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External sector: What decoupling? - Views on News from Equitymaster
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  • Jul 2, 2009

    External sector: What decoupling?

    India and other emerging markets were not affected in the early stages of the global financial crisis in late 2007. This had given rise to the 'decoupling theory'. But the crisis hit home last year. A slowdown in global demand and reduced access to global credit had an impact on India's external sector in the form of declining capital flows. In fact, capital flows to emerging economies as a group declined from a peak of US$ 618 bn in 2007 to US$ 109 bn in 2008. The trend is likely to continue, as an estimated US$ 190 bn will flow out from emerging economies this year.

    Both capital and current accounts of the balance of payments (BoP) were affected. Initially, the capital account was affected as foreign institutional investors led portfolio flows out of India. After September 2008 though, it was the current account that suffered as exports slowed down.

    Capital account flows
    Capital account flows include equity flows in the form of foreign investment (foreign direct investment -FDI - and portfolio investment), and debt flows in the form of loans and banking capital. Net capital inflow during 9mFY09 was US$ 15 bn (US$ 108 bn in FY08).

    FDI is considered to be the most attractive type of capital flow for emerging economies as it brings along the latest technology and enhances production capabilities of the economy. In 9mFY09, FDI into India was US$ 27 bn (US$ 20 bn in 9mFY08). High FDI inflows reflect India's status as an attractive investment destination due to the ongoing liberalisation, economic and political stability and growth opportunities. During this period, FDI out of India was US$ 12 bn in 9mFY09 (US$ 13 bn in 9mFY09). FDI outflows reflect the growing competitiveness of Indian corporates.

    Global FDI flows: India shines in a sluggish environment
    Rank Countries 2007 2008 Growth rate
    1 USA 232.8 320.9 38%
    2 France 158.0 126.1 -20%
    3 UK 196.4 96.8 -51%
    4 Belgium 70.0 94.2 35%
    5 China 83.5 92.4 11%
    6 Russia 52.5 70.3 34%
    7 Spain 68.8 65.5 -5%
    8 Hong Kong 59.9 63.0 5%
    9 India 25.1 46.5 85%
    10 Brazil 34.6 45.1 30%
    11 Sweden 22.1 40.4 83%
      World 1,940.9 1,658.5 -15%
    Source: United Nations Conference on Trade and Development

    In debt flows, net external commercial borrowings (ECBs) slowed down to US$ 7.1 bn in 9mFY09 (US$ 17.4 bn in 9mFY08) mainly due to liquidity crunch in the developed economies.

    On an overall basis, capital account balance during stood at US$ 16 bn during 9mFY09, down 81% from US$ 83 bn during 9mFY08.

    Current account flows
    Current account flows includes merchandise (export and import) and invisibles. In 9mFY09, India's merchandise exports grew by 17.5% on a YoY basis (23% in 9mFY08) driven by engineering goods and petroleum products. Imports grew by 30.6% YoY during 9mFY09 (28% in 9mFY08) on the back of oil imports. Due to higher imports and lower exports, trade deficit (exports minus imports) stood at US$ 105 bn during 9mFY09, which was 12% of the GDP during the period.

    The surplus on the invisibles has traditionally helped in compensating for the high trade deficit and keeping the overall current account deficit in check. Software services have played a key role in this. They continued to do so with a growth of 28% in 9mFY09.

    Selected indicators of the external sector (as a % of GDP at current market prices)
    Items FY04 FY05 FY06 FY07 FY08 9mFY08 9mFY09
    Exports 11.1 12.2 13 14.1 14.1 13.5 15.2
    Imports 13.3 16.9 19.4 20.9 21.9 21.8 27.1
    Trade balance -2.3 -4.8 -6.4 -6.8 -7.8 -8.2 -12
    Invisibles balance 4.6 4.5 5.2 5.7 6.3 6.4 7.8
    Goods & services balance -0.6 -2.6 -3.6 -3.6 -4.6 -4.7 -7.7
    Current account balance 2.3 -0.4 -1.2 -1.1 -1.5 -1.8 -4.1
    ECBs -0.5 0.7 0.3 1.8 1.9 2.1 0.8
    Foreign Direct Investment (net) 0.4 0.5 0.4 0.8 1.3 0.8 1.7
    Portfolio Investment 1.9 1.3 1.5 0.8 2.5 4 -1.3
    Total capita Account (net) 2.9 4.1 3.1 5.1 9.3 9.8 1.8
    External debt 17.8 18.5 17.2 17.9 18.9 24.5 26.2
    Source: Economic survey 2008-09

    What came to India's rescue?
    The following factors helped the Indian external sector during 9mFY09:

    • Lower oil imports bill due to decline in the global crude prices.
    • Remittances and receipts from software services grew on a YoY basis.
    • Net FDI flows more than doubled to US$ 15.4 bn.
    • The cushion of foreign exchange reserves.

    The outlook for external trade from India is not very encouraging for 2009 as import demand has been showing a falling trend from our major trading partners. There is also the worry of protectionist measures originating from these countries. However, recovery is expected in 2010.

    The Economic survey recommends fundamental policy changes. For trade it recommends measures such as:

    • Reduction in customs and excise duty to make Indian exports competitive
    • Streamlining of existing export promotion schemes
    • Giving special attention to export infrastructure
    • Weeding out unnecessary customs duty exemptions
    • Rationalising the tax structure
    • Checking the proliferation of SEZs

    For services it recommends including 'services' in negotiations in different regional and bilateral trading arrangements. It also recommends measures such as domestic regulations for:

    • Licensing requirements and procedures
    • Qualification requirements and procedures
    • Technical standards
    • Regulatory transparency



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