The sharp (by our standards) rise of the rupee in the last three working days of March 2004 has left behind a trail of confusion as to whether exchange rate management policy had changed. The finance minister, in an interview in this newspaper last Saturday, seemed to suggest that such interpretation was without basis, and the general comments on rupee management and inflation are unfair to both the Reserve Bank of India (RBI) and finance ministry. This reinforces the view mooted in my column last Monday, that the RBI is perhaps making a fine distinction in the nature of the inflows. Choosing to intervene in a manner that keeps management flexible, while guarding against volatility, something that is more readily conceived in the context of capital flows that are potentially reversible. But not, when it comes to current account flows stemming from improved competitiveness in the export of both services and of goods. While there were capital inflows in March 2004 (in part flowing from the disinvestment offers), surging exports of both goods and services had created perhaps equally large current account inflows.

We now know that the net accretion to the RBI?s foreign currency assets in the month of March 2004, up to March 26, 2004 was $2.1 billion, about the same as in the corresponding period of March 2003. Capital flows in March 2003 were much smaller than that in March 2004. The only conclusion that one can draw is that the idea of a distinction being made between current account and capital account inflows, has some validity.

The balance of payment (BoP) numbers for the third quarter of 2003-04 was released on March 31, 2004, and there are several noteworthy things. First, the current account surplus for the July-Sept quarter was revised upward from $524 million to $1,637 million. Second, this was despite a downward revision in net earnings from service exports, and an increase of $520 million in net investment income outflows. Third, the revised merchandise trade balance improved by about $2 billion. Fourth, the current account surplus for the third quarter (Oct-Dec) was $1.8 billion, double that of the corresponding quarter in 2002-03. Fifth, service sector net earnings, including tourism and software exports, grew 70 per cent over the third quarter of 2002-03. Sixth, the expansion in the BoP trade deficit for the quarter was significantly lower than that reported by the DGCI&S, perhaps indicating improvement in data coverage by DGCI&S in recent months. Finally, in light of the recent data releases, it is certain that the BoP merchandise trade deficit for the completed year 2003-04 is going to be in the region of $21 billion, some $4 billion less than previously expected. That would leave a current account surplus for the full year in excess of $5 billion.

The 10.4 per cent GDP growth in the third quarter of 2003-04 and the attendant controversy, has been big news. While it is true that were we to compensate for the downward revisions made to last year?s agricultural GDP numbers and the unusually good monsoon we had in 2003, the underlying normal growth for the quarter would have been less. But not by much: it would still be well above 8 per cent. The fact is that in 2003-04 non-agriculture ? industry and services ? constituting 78 per cent of GDP grew by over 8 per cent. Most recent data on industrial production show manufacturing consistently expanding at a rate between 7.5 and 8 per cent, with overall industrial growth also approaching 8 per cent.

Anecdotal evidence sugges-ts that a new investment cycle is about to begin and might come into evidence after the elections, once the political situation becomes a matter of fact, not of conjecture. Credit flow from the banking system has been strong, with total accommodation extended to commerce and industry increasing by Rs 116,877 crore up to the last reporting Friday of the year (March 19, 2004), compared to Rs 101,791 crore (March 21, 2003, net of mergers). This inc-rease was particularly notable, given that in 2002-03, there had been a massive increase in credit flows, with non-food credit rising by 20 per cent.

Fiscal year 2004-05 is likely to see a significant stepping of private corporate investment in addition to higher levels of infrastructure investments in both the public sector and through private-public partnerships. We may recollect that private corporate investment had been in excess of 8 per cent of GDP at the top of the previous investment cycle between 1995-96 and 1996-97. In the years since 2000, this ratio has fallen to below 5 per cent. It is reasonable to expect it to go up by at least 2 percentage points of GDP over coming years. With infrastructure investment spending also likely to be pushed up by another 1 to 2 percentage points of GDP, there clearly will not be financial space to accommodate all of these competing demands on funds, since a miraculous relapse of the (consolidated) fiscal deficit is unlikely.

Thus, external commercial borrowings (ECB) will be an important resource to finance the investment cycle. Since government is reluctant to borrow from markets overseas, corporates will be (as they indeed are being) encouraged to go for ECB. With continued growth in IT/BPO earnings, more inbound tourist traffic, and strength in goods exports, this year too seems to be set for a sizeable current account surplus. Add to that the ECB flows, foreign direct investment and portfolio flows, and we are looking at an overall BoP surplus not much smaller than the $30 billion or so for 2003-04. The RBI could, of course, buy it all up. Or it could allow the rupee to rise dramatically, setting off a boom in all kinds of rupee assets (including real estate) and decapitate all of the businesses that have become globally competitive over the years. All such booms go bust eventually, returning the currency to equilibrium? but that is cold comfort and poor advice.

The judicious thing perhaps is to combine buying forex with trimming the import duties, which are still quite high. That would serve to provide cheaper goods to domestic producers and consumers, help keep inflation quiescent (a difficult task when non-agriculture is growing at 8 per cent), contribute to widen the merchandise trade deficit helping return the current account to balance, while keeping domestic manufacture and exporters competitive.

The writer is economic advisor, ICRA Ltd