India's External Sector*
Portents
for the global economy are gloomy at best. And recent events have already
shown that the Indian economy will be also be affected by adverse developments
in the rest of the world, whether through the impact of mobile capital
flows, or through exports being dragged down by the recession in Europe
and the economic uncertainty in the US.
How resilient is the Indian economy at present, in the face of these
negative global forces? In terms of domestic demand, it is certainly
possible for the government to think of ways of rejuvenating the economy,
ideally through more broad-based employment-led growth. But externally,
the recent pattern of growth has been crucially related to India's greater
global integration, and therefore it has created patterns of dependence
on international markets and international capital. This makes the economy
significantly more vulnerable, especially because the growth has been
reliant on capital inflows to generate domestic credit-driven bubbles,
rather than trade surpluses.
Chart 1 describes the main elements of India's balance of payments.
(All data in this and the following charts are from the Reserve Bank
of India's online statistical database, accessed on 6 January 2012.)
Several features of importance emerge from this chart. First, the trade
balance has been negative and progressively worsened over the course
of the decade. Second, in the early years of the decade, this impact
could be kept in check because remittance inflows and software exports
ensured that the current account was either in surplus or ran small
deficits. But in the second half of this period, even large remittance
inflows could not prevent a substantial deterioration of the current
account. Third, despite this, external reserves have kept growing, except
for the crisis year 2008-09. Fourth, this was entirely because of capital
inflows, which increased over the decade except in the crisis year,
and the capital account peaked in 2007-08 with more than $100 billion
net inflow.
What this suggests is that India's external reserves were effectively
borrowed rather than earned, as they were largely growing because of
capital inflows that were dominated by portfolio inflows and external
commercial borrowing. This is confirmed by Chart 2, which shows that
– especially in the second half of the decade – foreign investment and
external commercial borrowing were dominantly responsible for the inflows
on capital account.
In this context, another recent feature of foreign investment is worth
noting. In the past, it made a lot of sense to separate portfolio inflows
from direct foreign investment, on the grounds that the former are typically
more short-term in orientation and more likely to be volatile and therefore
exit the country in periods of downswing. However, the emergence of
private equity, especially after 2000, has changed this considerably,
since this is typically included in FDI. Private equity is also essentially
short term in orientation, since it seeks to make relatively rapid capital
gains on the acquisition of domestic assets. A significant proportion
of inward FDI into India in the recent past has been in the form of
private equity. As a result, a significant proportion of inward FDI
is also effectively short term, and cannot be assumed to be in for the
long haul, any more than explicitly portfolio inflows.
There is a widespread perception that the rupee has depreciated significantly
in recent times. Certainly, in nominal terms vis-à-vis the major
currencies, there is evidence of substantial decline in value. Chart
3 shows the rupee relative to the US dollar, Euro and Japanese Yen.
Nominal depreciation has been particularly evident over much of 2011,
which has not been captured in this chart.
However, it should be noted that this was also a period in which inflation
in India was significantly higher than in many if not most of its trading
partners. As a result, the real effective exchange rate, shown in Chart
4, barely changed very much over the entire course of the decade. The
net barter terms of trade declined until 2007, especially because of
high world oil prices, but then improved, so that even in terms of this
variable there was not much change by the end of the decade.
Chart 5 describes the indices of trade in terms of quantum and unit
value, separately for exports and imports. This is an extremely significant
chart, because it highlights that the quantum index for imports moved
up much more rapidly than all the other indices. Further, it does not
seem to have been at all affected by the global crisis. So it would
be unwise to blame high oil prices alone for the high and growing total
import bill – clearly import liberalisation has resulted in a significantly
increased propensity to import within the economy.
This also has another implication: the domestic impact is greater than
would be evident from just the total value of imports, since significantly
greater quantities of imports are entering the country. This has direct
effects on import-competing activities, on employment and livelihood
particularly of small producers. The slow growth of non-agricultural
employment despite rapid aggregate GDP growth may be at least partly
related to the impact of substantially increased import volumes of a
wide range of manufactured commodities.
In
terms of direction of trade, it is evident from Chart 6 that the European
Union remains an extremely important destination for exports. This is
bad news, given the likely recession in Europe which is also bound to
affect their imports. OPEC as a group recently overtook the EU in becoming
the grouping to receive the largest amount of India's exports (in value
terms) but it is worth noting that China and other developing countries
in Asia have become increasingly significant as export markets for India.
Chart 7 shows that in terms of imports, the global increases in oil
prices propelled OPEC countries dramatically to the top of the groupings
in terms of sources of imports in the second half of the decade. But
once again, it is important to note that China and other developing
Asia have become major sources of imports, exhibiting the fastest rate
of growth for non-oil imports.
These non-oil imports have in fact been growing very sharply. Chart 8 makes it clear that the recent increases in the total import bill cannot be ascribed to oil prices alone, because non-oil imports have been growing much faster in value terms.
So recent trends in the external sector were already cause for concern,
even before the latest impact of the ongoing global economic crisis
can be felt. It is not just high energy dependence which is a strategic
problem for India. The rapid expansion of non-oil imports suggests an
economy that (despite two decades of liberalising ''reforms'') is becoming
less externally competitive and generating trade patterns that are likely
to continue to have adverse employment effects. Most of all, a trajectory
of growth based on capital inflows that generate domestic finance-driven
consumption, including significantly high imports and worsening trade
balances, is obviously not sustainable. We do not need a global crisis
to recognise these danger signals.
*This article was published in the Business
Line on January 9, 2012.