With better performance on the invisibles front unlikely, the BoP could soon come under strain
India’s Balance of Payments (BoP) improved further in FY15. The CAD declined to 1.3% of GDP from 1.7% in FY14.
The country has thus left far behind the runaway external imbalances that characterised its economy in FY12 and FY13. What does this improvement mean for the economy?
The role of trade
The current account recovery of BoP in the last two years has been due to a substantial decline in merchandise trade deficit from more than 10% of GDP in FY12 and FY13 to nearly 8% of GDP in FY14 and to a lower 7% in FY15.
The other component of the current account is the invisibles balance which consists of services, transfers and factor incomes. Invisibles account has always been in surplus for India. This surplus, which crossed 6% of GDP in FY14, actually declined to 5.7% of GDP in FY15. The net receipts under all items of invisibles deteriorated during FY15, except for private transfers and software services. Net receipts of private transfers increased marginally from $65.5 billion in FY14 to $66.3 billion FY15. Net receipts under software services had reached $67 billion in FY14 and it rose further to $70 billion last year.
How did India achieve the reduction in trade deficit—the chief reason behind the turnaround in BoP—in the last two years? Merchandise imports were nearly stagnant in FY13 and declined in the next two years. Merchandise exports, by the way, did not improve but remained stagnant in the last three years. The poor performance of imports has been on account of two factors: one, the fall in international oil price and, two, the slowdown of the Indian economy. The stagnation in merchandise exports has also been due to two things: one, the slow growth in the world economy and, two, appreciation of the real exchange rate.
Some of these trends are continuing into the current financial year: merchandise imports have declined by 12% and exports much more by 17% during April-May 2015, and the real exchange rate appreciated further by more than 7% during April-May 2015.
One can see a shift in the pattern of merchandise imports: while in FY14 there was a large decline in imports of gems & jewellery and capital goods, in FY15 imports of both these items increased. The decline in imports in FY15 was mainly in oil imports. In the current year as well, the compositional change in imports has continued. During April-May 2015, capital-goods imports rose by about 10% and so the gems & jewellery imports. The major reason for the 12% decline in merchandise imports during this period has been the massive 42% decline in oil imports.
There are indications of a pick-up in the economy. Industrial growth has improved since the third quarter of FY15. Particularly, the growth in the production of capital goods has been strong. Capital goods imports have shown a remarkable rise. There has been a substantial rise in indirect tax receipts by the central government in the current year so far. Moreover, international oil prices are rising. Gems & jewellery imports are also on the rise with the removal of restrictions on their imports in November 2014. All these point to a revival of merchandise imports in the current year.
In contrast, there are no signs of improvement in merchandise exports. The IMF has projected just a 3.5% growth in the world economy in 2015 against a growth of 3.4% in 2014 and the previous two years. Furthermore, the rupee remains overvalued despite some mild rupee depreciation in recent months.
The capital account
The improvement in BoP in FY15 is also reflected in the capital account showing net capital inflows of nearly $90 billion. This is contributed by the record net FDI inflows of about $33 billion and portfolio investment of $41 billion. As a result, there has been a huge build-up of reserves of $61 billion (excluding valuation effects). Including the valuation change, the reserve accumulation has been $37 billion in FY15.
To sum up, the remarkable improvement in India’s BoP in FY14 and FY15 is on account of special circumstances which are to change, going forward. As the economy improves further and oil prices increases, the import bill will mount. Exports are not expected to improve as the world economic growth remains sluggish and the rupee stays overvalued. Better performance on the invisibles front is also unlikely. Therefore, BoP could come under renewed strain in the current year.
The author is professor, Rajagiri Business School, Kochi. Views are personal