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Is the Comfort in the External Sector Tenuous?

India's international investment position shows her net external liabilities in the red and on occasion these have grown. That a large proportion of capital inflows are of the "non-debt" variety is no comfort, for much of these inflows - mainly portfolio capital - is extremely volatile. The large foreign exchange reserves have been built not with current account surpluses but with capital receipts, which are a potential source of future trouble and have already put pressure on the rupee and affected exports.

MONEY MARKET REVIEWfebruary 23, 2008 EPW Economic & Political Weekly26Piyusha Hukeri drafted the initial note and V P Prasanth compiled the accompanying tables and graphs.Is the Comfort in the External Sector Tenuous? EPW Research FoundationIndia’s international investment position shows her net external liabilities in the red and on occasion these have grown. That a large proportion of capital inflows are of the “non-debt” variety is no comfort, for much of these inflows – mainly portfolio capital – is extremely volatile. The large foreign exchange reserves have been built not with current account surpluses but with capital receipts, which are a potential source of future trouble and have already put pressure on the rupee and affected exports.Table 1: India’s International Investment Position (IIP)(US$ billion)Period AssetsLiabilitiesNetIIPMarch 2003 (PR) 95.59 156.05 -60.46March 2004 (PR) 137.78 183.12 -45.27March 2005 (R) 166.84 210.79 -43.96March 2006 (PR) 182.78 232.00 -49.22March 2007 (PR) 243.60 290.55 -46.95June 2007 (P) 259.73 322.18 -62.45R: Revised PR: Partially Revised. Source: RBI Press Release onInternational Investment Position (IIP) of India, September 2006 and December 2007.The professed comfort level on the external sector front, its manage-ment and the management of its fallouts are increasingly coming into question. Apart from the widely propagated official thinking and similar perceptions advocated by commentators, even the multilateral agencies like the Internation-al Monetary Fund and the World Bank speak highly of India’s performance in this respect and internationalcredit agen-cies confer high sovereign credit ratings on India precisely on the ground of this comfort level based on the strength of the growing foreign currency reserves.1 QuestionableComfortContrariwise, all recent data on the external sector – balance of payments (BoP), foreign debt and international investment posi-tion (IIP) – point to portents of danger ahead, if only the blinkers of globalisation do not close our thinking. During April-September 2007, for instance, there has been a sizeable $ 50.41 billion accrual un-der net capital inflows out of which, how-ever, foreign direct investment (FDI) has constituted only $ 3.88 billion; the rest, constituting over 90 per cent, can only be considered as volatile sources: portfolio investment ($ 18.33 billion), other bank-ing capital ($ 5.34 billion), short-term trade credits ($ 5.77 billion) and other miscellaneous capital ($ 5.98 billion). Even external commercial borrowings worth $ 10.56 billion cannot be assumed to be of a durable nature.The quality of these periodic flows has thus deteriorated over the years resulting in unhealthy features in the structure of the country’s external assets and liabili-ties. As per the IIP data, net liabilities have remained in the red and the latest data show that the deficit has again tended to grow (Table 1). The official agencies claim comfort from the conventional classification of liabilities into debt creating and non-debt creating liabilities. As shown in Table 2, the proportion of debt liabilities has declined from 67 per cent in March 2003 to 51 per cent in June 2007, the latest data available. There has been a corresponding increase in the share of non-debt liabilities – a claim of prudence in the accessing of external resources But from the point of view of the stabil-ity of the external sector, the above classi-fication of debt and non-debt liabilities is a misnomer, for a substantial part of the non-debt liabilities constitutes items of a volatile nature. As depicted in Table 3 (p 27), of the total liabilities at the end of June 2007 valued at $ 322.18 billion, only one-fourth or $ 82.98 billion represent direct investment. Other liabilities such as port-folio investment ($ 93.46 billion), currency and deposits ($ 43.81 billion) and trade credits ($ 14.72 billion) carry a distinctly volatile tag and also a high cost for the domesticeconomy; so do loan outstandings ($ 86.04 billion). Looking at it differently, ofthetotal non-debt liabilities of $ 158.15 billion, $ 75.17 billion (or 47.5 per cent) represent portfolio investment in equities.Such a liability profile raises serious questions of external sector stability in the periods to come. The vast reserves giving comfort to the external sector have not been earned on the basis of current account surpluses. Instead, they represent borrowed reserves (S Venkitaramanan,The Hindu Table 2: Share of External Debt and Non-Debt Liabilities in Percentages(as Classified by RBI)Period Non-Debt Liabilities Debt Liabilities TotalMarch 2003 32.9 67.1 100.0March 2004 39.4 60.6 100.0March 2005 41.6 58.4 100.0March 2006 45.6 54.4 100.0March 2007 46.7 53.3 100.0June 2007 49.1 50.9 100.0For Source, See Table 1.
MONEY MARKET REVIEWEconomic & Political Weekly EPW february 23, 200827Business Line,February 4, 2008) and what is more, an overwhelming proportion rep-resents some unstable sources of borrow-ings. Besides, what may be called the “ten-uous” nature of external sector comfort, has produced serious macroeconomic implications. Apart from the problems for liquidity management and vast increases in asset prices, which have created con-straints on infrastructure development, a more discomforting repercussion has been in the form of a strengthening of the rupee that has begun to hurt India’s export com-petitiveness and inflict damages on many foreign-exchange earning industries in the form of losses in both incomes and em-ployment. That the rupee value should be allowed to be determined in this manner by the capital account of BoP and not cur-rent account, speaks poorly for external sector management. In the above respect, we have a gem of an observation in the latest annual report for 2006-07 of the Bank for International Settlements (BIS), which reads as follows: The Asian crisis of 1997 was preceded by ap-preciation pressures associated with capital inflows, and easy money, which led in turn to higher asset prices. ‘Sudden stops’ or reversals in capital inflows were then linked with sharp currency depreciation, collapsing asset prices and severe downturns. Previous cur-rent account deficits and losses associatedwith currency mismatches aggravatedtheseprob-lems, sometimes leading to banking crises. Some similarities to pre-1997 crisis condi-tions are apparent inEMEs today, including appreciation pressures, easy money and higher asset prices (p 46).However, the BIS does discern a silver lining for most of the emerging market economies (EMEs) in that, in contrast to the 1990s, “the main source of foreign currency inflows in recent years has been current account sur-pluses rather than capital flows” (ibid).It is worrying that in the case of India, even the above silver lining is conspicuous by its absence, and when juxtaposed against each aspect of the other BIS observa-tions, India’s cur-rent external situa-tion obviously stands out as a readycan-didate for an “Asian crisis” in the making. 2 Money,Gilt-Edged and Forex MarketsIn January, the outlook for money, forex and government securities markets was influenced by four notable developments: considerable improvement in liquidity situation; the union finance minister’s state-ment asking banks to soften interest rates, the Reserve Bank of India (RBI) governor ex-pressing a preference for greater flexibility in managing the rupee value; and finally, theUnited States Federal Reserve’s decision to reduce interest rates and the RBI’s decision to maintain the status quo. The liquidity overhang increased substantially due to the return flow of advance tax pay-ments, through increased government spending, interest payments on the special deposit scheme (SDS), and redemptions of dated government securities including those from the market stabilisation scheme (MSS). It manifested itself in sharp de-clines in liquidity injections through repos and easing of short-term money market rates. Following the finance minister’s statement asking banks to reduce lending rates to maintain growth, market senti-ments became buoyant and the secondary market trading in gilt-edged securities surged to record levels and yields began fallingacross the maturity spectrum. In the second half of the month, the overflow of liquidity made the RBI undertakeMSS op-erationsthrough dated securities as well as treasury bills, which resulted in an in-crease in the yield rates and arresting of the secondary market turnover in gilt-edged securities. As the RBI governor indi-cated that greater flexibility was required in the rupee exchange rate, the rupee con-tinued to appreciate which was also sup-ported by huge inflows due to mega initial public offerings (IPOs) and buoyancy in stock markets. With the unfolding of the impact of the sub-prime mortgage crisis in theUS to credit markets and then to the global stock markets, the US Fed an-nounced an unscheduled 75 basis points cut in the benchmark rates – the highest cut effected in more than a decade, following which gilt-edged markets in India turned buoyant expecting that in view of the Table 3: Possible Volatile Items and Non-Volatile Items of External Liabilities (US $ billion)Period March 2003 March 2004 March 2005 March 2006 March 2007 June 2007Volatile items 124.83 144.95 166.30 180.88 218.26 239.19 (80.0)(79.2)(78.9)(78.0)(75.1)(74.2) Portfolio investment 32.41 43.70 55.96 64.59 79.14 93.46 Trade credits 4.88 6.28 9.57 10.51 13.71 14.72 Loans 61.05 61.87 65.94 67.87 82.24 86.04 Currency and deposits and other liabilities 26.49 33.10 34.83 37.91 43.17 44.97Non-volatile investments 31.22 38.18 44.49 51.13 72.29 82.98 (20.0) (20.8)(21.1)(22.0) (24.9) (25.8) Directinvestment 31.22 38.18 44.49 51.13 72.29 82.98 Total 156.05 183.13 210.79 232.01 290.55 322.17Figures within brackets are percentages to total.For Source, See Table 1.Table 4: Money Market Operations(RBI’s Daily Data) Average January 2008 Average December 2007 Items for Four Weeks 25 18 (RF) 11 4 (RF)* for Four Weeks 28 20 14 7 (RF)* No of working days 23 5 6 6 6 22 5 5 6 6CallMoney Weighted average of call rates: per cent (weekly range) per annum 5.55-7.67 6.22-7.67 6.01-7.59 6.04-7.06 5.55-7.11 4.52-7.95 7.25-7.95 7.35-7.617.45-7.904.52-7.64 (7.59)(5.55) Daily averages (Rupees crore) 12,046 15,309 11,238 11,449 10,731 7,615 7,528 8,040 8,350 6,599 Total call market borrowings (14,478) (636) (208)NoticeMoney Weighted average of notice money rates: per cent (weekly range) per annum 4.75-7.77 4.83-7.77 4.75-6.10 5.15-7.26 5.25-7.52 5.74-7.90 6.00-7.786.00-7.766.29-7.835.74-7.90 (6.1)(6.0)(6.0)Daily averages (Rupees crore) 2,083 3,008 133 2711 3,160 1,991 2,813 8,688 1,677 1,831 Total notice market borrowings (496) (15544) (9503)Turnover in term money market 245 177 242 293 258 299 256 415 268 268 (borrowings)$$ (255) (140) (250)*Data for reporting Fridays are given within brackets and they are also included in the weekly range/daily averages. $$ No of reporting/traded days is fewer than given above.

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MONEY MARKET REVIEWEconomic & Political Weekly EPW february 23, 200831Appendix Table: Secondary Market Operations in Government Papers: NDS and NDS-OM Deals(Amount in rupees crore) Descriptions Week Ending January 2008: Yield to Maturity on Actual Trading Total for the Month 25 18 11 4 of January 2008 AMT YTM CY AMT YTM CYAMT YTM CY AMT YTM CYAMT YTM CY1TreasuryBills A91-DayBills 746.116.97695.356.93 377.446.45 995.086.56 2813.986.75 B182-DayBills 584.437.02711.506.80 875.116.75 813.596.96 2984.636.87 C364-DayBills 1078.757.241430.226.76 2732.527.20 4367.837.19 9609.327.13 2 GOI DatedSecurities A Regular (in % Year) 10.80 , 2008 ---30.00 7.05 10.60 1.00 7.30 10.61 1.00 7.47 10.62 32.00 7.07 10.6012.00 , 2008 ------10.00 7.3611.84 ---10.00 7.3611.84 5.48, 2009 1355.00 7.39 5.62 1510.00 7.48 5.63 4110.88 7.46 5.63 4160.00 7.54 5.64 11135.88 7.48 5.63 6.65,2009 915.00 7.35 6.70 666.95 7.44 6.71 919.15 7.43 6.71 1230.50 7.53 6.72 3731.60 7.45 6.717.07 , 2009OMC SB ---------5.007.907.145.007.907.14 7.33 , 2009OIL MKT BONDS - - - 85.00 8.05 7.39 25.00 8.00 7.38 - - - 110.00 8.04 7.395.87 , 2010 3814.00 7.366.03 2505.00 7.486.047450.35 7.45 6.046060.50 7.53 6.0519829.85 7.466.04 7.55,2010 70.00 7.43 7.53 75.00 7.44 7.53 65.20 7.49 7.54 95.00 7.55 7.55 305.20 7.48 7.5411.30 , 2010 2225.00 7.45 10.40 1113.70 7.51 10.41 539.65 7.53 10.41 1005.00 7.57 10.41 4883.35 7.5010.4012.25 , 2010 35.00 7.3711.07 ---------35.00 7.3711.0712.29 , 2010 ---60.00 7.52 11.29 ---200.00 7.61 11.29 260.00 7.5911.296.57, 2011 53.08 7.326.71 ---------53.08 7.326.71 9.39,2011 150.00 7.48 8.88 10.00 7.52 8.89 319.14 7.50 8.89 325.00 7.59 8.91 804.14 7.54 8.8910.95 , 2011 10.00 7.559.96 ---------10.00 7.559.967.40, 2012 ---30.00 7.49 7.43 ------30.00 7.49 7.43 7.44 , 2012 OMC SB 25.00 8.33 7.68 ------10.00 8.25 7.66 35.00 8.31 7.67 7.47 , 2012OIL MKT BONDS 75.00 8.30 7.69 75.00 8.29 7.69 - - - - - - 150.00 8.30 7.69 7.27,2013 2854.05 7.40 7.31 1910.00 7.50 7.35 3537.25 7.52 7.36 2887.00 7.63 7.39 11188.30 7.52 7.357.37,2014 255.007.427.39 ---772.107.567.44337.007.677.481364.107.567.44 11.83 , 2014 35.00 7.58 9.68 30.00 7.62 9.69 85.00 7.75 9.75 25.00 7.81 9.78 175.00 7.70 9.73 7.38,2015 230.00 7.45 7.41 300.00 7.52 7.44 760.52 7.57 7.46 544.00 7.68 7.51 1834.52 7.58 7.47 7.59,2016 1063.00 7.45 7.53 273.00 7.57 7.58 960.74 7.62 7.60 235.86 7.72 7.65 2532.60 7.55 7.57 7.46,2017 7.17 7.63 7.54 6.00 7.65 7.56 26.99 7.77 7.62 10.00 7.88 7.68 50.16 7.76 7.61 7.49,2017 4541.10 7.49 7.49 3119.50 7.56 7.53 10067.80 7.64 7.56 6482.60 7.77 7.63 24211.00 7.64 7.56 7.99,2017 28684.85 7.45 7.71 19031.40 7.55 7.76 21699.77 7.61 7.79 20940.75 7.75 7.87 90356.77 7.58 7.788.07,2017 1133.507.487.78 ---1590.257.667.86800.507.767.923524.257.637.85 5.69,2018 1.31 7.79 6.69 0.35 7.58 6.59 1.40 7.73 6.67 36.00 7.89 6.75 39.06 7.87 6.74 6.25, 2018 20.77 7.58 6.88 19.50 7.71 6.95 25.72 7.80 6.99 18.00 7.87 7.03 83.99 7.74 6.96 5.64, 2019 0.40 7.64 6.61 ---10.30 7.85 6.72 18.30 7.99 6.79 29.00 7.94 6.76 6.05,2019 0.50 7.94 7.03 1.50 7.65 6.88 4.75 7.94 7.04 1.25 7.98 7.06 8.00 7.89 7.01 7.75 , 2021 OMC SB 1374.00 8.40 8.18 - - - 17.00 8.40 8.18 3.00 8.40 8.18 1394.00 8.40 8.18 7.94,2021 100.00 7.64 7.75 50.00 7.68 7.77 285.00 7.78 7.84 35.10 7.91 7.92 470.10 7.75 7.82 8.13 , 2021 OMC SB 10.00 8.22 8.19 0.35 8.32 8.26 50.10 8.24 8.2039.34 8.38 8.3099.79 8.298.245.87 , 2022 45.00 6.176.04 ---------45.00 6.176.04 8.15 , 2022 FCI SB 5.25 8.15 8.15 ---1.15 8.31 8.27 61.00 8.31 8.27 67.40 8.30 8.26 8.20,2022 2765.00 7.62 7.81 1607.51 7.66 7.84 5950.85 7.76 7.90 4122.40 7.93 8.02 14445.76 7.77 7.91 8.35,2022 2411.00 7.60 7.85 1350.00 7.66 7.88 5359.53 7.77 7.96 4771.85 7.93 8.06 13892.38 7.79 7.976.17,2023 5.60 7.787.20 0.90 7.71 7.15 5.30 7.95 7.322.488.017.3614.28 7.887.27 6.30,2023 1.05 7.96 7.37 20.00 7.77 7.24 5.00 7.74 7.22 40.00 8.07 7.45 66.05 7.95 7.37 8.01 , 2023 OMC SB 817.68 8.38 8.28 104.77 8.40 8.29 3.40 8.34 8.25 23.06 8.43 8.31 948.91 8.39 8.28 8.30 , 2023 FERT SB 1214.99 8.27 8.28 876.12 8.33 8.33 1906.98 8.46 8.42 206.07 8.49 8.44 4204.16 8.38 8.36 8.03 , 2024 FCI SB ------7.00 8.35 8.27 13.20 8.41 8.31 20.20 8.39 8.30 8.20 , 2024 OMC SB 578.31 8.37 8.33 296.72 8.37 8.33 45.93 8.48 8.40 27.20 8.50 8.42 948.16 8.38 8.33 8.40 , 2026 OMC SB 37.90 8.30 8.32 52.90 8.37 8.38 240.44 8.48 8.46 146.00 8.51 8.48 477.24 8.46 8.45 8.23 , 2027 FCI SB 293.59 8.24 8.24 81.70 8.35 8.32 455.67 8.41 8.37 1884.50 8.46 8.41 2715.46 8.42 8.398.24, 2027 ---------60.00 8.068.1060.00 8.068.10 6.01,2028 18.24 7.84 7.36 0.50 7.82 7.35 33.26 8.05 7.53 0.02 8.00 7.49 52.02 7.97 7.476.57, 2028 100.007.346.71 ---------100.007.346.71 7.95,2032 2717.00 7.74 7.77 1941.25 7.82 7.84 3390.05 7.96 7.96 1988.85 8.09 8.07 10037.15 7.90 7.91 8.32 , 2032 ---5.00 7.85 7.92 ---15.00 8.08 8.12 20.00 8.02 8.07 7.50,2034 34.70 7.83 7.78 8.80 7.87 7.82 11.00 8.05 7.98 - - - 54.50 7.88 7.83 7.40,2035 19.35 7.86 7.80 2.00 7.96 7.89 38.00 8.04 7.97 15.35 8.23 8.14 74.70 8.03 7.96 8.33,2036 12948.80 7.74 7.80 10002.20 7.83 7.88 13336.79 7.96 8.00 9422.25 8.09 8.12 45710.04 7.90 7.94 Sub-total 73058.62 7.57 7.68 47258.65 7.64 7.67 84139.67 7.70 7.57 68305.28 7.81 7.64 272762.22 7.69 7.63BRBI’sOMO:Sales ---90.00 --- - -2495.00 --2585.00 -- Purchase ---490.00 --1230.00 --1040.00 --2760.00 -- Sub-total ---580.00 --1230.00 --3535.00 --5345.00 -- (A+B) 73058.62 7.57 7.68 47838.65 7.64 7.67 85369.67 7.70 7.57 71840.28 7.81 7.64 278107.22 7.69 7.633MarketRepo 84157.46 96198.24 101674.90 92834.34 374864.94 4 State Govt Securities 245.38 7.91 8.06 251.67 7.96 9.33 824.52 8.13 8.27 716.70 8.23 8.71 2038.27 8.12 8.53 Grand total (1 to 4) 159870.75 147125.63 191854.16 171567.82 670418.36 (-) Means no trading. YTM = Yield to maturity in percentage per annum. CY = Current yield in per cent per annum. SGL = (RBI’s) Subsidiary General Ledger. OMO = Open Market Operations. OMC SB= Oil Marketing Companies Special Bonds. NDS = Negotiated Dealing System. OM = Order Matching Segment. Securities with small-size transactions (Rs 2 crore or less) have been dropped from the above list but included in the respective totals. (1) Yields are weighted yields, weighted by the amounts of each transaction. (2) Current yield has not been worked out for treasury bills. (3) For Floating Rate Bonds (FRB’s) Current yields are based on the latest half-year yield determined in the auction.

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