Three kinds of dollar avalanches

Revised balance of payments data in the RBI Bulletin for October suggest that India’s external strength is even greater than believed earlier. The data contain some puzzles:  India is overflowing with dollars for reasons still poorly understood.

See the accompanying table. Readers will be familiar with many of the trends— rising exports and imports; a rising trade deficit that is more than offset by a rising inflow of invisibles and foreign investment; and burgeoning foreign exchange reserves. Three trends are striking enough to merit more detailed research.  One is the rise in remittances to a stratospheric level ($ 23.2 billion) that defies easy explanation.  A second is the inflow of no less than $4 billion miscellaneous services. A third is the increase on foreign portfolio investment in 2003-04 to the mind-blowing level of $ 11.4 billion.

Balance of payments: in $ billion

Source: RBI Bulletin October 2004

Remittances from overseas Indians were no more than $ 2 billion 1991. Since then they have soared, although the overseas Indian population has risen only modestly. Till recently, most of us quoted RBI data for the calendar year 2003 to say that remittances were $ 18 b. a year. We could not have guessed that a slight change of time period, to 2003-04, would increase the figure to $ 23.2 billion.

This is close to 5% of GDP. It is by far India’s biggest dollar earner, earning almost twice as much as software/BPO ( $ 12.2 billion).

We have detailed data on minor merchandise exports, but not on remittances. Some studies suggest that low-skilled workers in the Gulf have ceased to be the key contributors, and more comes from high-skilled workers in North America and Europe.  This still leaves us guessing about the dynamics. Why are remittances growing so explosively, who exactly is sending these sums, how sustainable are these flows, and how can we safeguard these against a sudden fall?  This needs to become  a major area of research.

One Harvard economist has hypothesized that the dollar flood from the USA could be from Indian software engineers doing onsite work in the USA. They have high earnings, and have an incentive to remit these since they are returning home. But  H1-B visas for Indians have been reduced, and yet remittances are rising faster than ever.

 One  CII survey suggests that a majority of remittances come from Indians outside software—in finance, medicine, education and laboratories. The US census of 2000 showed a virtual doubling of the Indian population, a sign that permanent migration is rising fast, possibly accelerated by families joining a bread-winner. But why should  permanent migrants remit large sums? We are still unclear about the dynamics and sustainability of remittances.

Some economists have expressed the belief that believe that India’s relatively high interest rates have sucked in dollars in search of interest arbitrage, using NRIs (non-resident Indians) as a front. Our table shows that net NRI deposits grew from $ 2.3 billion in 20001-02 to $ 3 billion in 202-03 and $ 3.6 billion in 2003-04. The numbers are very modest in comparison with remittances, which earn no interest at all.

Some years ago, workers sent remittances to India through the hawala market where they got a currency premium. This meant remittances were under-reported officially. The gradual disappearance of the hawala premium explained some of the rise in remittances in the 1990s. But it cannot explain the virtual doubling of remittances in the last three years.

Many Indians think that software is the lynchpin of our service exports. But service exports totaled $ 24.9 billion in 2003-04, of which barely half ($ 12.2 billion) consisted of software/BPO. What are the other service exports?  Travel and transport have always accounted for significant inflows as well as outflows. What seems a mystery, and needs elucidation, is the category called “miscellaneous services”, under which software is lumped. Miscellaneous exports other than software have risen from $ 3.5 billion in 2000-01 to $ 4.7 billion last year. That is big money, and cannot be dismissed as a mere miscellany.

The third striking figure is the inflow of portfolio investment, from FIIs and NRIs. This was a mammoth $ 11.4 billion in 2003-04, up from just $ 0.9 billion the previous year and $ 2.6 billion in 20000-01. Portfolio investment last year was almost as big as  software/BPO exports. India may be far behind China in foreign direct investment, but is far ahead in portfolio investment.

Economists treat portfolio investment as a capital flow. Yet it has some characteristics of a high-tech service export. Till the 1990s, the sleazy Bombay Stock Exchange dominated the Indian market. It had rigged outcry markets, paper certificates that were frequently forged (almost one-tenth of deliveries were bad), high commissions, and settlement periods that could be extended almost forever.

 Then the National Stock Exchange in 1994 brought in an electronic high-tech market that matched trades through computers long before the London StockExchange did so. Dematerialisation replaced paper ownership with electronic ownership. Stock market reforms now provide rolling trades that are settled two days after each trade, and derivative trading. This amounts to such a high quality of stock-market services that even Calpers, the biggest pension fund in the world, has decided to invest in India.

 Markets are fickle, of course, and what goes in can rush out. We need more detailed research on the factors behind the flow, and its sustainability. My guess is that India’s stock-market modernisation has yielded a permanent (if cyclical) benefit, and is a much under-rated achievement. We have beaten China not only in marketing software/BPO but in marketing equity too.