Fdi Inflow, Industrial Growth, Bullish Market Aids To Keep Re In Buoyancy!

It was almost a shared feeling that the rupee would fall in the current year.

It did but to an extent that surprised far too many. There were currencies like the Indonesian rupiah that went through unnerving gyrations. Even the euro lost 15 per cent. The currencies that did not budge at all were the Chinese renminbi and the Malaysian ringgit more because of the policies of the governments than the free play of the market.

The fall in the rupee by 3 per cent in the international currency movements and in the context of our own past looks rather insignificant. Even then there is not enough confidence that the rupee will hold in the tear 2000.

 

There were reasons why the rupee was nearly stable in the current year. Exports did pretty well. After the fall last year, the pick up since March 1999 was heartening and the year may end up with at least a 10 per cent growth. Imports have also been rising mainly due to the escalation in oil prices. From $10 a barrel they shot up to $32 in just 12 months.

That was responsible for the 10 per cent increase in imports, leaving $5.5 billion current deficit to be funded from foreign capital inflows.

We actually received more than that and the Reserve Bank of India (RBI) was able to build up reserves and stabilise the rupee. It was not external aid that salvaged the balance of payments. Rather, it was the foreign investment, both direct and portfolio, that filled the gap.

Aid is no longer significant and the sooner we get rid of it the better. That would take away the easy but embarrassing option and compel us to be more business-like. The major sources of external resources were commercial borrowing and foreign investment. It is the latter particularly that has acquired greater importance and can be relied upon in future.

In 1999-00 borrowing and investment came in the ratio 2:3. If the second generation reforms are put through, investment alone will make up the current account deficit.

The inflow of foreign direct investment slowed down in the current year. It had crossed $3.5 billion in 1997-98 and shrank to $2.5 billion annually since. This was mainly because industrial growth had eased and, in some of the industries, recessionary conditions prevailed.

The economic sanctions that were imposed after the Pokhran nuclear test also closed some of the attractive sources of finance, such as the Exim Bank, to foreign investors. Had the viability of projects been high even these irritants would not have come in the way.

It was the FIIs that finally ruled the roost. The buoyant stock market was a big attraction. In the last one year the sensex was up 80 per cent, more than in most other markets and money flowed in to grab shares in the most favoured sector, the IT.

FIIs' net investment was at the rate of $200 a month, on an average. It is the money that really bloated up the foreign exchange reserves of the RBI and lent stability to the rupee. It was expected that the budget would be a new turning point. It proved a damper. What is more, it started a process which would put the balance of payments (BoP) under pressure that may not leave the rupee unscathed.

Take exports; in deference to the WTO norms, export incentives are being phased out. From next year, export profits will be subject to income taxation. A very promising incentive will disappear and may divert some potential exports to domestic market.

Quite likely, therefore, export growth may not be sustained unless world demand significantly increases. That is rather doubtful. The best that can be expected is about 10 per cent increase in our exports next year.

Imports, on the contrary, will become more attractive, mainly for two reasons: The Finance Minister has knocked down peak customs duty from 40 to 35 per cent. This was necessary to conform to our commitments to the WTO.

We are still the highest taxed nation with the average customs duty at 25 per cent. Most ASEAN countries have brought down these duties to less than 10. The reduction may have been inevitable but its side effect will be an increase in imports. That will be further enhanced by the likely exit of hundreds of commodities from quantitative restrictions (QRs) possibly in April.

It is quite possible therefore that non-POL imports which had been stagnant so far will shoot up. If oil prices do not fall during the year, a 15 per cent growth in total imports is not unlikely.

That really widens the trade gap and, consequently, the current account deficit by about $4 billion. Not difficult to make up if the inflow of foreign resources is accelerated. Net borrowing can move up by $1-2 billion, FDI by $1-2 billion to catch up with the investment in 1997-98 an FFI investment by $1-2 billion.

External commercial borrowings have been much higher in earlier years and should not pose insurmoutable problems next year. Besides, companies are in a position to float GDRs and ADRs to raise capital in Europe and the US.

FDI will pick up if domestic investment becomes more active. There are no clear signs about the latter even though, with industrial recovery this year, excess capacity has been nearly utilised.

The budget has offered some lift to the IT but has generally abstained from revving up traditional industries. Perhaps, with a good agricultural crop demand will be stimulated and investment will follow. Also, if after the visit of President Clinton, the economic sanctions are lifted, there would be a larger inflow of foreign investment.

The critical element, however, is the portfolio investment by FIIs. They can move the resources either way. Last year, for instance, the FIIs took money out which forced the rupee drop 13 per cent. This year, money flowed in because the stock market was bullish. If this trend continues, the inflow from FIIs wil be high.

The budget did not quite motivate the market. Its initial expression was one of disapproval with the sensex dropping 300 points the moment the Finance Minister wound up his budget speech. Even so, the response from FIIs is rather encouraging. That is because the budget increased the investment ceiling from 24 to 40 per cent of equity. If the market gets back into the swing once again, perhaps led by the information technology industry, FII investment will flow in.

The inflow of foreign resources from borrowing and investment can make up the widening trade gap if the climate for investment is congeneal. Industrial growth has to accelerate and the stock market has to be bullish.

With that, there is every chance that the balance of payments will be in surplus and the rupees remain stable. In the absence of these conditions, the rupee will slide by at least 5 per cent in spite of the good reserves that have been accumulated by the Reserve Bank of India.