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India’s
external balance of payments appears robust. In the
net there is far more foreign exchange flowing into
the country than flowing out. As a result, the year
2002 ended with foreign exchange reserves crossing the
$70 billion mark This followed the accretion of as much
as $10 billion over the previous four months and another
$10 billion in the six months prior to that. As has
been noted in the financial media, this trend represents
a substantial acceleration of the rate of growth of
reserves, which rose from $20 to $30 billion over a
period of more than four years ending December 1998
and from there to $40 billion over a two-year period
ending December 2000. A part of the increase in reserves
is the result of a revaluation of the dollar value of
non-dollar foreign currency holdings, as a result of
the depreciation of the dollar against other currencies,
especially the Euro. But even an overgenerous estimate
suggests that over the period April to September 2002
only about $2.5 billion of the 9 billion dollar reserve
accumulation was the result of such revaluation. The
dollar excess is substantially due to an excess of inflows
over outflows.
Interestingly the recent acceleration in the pace of
reserve accretion occurred despite the fact that in
the past the government had issued Resurgent India Bonds
(in August 1998) and India Millennium Bonds (November
2000), which together resulted in an inflow of close
to $9 billion in foreign exchange. Despite the lack
of any such concerted effort in recent times to mobilise
foreign exchange through borrowing against bonds and
despite indications that both the government and the
private sector are retiring and reducing their holding
of high cost foreign debt, the RBI has been forced to
mop up foreign exchange inflows to prevent any undue
appreciation of the rupee.
The RBI’s efforts notwithstanding the rupee has indeed
been appreciating, nudging its way “upwards” from above
Rs. 49 to the dollar to below Rs. 48 to the dollar.
This could be seen as reflective of the strength of
the rupee and the growing weakness of the dollar. But
appreciation of the currency in a country that has not
been able to trigger any major export explosion despite
ten years of neoliberal economic reform is not necessarily
a good sign. At given prices, appreciation of a country’s
currency by definition increases the dollar value of
exportables and reduces the local currency value of
its imports. Inasmuch as this triggers a decrease in
aggregate export earnings and increases the import bill,
appreciation can be damaging for the balance of trade.
And since this occurs in India at a time when oil prices
are hardening internationally, the rupee’s appreciation
does threaten to widen the balance of trade deficit,
or the excess of imports of goods and services over
exports of goods and services.
There are two reasons why this has as yet not given
cause for worry to the government and the central bank.
First, the most recent figures on exports point to some
recovery in India’s export performance. Thus the dollar
value of India’s exports rose by 15.7 per cent during
the first eight months of the current financial year
(April-November), which compares well with the performance
during the corresponding period of the previous year.
However, while this may dampen concerns about the possible
damaging effects of exchange rate appreciation, it cannot
be held responsible for the improvement in India’s reserves
position. A sharp 21 per cent increase in the dollar
value of oil imports and a unexpected 12 per cent increase
in the dollar value of non-oil imports have actually
increased the size of the trade deficit recorded during
the first eight months of this financial year ($6247.65
million) as compared with the corresponding figure for
the previous year ($5814.93 million).
The second reason why the rupee’s appreciation has not
given the government and the central bank cause for
concern is the fact that as a result of a $1.3 billion
increase in Private Transfers (largely remittances)
and a $1.5 billion increase in net receipts from Miscellaneous
Factor Services (which includes software and business
services exports), the current account of the balance
of payments recorded a surplus of $1.7 billion during
April-September 2002-03 as compared with a deficit of
$1.5 billion during the corresponding months of 2001-02.
That is, the relatively new tendency for the current
account of the balance of payments to record a surplus
noted over the whole financial years 2001-02, has persisted
and gathered strength during the first six months of
2002-03.
But even allowing for this increase in the current account
surplus and after taking account of the possible effects
of dollar depreciation on value of reserves, there remains
around $5 billion dollars of reserve accretion that
remains to be explained even for the April-November
2002 period. What is more, since the balance of payments
statistics indicate that there was a net outflow of
$2.2 billion under the external assistance and commercial
borrowing heads, we must account for more than $7 billion
of inflows on the capital account if reserve accumulation
during that period is to be explained. The RBI’s Balance
of payments statistics suggest that about $1.3 billion
of this is on account of foreign investment, another
$1.4 billion on account of NRI deposits, around $1 billion
on account of Other Banking Capital, $2.1 billion on
account of Other Capital and $1.4 billion on account
of “errors and omissions”.
Put simply, large “autonomous capital inflows”, occurring
at a time when India’s requirements of capital inflows
to finance any deficit on the current account have vanished,
have played a major role in explaining reserve accumulation.
And inasmuch as the easy availability of dollars on
account of such inflows have resulted in an appreciation
of the rupee’s value in India’s liberalized exchange
markets, exporters who in the past preferred to delay
repatriation of receipts in order to benefit from any
depreciation of the rupee have been keen on bringing
back their dollar receipts in order not to loose out
on the rupee value of receipts because of the appreciation
of the domestic currency. Such delayed repatriation
of exports receipts get included according the RBI under
the “errors and omissions” head.
Thus when we breakdown dollar receipts by source, it
becomes clear that the robust balance of payments position
as indicated by reserve accumulation and currency appreciation
are largely due to autonomous flows from abroad. Those
autonomous flows result in a tendency towards currency
appreciation, which has a peculiar effect on export
receipts. In the short run by encouraging the quick
repatriation of past and current export receipts rupee
appreciation increases such receipts. But in the medium
and long-term, by raising the unit dollar value of India’s
exports it affects export revenues adversely.
If any such appreciation-induced worsening of the balance
of trade combines with other factors such as an increase
in oil prices and a rise in imports on account of buoyancy
in the domestic market, a country can be confronted
with a situation of rising reserves and an appreciating
currency precisely at a time when trade and possibly
even current account “fundamentals” are worsening. The
process can be especially damaging if foreign investment
inflows that involve servicing costs in foreign exchange
do not contribute to the country’s foreign exchange
earning. This would be true of portfolio flows, of acquisition
of domestic companies catering to the domestic market
by foreign firms and of foreign direct investment flows
into joint venture companies catering to the domestic
market where the existing foreign partner seeks to use
the benefits of liberalisation to increase equity share.
These are the principal forms of foreign investment
flows into India. Despite all this, as we have seen
earlier, India is still not in a situation where its
balance of payments has been substantially damaged.
Yet there is a cause for concern for a number of reasons.
Virtually pushed by the embarrassingly large level of
reserves, and unable to keep acquiring dollars from
the market in order to prevent the rupee from appreciating
too fast, the central bank has accelerated liberalization
of rules relating to availability of foreign exchange
for both current account and a growing set of capital
account transactions. Easier access of foreign exchange
for travel, education and the like, larger access to
foreign exchange for companies wanting to establish
or acquire a presence abroad, slack rules governing
use of international credit cards, increase in the limits
to which foreign exchange can be used by importers without
RBI clearance and changes in rules regarding hedging
of foreign exchange transactions are all signs of a
process of creeping liberalization. The thrust is clearly
in the direction of encouraging use of foreign exchange
and liberalizing rules governing cross border movements
of goods and capital. In fact, discussion on moving
towards full convertibility of the rupee, as recommended
by the Tarapore Committee, which had been shelved after
the East Asian crises, has once again revived.
Unfortunately, liberalisation can aggravate rather than
resolve the problem currently confronting the government.
It is to be expected that when a country with a relatively
liberalised trading environment experiences currency
appreciation, incentives for investors in that country
to produce tradable commodities that can be exported
or are substitutes for imports deteriorate relative
to the incentive to invest in activities involving the
production or provision of non-tradable goods or services.
The desire to borrow abroad to invest in infrastructural
activities producing non-tradable services, to invest
in real estate and construction and to invest in the
stock market increase substantially. This most often
leads to excess capacity in certain infrastructural
areas and even sets off a speculative investment boom
in real estate and stock markets. Such irrational and
speculative investments have in other contexts been
the precursors for a crisis.
The danger is all the more real because the costs of
the inflow of foreign exchange into the country have
to be serviced in time in foreign exchange. Further
while the emerging trends increase dependence on foreign
capital inflows, it also increases the risk that such
flows can dry up and that past inflows are rapidly repatriated.
That is, reserve accumulation and currency appreciation
of the kind that India is experiencing, the factors
that underlie those tendencies and the government’s
liberalising response to the tendencies are reminiscent
of the process by which countries that were relatively
healthy in East Asia and Latin America were pushed into
crisis. This curious similarity makes India’s remarkable
dollar reserve even more noteworthy than it is being
made out to be. It could be the first sign of a crisis
that India has managed to stave off thus far.
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