Maharashtra Economic Development Council
Union Budget 2010-11
- Impact on External sector
Introduction
Union Budget 2010-11( UB11) was presented in the
backdrop of a revival of economic growth, double digit
food price inflation, and reversal of capital flows. One
of the challenges of UB11 is to quickly revert to the high
GDP growth path of 9 per cent and then find means to
cross the double digit growth barrier.
It is pertinent to note that the growth story of India so
far has been domestic. In other words, the savings
and investment that helped Indian growth have been
domestic and foreign savings have been modest. In a
macro economic sense, the foreign savings represent
the current account deficit. (CAD)in the balance of
payments. In an open economy context , that India is
now, to cross the double digit barrier , whether the
hitherto development of domestic source of growth
would be adequate is the moot question. Or, Indian
authorities may have to depend upon higher foreign
savings in terms of higher CAD.
There has been some debate on the impact of UB 11 in
the media and it has been observed that this budget
is least controversial. However, there has not been
enough debate on the impact of UB 11 on the external
sector. The present article makes an attempt to review
the external sector development and then presents the
impact of the UB11 on the external sector.
2. Review of the External sector development
Indian economy during the period 2004-2008 witnessed
a higher growth accompanied by reasonable price
stability coupled with strong fiscal consolidation under
the FRBM Act. In tandem with the comfortable domestic
sector development the external sector also exhibited
positive developments in terms of export and non oil
import growth, accompanied by significant capital flows
April 2010 Maharashtra Economic Development Council, Monthly Economic Digest
India Review
Dr. R.K. Pattnaik Prof Siva Kumar
Professors of Economics
K. J. Somaiya Institute of Management and Research
with substantial accretion to foreign exchange reserves
(Table 1).
The direct impact of unprecedented Global Economic
Crisis was transmitted to India during 2008-09 through
trade channel (decline in exports) and financial channel
(reversal of capital flow). The transmission of external
demand shocks was much more swift and severe on
export growth, For the fiscal year 2008-09, trade deficit
witnessed a marked expansion to 10.3 per cent of GDP.
Two components of the current receipts, which remained
relatively resilient in the face of the global slowdown
were software services and workers’ remittances.
The remittance inflows from overseas Indians, though
witnessed a slowdown in the second half of 2008-09,
still remained relatively stable as compared to the
earlier shocks during the Gulf crisis and the Asian
crisis. Notwithstanding higher invisibles surplus of 7.7
per cent relating to GDP, the large expansion in trade
deficit led to a higher current account deficit of 2.6 per
cent of GDP in 2008-09 (1.5 per cent of GDP a year
ago). It may be recalled that India’s current account
balance averaged a deficit of 1.05 per cent during the
period 2004-08 supported by strong invisibles surplus
which averaged 5.43 per cent
The net capital flows during 2008-09 was lower at 0.8
per cent than that of 9.2 per cent in 2007-08 and 5.3
per cent on an average during the period 2004-08.
As in the case of other major EMEs, there was some
withdrawal of funds from the domestic equity markets
by portfolio investors as part of the global deleveraging
process as also a significant reduction in access of
Indian corporates to overseas financing. Consequently,
there were large capital outflows by portfolio investors
in the third quarter of 2008-09. While FDI flows
exhibited resilience, access to ECBs and trade credits
was rendered somewhat difficult.
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 Maharashtra Economic Development Council India Review

Table 1: Balance of Payments : Key Indicators

Item/Indicator 1990-91 2001-02 2004-05 2005-06 2006-07 2007- 2008-09P
08PR
1 2 3 4 5 6 7 8
Items (US $ billion)

i) Trade Balance -9.4 -11.6 -33.7 -51.9 -61.8 -91.6 -119.4

ii) Invisibles, net -0.2 15.0 31.2 42.0 52.2 74.6 89.6

iii) Current Account Balance -9.7 3.4 -2.5 -9.9 -9.6 -17.0 -29.8

iv) Capital Account 7.1 8.6 28.0 25.5 45.2 108.0 9.1

v) Foreign Exchange Reserves* 1.3 -11.8 -26.2 -15.1 -36.6 -92.2 20.1
(Increase -/Decrease +)
Indicators (in Per cent)

1. Trade

i) Exports/GDP 5.8 9.4 12.1 13.0 14.1 14.2 15.1

ii) Imports/GDP 8.8 11.8 16.9 19.4 20.9 22.0 25.5

iii) Trade Balance /GDP -3.0 -2.4 -4.8 -6.4 -6.8 -7.8 -10.3

iv) Export Volume Growth 11.0 3.9 17.5 11.8 15.8 5.4 ..

2. Invisibles

i) Invisibles Receipts/GDP 2.4 7.7 9.9 11.1 12.5 12.7 14.0

ii) Invisibles Payments/GDP 2.4 4.6 5.5 5.9 6.8 6.3 6.3

iii) Invisibles (Net)/GDP -0.1 3.1 4.4 5.2 5.7 6.4 7.7

3. Current Account

i) Current Receipts@/GDP 8.0 16.9 21.9 24.0 26.6 26.8 29.1

ii) Current Payments/GDP 11.2 16.3 22.4 25.3 27.7 28.3 31.8

Iii) Current Receipts Growth@ 6.6 4.5 29.3 26.0 25.1 29.3 7.4

iv) Current Account Balance/GDP -3.1 0.7 -0.4 -1.2 -1.1 -1.5 -2.6

4. Current Capital Account

i) Foreign Investment to India (net) / GDP - 1.7 2.2 2.6 3.3 5.4 1.8

ii) Capital Flows(net)/GDP 2.2 1.8 4.0 3.1 4.9 9.2 0.8

iii) Capital Inflows/GDP 7.2 9.1 14.0 17.9 25.4 36.9 26.1

iv) Capital Outflows/GDP 5.0 7.3 10.0 14.7 20.5 27.7 25.3

5. Others

i) Debt - GDP Ratio 28.7 21.1 18.5 17.2 18.1 19.0 22.0

ii) Debt - Service Ratio 35.3 13.7 6.1 9.9 4.7 4.8 4.6

iii) Liability - Service Ratio 35.6 14.9 7.1 11.2 6.1 5.9 5.5

iv) Import Cover of Reserves (in months) 2.5 11.5 14.3 11.6 12.5 14.4 10.3

PR: Partially Revised. P : Preliminary. @ : Excluding official transfers. - : Negligible * : Excluding valuation. .. : Not Available.

Source: Reserve Bank of India – Annual Report 2008-09

It may be noted that the Foreign Direct Investment (FDI) remained buoyant during 2008-09 though portfolio outflows
were large due to deleveraging triggered by the crisis(Table2)

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 Maharashtra Economic Development Council India Review

Table 2: Foreign Investment Flows to India

(US $ million)
Item 2005-06 2006-07 2007-08 (P) 2008-09 (P)
1 2 3 4 5
A. . Direct Investment (I+II+III) 8,961 22,826 34,362 35,168

I. Equity (a+b+c+d) 5,975 16,481 26,867 27,995

a. Government (SIA/FIPB) 1,126 2,156 2,298 4,699

b. RBI 2,233 7,151 17,129 17,998

c. Acquisition of shares* 2,181 6,278 5,148 4,632

d. Equity capital of 435 896 2,292 666

unincorporated bodies
II. Re-invested earnings 2,760 5,828 7,168 6,426

III. Other capital # 226 517 327 747

B. Portfolio Investment 12,492 7,003 27,271 -13,855
(a+b+c)
a. GDRs/ADRs 2,552 3,776 6,645 1,162

b. FIIs @ 9,926 3,225 20,328 -15,017

c. Off-shore funds and others 14 2 298 -
c. Total (A+B) 21,453 29,829 61,633 21,313

P : Provisional - : Nil/Negligible.
* : Relates to acquisition of shares of Indian companies by non-residents under Section 6 of the FEMA, 1999. # : Data pertain
to inter-company debt transactions of FDI entities. ; @ : Data represent net inflow of funds by FIIs.
Note:
1. Data on equity capital of unincorporated bodies and reinvested earnings for 2007-08 and 2008-09 are estimates.

2. Data on foreign investment presented in this table represent inflows into the country and may not tally with the data presented
in other tables. They may also differ from data relating to net investment in stock exchanges by FIIs.

Source: Reserve Bank of India – Annual Report 2008-09

The adverse impact of the global trade and financial
shocks on the BoP of India could be contained
due to the adequate cushion in the form of foreign
exchange reserves. The foreign exchange reserves
of India (excluding valuation effects) fell by US$
20.1 billion during 2008-09, even though the foreign
exchange reserves level (including valuation effects)
fell by US$ 57.7 billion during the year, reflecting the
impact of appreciation of the US dollar against major
international currencies.The details of key indicators
are set out in Table 3
3. Impact on External sector
3.1 FDI Policy
UB 11 has emphasized that improvement of
investment environment is critical in the growth
augmenting process. In this context the role of FDI
assumes immense significance. Accordingly, it has
been highlighted that simplification of FDI regime is
on the agenda of the authorities. A few steps in this
regard were: both ownership and control have been
recognized as central to FDI policy, methodology for
calculation of indirect foreign investment in Indian
companies has been clearly defined, and a consistent
policy on downstream investment has been formulated
Apart from this, there has been complete liberalsation
of pricing and payment of technology transfer fee,
trademark, brand name and royalty payments.
Furthermore, all these payments can now be under
automatic route.
Accordind to UB11, the Government intends to make

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 Maharashtra Economic Development Council India Review

Table 3: Key Indicators of India’s Balance of Payments (US $ million)

Item April - March April-Sept.

2007-08 2008-09 2009-10 2010-11
1 2 3 4 5
Merchandise Trade
1. Exports (US $ on BoP basis) Growth Rate (%) 28.9 13.7 48.1 -27.0
2. Imports (US $ on BoP basis) Growth Rate (%) 35.1 19.4 51.0 -20.6
3. Crude Oil Prices, Per Barrel (Indian Basket) 79.2 82.7 116.5 63.4
4. Trade Balance (US $ billion) -91.5 -118.7 -64.4 -58.2
5. Exports / GDP ( %) 14.2 16.3 - -
6. Imports / GDP ( %) 22.0 26.6 - -
7. Trade Balance / GDP ( % ) -7.8 -10.3 - -

Invisibles
8 Net Invisibles (US $ billion) 75.7 89.9 48.5 39.6
9. Net Invisibles Surplus / Trade Deficit (%) 82.8 75.8 75.4 68.0
10. Invisibles Receipts /Current Receipts (%) 47.3 46.4 43.4 48.2
11. Services Receipts / Current Receipts (%) 28.7 28.8 26.0 25.6
12. Private Transfers /Current Receipts (%) 13.8 13.3 13.4 17.6
13. Net Invisibles / GDP ( % ) 6.5 7.8 -
14. Private Transfers Receipts / GDP ( % ) 3.7 4.1 - -
15. Software exports / GDP (%) 3.4 4.0 - -

Current Account
17. Current Receipts (US $ billion) 315.0 352.5 196.4 156.5
18. Current Payments (US $ billion) 330.8 381.3 212.2 175.1
19. Current Account Balance (US $ billion) -15.7 -28.7 -15.8 -18.6
20. Current Account Balance / GDP ( % ) -1.3 -2.5 - -

Capital Account
21. Gross Capital Inflows (US $ billion) 438.4 312.4 184.4 175.3
22. Gross Capital Outflows (US $ billion) 331.8 305.2 172.5 145.8
23. Net Capital Flows (US $ billion) 106.6 7.2 12.0 29.6
24. Net FDI / Net Capital Flows (%) 14.9 241.5 116.0 47.8
25. Net Portfolio Investment / Net Capital Flows (%) 25.7 -193.6 -46.2 60.7
26. Net ECBs / Net Capital Flows (%) 21.2 109.6 26.5 2.5

Openness Indicators
27. Exports plus Imports of Goods / GDP ( % ) 36.1 42.9 - -
28. Current Receipts plus Current Payments / GDP ( % ) 55.0 63.4 - -
29. Net Capital Inflows / GDP ( % ) 9.1 0.6 - -
30. Gross Capital Inflows plus Outflows / GDP ( % ) 65.6 53.4 - -
31. Current Receipts plus Current Payments & Gross 120.7 116.8 - -
Capital Inflows plus Outflows / GDP ( % )
Reserves
32. Import Cover of Reserves (in months) 14.4 9.8 10.8 12.4
33. Outstanding Reserves as at end period (US $ billion) 309.7 252.0 286.3 281.3
Source: Reserve Bank of India – Annual Report 2008-09

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 Maharashtra Economic Development Council
FDI user friendly by consolidating all prior regulation
and guidelines to one comprehensive document .
This would enhance clarity and predictability of FDI
policy.
3.2 Corporate Governance and regulation , Export
and disinvestment
Improvement of corporate governance and regulation
is an important part of the over all investment
environment i the country The Companies Bill 2009
replacing the Companies Act 1956 will address issues
related to regulation corporate sector in the context
of changing business environment. The impact of this
will be favorable for foreign investment.
The proposal to extend interest subvention of 2
percent on pre shipment export credit would facilitate
export s covering handicrafts, carpets, handlooms
and small medium enterprises. Apart from this, the
emphasis on Special Economic zones(SEZs)
attracted significant flows of domestic and foreign
flows . The UB 11 has highlighted that government is
Committed to ensuring continued growth of SEZs to
draw investments and boost exports and employment
The provision of disinvestment to the tune of Rs. 40,
000 crore augment liquidity in stock market and would
attract FIIS investment also.
3.3 Tax proposals
The UB 11 proposes to rationalize the income
deemed to accrue or arise to non-resident in India
und4r section 9 of the Income Tax Act. Furthermore,
income of non resident providing services or facilities
in connection with prospecting for, or extraction or
production of mineral oil has been rationalized.
April 2010 Maharashtra Economic Development Council, Monthly Economic Digest
To give boost to investment in tourism sector which
has high employment potential UB 11 has proposed
to extend the benefit of investment linked benefit to
new hotels of two star category and above anywhere
in India.
The proposed amendments in Customs Act 1962
and Customs Tariff Act 1975 are welcome from the
international perspectives
3.4 Outlook
The Outlook for the external sector suggests that
despite persistent of the unprecedented Global
Economic Crisis the external sector is unlikely to
cause concern for growth and stability in India. This is
because the external sector has shown considerable
resilience on account of prudent capital and current
account management.
In an open economy frame work, given the domestic
has savings, the medium term growth critically hinges on
foreign savings and increase in efficiency . The former
depends upon absorption of a sustainable Current
Account Deficit(CAD) and the latter emphasizes on
enhancement of efficiency.
In Indian context, CAD has been lower than the
dynamic sustainable level of 3 percent. To cross the
barrier of double digit growth CAD has to increase to
3 percent and should be financed by non debt Capital
flows, particularly FDI. The UB 11 has highlighted
the importance of Liberal FDI Policy. It is expected
that the authorities will take appropriate policy action
to liberalize and rationales FDI Policy. The factor
productivity needs to improve with import of technology
apart from capital.
ranjitkpattnaik@gmail.com
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