Three reports of the Reserve Bank of India (RBI), all released on June 27, address the key issue of external sector weakness and the threat it poses to macro-economic stability.
The Financial Stability Report (June 2013), India’s External Debt (end-March 2013) and the Developments in India’s Balance of Payments (BoP) during the Fourth Quarter (January-March 2013) assume an even greater significance than what they normally have, as purveyors of important statistics and opinions from the central bank.
Financial Stability Report
This is because of the context. As the Financial Stability Report (FSR) puts it, “(the report) is being released at a time when debate about the appropriateness, timing and pace of imminent exit from unconventional monetary policies by the U.S. is intensifying and the consequent tremors are being felt in financial markets across the globe”.
The rupee fell to record lows. In all emerging economies, there has been a big sell-off in forex, bond and equity markets.
In turn, the threat to macro-economic stability has been increasing.
Global risks and domestic macro-economic risks are reinforcing each other.
The key question is can external management, however sound and far sighted, keep global contagions away from the domestic economy?
External sector management
External sector management that has served the country so well is under stress. Even as its linkages with the domestic economy have become more pronounced.
The FSR expects financial markets in India and other emerging economies to exhibit a high degree of volatility and uncertainty.
Domestic growth has slumped and corporate performance has remained sluggish. But the biggest worry is the size of the current account deficit (CAD) and the need to finance it in a “non-disruptive” manner.
That point has been amplified in the other two reports — dealing with balance of payments and India’s external debt situation.
Balance of Payments
The report on the BOP, which is for the fourth quarter of fiscal 2013, begins with some good news: India’s current account deficit (CAD) has come down to 3.6 per cent from a historically high level of 6.7 per cent in the previous quarter (third quarter of 2012-13). That brought the whole year’s CAD to 4.8 per cent of the gross domestic product (GDP) ($87.8 billion). By any yardstick that is still a high figure. The outlook is not encouraging as the merchandise trade deficit increased during the year and invisible earnings declined. Revival in both depends on factors which are outside the control of policy-makers.
For instance, India’s exports depend on a revival in the principal markets of the U.S. and the EU. The fall in invisible earnings is partly due to the uncertainty that software exporters are facing, not least due to the difficulties in getting visas and permits in the U.S.
It is, therefore, not difficult to appreciate the grim prognosis contained in the third report — on India’s external debt at the end of last year. India’s external debt has increased by more than three times from a little over $100 billion in 2004 to about $390 billion at the end of March 2013. The proportion of short-term debt to total debt has been increasing.
Consequently, repayments are getting bunched up. By March 2014, India has to repay $172 billion, which works out to nearly 60 per cent of forex reserves. Taken together with the nearly $90 billion needed to finance the CAD, the task becomes truly daunting.
Much can be said as to why India has landed in such a mess. The causes lie in external as well as domestic factors. There has been excessive liquidity at the global level, an outcome of ultra soft monetary policies pursued by the U.S. and more recently Japan to boost their domestic economies. Plenty of it came to India. India has been guilty of encouraging Indian companies to borrow abroad, blithely ignoring the fact that neither the money nor the interest rates would last for a reasonable period. It is unfortunate but true that many corporates have ignored the exchange risk and at repayment time face huge problems.
Very briefly, the macro-economy is threatened because of the global risks, more precisely because of the very short-sighted approach of our policy-makers to those risks. That is the main message from all the three recent RBI reports.