At the end of March the Reserve Bank of India released its preliminary balance of payments statistics for the third quarter of 2009-10. This permits an assessment of the performance of India’s external account during the April-December 2009 period when the global downturn had been moderated, stalled and possibly reversed. The news is both bad and good. The bad news is that this was the period when India was hit hard on the export front, with merchandise exports falling from around $150 billion to a little less than $125 billion. In addition, the receipts from the exports of miscellaneous services other than software services, consisting largely of business and outsourcing services of various kinds that have been buoyant in recent years, have fallen sharply from $24.5 billion to $12.8 billion.

The good news is that the effects of these developments have been neutralised by three other trends. To start with, imports have fallen even more than exports in absolute terms because of the slowdown in growth in India, so that the trade deficit during the April-December 2009 was, at $89.5 billion, significantly below the $95.4 billion recorded in the previous year. While this is no cause for celebration it does help dampen the impact on the balance of payments of the export slowdown. The second bit of good news is that the exports of software services, which amounts to one and a half times revenues from non-software service exports and more than a quarter of merchandise exports, fell by only 1.7 per cent during this nine-month period, moderating the decline in aggregate export revenues. Finally, belying all pessimistic expectations, remittances or receipts through private transfers rose from $37.5 billion during April-December 2008 to $40.8 billion during April-December 2009. Two factors possibly accounted for this development. First, the muted impact of the recession on India’s software exports may have been replicated in the case of software workers providing services onsite based on H1B visas. This would have sustained remittances from the dollar area that have significantly increased their share in aggregate remittances in recent years. Further, parts of the Gulf region were adversely affected by the crisis with attendant implications for employment of expatriate Indian workers. The transfer of their saving on return may have neutralised the effect of the fall in remittances of employed workers.

In the event, net receipts from what are termed “invisible receipts” fell by around 16 per cent and the deficit on the current account of the balance of payments increased by a manageable $3 billion from $27.5 billion to $30.3 billion. What is disconcerting is that this comforting outcome at the end of a period when the effects of a deep global crisis were being felt is now posing problems for the country. This is because of the surge in capital flows that is far in excess of the sum required to finance the small increase in the current account deficit. Balance of payments data indicate that net portfolio investment inflow during April-December 2009 amounted to $23.6 billion, as compared with an outflow of 11.3 billion during the crisis months of April-December 2008. This trend has since continued. According to figures from the Securities and Exchange Board of India, as of April 11, net investments by FIIs in debt and equity markets amounted to an additional $10.1 billion, during 2010.

This surge in capital inflows is explained largely by developments on the supply side. India is one of the countries that have been chosen as favoured destinations by financial investors seeking to exploit the cheap liquidity that developed country governments have pumped into the system in response to the financial crisis. In fact, like many other emerging markets, India is becoming a victim of the dollar carry trade, in which international players borrow in dollar markets, where liquidity is ample and interest rates are low because of anti-crisis measures, and invest in equity, debt and real estate in emerging markets, where returns are much higher, in order to profit from the differential between the cost of debt and the return on investment. This is a game that seems to especially attract international financial firms seeking to quickly recoup the losses they suffered in the recent recession.

One consequence of the resulting large capital inflow is the recent appreciation of the rupee. Standing at Rs. 44.4 to the dollar at the beginning of the second week of April, the rupee had appreciated by more than 13 percent vis-a-vis the dollar over the preceding 13 months. A corollary of such rupee appreciation is of course a weakening of India’s export competitiveness because the dollar values of the country’s exports rise as the rupee appreciates. Within the current policy framework the only way in which this can be neutralised is through open market intervention by the Reserve Bank of India to buy up foreign exchange, relax the upward pressure on the value of the rupee and stall its appreciation. But this would involve further loss of control over the monetary lever that possibly explains the hesitant response of India’s central bank.