A V Rajwade: Leads, lags and the current account

Just as the level of outstanding trade credit affects the stock of external debt, changes therein need to be accounted in the BoP data.

"Leads and lags: In international trade, the gaps between shipment and payment. These gaps can be exaggerated as importers and exporters try to advance or delay their payments or receipts according to how they expect exchange rates to move." Edna Carew in The Language of Money

In an earlier article (Business Standard, July 13), I had argued that the credit on imports, not being accounted in the balance of payments data as published by the Reserve Bank, could well be more than $50 bn, and to that extent, distorts the numbers on both short-term credit and the current account balance. After our Editor referred to my comments in his Weekend Ruminations (July 28), the point has attracted more attention. Some believe that since the RBI uses payments-based data, the non-inclusion of short-term credits does not in any way distort the picture, and that one would need to offset credits given in exports against credits received on imports. To my mind, the issue of short-term credit is important not only to the BoP data and hence to the exchange rate policy, but also in looking at the bank credit numbers. This is all the more necessary when, in the scenario of a rapidly appreciating rupee, the lagging of payments on imports has become extremely attractive""it provides, in effect, negative interest rate financing. I, therefore, thought it worthwhile to elaborate the issues involved, even at the cost of some repetition.

IMF's Balance of Payments Manual

The IMF's Balance of Payments Manual prescribes that the "change of ownership" principle should be used in determining the time of recording merchandise transactions in BoP data (paragraph 216). The Manual elaborates in paragraph 204 that "Goods for export are generally considered to change ownership at the time the exporter ceases to carry the goods on his books as a real asset (i.e. when he records a sale and makes a corresponding entry in his financial items). Goods for import are considered to change ownership when the importer enters them on his books as a real asset (i.e. when he records a purchase and makes a corresponding entry in his financial items)." As for trade credits, the Manual prescribes their classification in the capital account under "other investment", elaborating the provision as follows:

"Para 414. Trade credits consist of claims and liabilities arising from the direct extension of credit by suppliers and buyers for transactions in goods and services and advance payments for work in progress ... (or to be undertaken) that is associated with such transactions ... In the absence of actual data, trade credits may be measured by the difference between entries for the underlying transactions in goods and services, which are recorded as of the dates when ownership changes, and the entries for payments related to these transactions."

The RBI's practice

As far as exports are concerned, "the leads and lags in export receipts (difference between the customs data and the banking channel data)" are correctly classified in the capital account under "other capital". The implication is that credit for exports is being taken in the merchandise trade account of the Balance of Payments on the "change of ownership" principle. On the other hand, it seems that the same principle is not being followed in respect of the recording of imports under merchandise trade. Ostensibly, our short-term credit is low, $12 bn, as of March 2007. However, "this number does not include supplier's credits of up to 180 days", data covering which is just not available with the RBI. (In my view, even longer supplier/buyer credits are not being properly captured in the data.) In other words, imports are being reported under merchandise trade on payments basis, and not on the "change of ownership" principle prescribed by the IMF, and followed in respect of exports.

The implications

This has several major implications for the Balance of Payments numbers and the policy views being taken based thereon, which display considerable complacency about the deficit on the current account and the level of short-term credit:

After accounting for trade credit on imports, the level of short-term credit may well be nearer $70 bn, a not insignificant amount. This, together with the market value of FII investments ($150 bn?), equals the level of reserves!

The complacency about the deficit on the current account, also displayed in the recent report of the Economic Advisory Council, could be misplaced. Just as the level of outstanding trade credit affects the stock of external debt, changes therein ("flow") need to be accounted in the balance of payment data. If this were done, capital inflows, on the one hand, and imports and current account deficit, on the other, would be higher pro tanto. Given the obvious attraction of such credit, one would not be surprised if the level has gone up by $15 bn or so during the year 2006-07. (This means an increase of less than four weeks in the trade credit on imports, and is well within the realms of possibility.) If my numbers are reasonably correct, the "true" current account deficit in 2006-07 would be $25 bn; excluding exogenous elements like remittances, the deficit would be $52 bn, or 6 per cent of GDP.

In last week's monetary policy statement, the fall in the growth of bank credit has been noted with some satisfaction. Is this merely the result of a significant increase in short-term credit on imports in Q1? In other words, replacement of bank credit in rupees by dollar credit from abroad?

Will it be very difficult to get the data about trade credit on imports? To my mind, substantially accurate data could be readily compiled through the contra entries banks pass in their books, in respect of usance bills outstanding; introducing a reporting system for transactions individually in excess of $1 mn; or polling periodically say the hundred largest importers in the country.

One other thought: Even as our monetary authorities heroically fight capital inflows of a relatively stable nature (ECBs, investments, etc.), and are applauded for doing so by many commentators, they do not seem to have any idea of the huge amount of short-term capital flows in the form of trade credits, which are far more unstable in nature!

avrajwade@gmail.com