Indians working abroad send money home to their families. For some of them their immediate families live back home ? as is often the case with Indian workers in the Gulf countries. In others, the remittances are for the benefit of parents, siblings and other dependants. In the bad old days of the licence raj, the Indian rupee was overvalued, customs duties and restrictions on imports were both murderous. Enter therefore the professional smuggler and hawala man, and a sizeable chunk of the remittances never made it through the banking channels; but financed the smuggling of gold, electronic goods and other goodies. Now that the unintended consequences of control have been thrown overboard, most, if not all, the remittances enter India through regular banking channels and are accounted for in the balance of payments (BoP).
In 1990, the total of such remittances amounted to $2 billion. It steadily rose in the aftermath of reforms to $8 bn and then to $12 bn in 1996-97. Thereafter, it stayed at that level before climbing to $15 bn in 2002-03, crossing $19 bn in 2003-04 and it might touch $21 bn in the current fiscal. Part of the reason for the increase is the tens of thousands of Indians who have joined the expatriate workforce overseas as IT people, and there?s little reason to believe that the level of such remittances has peaked.
The size of such remittances is big in every way. Not just in terms of the fact that our current account surplus in 2003-04 was below $9 bn, but also as a proportion of gross domestic product (GDP) private remittances amounted to as much as 3.2%. Now, these remittances are part of the GDP of the economies the expatriate Indians are working in ? be it the UAE or the US. When they send back money home, it?s treated as factor income inflow and becomes part of India?s national income. That national income is expended on consumption and the balance becomes the national savings. In the absence of these remittances, (all other things being unchanged) the savings ratio in 2003-04 would have been 3.2 percentage points of GDP less. And the current account balance instead of being in surplus to the extent of 1.4% of GDP, would have been in a deficit of 1.8%. Other than this obvious fact, namely that there is in a sense an excess of savings in the Indian economy in recent years, is there any other material implication?
There indeed is. Government in India spends 30% of GDP and still has a fairly heavy hand in the macro-management of the economy ? as evidenced by the fact that the Central Plan alone amounts to over 5% of GDP.
The Tenth Plan, for instance, in working out its macro-balances was left with a current account deficit of over 2% of GDP over the Plan period, instead of which we landed up in surplus. A ready explanation for this is of course that this happened because investment fell far short of what was assumed and so did economic growth ? which is true in a way. However, look at it like this: the investment-savings balances that result from the domestic growth process are by definition linked to what activities go on within the physical domain of this economy, that is, in India. The net consequence of these outcomes on the external payments front is indeed a current account deficit of 1.8% of GDP. It so happened that savings made out of the GDP of some other country were then remitted to India amounting to 3.2% of our GDP and as a result the current account went into surplus. The economic process which generated these incomes and savings were completely independent of what has been going in this country.
Thus, even with both lower-than-planned investment ratio and GDP growth numbers, the Indian economy was actually still short of capital ? and therefore savings matter, especially government savings, which are of course a big negative number.
Something else matters more. Which is that in looking at the economic growth process, we ought to look more favourably at imports as augmenting the availability of raw materials, intermediates and capital goods within India, so as to provide the real resources for higher investment and faster economic growth.
This can be facilitated by lower import duties and a somewhat stronger rupee. Because, the current account deficit (CAD), which is the direct outcome of the domestic economic process, will be positively impacted by the inflow of incomes that is generated in other economies and of savings made out of such income.
Net capital inflows in 2003-04 amounted to 3.6% of GDP and 2.4% in the previous year. There?s every reason to believe that Indian equity assets remain attractive to both foreign direct and portfolio investors, and Indian corporates have the ability to borrow overseas to a significant extent.
With reasonable economic performance, it?s difficult to see how net capital inflows could fall below 2% of GDP. Now, if the level of remittances is over 3% of GDP, surely we can set our parameters to target a CAD of 5% and above, such that we will be left at the end of the day with an eventual CAD of about 2% of GDP ? which would find easy financing from the capital side. Any downside is mitigated by the fact that we have over $110 billion of forex reserves. Clearly, there?s much to be gained by making imports more competitive by way of further lowering duties and letting the rupee strengthen somewhat.
Higher levels of imports can add to customs revenues, and a stronger rupee will mean lower inflation.
There is some urgency for us to move on this path, for some of the earnings of software and BPO, are not dissimilar to that of remittances, in the sense that they are part of the economy of another country and are thus exogenous to the domestic economic process, and these businesses are going to only get bigger.
The author is economic advisor to ICRA