Looking ahead, several initiatives have been put in place and others are being launched on an ongoing basis to enable export industries to regain productivity and cutting edge competitiveness. They include upgradation of export facilities, integration of Indian farmers and their products with global value chains, and trade facilitation measures. More recently, efforts are going into reimbursement of taxes and duties, including electronic refund of input tax credits in GST. An action plan for 12 ‘champion’ services sectors, including IT, tourism and hospitality, and medical services has been developed since February 2018. The Reserve Bank of India and the government are actively engaged in the promotion of e-commerce platforms that will boost the exports of both merchandise and services. All these steps seek to create a more conducive climate for exports.
With regard to capital flows, India has adopted an approach marked by progressive liberalisation but calibrated to the realities of the domestic situation, including the evolution of financial markets. India’s hierarchical policy approach — preferring equity flows over debt flows, and preferring foreign direct investment (FDI) flows over portfolio flows within equity flows and long-term debt flows over short-term flows within total debt flows — has influenced the composition of capital flows.
Turning to equity flows, FDI policy has been liberalised across various sectors to make India an attractive investment destination. Sectors that have been opened up in recent years include defence, construction development, trading, pharmaceuticals, power exchanges, insurance, pensions, financial services, asset reconstruction, broadcasting and civil aviation. 100 per cent FDI has also been allowed in insurance intermediaries. In August 2019, FDI norms in single-brand retail trade have been further liberalised. FDI up to 100 per cent has been permitted under the automatic route in contract manufacturing and coal mining.
With regard to foreign portfolio investment (FPI), several measures have been undertaken to create an investor-friendly regime and to put in place a more predictable policy environment. FPI has been allowed in municipal bonds within the limits set for State Development Loans (SDLs). Greater operational flexibility has been granted to FPIs under a Voluntary Retention Route (VRR) which facilitates investment in G-secs, SDLs, treasury bills and corporate bonds while allowing investors to dynamically manage their currency and interest rate risks. The initial response to the VRR scheme has been encouraging. The Union Budget 2019-20 proposed to ease KYC norms for FPIs and also merge the NRI portfolio route with the FPI route for seamless investment in stock markets.
Outward direct and portfolio investment have also been liberalised to give Indian entities a global scan and presence.
External borrowing norms have also been simplified under two tracks: foreign currency denominated ECBs; and rupee denominated ECBs. The list of eligible borrowers has been expanded to include all entities eligible to receive FDI, registered entities engaged in microfinance activities, registered societies/trusts/cooperatives and non-government organisations. Rupee denominated bonds or Masala bonds under the ECB route offer an opportunity to domestic firms to borrow from international markets without the need for hedging exchange rate risk. ECBs up to US$ 750 million or equivalent per financial year are permitted under the automatic route. The mandatory hedging requirement had earlier been reduced from 100 per cent to 70 per cent for ECBs with minimum average maturity period between three and five years in the infrastructure space. Net disbursement of ECBs rose to US$ 7.7 billion in April-July 2019, as against net repayments of US$ 0.8 billion in the corresponding period of 2018-19.
Over the last couple of years, the exchange rate has seen large two-way movements with considerable volatility imparted mainly by global spillovers. During 2019-20 so far, the rupee has traded in a narrow range, with modest appreciation in Q1 giving way to some depreciation in August and the first half of September, accentuated by drone attacks on Saudi oil facilities on September 14, 2019. In its External Sector Report of July 2019, the International Monetary Fund (IMF) had employed a suite of models to assess the alignment of currencies with their fundamentals. For the rupee, the IMF estimates the REER gap to be zero, implying that the currency is fairly valued and broadly in line with fundamentals. India’s exchange rate regime is flexible and market-driven, with the exchange rate being determined by the forces of demand and supply. The RBI has no target or band for the level of the exchange rate. Interventions are intended to manage undue volatility. This is reflected in the two-sided interventions conducted during the past two years.
Overall, the outlook for India’s external sector is one of cautious optimism, albeit with some downside risks accentuated at this juncture. Among them, deepening of the global slowdown and escalation of trade and geopolitical tensions appear to be the most significant. Volatile international crude prices also continue to pose potential risks. Yet, there are underlying strengths that can be built upon to buffer the external sector from these risks. The search for new export markets and new niches must go on. Indian IT companies need to accelerate market diversification and invest in new skills and technologies to hone their comparative advantage. Remittances and non-resident deposits are likely to remain shock-absorbers. The overarching objective should be to keep the current account deficit within sustainable limits and financed by a prudent mix of debt and equity flows.
Edited excerpts from an address by RBI Governor Shaktikanta Das, September 19, at the Bloomberg India Economic Forum 2019 in Mumbai