With GDP figures pointing to a return of the era of 9 per cent growth, little attention is being paid to a disconcerting feature of India’s external payments position. Taking a long view, we find that the current account deficit on the balance of payments which fell from 3.4 per cent of GDP in crisis year 1990-91 to 0.6 per cent in 2000-01 (and even turned to surplus in the subsequent three years) has now widened from a marginal 0.4 per cent of GDP in 2004-05 to 3.3 per cent in 2009-10. This widening of the current deficit is on account of two factors. First, the merchandise trade deficit in India’s external account has risen from 2.3 per cent of GDP in 2002-03 to 10 per cent in 2009-10. And, second the year 2009-10 has seen a sudden decline in revenues from services, which fell from 4.6 per cent of GDP to 2.9 per cent of GDP. Matters would have been much worse if remittances as reflected in the Private Transfers figure had not remained at high levels.
It is true that in the short run these developments need not provide much cause for worry since India is once again receiving inflows of foreign capital that far exceed what is needed to finance its current account deficit. Foreign exchange reserves too are in excess of $280 billion, providing more than an adequate buffer. There is no fear whatsoever of a 1991-style balance of payments crisis.
But the figures do point to a long term syndrome that must colour the otherwise bright picture of the country’s economic performance. Ever since India opted for its first big IMF loan in 1981 in the aftermath of the second oil shock, increased dependence on foreign capital inflows has been justified on the grounds that they provide India the wherewithal to transform its economic structure and redress what is its long-term weakness: poor export performance. Capital flows it was argued would: (i) allow the country to liberalise trade and subject domestic economic agents to efficiency-enhancing international competition; (ii) permit Indian firms to access the foreign exchange needed to import the capital and technology required to modernise their equipment and establish internationally competitive capacities that would allow them to compete in export markets; (iii) bring with them international producers intent on using India as a base and source for production for the world market; and (iv) finance any “interim” deficit that may result from an import surge that follows trade liberalisation but precedes India’s transformation into a successful exporter.
What the long-term tendency in the merchandise trade deficit indicates is that close to two decades after the programme of accelerated liberalisation was adopted, these expectations have remained unrealised. India has been successful as an exporter of workers who send back remittances and as an exporter of services of various kinds, but has failed miserably in its original effort to become a hub for the export of manufactures. In fact, periods when the merchandise trade deficit was low were ones in which low growth or recessionary conditions were resulting in curtailed imports rather than years in which exports were booming. It was only because of the country’s “invisibles” income from remittances and services that the current account deficit for much of this period was kept low. Yet the deficit implies that India’s comfortable foreign reserves are borrowed and not earned
As the accompanying Chart shows, the period from 2004-05 when India has moved on to a high growth trajectory of between 8 and 9 per cent is a period when the merchandise trade deficit has widened quite sharply. This did not matter too much till recently since remittance incomes were sustained, while incomes from the exports of miscellaneous services (including, IT, IT-enabled and business services) were rising significantly. It was when the latter dipped in 2009-10 that the current deficit widened to levels that could be a cause for concern.
The change is of concern also because of the likelihood that remittance incomes may also dip. It has been known for long that the Gulf countries (which fall in the “Sterling area”) are no more the principal or dominant source of remittances. Since the mid-1990s that position has been acquired by countries in the “Dollar area”, especially the United States. This is because of the rising volume of remittances from temporary workers on H1 B visas, who move for relatively short periods to deliver services onsite in the United States. The recent controversy over the H1 B visa fee, which has been doubled, indicates that official hostility to such workers may be on the rise and onsite service delivery is likely to prove more expensive. If that results in a dip in remittances from the dollar area even while higher growth increases India’s import bill and widens its merchandise trade deficit, the current account deficit could become even larger. That may then give actual cause for concern and affect even India’s position as a favoured destination for the foreign investor. There is no visible crisis here, but a worrisome weakness maybe.