C. P. Chandrasekhar
Recent weeks have seen a weakening of the rupee, even as the BSE Sensex shows signs of buoyancy. Underlying this trend are developments on the balance of payments front which point to a transition that could lead to an increase in external vulnerability, argue C. P. Chandrasekhar and Jayati Ghosh.
WITH the rupee touching a 10-month low early this October and settling at well above the 44-to-the dollar mark, observers have begun to express concern over the strength of the currency.
The Reserve Bank of India Governor has, however, declared that such movements are "not unusual". On the surface, there could be two reasons for the rupee weakening. One, a growing demand for the dollar, driven by expectations of an appreciation of that currency. And the other could be a delayed response of the central bank, which could stabilise the rupee through sales of some of its dollar holdings.
Those holdings rose by more than $24 billion over the last 16 months, as a result of large net purchases by the RBI, especially during February and March 2005 (Chart 1). Offloading some of these reserves, exceeding $140 billion in total, can help the RBI raise the value of the rupee if it so desires.
But these grounds for complacency should not result in neglect of certain new trends in India's balance of payments, which point to an incipient transition in the direction of increased vulnerability.
The first sign of such a possible transition is the emergence of a deficit on the current account of India's balance of payments in recent times.
As Chart 2 shows, after three consecutive years of a current account surplus, which exceeded $10.5 billion in 2003-04, the country experienced a return to a current account deficit amounting to $6.3 billion in 2004-05. That this was not a short-term tendency is reflected in the balance of payments figures for the first three months of this financial year (April-June 2005), recently released by the RBI.
Those figures (Chart 3) point to the emergence of a quarterly current account deficit of $6.2 billion (equal to the 2004-05 annual average), as compared with a positive $3.4 billion current account balance during April-June 2004.
This increase in the current account deficit has principally been on account of a widening of India's trade deficit, which increased from $15.4 billion in 2003-04 to $38.1 billion in 2004-05.
Simultaneously, remittance inflows fell by $2.4 billion dollars, transforming a large current account surplus into a significant deficit despite the 41 per cent rise in revenues from exports of software services.
These trends have only strengthened in recent months. Thus, according to RBI figures the trade deficit more than tripled from $5.2 billion during April-June 2004 to 15.8 billion during April-June 2005.
Since invisible incomes did not rise very much (from $8.6 billion to $9.6 billion), this has resulted in the large quarterly current account deficit noted earlier. It is only because capital account inflows rose sharply from $4.2 to $7.4 billion that India's foreign reserves rose by $1.2 billion during the first three months of this financial year.
These trends are particularly disconcerting because they are accompanied by signs of vulnerability on the trade front.
According to the latest trade statistics released by the Directorate General of Commercial Intelligence and Statistics (which has a more limited coverage than that of the RBI) relating to the first five months of this financial year (April-August), the deficit in India's merchandise trade stood at $17431.2 million compared with $9728.5 during the corresponding period of the previous year.
A crude projection based on: i) this 80 per cent increase in the deficit; and ii) the average difference between trade deficit figures as reported by the DGCIS and the RBI for the last three years...