Disturbing signals

On the face of it, the recently released balance of payments (BOP) data for the last quarter (January-March) of 2007-08 do not indicate any sharp deviation from the broad trends that contributed to the external sector’s resilience in the recent past. However, a closer examination of the figures for the whole year reveals some disturbing features which, if ignored, can have a major impact on the macroeconomy. The current account deficit has shot up to $17.4 billion from $9.8 billion in 2006-07. Given the trade imbalance that is growing on the back of the ever-swelling oil import bill, the deficit was of course expected to rise, but not by as much as 77 per cent. The steep increase is disturbing for one important reason. Unlike in the past, remittances and services export earnings have not helped in moderating the deficit. However, net capital inflows, which amounted to nearly $110 billion, once again came to the rescue. The foreign exchange reserves rose by almost $92 billion in 2007-08, nearly three times the increase registered in 2006-07. The aggregate reserves have crossed the $300 billion mark. It would, however, be premature to conclude that the era of abundant foreign exchange is still with us and that no matter how rapidly the current account deficit mounts there is no cause for worry.

The factors responsible for moderating the deficit in the current account as also the composition of the capital account cannot be taken for granted. According to latest trade figures, merchandise exports grew at a much slower pace — 13 per cent in May compared to 35 per cent in April. The obvious inference is that even the sharply depreciating rupee has not helped exporters overcome the slackening demand from abroad. During the first two months of 2008-09, the trade deficit has widened to $20.6 billion, almost 50 per cent more than the $13.9 billion in April-May 2007. Earnings from exports of software and a variety of other services are expected to be less consequent on the slowdown in the United States. Capital flows, especially to the stock market, are not just slowing but are probably set on reversing direction. In the recent period foreign institutional investors have been net sellers to the tune of $6.5 billion. There seems to be no immediate threat to the BOP. There have been accretions to the already impressive reserves through the more stable foreign direct investment route. Yet there can be no doubt that external sector management is moving into a new, critical phase. With destabilising factors in sight, utmost vigilance is called for.

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