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  • : External sector: Good, but not enough!

    External sector: Good, but not enough!

    The economic survey that takes stock of the country's economic health is out and as far as the external sector is concerned, India seems to be on a strong footing. Let us look at some of the key highlights of FY06 and also delve into what the future holds for India on the external sector front.

    For the fourth year in a row, the global economy continued to expand and is expected to have grown by 5.1% in 2006, slightly higher than the near 5% growth achieved in 2005. That the world output managed to grow despite rising concerns about continuing global macroeconomic imbalances, protracted Doha negotiations and volatile international crude prices, indicates an emergence of new phase on the world economic stage. This new phase is nothing but a consistent and a broad based growth in emerging market economies, particularly in China and India, which together accounted for 40% of global growth measured in purchasing power parity terms. What more, India is being increasingly recognised as an important player in the global economic scenario.

    Among advanced economies, US, the world's largest economy continued to lead the charge with an expected growth of 3.4% in 2006. However, with the US current account deficit expanding at a fast pace, concerns regarding a sharp depreciation in dollar and the consequent rise in US interest rates have cropped up and this might lead to global recessionary trends. Hence, it is in this context that the need to correct the global imbalances should be given a priority.

    The table below highlights the GDP growth across different areas and timelines:

    GDP growth (%) 2004 2005 2006E 2007E
    US 3.9 3.2 3.4 2.9
    EU 2.1 1.3 2.4 2.0
    Japan 2.3 2.6 2.7 2.1
    CIS 8.4 6.5 6.8 6.5
    Developing Asia 8.8 9.0 8.7 8.6
    China 10.1 10.2 10.0 10.0
    India 8.0 8.5 8.3 7.3
    Russia 7.2 6.4 6.5 6.5
    World 5.3 4.9 5.1 4.9

    Source: World Economic Outlook, September 2006, IMF

    India Reserve accretion continues
    High oil prices not withstanding, India continued to add to its already impressive foreign exchange reserves in FY06. However, the current account deficit that had raised its head in FY05 after three previous years of surpluses, continued to take some sheen off the total reserve accumulation in FY06. Infact, if the 1HFY07 numbers are any indication, the trend has continued in this fiscal as well.

    Because of higher outgo on import of petroleum, oil and lubricants, imports grew rapidly in FY06, leading to sharp widening of the trade deficit. Trade deficit stood at 6.4% of GDP in FY06 as opposed to 5% in FY05. This was despite the robust growth in exports that stood at 13.1% in FY06 as opposed to 12.2% the year before. Impressive growth in net invisibles, led particularly by the software and business services segment, further helped soften the blow of higher crude oil prices and thus restricted the overall current account deficit to 1.1% of GDP or US$ 9.2 bn in FY06. As far as 1HFY07 is concerned, the figure stood at US$ 11.7 bn.

    On the capital account front, during both FY06 and 1HFY07, capital flows into India have remained strong on an overall basis. Rising foreign investment, both direct and portfolio, together with a sharp revival of inflows in non-resident deposits, in spite of the large repayment of India Millennium Deposits (IMDs) under external commercial borrowing, maintained a strong balance in the capital account, and even after financing the current account deficit, resulted in reserve accretion of US$ 15.1 bn in FY06. It is indeed heartening that India continued to be among the top nations with high levels of reserves.

    Source: RBI

    FDI: Need of the hour
    The net FDI inflows continued its growth for the second consecutive year in FY06 to climb to US$ 4.7 bn. The figure was obviously under reported owing to increased activity by Indian companies, which continued to make a splash abroad and invested almost US$ 3.2 bn in scooping up overseas assets in FY06. Further, if 1HFY07 numbers are any indication, we are in for another impressive year as there has been a 98.4% jump in equity investments into India in April-September FY07 over corresponding period previous year. This is indeed an encouraging sign, as India would need massive investments in the future, especially in the infrastructure segment as it attempts to plug the gaping hole between itself and China in so far as infrastructure is concerned. Furthermore, FDIs lend increased stability owing to their long-term nature as opposed to <>FII inflows, which can be pulled out a short notice.

    With the global economy further poised to expand in 2007, India should not have a problem in attracting capital and consequently, finance its current account deficit. However, as mentioned earlier, the current level of capital inflows are not sufficient if India were to build a world-class infrastructure and target a long term GDP growth rate in the region of 9%-10%. Hence, policies that enable and facilitate increased capital investments into infrastructure should be uppermost in the minds of the policy makers currently.

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