The Hindu Business Line : Assessing the external sector

Efforts have to be directed towards improving the BoP situation by achieving a current account surplus, as in comparable countries like China, says S. VENKITARAMANAN.

The Reserve Bank of India (RBI) document on macroeconomic and monetary developments in 2008-09, issued in conjunction with the annual credit policy statement, has always been a reservoir of information on important features of India’s economy. This article analyses the section on India’s external position.

Rising deficits

On account of the recession in developed economies and its linkages with India’s own manufacturing and services sectors, the year under review saw a decline in exports and increase in trade deficit. India’s current account deficit increased to $36.5 billion in April–December 2008 from $16.5 billon in the corresponding period of 2007. This increase is mainly led by trade deficit, accompanied by higher imports.

India’s exports increased by 17.5 per cent during April–December 2008 as against 21.9 per cent in April–December 2007. Import payments recorded a growth of 30.6 per cent in the same period compared to 28.3 per cent in the previous year. The lower growth of exports year-on-year was essentially on account of a 10.4 per cent negative growth of exports in the third quarter of 2008-09. Overall, however, the trade deficit was higher at $103 billion during April-December 2008, compared with $69.3 billion for the same period in the previous year.

A substantial part of the trade deficit was financed by invisible receipts, such as those from services, including software exports and transfer payments, which represent remittances from abroad on account of services exports. Gross invisible receipts grew by 18.8 per cent during April–December 2008, a decrease from 30.1 per cent in the corresponding period of the previous year. This decrease reflects the slow pace of growth in receipts from travel, business services and investment income.

It is noted that invisible payments also slowed down during April–December 2008, largely due to slowdown in international economic conditions. Net invisibles, viz. gross invisible receipts (minus) payments, however, increased by 28.1 per cent in the period, primarily led by receipts under private transfers and software services. The surplus on invisible account financed about 65.4 per cent of the trade deficit as against 77.6 per cent in April-December 2007.

Invisibles significant

What emerges, therefore, from the analysis is the significant contribution of invisibles to the balance of payments (BoP) . It is important to note that the apparently insatiable appetite of Indian public for crude oil, gold and the like is financed by earnings of our compatriots abroad as well as income from software services.

The importance of invisibles and their sustainability in the future in maintaining BoP at a relatively stable level is obvious. Policy conclusions that flow from this imply that software industry should be nurtured and the employment conditions of our compatriots abroad should be carefully monitored.

Capital inflows

In the year under review, however, the capital account was hit by the global market turmoil. Capital comes primarily in two forms — FDI and FII inflows. There is, of course, an additional element represented by external commercial borrowing (ECB).

Capital inflows, however, decreased during April-December 2008 to $246 billion, from $291 billion in the same period last year. There were higher outflows mainly due to portfolio transactions and higher payments under short-term credit during the period.

The capital account balance, which is usually a positive element, became negative in the period under review. One of the main reasons for this is the FIIs’ sale of securities, reflecting the markedly adverse conditions in the stock market.

The RBI’s review, however, points out that the FDI inflows were $27.4 billion in the period compared to $20 billion in the corresponding period of last year. This shows the continuing attractiveness of India to FDI.

Outward FDI during the period, however, continued to remain high at $12 billion in April-December 2008, a marginal decrease from $13.1 billion in the corresponding period of the previous year. The other element of capital inflows is ECB. The ECB flows to India moderated during April-December 2008. In short, as a result of the general hardening of international liquidity, the net inflows under ECB slowed down to $7.1 billion in April–December 2008 compared to $17.4 billion in April– December 2007.

Forex reserves

The total BoP situation thus was a combination of a sharp expansion in current account deficit and increase in net capital outflows. As a result, foreign exchange reserves declined by about $17.9 billion. This is including the revaluation effect.

This magnitude of decline in reserves in a single year led to some stress on exchange rate in the financial markets. Incidentally, this level of decline in reserves in any one period was relatively high. A similar contraction of $4.5 billion was observed only in the third quarter of 2005-06.

Overall, foreign exchange reserves of India declined by $20.4 billion in April-December 2008 as against accretion of $67 billion in April-December 2007. This shows that we in India are not immune to trade developments and the Indian international economic scene. This runs counter to the decoupling theory, which was advocated by some senior Indian economists earlier in 2008-09. India’s foreign exchange reserves remained at $252 billion as at the end of March 2009. This represents a decrease of $57 billion from end of March 2008.

External debt

The RBI’s report, however, is not alarmed by this decrease. It is a robust level based on a number of criteria. First of all, turning to external debt, RBI’s review discloses that India’s external debt at the last quarter of 2008-09 did not show any significant increase.

The ratio of short-term debt to total debt and the debt-service ratio remained at a reasonably low level. India’s total external debt stood at $230 billion at the end of December 2008, an increase of $6.2 billion over the level at the end of September 2008.

The increase in external debt was essentially due to increase in short-term debt outstanding, especially commercial borrowing.

Overall, the RBI’s review points out that the debt sustainability indicators are not uncomfortable. The debt-service ratio was placed at 5.3 per cent during the third quarter of 2009.

The ratio of short-term debt to total debt decreased to 20.6 per cent while the ratio of short-term debt to reserves was about 18.5 per cent. Taking an overall view, India’s foreign exchange reserves have exceeded external debt by $25.1 billion, providing a reserve/debt cover of 110.9 per cent.

Investment position

As is customary, the review indicates India’s net international investment position. The net international position is thus a negative figure, around $52 billion, which means that India owes more liabilities abroad than it owns in terms of assets, including foreign exchange reserves.

India’s net international investment position changed by minus $10.2 billion between end of June 2008 and September 2008. On the whole, we have to admit that India’s international assets were lower than international liabilities.

A reason for this negative international investment position is the continuing current account deficit. Efforts have to be directed towards improving the BoP situation by achieving a current account surplus, as in comparable countries like China.

This requires a change both in the Indian strategy towards manufacturing and the exchange rate policy.

blfeedback@thehindu.co.in

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