What is the issue?
India’s external account faces several structural issues that needs to be addressed.
What are the recent happenings?
- The rupee became the worst performing Asian currency recently.
- This was attributed to the rising interest rates of the developed countries from near-zero levels, which led the exit of portfolio investors from emerging markets.
- Also, emerging market currencies have been declining relative to the dollar with increased demand for dollars to finance oil imports.
- India has been placed among the group of countries whose currencies were particularly vulnerable.
- India’s current account deficit(CAD) has been widened from $14.4 billion in 2016-17 to $48.7 billion in 2017-18.
- There are also projections that CAD will at 2.6 per cent of GDP in 2018-19.
What are the structural weaknesses?
- Oil Imports - India’s net petroleum products import bill which stood at $83 billion in 2015-16, has risen to touch $109 billion with the rise in international price of Brent crude.
- This made the trade deficit has risen by around 50% in 2017-18 to touch $162.2 billion.
- But, given the multiple, technological and geopolitical factors affecting oil prices, such volatility will always prevail.
- So, ensuring balance of payments resilience requires an ability to ride through periods of high oil prices, without further fall in rupee value.
- Balance of trade - India was the largest recipient among developing countries of remittances from abroad and a highly successful exporter of software and IT-enabled services.
- This should have boosted the receipts and enabled India to have a strong and resilient current account.
- But the total of receipts from private transfers and from net exports of Telecom, Computer and Information Services either stagnated or declined since 2014-15.
- Hence neutralising the increase in revenue outflow in the trade balance through additional forex is getting difficult.
- Revenue neutralisation - Imports of IT and electronics goods is now matching or exceeding receipts from software and IT-enabled exports.
- This is reflected in the fact that the value of imports of Electronic Goods within the Capital Goods Category stands at 70% in 2017-18 of the receipts from net exports of Telecom, Computer and Information Services.
- Moreover, demand from both the government and the private sectors has arisen for such products with India holding less leverage in the domestic production of such products.
- This has undermined the role of IT-enabled services exports as a source of forex earnings that can make the balance of payments more resilient.
- Capital outflow – The RBI says that the net outflow of portfolio capital amounted to $8.1 billion in the first quarter of 2018-19, as compared with an inflow of $12.5 billion in the corresponding quarter of the previous year.
- RBI’s open market operations, designed to provide some backing to the rupee, drained India’s forex reserves, which fell by $25 billion from its recent peak of around $425 billion.
What lies ahead?
- Given these structural weaknesses in the current account, India is deeply vulnerable when faced with outflows of investment on the capital account.
- The rupee’s recent depreciation had initially been dismissed as reflecting global developments that affected all emerging markets, and not just India.
- Thus, rather than just attributing shifts in monetary policy in the advanced nations as a reason, India should also focus on the structural weaknesses in its external account to address rupee volatility.
Source: Business Line
