Monday, Nov 22, 2004
Reflections on India's balance of payments - Use the surplus for essential investments
S. Venkitaramanan
ONE of the positive aspects of India's macroeconomic landscape post-reforms has been the dramatic improvement in the external account. Economic policy-makers used to proudly announce that India's forex reserves have crossed $100 billion. These have now crossed $120 billion.
It is another matter that these reserves, which are kept invested in debt and equity of developed countries, yield low returns compared to the marginal cost of raising loans abroad, which our corporates even now indulge in, as also the cost of our NRI deposits.
It is also worth remarking that we are not alone in the abundance of reserves. Many other Asian countries have, in the wake of globalisation, come to possess significantly large reserves. Japan with its more than $550 billion, China with $514 billion, South Korea with $174 billion, and Taiwan with $174 billion are ahead of us in the league table.
That does not, of course, diminish the sense of achievement of our policy-makers, who have succeeded in unshackling India from the constraints of foreign exchange shortage, which had been with us for almost five decades since independence.
It is, indeed, a remarkable achievement of our economic reforms, in that as a result of the reforms India has been able to plan its moves forward without fearing a forex squeeze, which was a feature of our economy till recently.
Doubts have been raised about whether this development is too good to last, assuming that it is a "blessing", albeit in disguise. Certain fears centre round the volatile nature of the sources of this bulge in our forex reserves.
The foreign institutional investors' contribution to the reserves is around $32 billion. Whether FII investments are fairweather friends and will exit the moment a crisis hits India has not been tested as yet. But considering the size of this source of our reserves, I feel the magnitude of reserves is not too high.
Foreign direct investment, which contributes nearly $30 billion to the total reserves, is inherently less volatile than foreign portfolio investment. By its very nature, it cannot move out easily. By the same token, it is difficult to acquire.
Recently, India has - fortunately, in the views of most observers - developed into a hospitable destination for foreign direct investment. We can expect it to contribute more to our rising reserves and incidentally lead to a win-lose situation in respect of overall returns. This is because FDI normally gets a return of above domestic (India) market rates of interest to the investor, which is a debit to the country's account.
But the forex reserves are invested at rates of return that are well below these rates. This is a paradox, which seems inherent in our current abundance of riches unless we unlock the dilemma by increased imports, either to upgrade industries technologically or improve infrastructure, or both. But that takes us to other macroeconomic issues, which require to be dealt with separately.
Among the contributors to our strong balance of payments, the most prominent item is the rising inflow on account of invisibles. A recent issue of the RBI Bulletin dated October 2004 has invited some attention in this regard, especially as it presents data relating to the various items in regard to invisibles from 2000-2001 to 2003-2004.
True, these figures had also been covered in RBI's latest annual report, but the figures in the October bulletin have, for some reason, excited more interest to various observers.
A Table in the RBI's bulletin (page S919) shows that the net receipts under invisibles has risen from $9.7 billion in 2000-2001 to $26 billion in 2003-04. The growth under this head as a whole has been particularly sharp in the recent period.
The increase in total "invisible" receipts in the three-year period 2000-2001 to 2003-2004 is, indeed, remarkable. These receipts have been from $32.5 billion to $52.98 billion. More important, the net receipts under invisibles have gone up from $9.7 billion to $26.7 billion - a rise of nearly 300 per cent - or an average of 100 per cent per year.
The principal components of this dramatic jump are, of course, remittances from our non-resident diaspora - growing from $13.3 billion in 2000-2001 to $23.2 billion in 2003-04 - an increase of nearly $10 billion in three years.
Equally, the software sector has seen net inflows burgeoning from $5.8 billion in 2000-01 to $11.7 billion in 2003-04 - a leap of nearly 100 per cent.
The figures of gross receipts under software are, however, only around $12 billion - well below what is estimated by sources such as Naascom. This requires reconciliation.
The tourism sector - while showing signs of expansion - has registered only marginal changes in net receipts, which stand at $0.6 to $0.7 billion. The gross inflow from tourism has grown from $3.5 billion to $4.1 billion in the period, but this increase has been offset by outward tourism. More needs to be done to catch up with other Asian destinations in terms of attractiveness and infrastructure.
The net receipts of forex earnings under the head "Transportation" have shown a rise in the three-year period from a negative figure of -$1.5 billion in 2000-01 to a positive inflow of $2.5 billion in 2003-04. This must reflect the increase in shipping earnings as well as better outturns in our ports.
This aspect requires to be further gone into by disaggregating the figures under various detailed heads - shipping, port earnings etc. The receipts under the head "Insurance" show that in 2000-01, there was a net receipt of $0.05 billion. It remained at about the same level to just $0.06 billion in 2003-04. How does this reflect the impact of entry of foreign insurance firms or higher reinsurance charges?
In this context, it is important to set the contribution of invisibles in perspective against the overall balance of payment data. On account of imports and exports of goods, the country has a negative balance of trade amounting to roughly $15 billion (rising from 12.4 billion in 2000-01).
This negative balance on trade account is financed by the surplus on invisibles. The current account is consequently in surplus. But this surplus is bound to be temporary if the anticipated reduction in tariffs and further liberalisation of imports promised by the Government comes into effect.
That will mean that the current account may go back into deficit unless the Government and the RBI consciously attempt to modify policies, especially in respect of exchange rate management, to make exports more attractive and imports dearer. But that means depreciating the rupee - anathema to current policy-makers!
The healthy situation on the forex reserve front also depends on the continuing good trends in invisibles. Besides this, it is bolstered by the continuing inflows on NRI deposits, FDI and FII. The fluctuations in respect of investment income need to be carefully analysed. They reflect the interest and dividend paid out as well as the returns on our reserves.
A detailed analysis may bring out the paradox of our abundance. But policy-makers may have to think hard about choices in respect of the various increments to reserves, except perhaps FDI, which has spill-over effects in technology, productivity and market access policy.
They would have to factor in the high incremental costs of reserves, resulting from attracting FII investments and NRI deposits. Whether policy will turn out to be flexible enough to stem the inflows under these heads depends on how seriously the Government and the RBI view the quasi-fiscal costs of increasing reserves. It is true, however, that the structure of India's BoP gives the lie to the impression that it is built up mainly out of FII, FDI and NRI deposits. At least in the recent period, it has been the surpluses contributed by invisibles, remaining after financing the balance of trade deficit.
This gives reason to hope that there is space for planning a foray into using the forex reserves for essential investments, particularly for infrastructure. The more attractive the infrastructure, the greater the inflow of FDI and FII and consequent addition to forex reserves. Such a virtuous cycle is indeed a consummation devoutly to be wished for.
Copyright © 2004, The Hindu Business Line.