16 ECONOMIC SURVEY 2007-2008

Balance of payments in 2006-07. Thus, the rupee faced upward pressure

in the second half of 2006-07. Despite this, the
1.41 The World Economic Outlook (WEO, IMF
rupee depreciated by 2.2 per cent on an overall
October 2007) observed that the recent
yearly average basis. The excess of capital inflows
expansionary phase in the global economy, with
has risen to 7.7 per cent of GDP in the first half
average growth of 5 per cent, was the longest since
of 2007-08. Foreign exchange reserves increased
the early 1970s. The WEO update on January 2008
by US$ 91.6 billion to US$ 290.8 billion on
has, however, revised these estimates based on
February 8, 2008.
new PPP exchange rates from the 2005
international comparison programme (ICP). There Components of Capital Account
is considerable uncertainty in quantifying the
1.44 The composition of capital flows is also
downside risk to global growth arising from the
changing. Among the components of capital
downturn in housing market and the sub-prime
inflows, foreign investment has been a relatively
mortgage market crisis in the United States.
stable component, fluctuating broadly between 1
Monetary policy actions by the United States and
per cent and 2 per cent of GDP during this decade.
other developed countries seem to have contained
However, it seems to have shifted to a higher
its immediate impact, though more surprises in
plane from 2003-04 with the average for 2003-04
the next six months cannot be ruled out.
to 2006-07 roughly double that during 2000-01 to
1.42 The Indian economy has been 2002-03. The relative stability of investment flows
progressively globalizing since the initiation of is primarily due to steadily rising FDI. In contrast,
reforms. Trade, an important dimension of global debt flows have fluctuated much more, with net
integration, has risen steadily as a proportion of outflows in the three years to 2003-04. The
GDP. Inward FDI has taken off and there is a variations in debt flows have been primarily due to
surge in outward investment from a very low base, lumpy repayments on government guaranteed or
with net FDI continuing to grow at a good pace. related ECB. The ratio of debt flows to GDP was
The surge of capital flows in 2007-08 is a third on a down trend till 2003-04 and a rising trend
indicator that testifies to the growing influence of from 2004-05. Debt flows, primarily external
global developments on the Indian economy. commercial borrowings, shot up on a net basis in
Capital flows, as a proportion of GDP, have been 2006-07 to a level of US$ 16.2 billion. The trend
on a clear uptrend during this decade. They reached in net capital flows since 2003-04, therefore, seems
a high of 5.1 per cent of GDP in 2006-07 after a to be broadly driven by the rising ratio of debt
below trend attainment of 3.1 per cent in 2005-06. flows.
This is a natural outcome of the improved 1.45 The most welcome feature of increased
investment climate and recognition of robust
capital flows is the 150 per cent increase in net
macroeconomic fundamentals like high growth,
foreign direct investment inflows in 2006-07 to US$
relative price stability, healthy financial sector and
23 billion. The trend has continued in the current
high returns on investment. Even as the external
financial year with gross FDI inflows reaching US$
environment remained conducive, the problem of 11.2 billion in the first six months. FDI inflows
managing a more open capital account with were broad-based and spread across a range of
increasing inflows and exchange rate appreciation
economic activities like financial services,
surfaced.
manufacturing, banking services, information
1.43 The current account has followed an technology services and construction. With FDI
inverted V shaped pattern during the decade, rising outflows also increasing steadily over the last five
to a surplus of over 2 per cent of GDP in 2003- years, overall net flows (FDI balance in BoP) have
04. Thereafter, it has returned close to its post- grown at a slower rate.
1990s reform average, with a current account deficit 1.46 The globalization of Indian enterprises and
of 1.2 per cent in 2005-06 and 1.1 per cent of planting of the seeds for the creation of Indian
GDP in 2006-07. The net result of these two trends multinationals have taken place in the last few
has been a gradual rise in reserve accumulation years. Outward investment from India shot up to
to over 5 per cent of GDP in 2006-07. With capital US$ 14.4 billion in 2006-07 from less than US$ 2
inflows exceeding financing requirements, foreign billion in the period 2003-04. The trend continued
exchange reserve accumulation was of the order in the current year with outward investment of
of US$ 15.1 billion in 2005-06 and US$ 36.6 billion US$ 7.3 billion in April-September 2007. Net FDI

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 STATE OF THE ECONOMY 17
flows were, therefore, a modest US$ 3.9 billion even if net flows do not increase to the same
during this period. The proportion of payments to extent, as they can improve competition in the
receipts under FDI into India was in the range of real and financial sectors, improve the quality of
0.7 per cent to 0.4 per cent in 2005-06 and 2006- intermediation and the average productivity of
07, respectively. This indicates the lasting and investment, and thus raise the growth rate of the
stable nature of FDI flows to India. economy. The challenge for policy is to maximize
these benefits while minimizing the costs of
1.47 Increased volatility in Asian and global
exchange rate management.
financial markets in 2006-07 affected the flow of
portfolio investment. Net portfolio flows became 1.50 The rise and fall of the current account
negative in May-July 2006 (reflecting the slump in balance (as a ratio to GDP) during this decade
equity markets), picked up momentum in August- has been driven largely by the goods and services
November 2006, only to slow again in March 2007. (G&S) trade balance, with the two having virtually
Net flows were, therefore, only US$ 7.1 billion in the same pattern. The surplus from factor income
2006-07 compared to US$ 12.1 billion in 2005-06. including remittances, which fluctuated between 2
Euro equities, which were a relatively minor per cent and 3 per cent of GDP, has helped
component of portfolio flows (less than a billion moderate the substantial deficit on the trade
US dollars in the period 1997-98 to 2004-05), rose account. Both the trade (G&S) balance and the
to US$ 3.8 billion in 2006-07 constituting 54.3 per factor surplus improved between 2000-01 and 2003-
cent of the total net portfolio flows. Net portfolio 04 leading to an improvement of the current
investment inflow was US$ 18.3 billion in April- account. Both reversed direction thereafter resulting
September 2007, more than double the inflow in a declining trend in the current account. The
during 2006-07. Underlying these were gross peak values of the three as a proportion of GDP
inflows of $ 83.4 billion and outflows of US$ 65.0 were -0.6 per cent, 2.9 per cent and 2.3 per cent.
billion. In the past two years the current account deficit,
trade (G&S) deficit and factor surplus have averaged
1.48 The rapid accretion of reserves and 1.15, 3.5 and 2.35 per cent of GDP, respectively.
increased pressure on the rupee, necessitated
raising the limit on the market stabilization fund. 1.51 The trends in the goods and services trade
The annualized return on the multi-currency, multi- deficit have in turn been largely driven by the
asset portfolio of the RBI was 4.6 per cent in merchandise trade deficit since 2004-05. During
2006-07, indicating that the effective fiscal cost of 2000-01 to 2003-04 the merchandise trade deficit
sterilization may be 3.2 per cent. The fiscal costs was around 2 per cent of GDP and the rising
of sterilization in 2007-08 is placed at Rs. 8,200 services surplus resulted in an improving trend in
crore. The search for an appropriate policy mix for the overall G&S trade balance. From 2004-05 the
balancing a relatively open capital account, merchandise trade balance has been deteriorating
monetary policy independence and flexible and despite the continued rise in the services
exchange rate continues. surplus, the overall G&S balance had followed the
deteriorating trend of the former.
Current account components 1.52 Private transfer receipts (mainly
1.49 The current account deficit (CAD) mirrors remittances) shot up by 49.2 per cent in 2007-08
the saving-investment gap in the national income (April-September) over the first half of 2006-07
accounts and thus constitutes net utilized foreign when they had increased by 19.2 per cent.
savings. The challenge is to leverage foreign inflows Investment income (net), which reflects the
(i.e. foreign savings and investment) to promote servicing costs on the payments side and return
growth without having the long-term consequences on foreign currency assets (FCA) on the receipts
of external payment imbalances. The distinction side, grew by 60 per cent in 2007-08 (April-
between gross capital inflows and net inflows is September) reflecting the burgeoning foreign
useful. As the latter must equal the CAD, there is exchange reserves. Net invisible surplus grew by
no way in which net use of foreign saving can 35.2 per cent to reach US$ 31.7 billion in 2007-
increase without an increase in the CAD. The 08 (April-September), equivalent of 6.1 per cent of
gross inflow can, however, increase to the extent GDP. Thus, higher invisible surplus was able to
that it is offset by gross outflows in the form of moderate partly the higher and rising deficits on
build-up of foreign exchange reserves, reduction in trade account. CAD was, therefore, placed at US$
government external debt or outward investment 10.7 billion in 2007-08 (April-September), equivalent
by entrepreneurs. Higher gross inflows have value of 2 per cent of GDP for the half year.

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