Group No 1 MEE Term Report Section B

8/6/2019 Group No 1 MEE Term Report Section B

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CONTENTS

EXECUTIVE SUMMARY..........................................3

INDIAS MAJOR IMPORTS AND THEIR PRICE

SENSITIVITY IN THE INTERNATIONAL MARKETS.....4

INDIAS IMPORT BASKET & TRENDS...................................................................................................4

IMPORT PRICE SENSITIVITY..............................................................................................................6

ELASTICITY OF MAJOR IMPORT GOODS WITH

RESPECT TO EXCHANGE RATE...............................7

EXPLAINING THE J CURVE PHENOMENON.............11

J CURVE BASICS.......................................................................................................................11

J CURVE PHENOMENON: RELEVANCETO INDIA (RUPEEDEVALUATIONOF 1991)..............................................12

CONCLUSION.....................................................13

REFERENCES:....................................................15

References:

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Executive Summary

The objective of this paper is to discuss & study Indias import basket, trends in major imports by India

across the last decade. The paper also analyzes the impact of foreign exchange rate and devaluation of

the rupee in 1991 on Indias imports. Finally, we study the J- Curve phenomenon and its relevance to

Indias imports.

This paper demonstrates how oil imports/fertilizer imports are significantly price sensitive in India. Oil

imports constitute more than 30% of Indias import basket in the last decade and have grown by 500% in

the last decade. The rising share of oil imports is attributable to the sharp increase in international crude

oil price and volume growth of oil imports. The Indian basket oil price increased sharply from US$ 27.8

per barrel in 2003-04 to an average US$ 100 per barrel in the last 5 years; 33.2 per cent increase

annually during 2004-05 to 2007-08. Therefore, they are naturally impacted to Oil prices; same is true for

iron ore/fertilizer imports and are impacted by commodity prices.

This paper also studies the correlation between import and exchange rate and analyzes if there is real

linear significant relation between exchange rate change and imports. Our study concludes that the

exchange rate elasticity of India is -0.9 indicating an in-elastic inverse relationship. The Inelastic b1 for

India indicates that devaluation of rupee in 1991 did not lead to improvement of balance of trade.

We finally analyze the J Curve phenomenon - In economics, the 'J curve' refers to the trend of a countrys

trade balance following a devaluation or depreciation. A devalued currency initially means imports are

more expensive, or equivalently exports sell for less foreign currency, depreciating the current account (a

bigger deficit or smaller surplus). After a while, though, the volume of exports will start to rise because of

their lower more competitive prices to foreign buyers, and domestic consumers will buy fewer of the

costlier imports. Eventually, the trade balance should improve on what it was before the devaluation. If

there is a currency revaluation or appreciation there may be an inverted J-curve. To understand the JCurve phenomenon, the trade balance model was applied to quarterly data to India. The results from this

paper revealed that real depreciation of the Indian rupee after 1991 has neither short-run effect nor any

long-run effect on Indian trade balance

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Indias major imports and their price sensitivity in

the international markets

Indias Import Basket & Trends

Indias percentage share of imports by different commodities is:

As can be seen above, top ten imports include crude oil, precious metals, fertilizers, iron & steel.

4

* Imports % Share

S. No. Commodity 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-092009-

2010

1 MINERAL FUELS, MINERAL

OILS AND PRODUCTS OF

THEIR DISTILLATION;

BITUMINOUS SUBSTANCES;

MINERAL WAXES.

30.6764 32.0468 29.0473 31.2226 33.7276 33.3022 34.2983 33.9592 33.3774

2 NATURAL OR CULTURED

PEARLS,PRECIOUS OR

SEMIPRECIOUS

STONES,PRE.METALS,CLAD

WITH PRE.METAL ANDARTCLS

THEREOF;IMIT.JEWLRY;COIN

.

18.1889 17.0574 18.1128 18.6378 13.8708 12.1653 10.5157 14.3342 16.0037

3 NUCLEAR REACTORS,

BOILERS, MACHINERY AND

MECHANICAL APPLIANCES;

PARTS THEREOF.

8.2648 8.3543 8.8713 8.655 9.3286 10.0211 10.057 8.8148 8.3361

4 ELECTRICAL MACHINERY

AND EQUIPMENT AND

PARTS THEREOF; SOUND

RECORDERS AND

REPRODUCERS, TELEVISION

IMAGE AND SOUND

RECORDERS AND

REPRODUCERS,AND PARTS.

6.1887 8.2512 8.4002 8.0216 7.9769 7.8435 7.983 8.3716 7.6823

5 ORGANIC CHEMICALS 3.5869 3.5985 3.9996 3.749 3.4487 3.2516 3.2245 2.8268 3.2635

6 IRON AND STEEL 2.1469 1.8053 2.271 3.0091 3.6513 3.3006 3.6147 3.4136 3.0612

7 FERTILISERS. 0.8863 0.5841 0.6444 0.8623 0.6444 0.8623 1.823 3.9898 2.0884

8 PLASTIC AND ARTICLES

THEREOF.

1.5196 1.4762 1.5832 1.4952 1.7138 1.5927 1.6356 1.4832 1.916

9 MISCELLANEOUS GOODS. 0.168 0.2731 0.207 0.3019 0.337 0.3227 0.4781 0.5195 0.51

10 ANIMAL OR VEGETABLE FATS

AND OILS AND THEIR

CLEAVAGE PRODUCTS; PRE.

EDIBLE FATS; ANIMAL OR

VEGETABLE WAXEX.

2.8874 3.0458 3.305 2.2697 1.5372 1.2209 1.0994 1.1706 1.9577

11 OTHERS 66.44 64.91 67.65 66.51 64.74 65.48 64.60 64.87 64.6649


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The trend in Indias imports in rupees lacs over the last decade are plotted below:

So the oil imports by India has grown by 505% in a decade; fertilizers have grown by 1210% in a decade.

The ratio of imports to GDP at factor cost at current prices (M/ GDP), which is often used as the indicator

5

* Imports in Rs Lacs

S . No. Co mm odity 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-2010

1 Oil 7,521,846.57 9,524,486.48 10,431,108.36 15,644,545.25 22,274,023.83 27,990,727.16 34,720,546.38 46,674,735.21 45,517,882.51

2 Precious

Metals

4,459,922.22 5,069,572.39 6,504,450.89 9,338,734.69 9,160,413.69 10,224,988.19 10,645,199.13 19,701,502.53 21,824,846.49

3 Nuclear

Reactor

Material

2,026,519.31 2,482,937.08 3,185,745.86 4,336,697.57 6,160,677.64 8,422,825.23 10,180,867.34 12,115,423.59 11,368,281.72

4 Electrical

Machinery

1,517,469.88 2,452,306.37 3,016,567.62 4,019,330.79 5,268,039.75 6,592,491.37 8,081,248.76 11,506,217.85 10,476,582.61

5 ORGANIC

CHEMICALS

879,514.92 1,069,487.04 1,436,301.40 1,878,488.80 2,277,523.63 2,732,974.93 3,264,233.50 3,885,282.48 4,450,549.45

6 IRON AND

STEEL

526,429.29 536,542.02 815,531.10 1,507,741.82 2,411,334.32 2,774,187.19 3,659,216.08 4,691,725.38 4,174,653.67

7 FERTILISERS. 217,311.88 173,605.65 231,394.38 432,068.23 231,394.38 432,068.23 1,845,410.32 5,483,743.20 2,847,976.49

8India's Total

Import 24,519,971.86 29,720,587.40 35,910,766.3750,106,454.0366,040,890.3384,050,631.33 101,231,169.93137,443,555.45 136,373,554.76

0.00

10,000,000.00

20,000,000.00

30,000,000.00

40,000,000.00

50,000,000.00

60,000,000.00

70,000,000.00

80,000,000.00

90,000,000.00

100,000,000.00

110,000,000.00

120,000,000.00

130,000,000.00

140,000,000.00

150,000,000.00

mpornsacs

Years

1 Oil

2 Precious Metals

3 Nuclear Reactor Material

4 Electrical Machinery

5 ORGANIC CHEMICALS

6 IRON AND STEEL

7 FERTILISERS.

8 India's Total Import


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of aggregate import intensity in the economy increased from 6.7 per cent in 1950-51 to 22.9 per cent by

2007-08. Decade-wise, the import intensity which averaged 7.4 per cent in the 1950s, moderated to about

6.0 per cent in the 1960s and 1970s but accelerated to 8.7 per cent, 11.8 per cent, and 20.0 per cent

during the 1980s, the 1990s and the current decade (up to 2007-08), respectively. Since services

dominate the Indian economy, it is useful to relate merchandise imports to GDP originating from

commodities sector including agriculture, mining and manufacturing activities. From this perspective, the

ratio of total merchandise imports to GDP of the commodity sector (M/GDPG) increased from 10.5 percent in 1950-51 to 61.4 per cent in 2007-08.

Import Price Sensitivity

Large component of imports relates to the manufacturing sector in the form of industrial inputs.

Accordingly, imports of industrial inputs (non-oil imports less imports of bulk consumption goods, gold andsilver, manufactured fertilizer and professional instruments) should relate to GDP originating from the

industrial sector. Deriving from the Directorate General of Commercial Intelligence and Statistics

(DGCI&S) data, the ratio of imported industrial inputs to GDP originating from the industry sector (which

includes mining and quarrying, manufacturing, electricity, and construction sectors) increased from 24 per

cent in 1994-95 to 48 per cent in 2006-07; the acceleration was noticeable particularly during the current

decade.

Oil imports have accounted for more than 30 per cent of Indias total imports in the last decade, as

compared with the average 23.2 per cent in the 1990s, 27.2 per cent in the 1980s and 21.2 per cent in

the 1970s. The rising share of oil imports is attributable to the sharp increase in international crude oil

price and volume growth of oil imports. The Indian basket oil price increased sharply from US$ 27.8 per

barrel in 2003-04 to an average US$ 100 per barrel in the last 5 years; 33.2 per cent increase annuallyduring 2004-05 to 2007-08. According to the Petroleum Planning Analysis Cell (PPAC), oil imports in

volume terms grew on average 10.2 per cent per annum during 2004-05 to 2007-08. In quantity terms,

domestic consumption of petroleum products in India grew at an average of 3.2 per cent during 2000-01

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to 2007-08, as compared with 4.9 per cent growth in the 1970s and 6.3 per cent growth in the 1980s and

the 1990s.

Elasticity of major import goods with respect to

exchange rateFollowing table reports Indias import in US $ and exchange rate of rupee to dollar from 1079 to 2009. It

also tabulates % change in import and exchange rate during two consecutive periods.

Year Import

(I)

Exchange Rate

(Ex)

%change

(I)

%change

(Ex)

1979-80 11290.6 8.1467

1980-81 15866.5 7.8800 40.53 -3.27

1981-82 15172.9 8.6926 -4.37 10.31

1982-83 14786.6 9.4924 -2.55 9.20

1983-84 15310.9 10.1379 3.55 6.80

1984-85 14412.3 11.3683 -5.87 12.14

1985-86 16066.9 12.3640 11.48 8.76

1986-87 15726.7 12.6053 -2.12 1.95

1987-88 17155.7 12.9552 9.09 2.78

1988-89 19497.2 13.9147 13.65 7.41

1989-90 21219.2 16.2238 8.83 16.59

1990-91 24072.5 17.4992 13.45 7.86

1991-92 19410.5 22.6890 -19.37 29.66

1992-93 21881.6 25.9206 12.73 14.24

1993-94 23306.2 31.4439 6.51 21.31

1994-95 28654.4 31.3742 22.95 -0.22

1995-96 36675.3 32.4198 27.99 3.33

1996-97 39132.4 35.4280 6.70 9.28

1997-98 41484.5 36.3195 6.01 2.52

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1998-99 42388.7 41.2665 2.18 13.62

1999-00 49670.7 43.0552 17.18 4.33

2000-01 50536.5 44.9401 1.74 4.38

2001-02 51413.3 47.1857 1.73 5.00

2002-03 61412.1 48.5993 19.45 3.00

2003-04 78149.1 46.5818 27.25 -4.15

2004-05 111517.4 45.3165 42.70 -2.72

2005-06 149165.7 44.1000 33.76 -2.68

2006-07 185735.2 45.3325 24.52 2.79

2007-08 251439.2 41.2926 35.38 -8.91

2008-09 303696.3 43.4242 20.78 5.16

2009-10 286822.8 48.3567 -5.56 11.36

Using the above date we calculated coefficient of correlation between import and exchange rate. Its

come out to be 0.61. This is significant. However, further statistical tests will need to be performed to

confirm if there is really a liner relation between exchange rate change and import.

We have also calculated slot of line for change in import for corresponding change in exchange

rate. Slope of this line is -1.41. Negative slope implies that import is inversely proportional toexchange rate i.e. import will fall with rise in exchange rate.

For example, rupee was devalued significantly in 1991. One can see in above table that exchange rate

change jumped from 7% to 13% from previous period while import rise declined from 29% to -19% for the

same period.

Following graph plots Indias total import over time. It shows very small growth from 1980 to 2002 but it

rose sharply from 2004 onward.

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Following graph plots exchange rate change overtime

Above plots do not really indicate any relationship of exchange rate and impact on import.

We further explored other studies conducted on Indias exchange rate elasticity of import. One particularpaper by Deepak Garg and Sandeep Ramesh suggests following function for import demand -

Ln(Mt) = Am + b1 * Ln(Et,refer) + b2 * Ln(Yt,india)

Where,Mt is real import of IndiaEt,refer is real exchange rateYt,india is income

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Real GDP was used to represent Yt, India and WPI (wholesale price index) to deflate nominal imports incalculations. They performed several statistical tabulations such Johasen co-integration and Vector ErrorCorrection.

The final equation for import demand was as follows

Ln(Mt) = 2.07 - 0.9 Ln(Et,refer) + 0.993 Ln(Yt,india)

This implies that exchange rate elasticity of India is -0.9. Negative value indicates inverse relationship aswas also our finding above. Value less than unity means that it is in inelastic region. Inelastic b1 for Indiaindicates that devaluation of rupee will not lead to improvement of balance of trade.

Devaluation of rupee in 1991 did not result into any improvement in the balance of payments. There wereother factors which caused import to continue to grow even after devaluation. There was major economicreform during that time. Along with devaluation the government deregulated trade by reducing tariffs andquotas. Reduction in tariffs lead to import becoming more competitive than before and started rising.

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Explaining the J Curve Phenomenon

J Curve Basics

In economics, the 'J curve' refers to the trend of a countrys trade balance following a devaluation ordepreciation. A devalued currency initially means imports are more expensive, or equivalently exports sellfor less foreign currency, depreciating the current account (a bigger deficit or smaller surplus). After awhile, though, the volume of exports will start to rise because of their lower more competitive prices toforeign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the tradebalance should improve on what it was before the devaluation. If there is a currency revaluation orappreciation there may be an inverted J-curve.

Following the depreciation or devaluation of the currency, the volume of imports and exports will remainlevel due in part to pre-existing contracts for imported goods that have to be honoured. However, thedepreciation will cause the price of imports to rise and the price of exports to fall. Therefore, totalspending on imports will subsequently increase and total spending on exports will decrease. It is this thatcauses the worsening of the current account.

Moreover, in the short run, demand for the more expensive imports remains price inelastic. This is due totime lags in the consumer's search for acceptable, cheaper alternatives. As a result, the quantitydemanded for imports remain the same, although consumers are now paying a higher price for it. Ceterisparibus, a worsening of the current account, and hence the balance of payments, is to be expected in theshort run.

Over the longer term depreciation in the exchange rate can have the desired effect of improving thecurrent account balance. Demand for exports picks up and domestic consumers will switch theirexpenditure to domestic products and away from expensive imported goods and services. Equally, manyforeign consumers may switch to purchasing cheaper imported products instead of their own domesticallyproduced goods and services.

Empirical investigations of the J-curve have sometimes focused on the effect of exchange rate changeson the trade ratio, i.e. exports divided by imports, rather than the trade balance, exports minus imports.Unlike the trade balance, the trade ratio can be logged regardless of whether a trade deficit or tradesurplus exists.

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The J curve shows the effect of a devaluation of a currency on the net export (exports minus imports).When the devaluation takes place at t the net export falls from A to B, since the level of import isunchanged, but the currency is worth less. As time goes on the net export will gradually change sinceconsumers buy less imported goods, and other countries buy more goods from the country due to thelower real price. At C the net export break even. With time the net export will find equilibrium.

J Curve Phenomenon: Relevance to India (Rupee devaluation of 1991)

Many studies have confirmed that J curve phenomenon does not hold good as far as India is concerned.Once such study The J-Curve at the industry level: evidence from U.S.-India trade, wherein the tradedata between India and the rest of the world was disaggregated and used bilateral trade data betweenIndia and her seven major trading partners but No significant relation was found between the realexchange rate and the bilateral trade balance between India and her major partner, the U.S. In this paperthe trade data between India and the U.S. at industry level was disaggregate and trade data from 38industries was used to show that in most industries while real depreciation of the rupee has short-runeffects, the short-run effects last into the long run in almost half of these industries.

To understand the J Curve phenomenon, the trade balance model was applied to quarterly data to a fewdeveloping countries including India. The results revealed that real depreciation of the Indian rupee after1991 has neither short-run effect nor any long-run effect on Indian trade balance.

Since its theoretical introduction in 1973, the J-Curve hypothesis has received a great deal of attention. Itoutlines the short-run path that the trade balance follows after currency devaluation and on this regard;the trade balance of India is no exception. Researchers have tried to test the JCurve phenomenon forIndia using different data set. Those who employed aggregate trade data, i.e., trade between India andrest of the world, were not successful in finding empirical support for the J-Curve. They were alsounsuccessful in finding any long-run effect of real depreciation of the rupee on Indian trade balance. Aftercriticizing those studies, one study disaggregated the data at bilateral level and estimated the tradebalance model between India and her seven largest trading partners, i.e., Australia, France, Germany,Italy, Japan, U.K. and the U.S. While there was no specific short-run pattern in most cases, the favorablelong-run effects of real depreciation of the rupee was realized in the cases of Australia, Germany, Italyand Japan but not in the results for her largest trading partner, the U.S.

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ConclusionBased on the study presented in this paper and the information from the commerce ministry website and

its impact on the Indian economy, we can draw the following conclusions:

(i) The ratio of imports to GDP at factor cost at current prices (M/ GDP), which is often used as theindicator of aggregate import intensity in the economy increased from 6.7 per cent in 1950-51 to 22.9 per

cent by 2007-08.

(ii) Oil imports have accounted for more than 30 per cent of Indias total imports in last decade, as

compared with the average 23.2 per cent in the 1990s, 27.2 per cent in the 1980s and 21.2 per cent in

the 1970s.

(iii) The rising share of oil imports is attributable, mainly, to the sharp increase in international crude oil

price. The Indian basket oil price increased sharply from US $ 27.8 per barrel in 2003-04 to US $ 106.1

per barrel in 2007-08; 33.2 per cent increase annually during 2004-05 to 2007-08. According to the

Petroleum Planning Analysis Cell (PPAC), in quantity terms, domestic consumption of petroleum products

in India grew at an average of 3.2 per cent during 2000-01 to 2007-08, as compared with 4.9 per cent

growth in the 1970s and 6.3 per cent growth in the 1980s and the 1990s.

(iv) Indias dependence on food imports in general declined over the years. The share of food imports in

total imports was 4.8 per cent during 2000-2006, as compared with the average 5.0 per cent in the 1990s,

8.3 per cent in the 1980s, 18.3 per cent in the 1970s and 23.2 per cent in the 1960s. Currently, vegetable

oil is the major item of food imports; it accounted for 2.2 per cent and 1.8 per cent of total imports during

2000-01 to 2006-07 and 2003-04 to 2006-07, as compared with 3.3, 3.7 and 1.6 per cent in the 1970s,

1980s, and the 1990s, respectively.

(v) Within non-oil imports, industrial inputs including capital goods and raw materials account for a major

share of Indias total imports. Industrial inputs (non-oil imports less imports of bulk consumption goods,

gold and silver, manufactured fertilizer and professional instruments) accounted for 58.0 per cent of

Indias total imports or 82.8 per cent of total non-oil imports in 2006-07. Commodity-wise, capital goodscomprising machinery and transport equipment account for about a fifth of Indias total imports during

2003-07 (or 34.4 per cent of non-oil imports and 42.6 per cent of industrial inputs).

(vi) At the aggregate level, the quantum index of imports grew rapidly to an annual average growth of

27.0 per cent during 2003-07, from 5.8 per cent in the 1970s, 5.9 per cent in the 1980s, and 12.4 per cent

in the 1990s (Chart 7). Spurred by high growth and capacity expansion of Indian industries in the recent

years, the surge in import growth was accompanied by import volume growth of machinery and transport

equipments (46.6 per cent) and chemicals (25.3 per cent). Similarly, basic metals such as iron and steel,

copper, aluminum, lead and tin posted a high growth rate in volume terms above 20 per cent during 2003-

07. Bulk imports such as fertilizer and vegetable oil also grew at an average of 53.0 per cent and 26.0 per

cent, respectively, during 2003-07.

(vii) Indias hard battle to clinch competitive import prices for much needed fertilizers at home is set to

become tougher still in 2011-12, with a crucial global fertilizer outlook released recently spelling negative

news on the price front. The recent trend from commerce ministry data points to high demand, all time

low inventories and tight supply scenario, which are expected to prop up prices firmly in 2011. India, as

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the worlds top importer of urea, will not only have to deal with increased fertilizer use at home, but also

import at much higher prices, the report says.

(viii) The aggregate import price inflation in domestic currency term in the current decade (upto 2006-07)

softened significantly as compared with the trends in the 1950s through the 1990s, excepting the 1970s

which witnessed the first major oil shock. Indias import price inflation in US dollar terms remained

subdued through the 1950s to the 1990s. In the current decade, however, such measure of import priceinflation averaged 5.2 per cent, in contrast to the deceleration trend in the 1990s and the subdued trend in

the 1980s.

(ix) Import prices, capital flows and exchange rate had statistically significant positive association with

domestic inflation in the long-run.

(x) Based on our study, on devaluation, import are inversely proportional to exchange rate i.e. import willfall with rise in exchange rate. For example, rupee was devalued significantly in 1991. From the studypresented in this paper, when exchange rate change jumped from 7% to 13% in the previous period whileimport rise declined from 29% to -19% for the same period

(xi) The overall exchange rate elasticity of India is -0.9. Negative value indicates inverse relationship aswas also our finding above. A value less than unity implies that it is in inelastic region. Therefore the

devaluation of rupee in 1991 did not result into any improvement in the balance of payments. There wereother factors which caused import to continue to grow even after devaluation

(xi) Many studies have confirmed that J curve phenomenon does not hold good as far as India isconcerned. Once such study The J-Curve at the industry level: evidence from U.S.-India trade, wherein

the trade data between India and the rest of the world was disaggregated and used bilateral trade data

between India and her seven major trading partners but No significant relation was found between the

real exchange rate and the bilateral trade balance between India and her major partner, the U.S

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References:

1. http://commerce.nic.in/eidb/icom2q.asp

2. http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=2030#c5

3. Rajarshi Mitra and M. Bahmani-Oskooee (2007) The J-Curve at the industrylevel: evidence from U.S.-India trade" EconomicsBulletin, Volume 29,Issue 2.

4. http://en.wikipedia.org/wiki/J_curve

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Documents

Group No 1 MEE Term Report Section B