The Reserve Bank of India (RBI), in its bulletin issued on August 11, had published the detailed analysis of Balance of Payments (BoP) for 2010-11, along with Q4 data and the outstanding external debt position for that period.
One of the important features in the BoP article is that the data were presented in conformity with the latest Balance of Payments Manual 6 (BPM 6) of the International Monetary Fund (IMF).
This development is an important milestone in the history of BoP compilation, as India's BoP data dissemination is now in line with international best practices.
Against the above backdrop, here's a look at some of the features of the new method, followed by downside risks to the external sector.
NEW METHOD
Two important features of the new method are (a) the discontinuation of the concept of ‘Invisibles' in the Current Account and (b) the introduction of Financial Account and a new concept of Capital Account (instead of the old Capital Account). The Current Account now covers Goods and Services, Primary Income and Secondary Income. It may be noted that Goods in the new method corresponds to Merchandise in the old one. Items under Services mostly remain unchanged. The Transfer and Income categories were discontinued, and two new concepts — Primary Income and Secondary Income — were introduced.
The former covers mainly investment income and compensation to employees, which were included under Income in the old classification. The latter covers mainly private transfers (primarily workers' remittances).
While the Finance Account mostly covers the old Capital Account, the new Capital Account includes credit and debit transactions under non-produced, non-financial assets and capital transfers between residents and non-residents.
Thus, acquisitions and disposals of non-produced, non-financial assets, such as land sold to embassies and sale of leases and licences, as well as transfers which are capital in nature, are recorded under this account.
Two erstwhile Capital Account items — External Commercial Borrowings (ECBs) and Non-Resident Indian (NRI) deposits — were included under Finance Account, under the heads Loans (other sectors) and Currency and Deposits (deposit-taking corporations, except central banks).
Apart from providing details in Finance Account, it helps in better compilation of national account statistics, with the help of more disaggregated items in the external sector accounts.
SOME SUGGESTIONS
The RBI is one of the few central banks that has been compiling BoP since 1948; as such, its expertise is beyond question. However, here are a few suggestions for the RBI's consideration.
First, the RBI may revisit the figures and concepts set out in Table 10 of the BoP article under the head ‘Details of Other Receivables/Payables (Net)'. In this category, for the financial year 2010-11, the amount of net funds held abroad, at $4 billion, is not in conformity with the conventional wisdom of fund management, in keeping funds abroad at very low interest rates.
Similarly, the advances received, pending issue of share under Foreign Direct Investment (FDI), at $9 billion, is inconsistent with the FDI regulation of investing within 182 days.
Furthermore, items such as Derivatives and Hedging were shown as zero in their respective places. Therefore, it could be assumed that there is no figure under these heads. More important, items such as Migrant Transfer and Other Capital Transfer could now well be covered under the new head Capital Account. The RBI should avoid mechanical postings of these figures.
Second, the gap in the import data between the Directorate-General of Commercial Intelligence and Statistics (DGCI&S - Customs data) and RBI (banking channel) is alarmingly large, at $28.3 billion. The data gap was also higher during 2009-10 and 2008-09 at $12.2 billion and $9.7 billion, respectively.
Third, the leads and lags in export data mainly represent the gap between data reported by the RBI and DGCI&S. These leads and lags need to be bridged during a year. But their continuation for a longer period has implications on the magnitude of current account deficit, which is a policy variable for economic growth.
DOWNSIDE RISKS
The data released by the RBI reveal some downside risks for the external sector. First, there has been a slowdown in the FDI net flows.
Second, the debt component of capital flows (net finance account) has increased.
Third, higher imports have resulted in higher trade credits.
Fourth, increased share of local withdrawals of NRI deposits has potential for lower share of family maintenance and slowdown in workers' remittances.
Fifth, the increased share of short-term debt, at around 42 per cent, needs to be monitored.
Sixth, according to the World Bank, the BRIC nations (Brazil, Russia, China and India) were the highest externally-indebted countries in terms of absolute levels. As a proportion of national income, India's external debt was 18 per cent, compared with 9 per cent for China in 2009.
The above developments suggest that India's external sector has the potential for further deterioration. The foreign exchange reserves have been built with more debt flows.
In the present milieu of lower interest rate abroad, the net investment income from foreign currency assets (FCA) has been negative. The tendency to continue acquiring FCA at a higher cost and investing the funds at rates that yield lower return has obvious downside risks.
In view of the foregoing, it may be concluded that the build-up of foreign exchange reserves does not guarantee sufficient insurance. The downside risks of the external sector should not be ignored.
(The author is a professor of Economics at K. J. Somaiya Institute of Management Studies and Research.)