External Sector Turbulence

What is the issue?

• India’s external sector is becoming more vulnerable and less resilient due to various issues.
• Government need to take long term measures to address the rising concerns.

What are the external sector related concerns faced by India?

• Current account deficit of India stands at $15.8 billion or 2.4 per cent of GDP.
• In the case of portfolio investments the net inflows stood at $5.3 billion but substantial net capital outflow is around $8.1 billion.
• This resulted in a depletion of $11.3 billion of the foreign exchange reserves (on a BoP basis) as against an accretion of $11.4 billion in Q1 of 2017-18.
• In aggregate, the outflows from the outstanding forex reserves over end-March 2018 till date September 2018 were $25.26 billion.

• Income elasticity of demand for India’s export has remained stagnant and, therefore, the share of India’s export remained constant at 1.7 per cent in the world export.

What are the reasons behind such concerns?

• The slide in the value of the rupee has led to rise in the current account deficit and a substantial net capital outflow.
• Persistent rise in crude price and the pressure of rising protectionism in world trade is severely affecting India’s trade.
• Protracted stagnation in competitiveness is another important factor is the movement in the Real Effective Exchange Rate (REER).
• Apart from this the firming up of the US growth rate and appreciation of the US dollar against major currencies has also brought a host of trouble to India.
• All such interlinked and collective factors have resulted in India’s external sector becoming more vulnerable and less resilient.

What measures were taken in this regard?

• Government had taken non-monetary measures like restrictions on non-essential imports like finished electronics, certain textiles, automobiles, high-end consumer products.
• Government has also removed 5 per cent withholding tax on masala bonds, removal of the foreign portfolio investor exposure limits in corporate bonds and a freer ECB regime.
• The measures taken together are expected to garner $8-10 billion.
• There are also plans to adjust the Real Effective Exchange Rate by the RBI.

What are the issues with government’s measure?

• Essentially, the measures are of two types: restriction on imports; and encouragement of debt inflows.
• Import restrictions are fine as tools for crisis management but they go against the spirit of reform.
• Further, measures like the relaxation on “masala” bonds and ECBs amount to a quick fix just to postpone the problem.
• The burgeoning CAD could not be financed in a non–disruptive manner as the net capital inflows were not adequate.
• The rise in REER in India is lower than in many economies, however those economies are not seeing such a crash in their currency value as India because they do not suffer from a high CAD.
• At a conceptual level, increase in the REER index reflects diminishing competitiveness.
• Thus, the recent measures announced by the authorities may provide some short-term relief.

What measures need to be considered?

• The sustainable solution to India’s problem is encouraging Greenfield FDI and non-oil exports such as iron and steel, non-ferrous metal, and automobiles.
• Efforts should also be made to further strengthen exports of marine products and chemicals, It is important in this regard to enhance quality-control measures.
• The trend of the direction of exports is required to be shifted towards the Middle East and North Africa, apart from the US, China and the EU.
• This is the long haul, and this requires clear policies and prioritisation at India’s end.

Source: Business Line