India's import basket and its sensitivity to exchange rate

changes

By

Kumar Shreshtha, (WMP5029)

Dhananjay Joshi(WMP 6079)

Praveen Khanna(WMP 6100)

A report submitted in fulfillment of the assignments for

Macroeconomics

WMP 2013

Indian Institute of Management, Lucknow

Noida Campus

2011

1
 CONTENTS
EXECUTIVE SUMMARY..........................................3
INDIA’S MAJOR IMPORTS AND THEIR PRICE
SENSITIVITY IN THE INTERNATIONAL MARKETS.....4
INDIA’S 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: RELEVANCE TO INDIA (RUPEE DEVALUATION OF 1991)..............................................12

CONCLUSION.....................................................13
REFERENCES:....................................................15
References:

2
Executive Summary

The objective of this paper is to discuss & study India’s 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 India’s imports. Finally, we study the J- Curve phenomenon and its relevance to
India’s imports.

This paper demonstrates how oil imports/fertilizer imports are significantly price sensitive in India. Oil
imports constitute more than 30% of India’s 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 country’s
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 J
Curve 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

3
India’s major imports and their price sensitivity in
the international markets
India’s Import Basket & Trends
India’s percentage share of imports by different commodities is:

* Imports %Share
2009-
S. No. Commodity 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
2010
1 MINERAL FUELS, MINERAL 30.6764 32.0468 29.0473 31.2226 33.7276 33.3022 34.2983 33.9592 33.3774
OILS AND PRODUCTS OF
THEIR DISTILLATION;
BITUMINOUS SUBSTANCES;
MINERAL WAXES.
2 NATURAL OR CULTURED 18.1889 17.0574 18.1128 18.6378 13.8708 12.1653 10.5157 14.3342 16.0037
PEARLS,PRECIOUS OR
SEMIPRECIOUS
STONES,PRE.METALS,CLAD
WITH PRE.METAL AND
ARTCLS
THEREOF;IMIT.JEWLRY;COIN
.
3 NUCLEAR REACTORS, 8.2648 8.3543 8.8713 8.655 9.3286 10.0211 10.057 8.8148 8.3361
BOILERS, MACHINERY AND
MECHANICAL APPLIANCES;
PARTS THEREOF.
4 ELECTRICAL MACHINERY 6.1887 8.2512 8.4002 8.0216 7.9769 7.8435 7.983 8.3716 7.6823
AND EQUIPMENT AND
PARTS THEREOF; SOUND
RECORDERS AND
REPRODUCERS, TELEVISION
IMAGE AND SOUND
RECORDERS AND
REPRODUCERS,AND PARTS.
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 1.5196 1.4762 1.5832 1.4952 1.7138 1.5927 1.6356 1.4832 1.916
THEREOF.
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 2.8874 3.0458 3.305 2.2697 1.5372 1.2209 1.0994 1.1706 1.9577
AND OILS AND THEIR
CLEAVAGE PRODUCTS; PRE.
EDIBLE FATS; ANIMAL OR
VEGETABLE WAXEX.
11 OTHERS 66.44 64.91 67.65 66.51 64.74 65.48 64.60 64.87 64.6649
As can be seen above, top ten imports include crude oil, precious metals, fertilizers, iron & steel.

4
The trend in India’s imports in rupees lacs over the last decade are plotted below:

* Imports in Rs Lacs
S. No. Commodity 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 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
Metals
3 Nuclear 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
Reactor
Material
4 Electrical 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
Machinery
5 ORGANIC 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
CHEMICALS
6 IRON AND 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
STEEL
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
India's Total
8 Import 24,519,971.86 29,720,587.40 35,910,766.37 50,106,454.03 66,040,890.33 84,050,631.33 101,231,169.93 137,443,555.45 136,373,554.76

150,000,000.00

140,000,000.00

130,000,000.00

120,000,000.00

110,000,000.00

100,000,000.00

90,000,000.00
1 Oil
80,000,000.00 2 Precious Metals

70,000,000.00 3 Nuclear Reactor Material

Im

4 Electrical Machinery
R
a
L
s
c p
rtin
o

60,000,000.00
5 ORGANIC CHEMICALS
50,000,000.00 6 IRON AND STEEL
40,000,000.00 7 FERTILISERS.
8 India's Total Import
30,000,000.00

20,000,000.00

10,000,000.00

0.00

Years

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
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 per
cent 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 and
silver, 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 India’s 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 annually
during 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

6
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 rate
Following table reports India’s 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 Exchange Rate %change %change

(I) (Ex) (I) (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 to
exchange 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 India’s total import over time. It shows very small growth from 1980 to 2002 but it
rose sharply from 2004 onward.

8
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 India’s exchange rate elasticity of import. One particular
paper 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 India
Et,refer is real exchange rate
Yt,india is income

9
Real GDP was used to represent Yt, India and WPI (wholesale price index) to deflate nominal imports in
calculations. They performed several statistical tabulations such Johasen co-integration and Vector Error
Correction.
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 as
was also our finding above. Value less than unity means that it is in inelastic region. Inelastic b1 for India
indicates 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 were
other factors which caused import to continue to grow even after devaluation. There was major economic
reform during that time. Along with devaluation the government deregulated trade by reducing tariffs and
quotas. Reduction in tariffs lead to import becoming more competitive than before and started rising.

10
Explaining the J Curve Phenomenon
J Curve Basics
In economics, the 'J curve' refers to the trend of a country’s 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.
Following the depreciation or devaluation of the currency, the volume of imports and exports will remain
level due in part to pre-existing contracts for imported goods that have to be honoured. However, the
depreciation will cause the price of imports to rise and the price of exports to fall. Therefore, total
spending on imports will subsequently increase and total spending on exports will decrease. It is this that
causes the worsening of the current account.

Moreover, in the short run, demand for the more expensive imports remains price inelastic. This is due to
time lags in the consumer's search for acceptable, cheaper alternatives. As a result, the quantity
demanded for imports remain the same, although consumers are now paying a higher price for it. Ceteris
paribus, a worsening of the current account, and hence the balance of payments, is to be expected in the
short run.
Over the longer term depreciation in the exchange rate can have the desired effect of improving the
current account balance. Demand for exports picks up and domestic consumers will switch their
expenditure to domestic products and away from expensive imported goods and services. Equally, many
foreign consumers may switch to purchasing cheaper imported products instead of their own domestically
produced goods and services.
Empirical investigations of the J-curve have sometimes focused on the effect of exchange rate changes
on 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 trade
surplus exists.

11
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 is
unchanged, but the currency is worth less. As time goes on the net export will gradually change since
consumers buy less imported goods, and other countries buy more goods from the country due to the
lower 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 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. In this paper
the trade data between India and the U.S. at industry level was disaggregate and trade data from 38
industries was used to show that in most industries while real depreciation of the rupee has short-run
effects, 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 few
developing countries including India. The results revealed that real depreciation of the Indian rupee after
1991 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. It
outlines 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 for
India using different data set. Those who employed aggregate trade data, i.e., trade between India and
rest of the world, were not successful in finding empirical support for the J-Curve. They were also
unsuccessful in finding any long-run effect of real depreciation of the rupee on Indian trade balance. After
criticizing those studies, one study disaggregated the data at bilateral level and estimated the trade
balance 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 favorable
long-run effects of real depreciation of the rupee was realized in the cases of Australia, Germany, Italy
and Japan but not in the results for her largest trading partner, the U.S.

12
Conclusion
Based 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 the
indicator 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 India’s 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) India’s 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 India’s 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
India’s total imports or 82.8 per cent of total non-oil imports in 2006-07. Commodity-wise, capital goods
comprising machinery and transport equipment account for about a fifth of India’s 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) India’s 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

13
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. India’s import price inflation in US dollar terms remained
subdued through the 1950s to the 1990s. In the current decade, however, such measure of import price
inflation 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 will
fall with rise in exchange rate. For example, rupee was devalued significantly in 1991. From the study
presented in this paper, when exchange rate change jumped from 7% to 13% in the previous period while
import 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 as
was 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 were
other 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 is
concerned. 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

14
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 industry

level: evidence from U.S.-India trade" Economics Bulletin, Volume 29,Issue 2.

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

15