Who Moved my Current Account?

There is little doubt that we are living in an atypical world. In fact, some astonishing macro developments which we are currently witnessing are:

• Global interest rates have fallen to their lowest levels on record and a whopping US$10 trillion worth of global bonds are now trading with a negative yield

• There has been a remarkable collapse in global productivity growth (output per worker) which has slumped from a 1.7% annualised pace in the 2003-07 expansion to a paltry 0.3% pace since 2010 (with an outright contraction in 2015)

• Globalisation seems to be reversing while trade protectionism seems to be on the rise via increased tariffs as well as restrictions on the flow of labour and capital across borders

• The world is ageing rapidly – by 2020 the global economy will experience “peak youth” for the first time in human history with the number of 65+ expected to outnumber children under 5  

• There has been an unprecedented decline in global commodity prices. The current 10-year annualised commodity return of -5.1% is the lowest since 1933

•  Technological disruption (automation) is thwarting the war on deflation (“amazonification” of the retail industry exerts downward pressure on prices), reducing shelf-life of businesses and shrinking the demand for labour    

Of the above, two important trends which warrant close attention in the Indian context are a) the end of the commodity super-cycle and b) technological disruption resulting in reduced labour demand. 

Following the bear market of the 1980s and mid-1990s, the 10-year commodity super-cycle which lasted from 1998 to 2008 saw commodity prices surge an inconceivable 200%. China was the dominant input behind the surge – the long 30-year duration of its economic expansion and the remarkable late acceleration in its growth rate saw China guzzling almost 50% of every industrial metal. But as China’s hyper growth stopped dead in 2011, so did its demand for minerals. However, by then, global miners had spent an unprecedented US$1.25 trillion in expansion to keep up, helped in their efforts by several years of super-normal profits. The result – commodity prices have fallen ~65% from their 2008 peak, with the decline intensifying since the beginning of 2014.

As regards the second shift, while a shrinking global workforce is a well-know and well-discussed phenomena, what is relatively lesser know is the shrinking demand for labour due to increased industrial automation. A case in point is Foxconn (the 10^th largest employer in the world with 1.3 million employees) which recently replaced a mammoth 60,000 employees in one of its factories with industrial robots. In fact, Foxconn founder Terry Gao (who is a big fan of replacing humans with robots) plans to automate 70% of its assembly line work over the next three years. Even the traditional labour intensive sectors like garments and footwear are now facing the threat of automation. A recent ILO (International Labour Organisation) reported concluded that nearly 90% of garment and footwear workers in Cambodia and Vietnam are at risk from automated assembly lines – or “sewbots”. Thus, the idea that jobs threatened by automation are a rich country problem is rather myopic. It is much more of a problem for lower income economies where considerable labour market slack persists.      

The above two trends have had some significant ramifications for the Indian economy. The first one is rather obvious – India being a net commodity importer, the sharp decline in global commodity prices has resulted in an extremely positive terms-of-trade shock for the domestic economy. In fact, out of the total decline in India’s merchandise trade deficit from a peak of US$190bn in FY13 to US$118bn in FY16, ~55% is attributable to the decline in net commodity imports (oil, agriculture, ores & minerals, iron and steel, ferrous and non-ferrous metals). However, while the price effect has worked in India’s favour, the volume effect presents a rather bleak picture. This is well reflected in the ports data (a lose proxy for trade volumes) which shows robust growth in domestic import volumes and a complete collapse of export volumes (Chart 1). Thus, India’s underlying merchandise trade balance dynamics remain far more vulnerable than what meets the eye. While a sharp rise in commodity prices seems rather unlikely for now, any unexpected rebound could once again raise alarm bells on India’s external sector vulnerability.

                         Chart 1: Sharp divergence between India's import and export volumes

It is the second shift, however, which posits a far bigger challenge for the Indian economy. This is because it is occurring at a time when India’s demographics is at its tipping point -  as against the entry of 6 million people into the job market each year during FY00-12, the economy is now adding 9 million workers per year. Clearly, automation could quickly turn India’s “demographic dividend” to a “demographic nightmare”. In fact, a solemn reminder of the fact that India lacks the coping mechanism to deal with large-scale tech disruptions to its labour markets has been put on show by its labour exports (Chart 2).

                            Chart 2: India's labour exports have stagnated in the last four years

Ricardo’s free trade theory suggests that a country should export those goods/services in which it has a comparative advantage and import those in which it has a comparative disadvantage. Given India’s burgeoning and low-cost labour force, it has traditionally been a large net exporter of labour (IT exports + remittances) and importer of commodities. However, after growing at high double-digits (CAGR of 25%) in the last decade, India’s IT exports have been sluggish for the last four years. Rapid technological advances is putting the demand for India’s “low-skilled” IT services under serious threat, which in turn is impacting job creation in the sector. Similarly, growth in remittances has slowed down to a crawl in the last four years.

Prime Minister Narendra Modi’s pet project “Make in India”, aims at making India the “factory of the world” and thereby provide gainful employment opportunity to the scores of workers which enter the labour force each year. However, thanks to automation, there is increasing evidence that manufacturing is no longer the job-creation engine it once was. In fact, as the Economist bluntly concluded, “China may be among the last economies to be able to ride industrialisation to middle-income status”.

To conclude, there are significant shifts happening at the global level, which have far reaching impact on India, especially its current account. The global commodity deflation has helped India's merchandise trade deficit to decline to multi year's low level. However, barring few items like coal, the decline in imports looks like a price driven cyclical phenomenon. On the other hand, the unwinding of globalisation and increased automation are putting severe strain on India's services exports. The headwinds against IT exports and remittances look structural in nature. This comes at a time when anecdotally, India's unemployment is on the rise. On balance, these medium term shifts are not greatly in favour of India and it’s the already loose labour market which gets most impacted by these developments.