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  • : External sector: Reserves pile on

    External sector: Reserves pile on

    The year 2007 was yet another year, which was marked by growth across both emerging as well as developed economies and a relatively stable political environment. This in turn led to a quantum jump in net private capital inflows in most of the emerging market economies. Infact, they grew by a huge 124% YoY, posing adjustment problems in these economies.

    As far as the Indian external sector is concerned, it continued to post a deficit both on the trade as well as the current account front in FY07. However, higher commercial borrowings and foreign capital investments ensured that the forex reserves continued to swell, rising by an impressive US$ 36.6 bn as against US$ 15 bn in the preceding financial year.

    Let us first have a look at how the economy performed on the current account front during the year under consideration. Here, consistent with the historic trend, a trade deficit was witnessed as imports exceeded exports by US$ 63 bn. As India continued to depend on import for most of its energy needs, a high crude oil bill or what is popularly known as the POL imports continued to exert the maximum pressure on the trade deficit. Apart from this, rising gold prices also played an important role in pushing up the total import bill. As far as exports are concerned, although they witnessed an impressive 22% growth, they were not able to stop the trade deficit from widening to US$ 63 bn as against US$ 52 bn during FY06.

    While trade deficit swelled, there was a minor contraction in current account deficit over previous year, thanks mainly to robust growth in invisibles (IT an ITES, travel, transportation, financial services etc) and private transfers. On private transfers, as per a world bank report, India topped the countries that received remittances. Thus, strong growth in these invisibles enabled the economy to whittle down the overall current account deficit to US$ 9.8 bn.

    On the capital account front, India continued to emerge as a favorable destination for both FDI as well as portfolio investments, registering net foreign investments to the tune of US$ 15.5 bn, almost same as the year before. However, unlike FY06, where portfolio investments or the so called 'hot money' formed a major component of this inflow, in FY07, FDI accounted for more than 50% these inflows, a trend that signals increased confidence in India as a favored long-term investment destination. Among other form of capital inflows, commercial borrowings grew the most, registering a more than six fold jump and along with net foreign investments playing a crucial role in helping swell the capital account by US$ 46 bn. Thus, the current account and capital account combined together have eventually resulted in the Indian forex reserves growing by a strong US$ 36.6 bn during FY07.

    As far as exchange rates are concerned, with the demand for foreign exchange not keeping pace with supply, the rupee appreciated against other major currencies in the months of April and May 2007. However, in the later months, barring the dollar, it depreciated against other major currencies.

    If the first six months of the current fiscal are any indication, trade deficit is expected to widen further as crude prices have been going through the roof. Exports especially of the merchandise kind are likely to slow down in view of the lower projected global GDP growth, thus putting further pressure on the trade balance. On the capital account front, the current sub prime mess might result into more robust inflows as the monetary authorities try to make good the huge losses. On the other hand, reversal of sentiments might result in some moderation. Notwithstanding these short term hiccups, liberalization of the capital account should continue as it will not only foster competition but also improve the quality of financial intermediation and help bring some rigor to the domestic policies so that they are kept in tune with structural realities.

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