Download Relationship between the Current Account Deficit, Indian Rupee and

Relationship between the Current Account Deficit, Indian
Rupee and Foreign Investments: A Periodic Study.
Submitted By:
Omkar K.
Shweta Pillai
Date: 30.06.2013
Index
1. Introduction
2. Current Account Deficit
2.1 Introduction
2.2 Causes of the Current Account Deficit
3. Movement of the Indian Rupee
4. Financing the Current Account Deficit
4.1 Successive Software Services
4.2 Capital Account
4.3 Foreign Exchange Reserves
5. Reforms in the Financial Sector
6. Conclusion
Bibliography
Abstract:
Current Account Deficit is one of the major macroeconomic problems that India faced in the
fiscal years 2011-12 and 2012-13.CAD touched record highs of 6.7% of GDP in the third
quarter of fiscal 2012-13. In this study we have tried to investigate the relationship between
the CAD, the Foreign Investment and the Exchange Rate of the Indian Rupee. Studying the
data of these variables and their movements, we can say that there is theoretically
interdependence between these three variables. The CAD is affected by negative movements
of the exchange rate and negative Foreign Investments. The RBI is now following a more
market determined exchange rate. The exchange rate is influenced, amongst other factors, by
the movement of Foreign Investments, which are dependent on the monetary policies of
global central banks. The state of the world economy in comparison with the domestic
economy is another factor that explains the change in the direction of flow of capital. The
effect of depreciation of the Rupee also affects the import bill leading to increased strain on
the CAD.
1. Introduction:
India’s travails on the Balance of Payments front started from the Second Five-Year Plan
(1956), and continued till the crisis of 1991. The 1991 Balance of Payments crisis forced
India to open her long shut doors to foreign investments. This was done in a gradual manner
by removing various restrictions, which caused India to be under a License Raj. During the
License Raj, eighty government agencies had to be satisfied for private companies to produce
goods and, the government would regulate production. After the reforms the economy saw a
turnaround, from the ease of doing or starting a business to attracting capital flows from
abroad.
The opening up the economy led to the inflow of capital from the world. The inflow of
foreign capital was good for the economy. India was more connected to the outer world.
However, India also had to bear with the uncertainty and speculation surrounding the global
financial markets.
The free flow of capital can be a blessing and a curse. Heavy dependence on the inflow of
capital in the Capital Account to balance the Balance Of Payments account is dangerous.
India is a developing economy and heavily dependent on oil and petroleum products, not just
for transport, but for many other industries as well. India is not rich in oil reserves and
depends on oil imports for her needs.
CAD has gone up sharply in the last two years on the back of higher oil and gold imports.
Export growth slowdown has also hit the CAD.
Oil imports make up a large portion of the total imports and rupee depreciate pushes up the
oil bill causing problems to the CAD. In addition to oil, gold also has joined in to cause
trouble to the CAD. The metal is a favourite with Indians and is seen as a very attractive
investment. Gold imports are increasing and this is adding to the CAD.
The exports sector is not growing at a rate to cover the import bill. The Import bill has
increased at a rate of31% during 2011-12, while exports only grew at 23% for the same
period. Oil imports have increased at a rate of 46% and gold 38%. This rise in oil and gold
imports is alarming and can negatively impact the CAD if not checked.
A high and uncontrollable CAD may scare foreign investors which in turn would weaken the
rupee, which then would cause a further strain on the CAD. This effect is a chain-effect.
Hence in this study we analyse the cause and effects of the CAD, and the Indian Rupee
(INR)-to-US Dollar (USD) exchange rate, and their interdependence. The ways of financing
the CAD is analysed. In order to understand the volatility in the INR exchange rate, a brief
analysis is done on the major components of the capital account, namely, types of foreign
investment.
2. Current Account Deficit
2.1 Introduction
We first introduce the two variables that are analysed in this study and then go in depth into
the study of various other variables that are components of the two major variables.
Current Account (CA):
Current Account measures the flow of goods, services, transfers and, investment income
between domestic residents, businesses and governments and the rest of the world.
Hence it measures the exports and imports of commodities and services, the movement of
investment income from one home country to the rest of the world and vice-versa. It
measures unilateral transfers between the agents of the domestic country and the rest of the
world. If the balance of the Current Account is negative, i.e. if the imports are greater than
the exports then there is said to be a CAD.
The CAD is said to be necessary for a growing economy, though it is recommended in a
small amount. The sustainable CAD that is safe for India is said to be in the range 2.4-2.8 %
of GDP. This is a result of a study by Rajan Goyal, Director in the Department of Economic
and Policy Research, Reserve Bank of India.
The Indian Rupee(INR):
There is pretty much no definition better than that the INR is the currency of the nation, but
what we are going to be using is exchange rate of the INR with respect to the US Dollar. The
INR is fully convertible on the current account and partially convertible on the capital
account. INR exchange rate is largely market determined though the RBI does intervene
through direct and indirect intervention to control volatility.
2.2 The Causes of the CAD
The causes of the CAD can be identified once we identify the important components of the
Current Account.
The Components of the Current Account are:
1. Merchandise Trade
2. Invisibles
Merchandise Trade
Merchandise Trade refers to the foreign trade of India . Basically it is the export and import
of goods.
Imports
India has experienced heavy imports since independence. Imports have always been greater
than exports.
In the data that we have taken, 1999-2011, the imports have increased on an average of 21%
CAGR. In the last period 2011-2012, imports have risen by almost 32%.
The main components of imports are Oil and Gold.
Oil and Gold comprise of around 42.27% of total imports in 2011-2012.
Table 1:
Years
Gold
Oil
Oil and
Gold as
Oil (% Gold(%of %
of
Total
of total total
total
Imports imports) imports)
imports
1999-00
4151.8
12611.4
55383
22.77
7.49
30.26
2000-01
4121.6
15650.1
57912
27.02
7.11
34.14
4.56
2001-02
4170.4
14000.3
56277
24.87
7.41
32.28
-2.82
2002-03
3844.9
17639.5
64464
27.36
5.96
33.32
14.54
2003-04
6516.9
20569.5
80003
25.71
8.14
33.85
24.10
2004-05
10537.7
29844.1
118908
25.09
8.86
33.96
48.62
2005-06
10830.5
43963.1
157056
27.99
6.89
34.88
32.08
2006-07
14461.9
56945.3
190670
29.86
7.58
37.45
21.40
2007-08
16723.6
79644.5
257629
30.91
6.49
37.40
35.11
2008-09
20725.6
93671.7
308520
30.36
6.71
37.07
19.75
2009-10
28640.0
87135.9
300644
28.98
9.52
38.50
-2.55
2010-11
40546.9
105964.4
381061
27.80
10.64
38.44
26.74
2011-12
56249.3
154905.9
499533
31.01
11.26
42.27
31.09
%
Increase
in
Imports
Source: RBI Handbook of Statistics
As we can see from table 1, the imports have risen by about 32% in the year 2011-2012 and
by an average of 21 percent for the entire time period taken into consideration. Oil comprises
on an average nearly 30% of imports and gold around 8% of imports. Imports of oil and gold
have increased during this time period by around 25%. Hence the increase of the imports of
gold and oil has contributed to the overall increase of imports, which grew at an average of
21%.The Exports sector has not witnessed the same rise. Exports that are required to pay for
the imports of a country are not enough, growing at only 20% during this period.
We also analyse the quantity of oil imported and the value of this quantity. This helps in
understanding if the increase in the oil bill is due to increase in demand by India in terms of
quantity or is it the exchange rate depreciation and the price level of oil that inflates the oil
bill
Table 2:
Total
Qty.
(‘000
tonnes)
107189
117910
135972
152454
159421
182752
189359
196429
Year
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Total
Value
(Rs
crores)
133586
203039
265839
340896
419008
419374
520101
746759
The value of oil imports has been rising at greater proportion than the quantity. This is mainly
due to depreciation of the rupee and also the price of oil.
Chart 1:
800000
Value and Quantity
700000
Oil imports
600000
500000
400000
300000
Total Qty.
200000
Total Value
100000
0
Years
The Quantity of oil imports has doubled in the time period taken in to consideration from
107189 thousand tonnes to almost 200000 thousand tonnes. But the value of these imports
has risen by 5 times to Rs. 746759 Crores from a mere Rs. 133586 Crores in 1999-00.
The second part of the Current Account is the Invisibles section. This section includes
receipts and payments from the services sector and unilateral transfers.
The services sector includes transportation, tourism, professional and other services, interest
and other investment income.
Invisibles have grown on an average of 22% in this time period though in the two years 20012002 and 2003-2004, they have grown by 52% and 62% respectively.
3. The Movement of the Indian Rupee.
It is important to understand the movement of the INR with respect to the US dollar, in order
to understand its effect on the Current Account and the causes that lead to the change.
The exchange rate of the Indian rupee vis-a-vis the US dollar was Rs 17 in 1990-91, before it
was devalued and made Rs 30. This was due to the BOP crisis that India had been through.
From then on, it has been a downward trend for the rupee which reached Rs 60 in June 2013.
Though in the time period taken into consideration the rupee stood at an average rate of Rs 47
and at a yearend of Rs 51 for the year 2011-2012.
We have taken the year end value into consideration rather than the average, because the
yearend value gives us the direction of the movement of the rupee.
The connection between the CAD and the Indian Rupee’s exchange rate can be explained in
layman’s term. If the exports are not enough to cover the imports then there will be a trade
deficit and if there is a continuous rise in this gap the importers who have to pay for the
commodities in dollars would demand more US dollars in the market. Hence this will create
an increase in the demand for dollars and increase in the supply of rupees. This leads to
appreciation of the dollar and depreciation of the rupee. The weakening of the rupee
(depreciation) will in turn increase the CAD as the import bill has risen due to the
depreciation.
Chart 2:
INR
60.0000
50.0000
40.0000
30.0000
INR
20.0000
10.0000
0.0000
4. Financing the CAD
The CAD is mainly caused by the trade deficit. During the period of rising trade deficit, the
growth of the invisibles sector began to emerge as a way of financing the trade deficit or the
excess imports.
4.1 Successive Software Services
The invisibles sector receives contribution mainly from the exports of software services and
private remittances (transfers). India’s software exports got a boost following the demands to
address the Y2K challenge at the turn of the 21st century. This is turn encouraged migration
of Indian software professionals abroad which in turn increased the remittance account. This
sharp rise in the invisibles account more than offset the trade deficit during the period 20012004. The three years had witnessed a positive Current Account Balance, with 2003-04 being
the highest at US$14,083 million.
However, as the economy began to grow and the import needs increased, this resulted in an
increase in the imports of the country which in turn led to a negative Current Account
Balance. The income from invisibles seemed to be more credible and long lasting even as the
trade deficit increased rapidly.
Chart 3:
Current Account
150000
100000
50000
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
-50000
1999
0
Trade balance
Invisibles
Services
-100000
Transfers
-150000
-200000
-250000
Years
The receipts from software services had started to rise during the early 2000’s. This caused a
dip in the CAD initially, but the deficit soon recovered. This is due to excess income that had
come into the economy from the invisibles account that encouraged imports, which increased
continuously since 2001, from 14% to a high of 48% in 2004. The boost from the software
services and transfers account provided a temporary offset to the CAD.
The Continuous increase in the trade deficit continued till the recent financial crisis, where in
the trade deficit decreased by 1% compared to a 30% increase in the previous year of 20082009. But this was only short lived as the bad state of the global economy hit India’s exports
while imports weren’t as damaged as exports as India continued to grow and demand
commodities. The imports increased by about 45% in 2010-2011 while exports had only
increased by 23%.
The Invisibles account covers almost two-thirds of the trade deficit. But the weakening of the
global economy is threatening software businesses, which is affecting the receipts of software
services and transfers.
4.2 Capital Account
The Capital account is responsible for bringing inflows into the country in order to finance
the CAD. If the Capital Account does not have enough inflows to cover the CAD then the
Central Bank is forced to draw down from its Forex Reserves to pay for the deficit.
After a period of stability in the years 2000-2008, where there was a surplus in the BoP, India
had to draw down USD 20 billion from its reserves during 2008-2009. Though there was
some improvement during 2010-2011 this proved to be short lived as BoP was once again
under stress in 2011-2012, as slowdown in advanced economies spilled over to emerging and
developing economies, and there was a sharp increase in imports of gold and oil.
Prior to the famous reforms of 1991, capital flows was mainly debt creating, like NRI
deposits, commercial borrowing and external assistance. As the economy was closed the
inflow through foreign investment wasn’t an option.
During the 80’s external assistance comprised of 0.6% of GDP and NRI deposits and
commercial borrowing, 0.4% of GDP. This composition of capital inflows had dramatically
changed after the reforms of 1991. During 2000-2009, foreign investment comprised of 2.5%
of GDP whereas it was nil during the 80’s. External assistance declined to nearly zero,
though commercial borrowing and NRI deposits continued to remain the same. The opening
of the economy had given India a new way to attract capital, and a non-debt creating one.
This replaced the external assistance way of obtaining finance.
The main components of the Capital Account that draw inflows are:
1. Foreign Investment
a) Foreign Direct Investment
b) Foreign Portfolio Investment
2. Loans
a) External Commercial Borrowing
3. Banking Capital
a) NRI Deposits
The Foreign Investment account has been the major source of finance for the Capital
Account. Under the Foreign investment account, foreign direct investment and foreign
portfolio investment are responsible for the inflow.
Foreign Investment is the flow of capital from one nation to another in exchange for
significant ownership stakes in domestic companies or other domestic assets.
The foreign investment account has witnessed continuous inflows and it has been in the
positive square always. However this inflow is very volatile due to its heavy dependence on
foreign portfolio Investment rather than direct investment.


Foreign Direct Investment (FDI): FDI is direct investment into production or
business in a country by a company in another country, either by buying a company in
the target country or by expanding operations of an existing business in that country.
Foreign Portfolio Investment (FPI): This is also called Foreign Institutional
Investment (FII). This is a short term investment where there is an entry of funds into
a country by foreigners, where they make purchases in the country’s stock and bond
markets, sometimes for speculation.
Hence what we can see is that if the financing of the CAD is being done by the inflows of the
FPI, then there is a reason to worry as this inflow is volatile and may anytime turn back due
to speculative reasons. Whereas the FDI is a more stable and reliable source of inflow.
Though it would be perfect to have the FDI in charge of the Foreign Investment, in reality it
is not so. The FPI is a much larger source of capital inflow than the FDI and the trend and
movement of foreign investment graphs move as an imitation of the FPI graph.
The Foreign Investment in the decade taken into consideration shows a continues rise, except
for a fall in 2008-09 due to the global financial crisis, which originated in the developed and
advanced economies causing the investments that came from these countries to fall. Hence
there was a dramatic decrease in the inflow though foreign investment. The year 2009-10
witnessed an increase in the foreign investment more than the years before the crisis, but this
lasted only a year and the foreign investment fell again though not as bad as in 2008-09.
Table 3:
Years
Foreign
FDI
Investments (Rs
(Rs crores) crores)
FPI
(Rs
crores)
1999
5117
2167
3024
2000
5862
3272
2590
2001
6686
4734
1952
2002
4161
3217
944
2003
13744
2388
11356
2004
13000
3713
9287
2005
15528
3034
12494
2006
14753
7693
7060
2007
43326
15893
27433
2008
8342
22372
-14031
2009
50362
17966
32396
2010
39653
9360
30292
2011
39231
22060
17170
Source: RBI Handbook of Statistics 2011-12
The graph below shows the extent to which foreign investment depends on Foreign Portfolio
Investment.
Chart 4:
Foreign investment
60000
50000
40000
30000
Foreign inv
20000
FPI
FDI
10000
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
-10000
1999
0
-20000
The movement of Foreign Investment is as if it imitates the movement of FPI.
The FDI is more consistent than FPI and is less volatile.
The composition of the Foreign Investment between FDI and FPI has continuously been
changing.
The trend of FPI shows us how volatile FPI capital is and depending on this capital to fund
the CAD can be dangerous.
The second account of the Capital account is the Loans section.
India has always been dependent on debt creating inflows prior to the reforms of 1991 and
hence this section has always created an inflow of dependence, though it leads to the creation
of debt, which requires repayment at some date.
External assistance was a major source of inflow of capital prior to 1991. This section
contributed around 0.6 % of GDP during the 80’s and 0.5% during the 90’s. It then
dramatically decreased to almost nil during 2000-09. This was replaced by funds from
foreign investment.
Chart 5:
ECB
25000
20000
15000
10000
ECB
5000
0
-5000
Years
Data Source: RBI Handbook of Statistics 2011-12
External Commercial Borrowings
Commercial Borrowings has always been a source of capital for Indian companies and
comprises of around 0.4-0.6% of GDP.
NRI deposits have always provided as a source of capital for India and have remained stable
at around 0.4%of GDP over the years.
We have seen that CAD has to be financed by the Capital account if the RBI shouldn’t dig
into its FOREX coffers. However the Capital account relies heavily on FPI and this being
very volatile has always caused speculation about whether there would be enough investment
to cover the CAD.
There is an increased importance of the contribution of software services and remittances to
reduce the CAD. NRI deposits are encouraged to play a bigger role in financing of the CAD,
thereby trying to make the CAD less reliant on FPI. FDI is also being encouraged.
We now go on to see the relationship between the exchange rate of the INR, the CAD and the
Foreign Institutional Investments.
Foreign Institutional Investments (FII)
Foreign Investment in India can take the form of investments in listed companies (i.e., FII
investments), investments in listed/unlisted companies other than through stock exchanges,
(i.e., through foreign direct investment or private equity/foreign venture capital investment
route), investment through American Depository Receipts/Global Depository Receipts, or
investment by NRI's and Persons of Indian Origin(PIO).
ForeignInvestment in India
Investment in
listed/unlisted
companies (except
through the route
of stock exchange)
FDI
PE/F
VCI
Institutional
investment in
listed companies
through stock
exchange
FII
ADR/GDR
Investment
by NRI and
PIO’s
We take into consideration FII inflow into the country and see how it is affected by the INR
and the CAD.
Table 4:
Years
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
FPI
(USD
million)
3024
2590
1952
944
11356
9287
12494
7060
27433
-14031
32396
30292
17170
CAD/GDP
-1.0
-0.6
0.7
1.2
2.3
-0.4
-1.2
-1.0
-1.3
-2.3
-2.8
-2.7
-4.2
USD/INR
43.60
46.64
48.80
47.50
43.44
43.75
44.60
43.59
39.98
50.94
45.13
44.64
51.16
Source: RBI Handbook of Statistics 2011-12.
In the early part of 2000-2010 periods the CAD continued to fall in view of increasing
receipts from the services section of the Current Account. This increase is mainly due to the
sudden rise in software services receipts. The software services contribution increased from
US$5,750 mn in 2000-01 to US$12,324 mn in 2003-04 an increase of 114%. This increase
had caused a reversal in the CAD, from -1.0% of GDP in 1999-00 to2.3% of GDP in 200304. This reversal in the CAD gave a positive outlook for the economy causing the rupee to
strengthen. The exchange rate which was Rs 48.8 to the USD in 2001-02 rose to Rs 43.44 in
2003-04. The rupee remained strong from then onwards and rose to Rs 39 during 2007-08
the year before the 2007-08 financial crisis, which then caused a major outflow of Foreign
Institutional Investment. The FPI ran into negative numbers as a consequence of the financial
crisis. It was US$14,031 mn in 2008-09. The CAD continued downward to -2.3% of GDP.
The financial crisis affected the exports sector and this lead to the rise in the CAD. Though
the FPI flows returned the following year, this was mainly due to the relative stable Indian
Economy as compared to the other developed economies which were affected badly by the
crisis. The inflow of Foreign Investments continued, but the CAD increased ever more
rapidly due to heavy imports of oil and gold. Due to the unsustainable level of CAD the rupee
weakened, reaching to a level of Rs 51 in 2010-11. The Rupee depreciation has continued
and the currency touched all time lows of Rs 61.21 in July 2013.
4.3 Financing the CAD: Foreign Exchange Reserves
India has maintained a strong Foreign Exchange Reserves account after a bitter experience
which was the Balance of Payments crisis in the 1990’s when the country had to pledge gold
for USD. India experienced CAD very frequently, the inflow from the Capital Account was
needed to maintain and finance this deficit, failing which the RBI would then be forced to dip
into its foreign exchange reserves.
The Foreign exchange reserves are also used by the central bank as a tool for exchange rate
management. India follows a managed-floating exchange rate regime, wherein the central
bank intervenes in the exchange rate market to “curb volatility” caused by speculations.
Speculations disturb the market and cause the exchange rate to be very volatile for a short
period of time. To negate this, the RBI intervenes in the market.
The exchange rate fluctuations affect inflows of international investment portfolios and also
the export and imports of a country.
We look at the Foreign exchange reserves of the country during the period and look at its
gradual rise and stability.
The foreign exchange reserves grew from US$ 38 bn to US$ 294 bn during the period 199900 to 2011-12. This increase happened gradually during the period owing to the surge in
inflows in the capital account. The percent change in the reserves has been rising over the
period except for two periods where it has fallen.
Table 5:
Years
Actual
Change in
Forex
Forex
reserves Forex(reserves
(USD
/+) (USD (USD
Million) Million) Million)
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
38036
42281
54106
76100
112959
141514
151622
199179
309723
251985
279057
304818
294398
-6142
-5842
-11757
-16985
-31421
-26159
-15052
-36606
-92164
20080
-13441
-13050
12831
-4245
-11825
-21994
-36859
-28555
-10108
-47557
-110544
57738
-27072
-25761
10420
Source: RBI Handbook of Statistics 2011-1
Table 6:
Outstanding
Net Forward
sales (-) /
purchase (+)
at end of
month (USD
Million)
Purchase Sale
Net
(USD
(USD
(USD
Year
Million) Million) Million)
1999-00 24077
20828
3249
-10,129
2000-01 28203
25847
2356
-20,324
2001-02 22822
15759
7063
-7,225
2002-03 30635
14926
15709
10,254
2003-04 55414
24941
30473
27,592
2004-05 31398
10551
20847
781
2005-06 15239
7096
8143
0
2006-07 26824
0
26824
0
2007-08 79696
1493
78203
68,323
2008-09 26563
61485
-34922
62,533
2009-10 4010
6645
-2635
4,643
2010-11 2450
760
1690
1,970
2011-12 1665
21803
-20138
-8,999
Source: RBI Handbook of Statistics 2011-12.
USD/INR
43.6050
46.6400
48.8000
47.5050
43.4450
43.7550
44.6050
43.5950
39.9850
50.9450
45.1350
44.6450
51.1600
The table above gives us the Purchase and Sale of USD by the RBI.
Foreign Institutional investors and trends of foreign institutional investment over the
past few years
Foreign Institutional Investors (FII) is entities established or incorporated outside India and
make proposals for investments in India. These investment proposals are made on behalf of
sub accounts which may include foreign corporate, individuals, funds, and other such
investors. FII’s have designated banks that are authorised to deal with them. The biggest
source through which FII’s invest is the issuance of Participatory Notes (P-Notes), which are
also known as Offshore Derivatives.
5. The Reforms in Foreign Investment in equity and debt markets in India
for FIIs
The FII investment initiated after the reforms of 1991
In April 1998, FII’s were permitted to invest in dated government securities subject to a
ceiling of US$ 1 billion, which was increased to US$ 1.75 in 2004.
In November 2004, an outstanding corporate debt limit of US$ 0.5 billion was prescribed.
The objective was to limit short term debt flows.
In April 2006, outstanding corporate limit increased US$ 1.5 billion. The limit on investment
in government securities was increased to US $ 2 billion.
In January and October 2007, FII’s were allowed to invest US$ 3.2 billion in government
securities.(Limits were raised in two phases of 0.6 billion each, in January and October).
In June 2008, the while reviewing the External Commercial Borrowing Policy, the
government increased the cumulative debt investment limits from US$3,2 billion to US$ 5.0
billion and from US$ 1.5 billion to US$ 3.0 billion for FII investments in government
securities and corporate debt, respectively.
In October 2008, the government increased the cumulative debt investment limits from US$ 3
billion to US$ 6 billion for FII investment in corporate debt.
In November 2010, investment cap for FII’s increased by US$ 5 billion each in government
securities and corporate bonds to US$ 10 billion and US$20 billion respectively.
In March 2011, the investment limit in corporate debt was increased to US$ 40 billion, an
increase of US $25 billion. The US $25billion increase constituted of a
i.
ii.
iii.
US $ 10 billion investment in infrastructure Debt Funds (IDF) - (a) lock in period of
1 year (b) residual maturity of at least 15 months.
US $ 12 billion for FII investment in long term infrastructure bonds – (a) lock in
period of 1 year (b) residual maturity of at least 15 months
US $ 3 billion for QFI investment in MF debt schemes which hold at least 25% of
their assets (either in debt or in equity or in both) in the infrastructure sector.
In November 2011, the investment limits in government securities was increased to US $ 15
billion.
In June 2012, investment limits in both, corporate debt and government securities were
increased to US $ 46 billion and US $ 20 billion respectively (US $ 45 billion +1 billion of
investment by QFI in corporate bonds and mutual fund debt schemes).
In January 2013, the RBI enhanced the limit of investments by FII’s in government securities
to US $ 25 billion. The limit of investments in corporate debt was also hiked to US $ 50
billion.
Table 7:
Foreign Institutional Investment Components
FII
INVESTMENT
IN
INR(CRORES)
Year
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Average
Source: SEBI
Equity
9670
10207
8072
2527
39960
44123
48801
25236
53404
-47706
110221
110121
43738
Debt
453
-273
690
162
5805
1759
-7334
5605
12775
1895
32438
37317
49988
Total
10122
9933
8763
2689
45765
45881
41467
30840
66179
-45811
142658
146438
93726
%Equity
95.53
102.75
92.11
93.97
87.31
96.16
117.68
81.82
80.69
104.13
77.26
75.19
46.66
88.56
%Debt
4.47
-2.74
7.87
6.02
12.68
3.83
-17.68
18.17
19.30
-4.13
22.73
25.48
53.33
11.48
Foreign Institutional Investors invest in equity and debt market. Hence, the performance of
these two markets directly affects the inflows of foreign capital to the country, and in turn
affects the exchange rate through the capital movements.
Putting it all Together: The FPI, CAD and the INR
Table 8:
FPI
(USD
Years Million) CAD/GDP USD/INR
1999
3024
-1.0
43.60
2000
2590
-0.6
46.64
2001
1952
0.7
48.80
2002
944
1.2
47.50
2003
11356
2.3
43.44
2004
9287
-0.4
43.75
2005
12494
-1.2
44.60
2006
7060
-1.0
43.59
2007
27433
-1.3
39.98
2008
-14031
-2.3
50.94
2009
32396
-2.8
45.13
2010
30292
-2.7
44.64
2011
17170
-4.2
51.16
Source: RBI Handbook of Statistics 2011-12
The table 7 above shows us the trend of FPI, CAD and the exchange rate of the Indian rupee.
What can be noticed is that there has been a depreciation of the rupee, based on the flow of
FPI and also the strain on the CAD. The last year has seen a steep fall in all three variables. A
fall in the flow of foreign investment can dampen the spirit of the economy, by reducing the
funding of the Current Account and which in turn affects the INR.
6. Conclusion
It has been noticed that there is an interlink between the CAD, the INR and the FII. What has
to be noticed is the trend that they follow in comparison with each other. An outflow of
foreign investment may lead to the depreciation of the rupee, with foreign investors selling
their rupee investments for dollars, thereby increasing the supply of rupee and demand of
dollar. This may in turn affect the CAD by increasing the import bill, which has been
increasing more than the growth in exports, thereby offsetting any gains by increased exports
due to the depreciation.
This high CAD may in turn reflect badly on the market and create an outflow of investors,
due to an unsustainable CAD number. This will once again follow a similar pattern of
depreciation of the INR and then increase in the CAD.
This will lead to a slump in the economy which will decrease the imports and demand of the
economy, leading to a stable period before revival. Hence it can be interpreted that the
present slump in the economy is due to volatile foreign investment, combined with a
depreciating INR and an unsustainable number of the CAD.
Reforms have opened up the economy not only to opportunity but also to vulnerability. The
heavy dependence on the foreign investment to finance the CAD, is precarious, as we noticed
during 2007-08, there was an outflow of foreign investment leading to the RBI to dip into its
coffers for financing the CAD.
The heavy volatility of Foreign Investment needs to be stabilised if India is to possess a stable
exchange rate for a sustainable CAD. Regulations that encourage FDI and increase in the
exports are required.
The problem of CAD is mainly due to the imports of Oil and Gold. The latter can be
regulated, but the former is a necessity. The value of imports of oil has increased rapidly
owing mainly due to the depreciation of the Indian Rupee. Hence in order to ensure a
sustainable CAD it is imperative that there is stability in the exchange rate.
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