India’s external account faces several structural issues that needs to be addressed.
What are the recent happenings?
The rupee became the worst performing Asian currency recently.
This was attributed to the rising interest rates of the developed countries from near-zero levels, which led the exit of portfolio investors from emerging markets.
Also, emerging market currencies have been declining relative to the dollar with increased demand for dollars to finance oil imports.
India has been placed among the group of countries whose currencies were particularly vulnerable.
India’s current account deficit(CAD) has been widened from $14.4 billion in 2016-17 to $48.7 billion in 2017-18.
There are also projections that CAD will at 2.6 per cent of GDP in 2018-19.
What are the structural weaknesses?
Oil Imports - India’s net petroleum products import bill which stood at $83 billion in 2015-16, has risen to touch $109 billion with the rise in international price of Brent crude.
This made the trade deficit has risen by around 50% in 2017-18 to touch $162.2 billion.
But, given the multiple, technological and geopolitical factors affecting oil prices, such volatility will always prevail.
So, ensuring balance of payments resilience requires an ability to ride through periods of high oil prices, without further fall in rupee value.
Balance of trade - India was the largest recipient among developing countries of remittances from abroad and a highly successful exporter of software and IT-enabled services.
This should have boosted the receipts and enabled India to have a strong and resilient current account.
But the total of receipts from private transfers and from net exports of Telecom, Computer and Information Services either stagnated or declined since 2014-15.
Hence neutralising the increase in revenue outflow in the trade balance through additional forex is getting difficult.
Revenue neutralisation - Imports of IT and electronics goods is now matching or exceeding receipts from software and IT-enabled exports.
This is reflected in the fact that the value of imports of Electronic Goods within the Capital Goods Category stands at 70% in 2017-18 of the receipts from net exports of Telecom, Computer and Information Services.
Moreover, demand from both the government and the private sectors has arisen for such products with India holding less leverage in the domestic production of such products.
This has undermined the role of IT-enabled services exports as a source of forex earnings that can make the balance of payments more resilient.
Capital outflow – The RBI says that the net outflow of portfolio capital amounted to $8.1 billion in the first quarter of 2018-19, as compared with an inflow of $12.5 billion in the corresponding quarter of the previous year.
RBI’s open market operations, designed to provide some backing to the rupee, drained India’s forex reserves, which fell by $25 billion from its recent peak of around $425 billion.
What lies ahead?
Given these structural weaknesses in the current account, India is deeply vulnerable when faced with outflows of investment on the capital account.
The rupee’s recent depreciation had initially been dismissed as reflecting global developments that affected all emerging markets, and not just India.
Thus, rather than just attributing shifts in monetary policy in the advanced nations as a reason, India should also focus on the structural weaknesses in its external account to address rupee volatility.
