Invisibles overtake visible exports

Table: Latest Balance of Payments data ($ billion)

Source:RBI Bulletin November 2004

It has finally happened. India’s invisible exports have overtaken visible (merchandise) exports in the April-June quarter. The latest RBI Bulletin shows that invisible exports in this quarter shot up to $ 17.7 billion, against visible merchandise exports of $ 16.8 b. Merchandise exports rose fast, invisible exports even faster. To coin a phrase, India’s export boom is now mostly invisible.

Private transfers (remittances from overseas Indians) continue to be the biggest invisible item. They fetched $ 5.2 billion, up modestly from $ 4.9 billion last year.

A big  puzzle is “miscellaneous service exports other than software”, which totaled  $ 4.6 billion, far more than software exports ($ 3.5 billion). These miscellaneous service exports totaled  $ 4.6 billion in 2003-04. Now they have reached the same agnitude in a single quarter! If sustained, they will be 4% of GDP.

Now, the figures will probably be revised. In 2003-04, miscellaneous service exports were provisionally estimated at $ 7.6 billion, but later revised down to $ 4.6 billion. Simultaneously, remittances were revised up, from $ 19.2 billion to $ 23.7 billion. Apparently some miscellaneous service exports were reclassified as remittances. Possibly we will see a similar change when the data for the April-June quarter’s are revised.

Another major  change in the quarterly data  relate to”investment income”, which has almost doubled to $ 1.7 billion. Could this represent capital gains in Forex holdings in Euros and yen? If not, what else explains such a huge increase? The RBI needs to provide answers.

The quarterly current account deficit of $ 0.7 b. last year has become a surplus of $ 1.9 billion this year. To this we must add substantial capital inflows through external loans and FDI. Net foreign portfolio investment in the quarter was almost zero, thanks to the panic after the BJP lost the general election. NRI deposits also changed to an outflow of $ 0.8 b. from an inflow of $ 1.7 the previous year (because of the slashing of interest rates on NRI deposits). Yet despite a record merchandise trade deficit, sky-high oil prices, zero FII inflows and an outflow of NRI bank deposits, the forex  reserves rose  inexorably.

What are the implications for exchange rate policy? When asked what precisely our exchange rate policy is, RBI Governor Venugopal Reddy to be sphinx-like. Often he says that the exchange rate is market-driven, glossing over the fact that the market itself is RBI-driven. However, India’s real effective exchange rate (REER) against a trade-weighted basket of currencies has been more or less unchanged for more than six years. So many observers believe the main aim of exchange rate policy has been to keep the REER constant, thus keeping merchandise exporters globally competitive.

But if remittances and miscellaneous service exports keep growing explosively, the logic of a constant REER becomes questionable. I have long been among those economists who think that the exchange rate should be determined mainly by trade flows, not capital flows. Large capital inflows can appreciate a country’s exchange rate, causing exports to fall and imports to boom. When the resulting trade gap looks frightening, capital can flow out again in panic. It makes sense to limit this sort of damage (though this is better done by taxing/discouraging capital inflows rather than preventing rupee appreciation).

 But if  dollars flood in not through capital inflows but invisible exports, the logic changes. Some think that remittances are a sort of capital flow, even though we traditionally treat them as current flows. Remittances, like capital inflows, can suddenly dry up when a balance of payments crisis approaches.

Yet this is not a good enough reason to treat remittances (or miscellaneous service exports) as a sort of capital inflow. Capital seeks returns, by way of dividends, interest or capital gains. Remittances and miscellaneous service receipts seek no returns: they come in gratis. Capital inflows are (correctly) listed as liabilities in a company balance sheet, and in a country’s balance of payments too. Gratis inflows (like remittances) are not liabilities: they are current receipts, like export receipts. So, there is altogether less reason for the RBI to intervene if the rupee is appreciating because of strong invisible earnings.

A rising rupee can hit merchandise exports. It will also be adverse for software and BPO exports, but the margins in those industries are large enough to absorb quite a bit of currency appreciation. But remittances will, if anything, be encouraged by rupee appreciation: overseas Indians will hasten to change their dollars before they depreciate further. This will be true of  miscellaneous services that are analogous to remittances.

In sum rupee, a rising rupee may not hit current forex earnings, and may simply mean more invisibles and less visible exports. This weakens the case for RBI intervention to keep down the rupee.

Now, it is too early to be sure that invisibles have overtaken visible exports on a sustainable basis. We need to wait and watch what happens. The trigger for decisive action may well be a revaluation of the Chinese yuan.

The weak dollar is inducing a huge inflow of speculative dollars into China, and yuan revaluation seems inevitable. The most interesting story I have heard is of a beggar in China.  When given a dollar by a tourist, the beggar asked for euros instead. What does this beggar know that Alan Greenspan does not?

India’s main export rival in a wide range of manufactures is China. If China revalues by say 5%, India can, without fearing for its exports, allow the rupee to strengthen to the same extent. Indeed, I am willing to bet that several other Asian currencies will revalue when China does. In which case a revaluation of the rupee may have no adverse effect on even merchandise exports. That will make the decision really easy.