Even before global currents caused relatively rapid outflows of mobile finance capital

from India, the Indian economy was vulnerable on the external front.
Portents for the global economy are gloomy at best. And recent events have already shown that the
Indian economy will be affected by adverse developments in the rest of the world, whether through
the impact of mobile capital flows, or through exports being dragged down by the recession in
Europe and the economic uncertainty in the US.
How resilient is the Indian economy at present, in the face of these negative global forces? In terms
of domestic demand, it is certainly possible for the government to think of ways of rejuvenating the
economy, ideally through more broad-based, employment-led growth.
But externally, the recent pattern of growth has been crucially related to India's greater global
integration, and therefore it has created patterns of dependence on international markets and
international capital. This makes the economy significantly more vulnerable, especially because the
growth has been reliant on capital inflows to generate domestic credit-driven bubbles, rather than
trade surpluses.
BALANCE OF PAYMENTS
Chart 1 describes the main elements of India's balance of payments. (All data in this and the
following charts are from the Reserve Bank of India's online statistical database, accessed on January
6, 2012.)
Several features of importance emerge from this chart. First, the trade balance has been negative and
progressively worsened over the course of the decade. Second, in the early years of the decade, this
impact could be kept in check because remittance inflows and software exports ensured that the
current account was either in surplus or ran small deficits. But in the second half of this period, even
large remittance inflows could not prevent a substantial deterioration of the current account.
Third, despite this, external reserves have kept growing, except for the crisis year 2008-09. Fourth,
this was entirely because of capital inflows, which increased over the decade except in the crisis year,
and the capital account peaked in 2007-08 with more than $100 billion net inflow.
PRIVATE EQUITY
What this suggests is that India's external reserves were effectively borrowed rather than earned, as
they were largely growing because of capital inflows that were dominated by portfolio inflows and
external commercial borrowing. This is confirmed by Chart 2, which shows that especially in the
second half of the decade foreign investment and external commercial borrowing were dominantly
responsible for the inflows on capital account.
In this context, another recent feature of foreign investment is worth noting. In the past, it made a lot
of sense to separate portfolio inflows from direct foreign investment, on the grounds that the former
are typically more short-term in orientation and more likely to be volatile and therefore exit the
country in periods of downswing.
However, the emergence of private equity, especially after 2000, has changed this considerably,
since this is typically included in FDI. Private equity is also essentially short-term in orientation,
since it seeks to make relatively rapid capital gains on the acquisition of domestic assets. A
significant proportion of inward FDI into India in the recent past has been in the form of private
equity. As a result, a significant proportion of inward FDI is also effectively short-term, and cannot
be assumed to be in for the long haul, any more than explicitly portfolio inflows.
EXCHANGE RATE
There is a widespread perception that the rupee has depreciated significantly in recent times.
Certainly, in nominal terms vis--vis the major currencies, there is evidence of substantial decline in
value. Chart 3 shows the rupee relative to the US dollar, Euro and Japanese Yen. Nominal
depreciation has been particularly evident over much of 2011, which has not been captured in this
chart.
However, it should be noted that this was also a period in which inflation in India was significantly
higher than in many, if not most, of its trading partners. As a result, the real effective exchange rate,
shown in Chart 4, barely changed very much over the entire course of the decade. The net barter
terms of trade declined until 2007, especially because of high world oil prices, but then improved, so
that even in terms of this variable there was not much change by the end of the decade.
TOTAL IMPORT BILL
Chart 5 describes the indices of trade in terms of quantum and unit value, separately for exports and
imports. This is an extremely significant chart, because it highlights that the quantum index for
imports moved up much more rapidly than all the other indices. Further, it does not seem to have
been at all affected by the global crisis.
So it would be unwise to blame high oil prices alone for the high and growing total import bill
clearly import liberalisation has resulted in a significantly increased propensity to import within the
economy.
This also has another implication: the domestic impact is greater than would be evident from just the
total value of imports, since significantly greater quantities of imports are entering the country.
This has direct effect on import-competing activities, on employment and livelihood, particularly of
small producers.
The slow growth of non-agricultural employment despite rapid aggregate GDP growth may be, at
least partly, related to the impact of substantially increased import volumes of a wide range of
manufactured commodities.
EXPORT MARKETS
In terms of direction of trade, it is evident from Chart 6 that the European Union remains an
extremely important destination for exports.
This is bad news, given the likely recession in Europe which is also bound to affect their imports.
OPEC as a group recently overtook the EU in becoming the grouping to receive the largest amount of
India's exports (in value terms) but it is worth noting that China and other developing countries in
Asia have become increasingly significant as export markets for India.
Chart 7 shows that in terms of imports, the global increases in oil prices propelled OPEC countries
dramatically to the top of the groupings in terms of sources of imports in the second half of the
decade. But once again, it is important to note that China and other developing Asian countries have
become major sources of imports, exhibiting the fastest rate of growth for non-oil imports.
These non-oil imports have, in fact, been growing very sharply.
However, the recent increases in the total import bill cannot be ascribed to oil prices alone, because
non-oil imports have been growing much faster in value terms.
NON-OIL IMPORTS
So recent trends in the external sector were already cause for concern, even before the latest impact
of the ongoing global economic crisis can be felt.
It is not just high energy dependence, which is a strategic problem for India.
The rapid expansion of non-oil imports suggests an economy that (despite two decades of liberalising
reforms) is becoming less externally competitive and generating trade patterns that are likely to
continue to have adverse employment effects.
Most of all, a trajectory of growth based on capital inflows that generate domestic finance-driven
consumption, including significantly high imports and worsening trade balances, is obviously not
sustainable.

Financing Deficit is a major concern: RBI
The Reserve Bank of India (RBI) has said that non-disruptive financing of the high current account
deficit (CAD) and containing its size within sustainable levels have become key challenges in
managing the external sector and especially in mitigating its vulnerability to global shocks.
In addition to the magnitude of flows needed to finance the CAD, the composition of flows,
particularly dependence on portfolio and short-term debt flows, represent an added source of
concern. While lower commodity prices and moderation in gold imports could have a positive effect
on the current account balance, high CAD in a sluggish economy poses difficult macro-economic
policy challenges, the RBI said in its Financial Stability Report.
External debt
Rise in Indias overall external debt is an added source of concern. Short-term liabilities have also
been increasing. The ratio of short-term debt to total debt (both residual and original maturity)
increased in the second quarter and third quarter of 2012-13 from its level in the first quarter.
Reflecting the widening CAD, net IIP-GDP ratio increased to 15.4 per cent at end-December 2012
from 15.1 per cent at end- September 2012. In general, the external sector vulnerability indicators
have shown a worsening trend.
Rising gold imports have been a continuing concern. The share of gold in total imports has been
increasing since 2007-08, and was close to 3 per cent of GDP in 2012-13.
The RBI said that the rupee, which was largely range bound during January-April 2013, started
weakening in May 2013. Among other factors, strengthening U.S. dollar and relatively high trade
deficit during April-May 2013 exerted pressure on the Indian rupee, it added.
Viewed from a different perspective, against the backdrop of tepid global growth, the RBI said that
other emerging economies were also experiencing similar external sector challenges in terms of size
of the CAD and pressure on the exchange rate.
Asset quality of banks
The RBI said that the asset quality of banks, which was deteriorating continuously, recorded an
improvement in March 2013 quarter. The gross non-performing assets (GNPA) ratio of banks
improved to 3.4 per cent as at end-March 2013 from 3.6 per cent as at end-September 2012. The net
NPA ratio declined to 1.4 per cent from 1.6 per cent.
This decline in NPA was attributed to the lower slippage, improved recovery and higher write-off
during the quarter. Change in classification for restructured advances with effect from April 1, 2015,
may have some adverse impact on the NPAs, unless banks take preventive measures in this regard.
NPAs
At the bank-group level, the gross NPAs of public sector banks were highest and stood at 3.8 per cent
as at end-March 2013, followed by foreign banks.
The quarterly slippage ratio of public sector banks declined to 0.5 per cent for the quarter ended
March 2013 from 0.8 per cent recorded during September 2012. Quarterly slippage of foreign banks
increased to 0.3 per cent and 0.1 per cent for the corresponding periods.
Old private banks registered highest quarterly recovery at 21.2 per cent during the quarter ended
March 2013 followed by the public sector banks at 9.1 per cent. All the bank groups, except new
private banks, recorded higher write-off during the quarter ended March 2013 as compared to
quarter ended September 2012.
Keywords: Indian economy, economic growth, growth slowdown, Reserve Bank of India, D. Subba
Rao, CAD, Financial Stability Report