EDITORIALS

Deteriorating Balance of Payments
The Indian economy needs to overcome its abject dependence on foreign finance.
odafone seems to have friends in high places – two distinguished lawyers, one the union minister of law and justice, who is also the minister of communications and information technology, and the other, the union minister of finance. How else can one subvert a law without challenging it in a court of law? The two worthies, Kapil Sibal and P Chidambaram, have justified conciliation in the Rs 11,200 crore valid tax demand on Vodafone in the cause of promoting foreign direct investment (FDI). Why is the government bending backwards to appease foreign investors such as Vodafone? More recently, Chidambaram, together with his counterpart in the Ministry of Commerce and Industry Anand Sharma, and with the support of Prime Minister Manmohan Singh, is pushing the case for a significant hike of the permissible upper limits of FDI in a whole host of businesses, from armaments production to telecom, banking, pensions and insurance, even a further hike in the upper limit for multi-brand retail. A committee headed by the economic affairs secretary, Arvind Mayaram, duly obliged by recommending what his boss wants, just like the Parthasarathi Shome panel had done in its recommendations on “general anti-avoidance rules”. Why this desperation for FDI, one might ask? In a bid to boost “investor confidence”, Manmohan Singh and the two other members of the economics triumvirate, Chidambaram and Montek Singh Ahluwalia, called in all the ministers concerned with the infrastructural sectors – power, coal, railways, roads, shipping and civil aviation – to set out a target to roll out projects worth Rs 1.15 lakh crore in public-private partnerships by the end of the calendar year. The sharp depreciation of the rupee since August 2011, and especially over the last two-to-three months, to touch a low of Rs 60.76 to the dollar on 26 June has unnerved North Block and Mint Street. The month of June witnessed a net outflow of foreign institutional investment of $7.2 billion, of which $5.4 billion was from the debt market. Explanations from the mandarins in the Union Ministry of Finance and the Reserve Bank of India are only half-truths. The story doing the rounds is that the depreciation of the rupee is the result of an indication from the Federal Reserve Chairman Ben Bernanke that the Fed will go slow on its hitherto purchases of huge quantities of bonds, and thus its easy money policy and historically low interest rates. In the context of stagnation in the developed capitalist economies, international financial players have been borrowing cheap in the dollar markets and investing in the equity, debt and real estate markets of the emerging economies to earn huge premiums over the cost of such debt. But now, in anticipation of 8

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tight money policy and higher interest rates at home, as indicated by the Fed, these financial players are withdrawing part of their investments in the emerging economies to meet their domestic liquidity requirements. The original financial inflows had propped up the rupee, but now the sudden outflow has led to a precipitous fall in its value. But how does one account for the decline in the value of the rupee since August 2011, albeit with some short episodes of appreciation in-between? The US Federal Reserve was then persisting with its policy of quantitative easing (easy money and historically low interest rates), with Brazil even accusing it of indulging in a currency war to deter imports from the emerging economies. The downward pressure on the rupee is really a result of India’s weak balance of payments (BoP). On the merchandise trade front, import liberalisation, including that of gold, and increasing price-inelastic petroleum, oil and lubricants imports – all this when exports were/are severely constrained by demand in the developed capitalist countries – led to increasing merchandise trade deficits. As regards invisibles, there has also been a deceleration of services exports, even as investment income payments have soared and net remittances from overseas Indians have moderated. As a result, the current account deficit has widened, from 4.2% of the gross domestic product (GDP) in 2011-12 to 4.8% of the GDP in 2012-13. As regards the capital account of the BoP, net FDI has in fact fallen in 2012-13 as compared to the previous year, but this has been more than made up by the increase in foreign portfolio investment, non-resident Indian deposits and shortterm credit and advances in the same period. Indeed, despite the fact that net inflows on the capital account increased from $80.7 billion in 2011-12 to $85.4 billion in 2012-13, and overall, there was an accretion of $3.8 billion in India’s foreign exchange reserves in 2012-13, the rupee continued to depreciate. The weakness of the rupee is a reflection of the fundamental weakness in the current account of India’s BoP. Is the resumption of steady and high net FDI inflows, as North Block and Mint Street seem to believe, the solution to the problem? The rising flow of dividends and interest payments over the last decade should be a pointer to the fact that with the rise of the stock of inward foreign investment, both of equity and debt, dividend and interest payments on the current account of the BoP are bound to increase, and with the export of goods and services faltering, the BoP will steadily deteriorate. Reduction of the country’s dependence on foreign finance seems to be part of the solution to India’s BoP problem, but this is the last thing that the mandarins in North Block and Mint Street want to hear.
july 13, 2013 vol xlviII no 28
EPW Economic & Political Weekly

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