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HindustanTimes Sat,26 Jul 2014

Inside the forex chasm

Gaurav Choudhury, Hindustan Times  New Delhi, January 08, 2013
First Published: 22:53 IST(8/1/2013) | Last Updated: 23:13 IST(8/1/2013)
While the CAD is indeed worrying, I think it is within our capacity to finance the CAD, thanks to FDI, FII and ECB. I would again underscore the crucial importance of FDI and FII. As I have said before, attracting foreign funds to India has become an economic imperative, says finance minister P Chidambaram.

What does balance of payments (BoP) mean for an economy?

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An economy, like an organisation or a company, has a receipts and expenditure account. The balance of payments  (BoP) is a statement of account of the income and expenditure made through foreign exchange.


What is the current account and capital account in BoP?

A country’s BoP statement is divided into two major heads — the current account and capital account. In any economy, foreign exchange movements take place through two routes. Investments come into India such as foreign direct investment (FII), portfolio investment in India’s stock markets, overseas borrowing by Indian companies from foreign banks come through the capital account because these funds are used over a period of time.  On the other hand, there are expenses and income that are “current” in nature. These include export earnings, import payments, earnings from intangible services exports (such as tourism), a credit of income such as when an individual receives funds from a foreign entity and current transfers as foreign aid and donations.


How is the current account calculated?

The current account is calculated by the formula (X-M)+NY+NCT, which the net export earnings over import payments, net foreign income and net current transfers.


What does a deficit or a surplus in the current account signify?

A current account deficit means that there is more outflow of capital from the economy than inflow, which is not desirable.


Why is it critical to keep CAD within manageable limits?

In macro-economics, the twin deficits —CAD and the fiscal deficit — the amount of money the government borrows to fund its expenses -are of paramount importance. If no action is taken, we have to either earn about $80-$100 billion ( Rs. 4.4- Rs. 5.5 lakh crore) every year through the capital account or meet the deficit by depleting our foreign exchange reserves. Clearly, both the options are not realistic. A widening CAD — the difference between export earnings and import expenses net of cash payments and remittances — is a worrying sign for a slowing economy where fulfilling immediate dollar payment obligations may necessitate dipping into the pool of foreign exchange reserves. So far India has been able to finance its CAD without drawing on the $300 billion ( Rs. 16.5 lakh crore) foreign exchange reserves.


How has India managed to avoid dipping into its pool of foreign exchange reserves to finance the CAD?

This was mainly due to foreign direct investment (FDI) worth $12.8 billion ( Rs. 70,400 crore) and foreign institutional investment (FII) valued at $6.2 billion ( Rs. 34,100 crore). External commercial borrowings (ECB) worth $1.7 billion ( Rs. 6,600 crore) have also enabled India to avoid drawing from its forex reserves.


Why has the CAD widened in India?

The CAD has widened to 5.4% of GDP during the quarter and to 4.6% of GDP during the first six months of current fiscal year as exports contracted by 7.4% on the back of shrinking shipment orders from floundering US and European economies. Of the imports, gold and crude oil accounted for the largest component of India’s inward trade shipments, triggering a rise in dollar outflow. Gold imports constituted a substantial chunk of imports and are a huge drain on the current account. Suppose gold imports had been one half of the actual level, that would have meant that our foreign exchange reserves could have increased by $10.5 billion ( Rs. 57,750 crore).


How will a drop in gold imports help India’s economy?

Economists have attributed India’s widening CAD to rising gold imports, among other causes. A high customs duty will discourage gold imports by pushing up gold’s landed price and reduce foreign exchange outflows.


What is the flip side of a rise in customs duty in gold?

A high customs duty carries the risk of encouraging the smuggling of the precious metal. There are signs that smuggling of gold has jumped sharply since the government doubled import duty to 4% in March last year. The value of gold seized by the customs department as India’s borders has more than tripled during April to October 2012 as compared to the same period of the previous year. India’s official gold import during April to September, however, stood at 220 kg during the April-September period of 2012-13, nearly half of the 407 kg India imported during the year-ago period.


Why do people invest in gold?

Gold is one of several assets that people invest in. Unlike equities or bank deposits, gold is a physical asset and has been a traditional favourite avenue for parking surplus income.


Why have
gold prices remained high in the last 12 months?

Gold is considered a safe haven asset. With inflation high and stock markets volatile, gold prices have hit an all-time high. Its value has risen 35% over a year as investors in Europe and the US flock to add more glitter to their investment portfolio rather than park funds in unstable and risky equity markets.


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