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Posted by: Deepa Vasudevan on Thu, Jul 19th, 2018

India's International Investment Position - Not Fragile but Not Fit Enough!

India's external position is often assessed simply on the basis of three variables: current account deficit, foreign portfolio inflows, and the level of forex reserves. In the current scenario, for instance, it is commonly pointed out that despite net FPI outflows of $ 7 billion in 2018, India’s external position is strong because of a relatively low current account deficit (1.9% in FY18) and a huge war chest of forex reserves (over $400 billion). Unfortunately, this sort of analysis is incomplete for two reasons. One, because it focuses exclusively on FPI investment, and ignores all other international liabilities. And two, because it does not question the stability of our reserves. To get a more holistic picture of India’s external fitness, it is useful to at the its International Investment Position.

The International Investment Position of a country is a balance sheet of its international assets and liabilities. The asset side consists of the country’s foreign exchange reserves, as well as investments and loans made/given from Indian residents to foreign residents.  The liabilities side includes all investments and loans made by foreigners to India. As the table below shows, India’s international assets mainly consist of forex reserves. On the other hand, it has a varied set of international liabilities - including foreign direct and portfolio investment, NRI deposits, commercial loans and trade credit. Each liability item represents an amount owed in foreign exchange to an international creditor.

 

International Investment Position as on March 2018

Table 1: International Investment Position as on March 2018

Source: RBI

 

The net international investment position (NIIP) equals international assets minus international liabilities. India has a negative NIIP, which means that it is a net international debtor. Between 2010 and 2018, India’s NIIP widened from $159 billion to $420 billion, rising from 11.1% to 16.3% of GDP. The reason: Domestic savings were not enough to meet the country’s investment needs, so it had to rely on foreign capital to fund this gap. International liabilities nearly doubled during this period to meet India’s capital requirements.

It is quite normal for a developing country like India to have a negative NIIP; and it is also acceptable for NIIP to show a mild increase. Of greater significance is the composition of international liabilities, and their associated risks. Digging into the break up of the liabilities side over the past eight years throws up some interesting observations. First, there is a small increase in the contribution of foreign direct investment (FDI). Any rise in FDI is welcome because it is a stable long-term source of funds that creates jobs, output and incomes. Second, foreign portfolio investment (FPI), which is notoriously volatile, forms about one-fourth of liabilities. Third, the share of NRI deposits, also a relatively unreliable dollar source, has actually increased in this period. In March 2018, FPI and NRI deposits together accounted for nearly 38% of international liabilities, much higher than their combined 34% share in March 2010.

 

Figure 1: Break-up of India's International liabilities

Source: RBI

 

Thus the liabilities structure is quite dependent on volatile sources of foreign capital. This creates external vulnerability for the economy. That’s because our forex reserves have been built up from foreign capital inflows, and not due to current account surpluses. Hence whenever portfolio capital flows out, or the current account deficit increases, there is a risk that reserves may have to be run down to meet the country’s dollar commitments. Either we have to improve the quality of reserves by funding it through current account surpluses, or we have shift towards more stable sources of foreign capital. Until then, India’s external position will not be fully fit.

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