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Changing dynamics of Balance of Payments

The outlook for capital inflows, a major sustaining factor for the external sector, remains positive.

THE RECENT quarterly review of the Annual Monetary policy looks at the developments in India's external sector from the perspective of what is, without doubt, the single biggest challenge before economic planners everywhere, namely, the persistently high global oil prices. Needless to add that the entire Indian economy has been affected by the continuing oil shock. Solutions and palliatives to minimise the shock have to be sought from across all sectors. But it is the external economy that reflects the magnitude in the first instance.

The China factor

Another reason for the focus on the external economy rises from an entirely different direction. The Chinese currency revaluation took place days before the first quarterly review was released.

It might have been too early for monetary policy to assimilate the full implications and frame appropriate responses. But as the Reserve Bank of India says there has been a paradigm shift in the way China manages its exchange rate which will certainly have major consequences on the global economy.

Its new method, shorn of details, resembles closely the system of "managed float'' of the rupee except that the Chinese central bank has announced a target for the yuan and the method of arriving at the target range. For India, of course, China's new exchange rate policy matters a great deal.

India's trade relations with China have been on the upswing recently. RBI figures show that China's share in India's trade has gone up from 0.1 per cent in the early 1990s to 6.1 per cent in 2004-05. With India's exports to China growing at more than 50 per cent during 2000-05, there is every chance that the bilateral trade target of $20 billion set for 2008 will be achieved earlier.

With the revaluation of its currency, China's oil imports will become cheaper. Since China's (and India's) huge appetite for petroleum and petroleum products is one of the causes for the high global prices, the demand pressures may increase further.

As for India's balance of payments, a higher oil import bill will further widen the trade deficits. As it is, during April -June 2005, the trade deficit went up to $11.5 billion, substantially higher than the $6 billion gap in the same period last year. Imports rose by 37.8 per cent on the back of higher oil (33.1 per cent) and non-oil (39.9 per cent) purchases. Exports grew by 19.6 per cent in dollar terms as compared to a 34 per cent growth last year.

Yawning trade deficit

In fact the sharp widening of the merchandise trade deficit last year to $38 billion from just $15 billion in 2003-04 is one of the major developments in the external sector having a huge significance for policy. Consequently the current account of the BOP turned into a deficit during 2004-05 after having been in surplus consecutively for 3 years.

Figures for the first quarter do not offer any scope for reducing the deficit. The reliance on invisibles (remittances and software export proceeds) and capital flows will be further underlined.

During 2004-05 invisibles moved up to $32 billion from $26 billion earlier. Over the recent past, remittances from overseas Indians have not been all that buoyant and it is far from certain whether growth in this segment will be strong enough to substantially dent the current account deficit.

However, the outlook for capital inflows, another major source that has sustained India's BOP, remains positive.

Between January and June this year, foreign institutional investments have been of the order of $5.5 billion and well positioned to exceed last year's tally of $8.5 billion. Private equity investment from abroad too has been surging.

Portfolio managers from newer destinations such as Japan and Korea are making their presence felt.

However, as with all investments relating to stock markets, the present scenario, despite the record-breaking indices, can hardly be considered propitious.

C. R. L. NARASIMHAN

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