The outcome of a hardening rupee has been variously ascribed to improved trade balances, higher software exports and remittances, and rising foreign investment. The facts however do not add up. Our merchandise trade deficit for April-October this year, at about $5.5 billion, was a bit larger than last years. Then, foreign investment inflows have fallen. While foreign direct investment (FDI) inflows rose 75 per cent in the first quarter (April-June), they fell by 60 per cent in the second quarter (July-September). Portfolio inflows showed no improvement. Overall, foreign investment inflows were down by 47 per cent (from $1.6 bn to $0.8 bn) in the first quarter and by 75 per cent (from $1.5 bn to $0.4 bn) in the second quarter.
Software exports were up by 14 per cent in the first quarter and, reportedly, likewise in the second. An increment of about $0.5 bn for a quarter, if we base ourselves on gross exports under the miscellaneous general service category in the balance of payments (BoP). More realistically, after accounting for the sizeable overseas expenses involved, the increment would be smaller around $0.2 bn for a quarter. Surely, higher inflows from software exports could not have offset the decline in foreign investment, which were at least twice, possibly five times, as large. Was a spurt of remittances from overseas Indians the cause The BoP data for the first quarter shows that such remittances were at about the same level this year as in the last. It looks like a dead end, before we look at non-resident Indian (NRI) deposits. Overall, NRI deposits did not show any marked upsurge but the twist is in the details.
This year has seen an unprecedented drawdown of non-repatriable NRI deposits of $0.9 bn in the first quarter and over $1 bn in the second. There was a net drawdown in each of the first six months of 2002-03 for which we have data. It is easy to understand the motivation: as the rupee veered off from its regular 4 per cent a year depreciation against the dollar, holders of these dollar-denominated accounts switched to rupees.
There is another implication of this development. When an NRI account is drawn down into rupees, the transaction is booked as a debit in the capital account and a contra credit is provided against remittances in the current account. The upshot is that in the first quarter of 2002-03, as much as $0.9 bn of the $3.7 bn shown as remittances was not a current inflow and to that extent there was in fact a sizeable decline in current remittances from the previous year. Repatriable NRI deposits have swelled by $1 bn in each of the first two quarters arbitrage, no doubt inspired by large interest rate differentials.
While in absolute terms these amounts are not large, they appear to have played a catalytic role in changing perceptions in the foreign exchange market. Export remittances come early, importers probably resort to keeping their forex exposures open. In September and October 2002, in a long time, the Reserve Bank had large net forward purchase positions in addition to its current buying. With the bulk of capital flows and invisible earnings coming from dollar-denominated environments, the overdue adjustment of the greenback against the euro appears to have caused an over-shooting of sorts. We should see this phase yielding to a more realistic pricing of the rupee downwards.
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)