The absence of a crisis is usually a non-event. But I think the absence of a foreign exchange crisis this year (1996-97) is big news.
When India went bust in 1991, it borrowed from every possible source-IMF, World Bank, and non-resident Indians (for whom it floated $ 1.6 billion of India Development Bonds). Critics of reforms warned that this was myopic borrowing which would bring in immediate money, but cause a renewed crisis when the money had to be repaid.
The India Development Bonds, for instance, carried no annual interest payments, and entailed repayment of all the principal and interest (totaling $ 2.2 billion) in one go in 1996-97. Other repayments meant that debt servicing in 1996-97 would reach a peak of $ 14.5 billion, almost double the 1992-93 level of$ 7.66 billion. And so, said critics of reforms, do not be misled by the financial rescue of 1991, since the crisis will return by 1996-97.
Well the supposed year of crisis is now here, but there is not a ripple on the foreign exchange front. The India Development Bonds have been redeemed this week- end, IMF has been repaid its pound of flesh, and yet the foreign exchange reserves have risen from $ 17 billion at the beginning of the fiscal year to over $ 19 billion today. The country\’s debt service ratio is down from 35.5 per cent in 1990-91 to barely 25 per cent.
Once again, the critics of reforms have been exposed as second-rate astrologers. One reason is their understandable unwillingness to admit that they represented the problem rather than the solution. More important, they simply did not understand the importance of creating a climate where people find it worthwhile to keep money in India.
The main reason for India\’s solvency today is not an export boom. It is the willingness of Indians to bring dollars back to the country instead of sending it out, as in the past.
Commerce ministry data says the trade gap widened from $ 1.55 billion in 1991-92 to $ 4.53 billion in 1995-96, much less than in the 1980s when it averaged S 6 billion a year. However, this data excludes defence imports. These are captured by RBI data, which shows a much worse picture-the trade gap widened from $ 2.79 billion in 1991-92 to a whopping $ 8.94 billion in 1995-96, the biggest in history.
Why then, did this not cause a crisis in conjunction with rising debt servicing? The main reason is that remittances from Indians abroad have shot up from $ 2.77 in 1992-93 to $billion in 1995-96 and may touch $ 9 billion this year.
It is simply not true, as some critics claim, that we have survived by borrowing more and depending on foreign portfolio investment. As the table shows, net commercial borrowing has been very modest, thanks to large repayments. And while foreign investment (direct as well as portfolio) has risen to over $ 4 billion per year, remittances are now far larger.
Why have remittances shot up? The recession in the Gulf countries since 1991 has reduced the region\’s demand for Indian labour. Earlier, such labour accounted for two-thirds of all remittances to India.But now the share of remittances from Europe and North America has shot up, and the share of the Gulf has declined to around 40 per cent. In absolute terms, the inflow from rich countries now exceeds the global inflow in earlier years.
Why so? Unlike Gulf labourers, Indians in North America are affluent and have no need to send money to support families at home. Indeed, in the past affluent
Indians used to take huge sums out of the country through various illegal means-hawala transactions, underinvoicing exports, over invoicing imports. Some capital still flows out of India in these ways, but we are now witnessing a return flood too.
The reason is that India has become a country into which it is worth bringing money. This was not so earlier. Indian tax rates used to be extremely high, over 60 per cent. Pervasive foreign exchange controls made it worth paying a big hawala premium to accumulate dollars abroad. The rupee was so overvalued and weak that there was a financial profit to be made through capital flight.
Leftist moralists claimed in outraged tones that this was illegal. But ordinary Indians, ranging from labourers to students to businessmen, saw it as a revolt against stupid policies that made it attractive to take money out of India and stupid to bring money in.
There has been a huge change since 1991. The maximum income-tax rate is down to a reasonable 40 per cent. Foreign exchange controls have been eased enormously, you can quite easily get dollars for travel, education and other purposes, so there is little incentive to pay hawala premiums to take dollars out of India. Foreign goods which were earlier unavailable in India are now available, thanks to liberalisation of imports, production and foreign collaborations. The exchange rate has become competitive, which means capital flight is no longer economically rational—you cannot hope to make a big killing because a huge devaluation is in the offing. Interest rates are much lower over-seas than in India, so you pay a penalty when you take your money abroad, but reap a windfall when you bring dollars back. The opening up of the economy means that innumerable new opportunity as have arisen for deploying funds within India.
Earlier hawala operators garnered the bulk of Gulf labour remittances, keeping the dollar abroad while sending rupees to the relatives of the labourers. So billions of dollars of labour income never returned to India in the old days. The hawala premium has now gone down, and bank$ have reduced delays in transmission, so more labourers now send remittances through bank.
As long as people wish to evade taxes by sending their money abroad, there will always be hawala market. But many who took their money abroad in the old days want to bring it back after liberalisation. Indians have bee prominent in subscribing to Euro issues of Indian companies, an NRIs account for an astonishing one- third of all direct foreign investment since 1991. Given this climate of confidence, no wonder ordinary remittances are going up too
|Plugging the trade gap (in $ bn)