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Business
Policy options on rupee value
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With reserves continuing to mount, it is becoming difficult for the RBI to continue buying dollars in a non-inflationary manner, says Abhijit Roy.
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THE RESERVE Bank of India has recently come out with the details of the country's Balance of Payments position during the financial year 2002-03. Given the background of surging foreign exchange reserves, the BoP position is sound, but it is instructive to go beyond the overall numbers.
Current Account
As seen from Table I, the overall current account surplus during the year was $3.7 billion as compared to $800 million during 2001-02. The main points to be noted in this connection are:
The deficit on merchandise exports and imports was at $12, 474 billion. This is in spite of the fact that exports were up 18 per cent, while imports showed a growth of 13.6 per cent over the previous year. Overall, the trade deficit was $12.7 billion during the previous year.
The net earnings from invisibles were $16.2 billion, up from $13.5 billion during the previous year. The rise was mainly on account of software exports of $9.6 billion and private transfers of over $14 billion.
The net deficit on account of investment income was nearly $5 billion, representing payouts from India to foreign investors/ lenders.
Capital Account
Table II provides details of the capital account surplus of $12.6 billion. The surplus during 2001-02 was $10.6 billion.
Foreign direct investment (FDI) into India was down from $6.1billion in 2001-02 to $4.7 billion during 2002-03. FDI abroad by Indian companies was down from $1.4 billion to $1 billion during the same period. Net portfolio investment also showed a downward trend from $1.9 billion to $900 million.
Foreign currency loans, comprising mainly external assistance from multilateral financial institutions and commercial loans, showed a net outflow of $3.2 billion.
Net inflows under non-resident deposits at $2.8 billion were at about the same level of increase as in the previous year.
Net inflows under banking capital, excluding NRI deposits, were at a high $5.4 billion.
Other capital accruals amounted to $3.5 billion, mainly explained by RBI to be because of leads and lags in export receipts ($3.2 billion).
During 2002-03, the current account balance showed a surplus of $3.7 billion and the capital account a surplus of $12.6 billion. Including errors and omissions, the overall BoP surplus was 17 billion. However, foreign exchange reserves witnessed a growth of $20.8 billion. The difference of $3.8 billion is explained by the depreciation of the U.S. dollar vis-à-vis the other major currencies making up India's forex reserves.
The growth in reserves has been accompanied by substantial intervention in the market by the Reserve Bank of India. Cumulative net purchases in dollar terms during 2002-03 by RBI amounted to $15.7 billion or Rs. 75, 660 crores. Fortunately, the effect of the resultant increase in money supply on inflation has been limited. In fact, the net inflows have enabled the Government to finance in a comparatively non-inflationary manner its high fiscal deficit. This was also possible because of lack of sufficient demand in the system.
The foreign investment scenario during 2002-03 was quite disappointing, with all the major components showing a decline over the previous year. Further, the net position on account of loans was negative, thus providing another indication of insufficient investments by the corporate sector. The government however took the opportunity provided by the buoyant reserves to repay about $3 billion worth high cost loans during the year.
Perhaps the main contribution to growth in reserves during the year came from NRIs, in the form of net transfers as well as deposits. It is difficult to quantify the amount that flowed in on account of higher interest rates in India. The RBI is of the opinion that the quantum of such arbitrage seeking flows is low. The interest shown by FIIs in recent months seeking an enhancement of the debt cap of $1.5 billion shows that there is substantial interest in investing in Indian debt instruments. It should also be remembered that given the falling value of the dollar, there is scope for both covered and uncovered interest arbitrage.
With reserves continuing to mount, it is becoming difficult for the RBI to continue buying dollars in a non-inflationary manner. There are two basic approaches that the RBI/ Government could take. The first is to allow the rupee to find its level over the medium/ long term. This argument states that export performance may not only be a function of cheap exchange rate policy, but also competitiveness in terms of productivity, quality, delivery schedules and other conducive factors. Table III shows that during 2002-03, the rupee appreciated against the U.S. dollar but depreciated against the other major currencies. A major portion of India's trade is denominated in U.S. dollars, and in spite of the appreciation of the rupee against the dollar, exports went up by 18 per cent during the year.
The other option is to keep the rupee value low but reduce import duties and encourage more imports. This would be opposed by domestic producers, but may increase investment and GDP growth, while protecting exporters. It is not easy for policy makers to resolve the often conflicting demands posed while managing inflation rates, interest rates and foreign exchange rates.
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