By Akhil Raj Gupta

This paper attempts to highlight the growing impact of external savings on India’s investment and thereafter analyze the positive and negative consequences of this financing arrangement. This analysis becomes extremely pertinent in the backdrop of the 2008 financial crisis, following which loose monetary policy and loss of business confidence abroad led to a flurry of Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) in emerging-market economies such as Brazil, Indonesia, and most importantly India. This is measured largely by the widening current account deficits of these nations, which also captures a ‘stock’ representation of the savings-investment gap, necessitating the inflow of foreign capital towards this lacuna. However, a closer look might also reveal that ‘hot money’ from abroad can have a debilitating effect on the economic stability of a nation, as measured by the veritable  ‘free-fall’ of the nominal value of the Indian rupee upon announcements of the quantitative easing taper by the United States Federal Reserve. This section also encompasses the notion of allocative efficiency for this external capital and whether it is higher investment or overconsumption that is continuously driving the current account chasm wider. Accordingly, I have divided the analysis into the following subsections –

 

  1. 1.     Trends in external investment in India (Post 1991 under the framework of the New Economic Policy)
  2. 2.     Favorable impact of external investment in India
  3. 3.     Negative impact of external finance in India

1.     Trends in external investment in India – Equity flows

Year

A. Direct Investment

B. Portfolio Investment

Rs. crore

US $ million

Rs. crore

US $ million

1990-91   

             174

              97

             11

               6

1991-92   

             316

            129

             10

               4

1992-93   

             965

            315

           748

            244

1993-94   

           1,838

            586

       11,188

         3,567

1994-95   

           4,126

         1,314

       12,007

         3,824

1995-96   

           7,172

         2,144

        9,192

         2,748

1996-97   

         10,015

         2,821

       11,758

         3,312

1997-98   

         13,220

         3,557

        6,794

         1,828

1998-99   

         10,358

         2,462

          (257)

            (61)

1999-00   

           9,338

         2,155

       13,112

         3,026

2000-01   

         18,406

         4,029

       12,609

         2,760

2001-02   

         29,235

         6,130

        9,639

         2,021

2002-03   

         24,367

         5,035

        4,738

            979

2003-04   

         19,860

         4,322

       52,279

        11,377

2004-05   

         27,188

         6,051

       41,854

         9,315

2005-06   

         39,674

         8,961

       55,307

        12,492

2006-07   

        103,367

        22,826

       31,713

         7,003

2007-08   

        140,180

        34,835

     109,741

        27,271

2008-09   

        173,741

        37,838

     (63,618)

      (13,855)

2009-10   

        179,059

        37,763

     153,516

        32,376

2010-11

   

        138,462

        30,380

     143,435

        31,471

2011-12

NA

32,957

NA

17,171

2012-13

NA

26,953

NA

26,891

 

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

2.   Trends in external investment in India – Debt flows

Year

Gross External Debt

(USD million)

Short Term Debt (%) of Total Debt

1995-96

99,008

4.3

1996-97

93,730

5.4

1997-98

93,470

7.2

1998-99

93,531

5.4

1999-00

96,886

4.4

2000-01

98,263

4.0

2001-02

101,326

3.6

2002-03

98,843

2.8

2003-04

104,914

4.5

2004-05

112,653

3.9

2005-06

134,002

13.2

2006-07

139,114

14.0

2007-08

172,360

16.3

2008-09

224,407

20.4

2009-10

224,498

19.3

2010-11

 

260,935

20.1

2011-12

305,861

21.2

2012-13

345,498

22.6

2013-14

390,048

24.8

 

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

3.     Indices of International Finance

3.a Current account Deficit / Savings- Investment Gap

 To prove that the current account deficit is identically equivalent to the savings-investment gap, we start with the basic macroeconomic identity of national income-

Y = C + I + G + (EX – IM)

 YD = C + I + G + TR – T + CA                                                (CA = EX – IM by definition)

 YD – C = I + (G – T) + CA                                                       (TR = 0 by assumption)

Spvt = I + ( – Sgovt) + CA

CA ≅  Snational – I

 Accordingly, if current account is in deficit, it implies a savings-investment gap and necessitates a requirement of international borrowing.

Current Account Deficit in India – Historical Trends

Year

Current account deficit  (% of GDP)

1995-96

NA

1996-97

NA

1997-98

NA

1998-99

NA

1999-00

0.9

2000-01

0.6

2001-02

-0.7

2002-03

-1.2

2003-04

-2.3

2004-05

-0.3

2005-06

1.2

2006-07

1.0

2007-08

1.3

2008-09

2.3

2009-10

2.8

2010-11

 

3.51

2011-12

4.2

2012-13

4.61

 

Source – Planning Commission Data, dated 10/03/2014

(-ve sign indicates surplus)

3.b NER (Nominal Exchange Rate of Rupee v/s SDR, Dollar)

Year

SDR

US Dollar

Average

End-year

Average

End-year

2012-13  

83.0262

81.4764

54.4091

54.3893

2011-12  

75.3132

79.2512

47.9229

51.1600

2010-11  

69.7228

70.7930

45.5768

44.6450

2009-10  

73.7333

68.5335

47.4166

45.1350

2008-09  

71.2770

76.1742

45.9170

50.9450

2007-08  

62.6506

65.7307

40.2410

39.9850

2006-07  

67.2538

65.8289

45.2849

43.5950

2005-06  

64.4898

64.2566

44.2735

44.6050

2004-05  

66.9282

66.0987

44.9315

43.7550

2003-04  

65.6876

64.2393

45.9516

43.4450

2002-03  

64.1257

65.2550

48.3953

47.5050

2001-02  

60.2150

60.8446

47.6919

48.8000

2000-01  

59.5459

58.7969

45.6844

46.6400

1999-00  

58.9335

58.7505

43.3327

43.6050

1998-99  

57.5129

57.6132

42.0706

42.4350

1997-98  

50.6735

52.7677

37.1648

39.4950

1996-97  

50.8858

49.8032

35.4999

35.9150

1995-96  

50.4768

50.1633

33.4498

34.3500

1994-95  

45.7908

49.1558

31.3986

31.4950

1993-94  

43.8863

44.3133

31.3655

31.3725

1992-93  

37.1415

43.6511

30.6488

31.2354

1991-92  

33.4325

35.5143

24.4737

31.2256

1990-91  

24.8431

26.4140

17.9428

19.6429

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

3. Inflow of foreign reserves

Year

Accumulation of reserves (US$ million)

1995-96

21,687

1996-97

26,423

1997-98

29,367

1998-99

32,490

1999-00

38,036

2000-01

42,281

2001-02

54,106

2002-03

76,100

2003-04

112,959

2004-05

141,514

2005-06

151,622

2006-07

199,179

2007-08

309,723

2008-09

251,985

2009-10

279,057

2010-11

304,818

2011-12

294,398

2012-13

292, 046

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

 Conclusion

The data in the preceding tables unequivocally suggests an increasing AND accelerating trend of international capital as a mechanism of investment finance in India.  This has coincided with a generic rise in gross-domestic capital formation (GDCF) in India with very high rates of economic growth, implying a strong causal link between the two. However, quantitative numbers do not present the whole picture. One has to undertake a detailed qualitative assessment to determine whether productive capacity has been increased through an increase in investment. Some evidence points to the contrary. For instance, price of gold has surged recently due to increased imports. If household financial savings are being channelized towards such ‘unproductive assets’ due to inflation-hedging tactics, it reduces the pool of funds available for private corporate investment who are then forced to seek assistance from international capital markets.

The next section of the report deals with beneficial and negative impacts of external finance in India.

Appendix I – Analysis of the above data

  1. The years 2006-07 and onwards (highlighted) represent an inflexion point across all categories. There is a sharp difference in CAGR that has been analyzed and presented below
Category Pre-2006 CAGR Post-2006 CAGR Difference
Equity flows 13.66% 35.44% 21.78
Debt flows 1.30% 12.5% 11.2
  1. In the years post 2005-06, all economic indices seem to move in the direction corresponding to an increase in foreign investment, as predicted by economic theory. The specific trends are listed below –
  2. Current account deficit increased from -0.3 to 1.2 percent and stood at 4.8 percent in the last fiscal to represent savings-investment gap.
  3. Rupee appreciated significantly in 2006-07 against the dollar, registering an increase of approximately 10%. This can be attributed primarily due to the increase in supply of dollars on account of positive capital flows.
  4. A slightly worrying signal is the increase of debt-financing, especially short-term debt that has risen proportional to concessional debt. This increases the probability of a bankruptcy in case of a sudden loss of business confidence prompting a situation similar to a bank run.
  5. RBI has slowly but steadily accumulated foreign exchange reserves upto 294 billion dollars, with the greatest upswing being generated predictably in 2006-07 when reserves grew at 51% y-o-y.

Akhil is currently in his second year at college, pursuing a Bachelor of Arts degree in Economics (Hons) at Sri Ram College of Commerce, University of Delhi. He has been passionate about writing since an early age and is currently involved with the official College magazine and Economics Department magazine at SRCC. His areas of interest include behavioural economics / finance, econometric analysis, macroeconomic policy, and political theory. He spends his free time reading extensively, watching interesting videos on YouTube, and trying to convince everybody around him that he really does know a thing or two about economics in the midst of all the pontification!

Posted by The Indian Economist | For the Curious Mind