After several years of comfort, India's external account is under pressure. Latest RBI numbers of balance of payments contain several hints of greater deterioration and increasing vulnerability. They show that merchandise imports vastly exceed exports, exports of services and inward remittances are not enough to bridge the gap, portfolio investments are dominating capital inflows and short-term debt is rising while foreign direct investment is falling.
In short, the country is living beyond its means and is increasingly relying on short-term debt and highly unstable investment flows to foot the bill. To complete the picture, for the first time in seven years India's forex reserves have fallen below its external debt.
Preliminary data released by the Reserve Bank of India (RBI) show that India's current account deficit (net balance of cross-border transactions of goods and services) rose by a whopping 72 per cent to $15.9 billion during July-September 2010, compared to $9.2 billion in July-September 2009. This was because imports rose more than exports and net income from services was lower during the period. There was a surplus on the capital account, implying that inflows of debt and investment were more than the outgo. However, the composition of these inflows is a serious cause of concern. Inflows under portfolio investment by foreign isntitutional investors (FIIs) doubled to $19.2 billion, external commercial borrowings more than trebled to $3.7 billion and short-term trade credit more than doubled to $2.6 billion. At the same time, FDI inflows declined to $2.5 billion from $7.5 billion a year ago, owing to lower investment in construction, real estate, business and financial services. In other words, India's current account deficit is being financed largely by short-term credit or inflows which are notoriously foot loose and could exit at the first sign of trouble or better opportunity elsewhere, leaving India dangerously vulnerable.
Meanwhile, the surge in imports suggests that Indian manufacturing sector is losing competitiveness. Indian shops are stuffed with imported articles, electrical accessories, furniture, furnishings and toys. Even services like tourism and tailoring are becoming uncompetitive. Economic Times reported on December 22 that Indians find it cheaper to holiday abroad now. It is now much cheaper to buy a made-to-measure suit in Bangkok than in Mumbai. Philippines is becoming an increasingly strong competitor in the BPO segment, and China in IT.
The country may end the fiscal year with a trade deficit of 7-8 per cent of GDP and current account deficit of 4 per cent of the GDP. Yet, the Reserve Bank keeps assuring the country that the rupee is not overvalued, that it actually depreciated 0.4 per cent Since April 2010 up to October 22 — glossing over what happened in the previous fiscal year.
The present scenario is unlikely to change significantly in the foreseeable future. Quantitative easing in the United States will lead to a surge of liquidity, which will find its way to star performing economies like India to leverage the interest rate differential. India's ECB is headed north for the same reason. With Indian firms aggressively scouting for natural resources, commodities and technology abroad, outward FDI from India is also expected to increase sharply.
India urgently needs policies oriented to improving the global competitiveness of Indian exports and creating the enabling conditions to attract and retain FDI. There is no dearth of experts and analysts who assure us that 'as of now the situation is within our comfort zone.' But, as the West discovered to its cost, in financial markets the music does not play on forever. It has a nasty habit of stopping suddenly.
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