India's Dollar Glut
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.