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august 30, 2008

Trouble Ahead on the Balance of Payments?

Some recent happenings on the balance of payments could be smoke signals of trouble ahead.

ndia’s foreign currency assets as of August 15 were $ 285,975 given to inflation. But are the more recent signals coming from
million, having fallen by $ 13,255 million since end-March the decline in foreign currency assets, the net outflow of foreign
2008. This is a marked reversal when compared to the accretion portfolio capital and the depreciation of the rupee indicative of a
of $ 110,500 million to foreign exchange reserves in 2007-08. Further, possible reversal in capital inflows that may lead to falling
with the world’s major stock markets rendered weak and volatile f­inancial asset prices and an economic downturn?
and with foreign capital withdrawing from the emerging markets, Let us then turn to what the EAC has to say on India’s inter­
there was a net outflow of foreign portfolio investment to the extent national transactions. On the assumption of a continuation of the
of $ 3,735 million in the last quarter of 2007-08, compared to a net high price of crude oil in the range of $ 125-130 a barrel, the EAC
inflow of $ 8,168 million in the corresponding quarter of 2006-07. forecasts a merchandise trade deficit of $ 134 billion (10.4 per cent
(In 2007-08, net foreign portfolio investment inflow was $ 29,261 of GDP) for the current financial year, 2008-09. (Mercifully, the
million compared to only $ 7,062 million in 2006-07.) And during price of crude has since fallen by as much as $ 10-15 from those
the seven months of the current calendar, there has been an out- figures and hopefully will not rise again during the year.) With
flow of around $ 7 billion on the foreign institutional investor their presumption of a decline in the growth of software service
account. Are these happenings, first highlighted by the EPW export revenues and remittances, the EAC forecasts a CAD of $ 41.5
Research Foundation (EPW, August 23, 2008) cause for concern? billion (3.2 per cent of GDP). Further, with expectations of only a
It might be fruitful to take a look at the preliminary data of the modest increase in net foreign direct investment, a significant
balance of payments (BOP) for the financial year 2007-08 as also decline in foreign portfolio investment ($ 4.1 billion in 2008-09
relevant sections of the Economic Outlook for 2008-09, submitted compared to $ 29.3 billion in 2007-08), and a modest dip in loans,
by the Economic Advisory Council (EAC) to the prime minister on banking capital and other capital, net inflows on the capital
July 30. a­ccount   of the BOP are estimated at $ 70.9 billion, as compared to
The merchandise trade deficit on the BOP during 2007-08 was $ 108.03 billion in 2007-08.
$ 90.1 billion (7.7 per cent of the gross domestic product). But, Total net capital inflows are thus forecast to be much lower
due to buoyancy in the two main items on the invisibles account – than in 2007-08 but still adequate to finance the CAD, adding
software services and private transfers (remittances) – the current $ 29.4 billion to the foreign exchange reserves compared to $ 92.2
account deficit (CAD) was only $ 17.4 billion (1.5 per cent of GDP). billion in 2007-08. The EAC also expects greater volatility in capital
During the year, net capital inflows were $ 108,031 million, a inflows in the current financial year.
large part of which were potentially volatile in nature – net foreign Now a CAD of 3.2 per cent of GDP implies a significant increase
portfolio investment ($ 29,261 million), banking capital excluding in the net liability of the country to the rest of the world, and if
NRI deposits ($ 11,578 million), short-term trade credits ($ 17,683 this persists then net claims of foreign capital on the economy will
million), and other capital ($ 9,627 million) together constituted grow with the passage of time. The questions will be whether the
63 per cent of such inflows. Thus, a large part of the net accretion inflows of foreign capital that finance the CAD are spent more on
to the foreign exchange reserves was constituted of volatile capital consumption than on investment, the prospects of Indian exports,
inflows, there being a phenomenal increase in such inflows during and whether the supply conditions of India’s essential imports
2007-08 as compared to the previous financial year. (e g, petroleum, oil and lubricants) deteriorate over time. But what
The value of the rupee, largely determined by the capital ac- of an impending fall in asset prices? The latest available estimate of
count of the BOP and the RBI’s intervention, appreciated last year the stock of foreign portfolio investment, the largest constituent of
and in turn adversely affected the price competitiveness of ex- volatile capital, is $ 124.5 billion (as of December last year); but
ports, though this appreciation has been reversed during the this is misleading. Its market value would be of a much higher
course of 2008. That apart, associated with the huge capital in- order, significantly more than the size of India’s foreign exchange
flows and the easy money that has accompanied them are high reserves (Nirmal K Chandra, ‘India’s Foreign Exchange Reserves:
asset prices, not to mention the impetus the large liquidity has A Shield of Comfort or an Albatross?’, EPW, April 5, 2008).
Economic & Political Weekly  EPW   august 30, 2008 5

Large capital inflows over the past two-three years – in the form set of problems. One can only imagine the downside risk of a
of portfolio investment and external commercial borrowings – r­eversal of capital inflows that is linked to sharp currency
have created significant problems for the Indian economy. But a d­epreciation, falling asset prices and a severe economic
sudden and major reversal will cause another and equally major d­ownturn   aggravated by the high CAD.

A Cauldron of Communal Violence

State inaction against communal elements has exacerbated an already polarised region in Orissa.

ommunal violence is becoming a regular feature of Orissa the south, many in the dalit community who have become Chris-
society, differing from much of the rest of the country only in tians have not been able to claim scheduled caste (SC) status to
that it is the Christian minorities rather than Muslims who achieve social mobility through employment in the government
are at the receiving end. The violence against Christians and the apparatus because the Constitution (Scheduled Castes) Order, 1950
community-run institutions in Kandhamal district following the prevents them from availing of reservations. Those among the
murder of a Vishwa Hindu Parishad (VHP) activist Lakshmanananda dalit Christians in Orissa who speak the Kui language are instead
Saraswati and four others comes less than a year after a string of demanding ST status, since tribal groups irrespective of their religion
attacks in Kandhamal district by the Sangh parivar on Christians can utilise reservations. The antagonism between the Christian
on Christmas eve of 2007. At that time the conflagration was a cul- dalits and others has only increased because the kandh tribals who
mination of various factors: the issue of conversion and re-conversion, have been accorded ST status feel threatened by the demand from
demands for scheduled tribe (ST) status by some groups, and, of the dailt groups for a similar position. These antagonisms have
course, the underlying poor socio-economic status of the people in become exaggerated in a region mired in poverty, state inaction,
the mostly tribal area in an already communally affected Orissa. poor governance and where social provisions and functions such as
Investigations are still under way to identify the murderers of education and health are hegemonised by communal groups. This
Lakshmanananda Saraswati. Despite rumours and “beliefs” that is not to mention the fallout of political rivalry between the
the attack was conducted by Maoists, no concrete proof has emerged. B­haratiya Janata Party (BJP) and the Congress who have been
The subsequent rioting and burning of Christian missions, schools openly allying with communal groups to build up electoral support.
and households and deaths of around 10 people at the time of It goes without saying that the state government has to reassert
writing reveal that the Sangh parivar has few qualms in d­irecting its presence, punish those responsible for communalising the
violence at the poor of other communities. situation and bring back normalcy to this violence-prone region.
Kandhamal district has, over the years, emerged as a cauldron The presence of the BJP as a partner in the Navin Patnaik-led
for rival communal groups who are engaged in proselytism and coalition has tied the government’s hands, if indeed it wanted to
“re-conversion”. Lakshmanananda Saraswati was a VHP activist respond to the situation. That the government has been lax in
who was based in the region for close to four decades. A lynchpin punishing those engaged in communal violence even as the death
of the Sangh parivar’s efforts to forge a presence in the tribal areas of Lakshmanananda Saraswati has given the BJP an opportunity
of Orissa, he was involved in activities such as “re-conversion” of to further whip up communal sentiments is there for all to see.
non-Hindus back to the “Hindu fold”, apart from running institu- The State has to reclaim the space where it has a major part to play
tions for Hindutva groups. Much like in December 2007. Saraswati’s in development and in the provision of social services. The govern-
murder produced a predictable reaction in the communally ment has been hitherto more concerned with promoting a model of
f­ragile region. In these sensitive tracts, action such as the target- development in which commercial interests are given free rein over
ing of religious symbols by communal organisations on both sides the resources traditionally under the control of the tribals. The com-
has time and again resulted in violent reprisals by the other side. munal forces have used the vacuum left by the state to “win over”
The communally charged atmosphere has turned all the more t­ribals in the name of their upliftment and have used this to establish
tense because of certain caste issues. As in some of the states in themselves in the region to further their narrow and divisive agenda.

Proxy War in the Caucasus

Russia sends a message that it will not tolerate western-backed adventures in the Caucasus.

n August 8, after days of escalating skirmishes over its with Russia very much the master of the region. If it was Georgia’s
breakaway province South Ossetia, Georgia launched a intention to portray to the world that Russia was an aggressor,
full-scale military assault on Tskhinvali, the capital of Moscow was able to pass on an even stronger message not only to
South Ossetia and set off a chain of bloody events that has ended Georgia but also to the others in Russia’s “sphere of influence”:
6 august 30, 2008  EPW   Economic & Political Weekly