The Hindu : Opinion / Editorials : GROWING LINKAGES

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Tuesday, Apr 06, 2004

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GROWING LINKAGES

TWO RECENT RBI reports capture the broad trends on two interrelated aspects of the external economy — the balance of payments and foreign reserves, during the first nine months of the financial year 2003-04. The payments surplus of $7.2 billion for the October-December 2003 quarter (up from the $6.1 billion during the corresponding period the previous year) helped raise the forex reserves to $101 billion by December last year. Evidently some or all the factors contributing to the surplus have continued into the fourth quarter taking the forex reserves to $110 billion last week. The payments surplus in April-December 2003 has come despite a sharp increase in the trade deficit to $15 billion from $ 9.8 billion in 2002-03. The higher imports, even if the increased oil bill exaggerates that, are indicative of the ongoing industrial recovery. Exports have surged too but not sufficiently to offset the rise in imports. But net invisible earnings, underpinned by inward remittances by Indians overseas, resilience of software exports and a surge in tourism earnings, grew robustly to $18.2 billion during April-December 2003, more than offsetting the trade deficit. The current account surplus at $3.2 billion is higher than the $2.9 billion recorded during the first nine months of 2002.

A year-on-year comparison of trends in capital flows is also illuminating. During the first nine months of 2003 net capital flows were significantly larger at $17.3 billion compared with $10.3 billion during the previous year. Foreign investment accounted for more than 38 per cent of such flows. Not surprisingly, portfolio investment (at 28.8 per cent) has been the main driver of capital flows with the more stable foreign direct investment accounting for only 9.5 per cent. Deposits from non-resident Indians at $ 3.5 billion accounted for 13 per cent of the capital flows during 2003. A policy decision taken in March 2003 to accord convertibility status to certain types of non-resident deposits, which were previously non-repatriable, has no doubt boosted the figure. In a broad sense, the above data reinforce the positive perceptions on the external sector. But what do these developments portend for the rupee's external value and the related policy issue of making it convertible on capital account? The rupee's surge over the past two weeks has taken it to a 47-month high against the dollar. Significantly, the RBI has not intervened with its characteristic vigour to check the rupee's rise.

A costlier rupee is good news for the importers, especially the public sector oil companies. Global crude oil prices have been ruling high and any savings made on account of the rupee appreciation will reduce the cost of import, though the elections-induced freeze on retail fuel prices will still drill a gaping hole in their balance sheet. Exporters have traditionally lobbied for a cheaper rupee and the latest spurt in the rupee's value will set a new challenge for them. Clearly there are avenues they will need to work on, such as productivity improvements. The accretion to reserves is keeping alive the debate over an early convertible status for the rupee. Yet inasmuch as the bulk of incremental reserves has come from portfolio investors, the RBI is right in remaining circumspect. Perhaps the biggest message from the buoyant external sector is for the macro economy. In the process of managing the rupee's exchange rate, the RBI has been mopping up dollars and releasing rupees which will have to be "sterilised" through novel means such as stabilisation bonds if these are not to stoke inflation. More than at any time before, the external economy closely influences domestic macro-economic variables such as inflation and interest rates.

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