India's international investment position has deteriorated from (-) $80 billion to (-) $350 billion over the last seven years, thanks to persistent deficits on the current account: the increase is the aggregate of the deficits on current account, or a measure of the domestic expenditure financed by creating external liabilities. In other words, the output loss represented by the deficits is of the order of, say, two per cent per annum of gross domestic product (GDP). I am probably old-fashioned enough to believe that exchange rates matter to global competitiveness - and persistent deficits are a clear evidence of an overvalued exchange rate. In my previous article for this column, I had referred to the permanent damage overvalued exchange rates can cause by 'hysteresis': markets, domestic or foreign, once lost are difficult to regain.
To come back to the current account balance, we need to look at its composition: arguably, in our case, the output loss on the external account is significantly more than the current account deficit, thanks to the very significant contribution of the 'secondary income' account to the overall balance. The International Monetary Fund's (IMF) balance of payment manual separates current external receipts and payments into three parts: (i) Goods and services, in our case a deficit of $17 billion in Q1 of 2015-16, despite a surplus of the same order on services; (ii) Primary income, a deficit of $6 billion, mainly because of investment income: no wonder, given the net external liabilities; (iii) 'Secondary income', a surplus of $16 billion, mainly because of personal transfers (private remittances).
The IMF's balance of payments manual makes a distinction between exchanges and transfers. An exchange involves provision of something of economic value (export/import of goods or services), while a transfer provides no corresponding return of an item of economic value. In other words, transfers included under 'secondary income' are not the result of corresponding economic output.
Technicalities apart, empirical evidence of the effect of private transfers or remittances from abroad on economic activity comes from Kerala, the Indian state that has sent a large number of its people to work in the Gulf countries. The money they remit is equal to 36 per cent of the state's domestic product, according to a report by the Centre for Development Studies. The result is that Kerala's per capita income is about 50 per cent higher than the country as a whole, although it has very little in terms of manufacturing or information technology businesses, unlike neighbouring states Karnataka and Tamil Nadu. (The only activity flourishing in Kerala seems to be real estate and construction.) In other words, the 'secondary income' from abroad correspondingly reduces the need for domestic output and employment, without hampering consumption.
At the macro level, remittances make overvalued exchange rates more affordable, by hiding at least a part of the true output gap originating in the external sector. I have often wondered whether one reason for the gap between GDP estimates on gross value added (GVA) and expenditure bases is this 'secondary income': the gap between the two numbers was $33.5 billion in Q1. We should perhaps aim at balancing our current account net of remittances to optimise output and employment, and create a sovereign wealth fund by transferring to it the 'secondary income' from abroad each year. What will our reserves be then?
Another point occurs to me: the draft Indian Financial Code says very little about the management of the external value of the currency. We should perhaps consider giving the central bank a mandate to so manage the rupee's external value as to keep the current account balance, net of 'secondary income', below a particular percentage of GDP.
The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com