The data released by the Reserve Bank of India till 2007-08 had highlighted how the country’s external sector was growing in strength over the last few years. There was robust growth in merchandise and services exports, global capital was pouring into the economy by way of portfolio and foreign direct investment. Net capital inflows into India had increased sharply to $108 billion in 2007-08 or 2.4 times higher than that in 2006-07.
However, there has been a dramatic change in the situation following the global financial and economic crisis with a big slowdown in country’s exports, a surge in trade deficit, and a big drop in capital inflows and flight of portfolio investments from the country. This has taken its toll on the country’s external sector balance-sheet with current and capital accounts turning negative during the third quarter of 2008-09.
WIDENING TRADE DEFICIT
Despite a robust growth in exports over the past few years, India had a trade deficit because of higher levels of imports. Since last year, the country’s trade deficit has been widening sharply, worsening this imbalance. During 2007-08, the trade deficit soared to a record $ 82.2 billion; it touched a new high of $115 billion during April-February 2008-09.
The deficit widened further mainly because of the big drop in export earnings in dollar terms and despite slower import growth over the last few months following a decline in crude and other commodity prices.
According to latest estimates, total exports during 2008-09 have been valued at $169 billion against the original target of $200 billion (subsequently lowered to $175 billion). Imports during the fiscal have been estimated at $288 billion resulting in a huge trade deficit of $119 billon for the year. Since the mid-1990s, India’s invisibles receipts were rising at a healthy pace resulting in net invisibles surpluses that could offset a significant portion of the expanding trade deficit. Consequently, the deficit in the current account balance was being contained at just around one per cent of GDP; in 2007-08, it touched 1.5 per cent of GDP.
Unfortunately, this cushion is now getting eroded rather sharply because of the slowdown in invisibles receipts. It is seen from the BoP data that the extent of trade deficit that could be financed by invisibles account has fallen sharply to 59.7 per cent in Q3 of 2008-09 from 82.6 per cent a year ago and to 65.5 per cent during April-December 2008 from 77.6 per cent during the previous corresponding period.
GROWING STRESS ON BoP
The latest data on the country’s Balance of Payments (BoP) released by the Reserve Bank of India on March 31 show that the current account deficit at $14.6 billion during the third quarter (October-December) of 2008-09 was the highest quarterly deficit since 1990. During the corresponding last quarter, this deficit was just $4.5 billion.
For the nine month period (April-December 2008), the current account deficit was $36.5 billion. According to some estimates, the current account deficit for the full year (2008-09) could be around $44 billion or over 3.5 per cent of GDP, much above the comfort zone of up to 2 per cent of GDP.
What is more worrisome, the capital account balance also turned negative in the third quarter of 2008-09 for the first time since Q1 of 1998-99 showing net outflows of $3.7 billion or 1.3 per cent of GDP. During the previous corresponding quarter, the capital account was in surplus of $8.09 billion.
The negative capital account balance during Q3 of 2008-09 was mainly due to net outflows under portfolio investment, banking capital and short-term trade credit. Inflows under FDI and external commercial borrowings (ECBs) were lower compared to last year.
The deficit on both BoP accounts has resulted in the depletion of the country’s foreign exchange reserves which fell sharply by $17.9 billion during the quarter ending December 2008. The total foreign exchange reserves, which had touched a peak of $316 billion in May 2008, have now come down to $252 billion taking into account the valuation changes. The big rise in foreign exchange outflows and the decline in their reserves resulted in the sharp depreciation of the rupee. It has depreciated vis-À-vis the dollar from Rs 39 at the beginning of 2008 to over Rs 50 now.
SOME LESSONS
The rapid deterioration in the country’s balance of payments position over the past one year, and more so over the last two quarters, shows it is increasingly being influenced by global developments. This is not surprising considering that:
India’s two-way trade (merchandise exports plus imports) as a proportion of GDP, increased from 21.2 per cent in 1997-98 to 34.7 per cent in 2007-08, and
The ratio of total external transactions (gross current account flows plus gross capital flows) to GDP, has more than doubled from 46.8 per cent in 1997-98 to 117.4 per cent in 2007-08. Hence, India can no longer remain immune to any contagion of global financial and economic crisis and it has to respond quickly to the developing global situation with appropriate measures so that the pain is minimised.
In particular, the export-intensive sectors should be given a much higher level of policy support and the country’s FDI policy should be liberalised further to attract more inflows of a relatively stable nature into the country.
Until last year, there was a view that India’s forex reserves were far in excess of the requirements. This crisis has shown that the country needs a much bigger arsenal of forex reserve to fight any financial crisis taking into account not only the country’s import needs, but also the total gross foreign liabilities for the next 12-18 months. As of September, 2008, India’s external debt was $228 billion.
Dr Arvind Subramanian, an economist at the Institute of International Economics, Washington DC, has rightly pointed out that India should aim at building up foreign exchange reserves of $500 billion to $1 trillion so that it is in a better position to deal with any unforeseen crisis like the present one.
Source : Business Line