Is the external sector resilient?

Last month, the RBI released key datapoints that throw light on the external sector for 2022-23, in terms of Balance of Payments (BoP), external debt and the international investment position (IIP). While these documents present the factual developments, the Reserve Bank’s annual report released before these, on May 29, 2023, gave an analytical assessment of the external sector. More recently (on July 05, 2023), the RBI “Report of the Inter-departmental Group (IDG) on Internationalization of INR” examined the prospects of internationalisation of the Rupee and recommended a roadmap to achieve the same. 

Current account deficit, volatile capital flows and data dissemination issues have to be closely watched

The releases and data throw up several issues, broadly under two heads (A) analytical issues and (B) data dissemination concerns. The analytical issues include (i) sustainability of the current account deficit, (ii) financing of the current account deficit in a non-disruptive manner, (iii) net capital outflows, (iv) pressure on foreign exchange reserves, (v) short term debt on residual maturity, (vi) net external liabilities position and (vii) rupee as a vehicle currency (a globally accepted currency for public and private international transactions, much like the US dollar is today).

Key concerns on data dissemination relate to (i) unexplained items in secondary income and (ii) focus on the data presented in the Balance of Payments Manual 5 (BPM5) format, particularly ‘invisibles’ misleading the cross-country comparison as most of the countries do not publish external sector data in terms of BPM 5.

Because of the volatile capital flow there is pressure on the foreign exchange reserve built up, leading to vulnerability in the external debt position

The current account deficit as a proportion of the GDP was 2 per cent (US$ 67.01 billion) in 2022-23. At this level, the CAD could not be financed in a non-disruptive manner as net capital flows at US$ 58.94 billion were lower than the CAD. Thus, on a BoP basis, there was depletion in foreign exchange reserves to the tune of US$ 9.1 billion. This raises questions on the sustainability of CAD. Similarly, on an earlier occasion, during 2018-19 when the CAD-GDP ratio was 2.12 per cent, there was a depletion of reserves on BoP basis in the order of US$ 3.34 billion because net capital flows could not fully finance the CAD.

During 2022-23, the net capital flow (gross capital flow of US$ 672.55 billion and repayment of US$ 613.61 billion) amounted to US$ 58.94 billion. It is important to note that 47.7 per cent (US$ 28.1 billion) of the net capital flows were on account of debt flows. Debt capital flows contributed to higher liabilities in the international investment position as the share increased to 50.2 per cent as on end-March 2023 from 49.1 per cent at end-March 2022. Furthermore, the total external debt as on end-March 2023 stood at US$ 624.7 billion. It is important to note that the ratio of foreign exchange reserves (US$ 578.5 billion) to total external debt was 92.6 per cent. The share of short-term debt on residual maturity (i.e., debt obligations that include long term debt by original maturity falling due over the next twelve months and short- term debt by original maturity) at US$ 274.4 billion accounted for 43.9 per cent of the total external debt and 47.4 per cent of foreign exchange reserves.

China’s foreign exchange reserves at the end of June 2023 stood at US$ 3.193 trillion, which is nearly five times higher India’s forex reserves

In this context it is pertinent to note that because of the volatile capital flow there is pressure on the foreign exchange reserve built up, leading to vulnerability in the external debt position. This is because foreign exchange reserves depleted by US $ 28.9 billion as on end March 2023 as against an increase in external debt.

The RBI study on “Interest Rate Sensitivity of Capital Flows: The Indian Experience” (Box II.7.2, page 89, RBI Annual Report 2022-23) has concluded that the  interest rate differential is an important factor in influencing portfolio, trade financing, banking capital and external commercial borrowings flows but not the overall gross capital inflows to India. It is important therefore to build up reserves more through equity particularly through foreign direct investment. Net FDI inflows at US$ 28.0 billion in 2022-23 were lower than US$ 38.6 billion in 2021-22.

The unsustainable current account deficit, volatile capital flows with predominance of debt flows, pressure on building of foreign exchange reserves, and the  downside risks from external debt in terms of residual maturity question the resilience of  India’s external sector. It is important to assess the RBI’s recommendations of the inter-departmental group on Internationalisation of INR in addition to the external sector vulnerability. We have to assess the macroeconomic fundamentals also in this context.

Fiscal deficit accompanied by higher revenue deficit has been above the FRBM target (3 per cent of GDP each for central government and state government) for many years. For e.g. according to the Controller General of Accounts (CGA), the fiscal deficit as a proportion of the GDP stood at 6 per cent for fiscal 2022-23. Our economic growth (real GDP growth) for 2023-24 is projected at 6.5 per cent (RBI’s projection, Governor’s statement June 08, 2023). At this level of economic growth, India is much below its potential growth of 7.5 to 8 per cent. Inflation measured in terms of consumer price index is projected by RBI at 5.1 per cent for 2023-24, which continues to above the 4 % target mandated in the flexible inflation target( FIT) and questions the objective of  price stability .

In the above context, it is important to mention that the RBI’s inter-departmental group has observed that “…over the longer term INR would be preferred by other economies as a vehicle currency and the group has recommended that efforts should be made for the inclusion of INR in IMF’s SDR bracket”. The report offers a comparison of India with China, a meaningless exercise because the economies being compared are not really comparable. China’s foreign exchange reserves at the end of June 2023 stood at US$ 3.193 trillion, which is nearly five times higher India’s forex reserves. Any reference to the long-run is generic and vague. As Keynes put it: “In the long run, we are all dead.”

Since some thinking is on in the RBI for internationalisation of INR, the data dissemination by RBI should be relooked and revisited. Let us turn to data dissemination concerns. The RBI in its press release publishes two sets of data following the IMF’s balance of payments manual 5 and 6. Two sets of data create confusion, particularly in the context of “analysis of invisibles” which is a part of BPM 5. Since internationally almost all countries have switched over to BPM 6, RBI may relook and revisit data dissemination with two sets of data.

The second aspect is in connection with dissemination of secondary income data. Personal transfers (current transfer between resident and non-resident households) mainly represent secondary income. Workers’ remittances are a component of personal transfers. While the press release of RBI presents the data on workers’ remittances, the time series data released by RBI in the handbook of statistics on the Indian economy does not provide this data. Furthermore, for 2022-23, the personal transfer’s data (net) amounted to US$ 101.776 billion out of which workers’ remittances stood at US$ 63.227 billion. Thus, nearly US$ 37 billion remained unexplained. These are concerns that the data released by RBI must answer.

To conclude, on the surface though external sector developments look resilient, a deeper study unfolds many weaknesses including concerns on data dissemination. In the context of promoting INR as a vehicle currency, it is important for us to rethink whether our external sector is resilient enough.

(The writer is a professor at the Gokhale Institute of Politics and Economics, Pune and former central banker. Views are personnel)