India, External Flows and Crisis Potential

Recently, in a post, my colleague Yin-Wong Cheung compared India and China’s reserves and capital inflows. India obviously looks less secure than China, since it has a current account deficit, and has relied more on portfolio inflows than FDI. But I think Yin-Wong’s assessment of India was too pessimistic. I also thought the comments on his post missed the mark. There are some problems with the Indian economy, but they are with respect to fiscal deficits (including off-budget items) rather than the external sector.

RBI governor Y.V. Reddy just gave his assessment of the economy. Here is an excerpt with the data on the external sector:

“During 2007-08, gross invisible receipts comprising services, current transfers and income at US $ 145.2 billion recorded an increase of 26.2 per cent and amounted to nearly 92 per cent of merchandise exports. There was sustained growth in software exports, travel and transportation along with steady inflows of remittance from overseas Indians. Private transfer receipts, mainly comprising remittances from Indians working overseas, amounted to US $ 42.6 billion as compared with US $ 29.0 billion in 2006-07. Invisible payments increased by 17.7 per cent during 2007-08, mainly on account of a surge in travel payments related to outbound tourist traffic as also the impact of liberalisation of outward foreign exchange remittance for individuals, business and management consultancy services, engineering and technical services as well as dividend, profit and interest payouts. During 2007-08, the net invisibles surplus was US $ 72.7 billion as compared with US $ 53.4 billion in the previous year. Accordingly, the current account deficit (CAD) amounted to US $ 17.4 billion (1.5 per cent of GDP), up from US $ 9.8 billion (1.1 per cent of GDP) in 2006-07.

“Gross capital inflows to India amounted to US $ 428.7 billion, while gross capital outflows were of the order of US $ 320.7 billion during 2007-08. Net capital flows at US $ 108.0 billion were 2.4 times and 4.2 times higher than net capital inflows during 2006-07 and 2005-06, respectively. Sizeable increases in net inflows were received under portfolio investment, external commercial borrowings (ECB), foreign direct investment (FDI), short-term credit and banking capital excluding non-resident Indian (NRI) deposits. Net FDI inflows amounted to US $ 15.5 billion in 2007-08, sizeably higher than US $ 8.5 billion in 2006-07. Inward FDI were channelised into sectors such as manufacturing, construction, business and computer services. Net ECBs of US $ 22.2 billion were higher than US $ 16.2 billion in the previous year and were enabled by finer spreads and rising financing requirements. Net portfolio inflows were significantly higher at US $ 29.3 billion than US $ 7.1 billion in 2006-07, mainly due to net foreign institutional investment (FII) inflows at US $ 20.3 billion as against US $ 3.2 billion, reflecting net purchases in the Indian stock market as well as resource mobilisation by the Indian companies through their global offerings of American Depository Receipts/Global Depository Receipts (ADRs/GDRs) in view of the favourable external market conditions. Driven by increased financing requirements of crude oil imports, net short-term trade credit increased by US $ 17.7 billion againstUS $ 6.6 billion in the previous year. Net accretion to NRI deposits increased marginally by US $ 0.2 billion as compared with US $ 4.3 billion in the previous year.”

The latest flow data reflects the change in sentiment among foreign investors:

“Available information points to deceleration in capital flows during the current financial year so far. Portfolio investment in India recorded net outflows by FIIs amounting to US $ 6.5 billion during 2008-09 (up to July 18, 2008); on the other hand, ADR/GDR issues by Indian companies amounted to US $ 999 million during April-May 2008 as compared with US $ 16 million in the corresponding period last year. Gross FDI inflows during April-May 2008 were placed at US $ 7.7 billion as against US $ 3.8 billion a year ago. There were net inflows of US $ 292 million during April-May 2008 under NRI deposits as against net outflows of US $ 559 million a year ago. The foreign exchange reserves declined marginally by US $ 2.6 billion during the current financial year so far and stood at US $ 307.1 billion on July 18, 2008.”

These numbers just do not point toward an external crisis. The stock position is also not dire:

” India’s external debt increased by 30.4 per cent during 2007-08 and amounted to US $ 221.2 billion at end-March 2008. The increase was mainly due to ECBs and short-term borrowings that contributed around 39.5 per cent and 34.8 per cent, respectively, of the total increase of US $ 51.5 billion in external debt. Multilateral and bilateral debt registered a moderate increase. Valuation effects, reflecting the depreciation of the US dollar against other major international currencies and the Indian rupee, accounted for US $ 9.9 billion. The US dollar had a dominant share of 57.1 per cent in India’s external debt whereas rupee-denominated debt had a share of 14.5 per cent. The share of short-term debt in total debt increased to 20.0 per cent at end-March 2008 from 15.5 per cent a year ago.”

Again, not everything is right with the Indian economy: fiscal policy, monetary policy and the economic reform agenda all need attention. But I think hot money and capital flight are relatively minor concerns for India.

4 Responses to "India, External Flows and Crisis Potential"

  1. Satish   July 31, 2008 at 8:30 pm

    What could appen if oil price double from current level. That’s the single most issue concerning oil importing current account deficit countries.

  2. Nirvikar Singh
    Nirvikar Singh   August 1, 2008 at 12:20 am

    If the oil price doubles, the whole global economy is going to be in turmoil. I don’t think it will happen, unless there are severe negative political developments. India’s oil import bill in 2007-08 was USD 68 billion. A doubling of that import bill would be catastrophic for India’s external accounts. But that’s a different issue than capital flight and hot money, no? I guess a doubling of the oil price would put the IMF back in the lending business.

  3. Anonymous   August 1, 2008 at 6:35 am

    Mr Singh, so do you think Indian Stock market has hit the bottom and it won’t go down more ? I know this is difficult to predict but wanted your thoughts on it. Thanks !!

  4. Nirvikar Singh
    Nirvikar Singh   August 1, 2008 at 11:53 am

    If I could predict anything about the stock market I’d be rich. It’s probably a good bet over a 20 year horizon, based on projections of 8% annual real GDP growth, but short-term timing is beyond me.