The external sector imbalance

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: for the next 50 years. Any expectation that China will run out of steam due to adverse demographics, wage increases or large-scale excess capacity should be discarded.

The data reveals that the Indian economy’s dependence on consumption expenditure is also declining, though not as sharply as in China. Consumption contribution to GDP growth has declined from 75% in 1993-2000 to 59% in the latest period (2001-2007). This has seen a rise in investment expenditure’s contribution from 26% to 46% over the same period. This is indeed a positive trend that is likely to continue, thanks to the country’s favourable demographic structure. However, as larger numbers enter their productive years, accessible education, especially vocational education, and external demand (read exports of goods and services), would have to help generate the requisite employment.

Traditional macroeconomic theory had it that capital flows help to balance the economy’s balance of payments by compensating for changes in the current account. This has now been stood on its head, with capital account flows bearing little relation to the current account. How does one otherwise explain the fact that in 2007-08, according to our conservative projections, India is likely to receive $123 billion of capital inflows that will result in an increase of $104 billion in the reserves? These will reach about $365 billion by the end of March 2008, putting tremendous upward pressure on the rupee. The current account deficit for 2007-08, on the other hand, is expected to be a modest (-) 1.6% of GDP ($18.9 billion), with a merchandise trade deficit of $91 billion being almost fully covered by an invisibles surplus of $72 billion.

It is clear that these huge unsolicited inflows can be traced to treasury managers, portfolio funds and speculators trying to cash in on the “India story”.