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An update on balance of payments

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DATA DISSEMINATION: Economic Adviser to Prime Minister C. Rangarajan (left), and RBI Governor Y. V. Reddy at a National Development Council (NDC) meeting recently.
DATA DISSEMINATION: Economic Adviser to Prime Minister C. Rangarajan (left), and RBI Governor Y. V. Reddy at a National Development Council (NDC) meeting recently.

The large capital goods imports under non-oil category correlate with the heightened economic activity

The Economic Advisory Council has projected the current account deficit at 1.5 p.c. of the GDP by the year-end.

THE ECONOMIC Advisory Council to the Prime Minister recently presented an update on India's balance of payments outlook for the current year. Just days earlier, the Reserve Bank of India had released its report on the BOP for July-September, thereby bringing up-to-date the first half data. The most significant area of concern in both reports has been the widening current account deficit (CAD). However, the EAC's task was to make projections from current trends and arrive at estimates for the end of the year (March 2007), while the BOP data relate to the recent past. According to the BOP data, during the first six months, the CAD had widened to $11.7 billion from $7.2 billion a year ago. The principal reason for this was the much larger trade deficit that had gone up to $35.1 billion from $27.1 billion last year. The EAC, headed by C. Rangarajan, has projected a CAD of 1.5 per cent of the GDP by the year-end. This looks extremely positive especially in the context of the widening trade and current account deficits captured by the BOP data. But the EAC has the explanation. Its arguments go like this:

Justification

If one were to mechanically extrapolate the reported CAD for the first six months ($11.7 billion) after adjusting for seasonal variation, the figure for the whole year would be a deficit of around $20 billion or 2.5 per cent of the expected GDP ($900 billion). That would set off alarm bells even among those who would countenance a larger CAD and even go the extent of reading positive meanings into it. However, past experience with such data collection suggests that a mechanical extrapolation of past trends will lead to highly misleading results. It has been invariably the experience that provisional figures are adjusted downwards. Hence (and after applying the correction) the EAC estimates the CAD for the first half at $6.5 billion, sharply lower than the BOP figure of $11.7 billion. On this basis its estimate for the whole year comes to $13.4 billion, which translates into 1.5 per cent of the projected GDP.

Wide divergences

Could there be such sharp variations both in the past data and the extrapolated figures? The EAC has pointed out that substantial downward revisions "which have become a common feature" erode the credibility of official data. Moreover, there has been a substantial divergence between the trade data furnished by the DGCI&S and RBI. Although there has been considerable improvement here recently, the divergence remains and calls into question the credibility of official statistics. In brief, the EAC is banking on a significant revision of the official figures while arriving at its year-end CAD projection of 1.5 per cent of the GDP. Even conceptually the issue of current account balance has evoked strong opinions. Until three years ago it was in surplus. That indicated deployment of a part of our savings abroad, clearly an untenable situation for a capital starved economy such as ours. However, it was possible to view a surplus current account in a more positive way in the larger context of BOP. Unlike the situation now there was no overt dependence on certain types of capital inflows to prop up the BOP. As the current account went into deficit, principally due to a widening trade deficit, mainstream opinion has veered round to the view that it is a logical reflection of the underlying investment activity within India .Not only are most of domestic savings channelled into investment avenues within, savings from abroad are also being drawn in. As the RBI notes, many emerging economies continue to have large surpluses in their current accounts. India is clearly better off. Even the worsening trade deficit was attributed to the growth in non-oil imports as well as oil imports. The growth under the first category consisting of capital goods, intermediates and raw materials correlates with the heightened economic activity within the country. Yet, as the RBI report shows, during the first six months, there has been a deceleration in merchandise exports and imports, the former growing by 22.9 per cent compared to 34.2 per cent last year. Non-oil imports had a slower 11.5 per cent growth, and oil imports grew by 36.9 per cent, marginally lower on a year-on-year basis but still high enough to adversely impact on the balance of trade. International oil prices remained high during the first half and despite some recent softening are not expected to come down appreciably. Despite a net invisible surplus of $23.5 billion, the CAD widened sharply during the first half, according to the BOP data. Clearly there will be plenty of adjustments in the data if the EAC's deficit projections were to materialise. The EAC has made the following observations which individually and collectively supplement the optimism generated by its CAD forecast: (1) For the first time in several years net FDI at an estimated $9 billion is expected to be larger than portfolio flows. This has significant positive implications for the stability of the external sector. (2) There will be a net accretion of $22.6 billion to reserves by the end of this year. Last year's figure was $15.1 billion. (3) The ratio of total trade to GDP is projected at 35.9 per cent by the year-end, up from 32.8 per cent last year. This indicates the growing global integration of the Indian economy. If software exports too are included, (as they should) the ratio would go up to 39 per cent. C. R. L. NARASIMHAN


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