch is bound to hit them the most. Exporters who thrive on procuring finished goods from a least developed country (LDC) and exporting the same at a higher price after value addition to a developing or developed country would find it difficult to sustain their business due to unavailability of cash in the system and thereby lowering down their ability of procurement.
In case of imports also, they would fall down because of usual cash crunch. Currently, the domestic economy would start hoarding cash again (i.e. in savings mode) and the people would not be willing to spend money freely which would reduce demand of domestic as well as international products. Lowering down of imports would save India of its precious foreign exchange, hence stabilizing India’s foreign exchange currency basket. This would mean stability of rupee and possible appreciation of the currency. In case there is an appreciation of the domestic currency, it would make our exports costlier and seize off the tag of price competitiveness of our exports in the international markets, hence affecting the overall exports from India. Decrease in essential imports like plant and machinery would seriously affect business expansion plans of Indian companies due to unavailability of technology required to start and expand a business. Note – Plant and machinery is one of the major component of various factors of production. Businesses in India that thrive on procurement of raw materials from outside and production of finished goods inside India would suffer a major blow in the short run due to unavailability of cash. Hence, this cash crunch might force them for a temporary shutdown and lower productivity in the near term. Again, those exporters who import finished goods from a least developed country (LDC) to be further exported to a developing or developed country would find it difficult to import the goods due to unavailability of cash in the market therefore, hurting the entire chain of value addition business. The losing sheen of the Indian market and declining imports by India might push few major business conglomerations outside India because of business losses to explore other attractive markets. This would be a big blow to ‘Make in India’ dream.
Economists are discussing the long term effects of the demonetization move. While some are in favor, some are against this scheme in context of its effect on the Indian economy. Commentators are making future predictions without taking all the factors into consideration. An acceleration requires the catapult to be slowed in the beginning to realize its maximum potential later when it is fired at the right time. This whole exercise has pulled money out of the economy from both formal and informal sectors. It all depends how the Government plans to push this hard earned economic resources back into the economy and at what speed. Till then, it is an exercise in futile to speculate about the long term effects of demonetization on the economy.