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Ask Mint: What does the forex forecast on raining dollars really mean?

Ask Mint: What does the forex forecast on raining dollars really mean?
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First Published: Sun, Jun 24 2007. 11 41 PM IST
Updated: Sun, Jun 24 2007. 11 41 PM IST
Johnny was engrossed in reading the forecast of the day, which said that it might rain today. He was amused because what he was reading was not a weather forecast talking about the Mumbai rains, but a forexforecast talking about raining dollars.
In India, dollars are coming like the monsoon deluge. Initially, the inflow was like a drizzle—soothing the starving nerves of the country that had seen scarcity. Soon, the drizzle turned into a downpour and we started filling our buckets with a cheer. Now that all our buckets are full, the downpour has turned into a deluge. Our forex reserves have already crossed $210 billion (Rs8.6 trillion). What to do now?
Johnny has no idea how the inflow of dollars has changed our life. But the forecast that he read today forced him to think. Soon, he got an opportunity to discuss this with his trusted partner Jinny:
Johnny: The forecast of today has really left me clueless. How could dollars rain? I have never seen dollars hanging on the clouds. Some say that we may catch a cold if we continue to get further soaked in the dollars?downpour.?I don’t know what this talk is all about.
Jinny: Well, I think you have missed the point. Don’t get confused by the comparison of forex inflows with the rainfall. Dollars don’t fall from the clouds. However, like the rains, their inflows sometimes may cause a problem of plenty.
I think I should tell you briefly about how inflows of forex take place in our country. But first of all you should know that the forex reserves of our country, apart from foreign currency, also include gold, special drawing rights (SDRs) and reserve tranche position. But here we would be discussing only inflows of foreign currency.
There are many sources through which a country can earn forex. Take, for instance, the most common source—exports of goods. We make clothes in Mumbai and send these to London.
In this manner, we earn dollars. However, we have to also import goods that we require for ourselves, say the crude oil for which we may have to pay dollars.
The difference between the payment and receipts determines whether we are earning or losing dollars. Historically speaking, our imports have been more than exports and so we have been net losers of dollars on our trade account.
In 2005-06, we had a deficit of about $51 billion on our trade account (imports minus exports).
Johnny: If our forex is slipping because our imports are bigger than exports, then how are the piles of dollars accumulating?
Jinny: Well, export and import of goods is one part of the story. The other part is that we have been receiving net foreign exchange on account of invisibles. Please don’t get confused by the nomenclature invisibles. Simply put, invisible receipts are constituted of all our exports of services, incomes form our investment abroad, remittances from Indians working abroad, and official transfers received by the government.
Out of these, export of services and receipt of remittances have really been our shining stars. In 2005-06, the net earning on account of export of services has been $23 billion and the remittance receipt has been around $24 billion.
But, due to a negative net balance on account of investment income, the total invisible receipts have been around $42 billion. Not enough to completely wipe out the deficit on account of imports and exports, but covering a substantial portion of it.
Johnny: But we are still running a deficit…
Jinny: Don’t be impatient. You have still not seen the full picture. There are three more stars to come. These are foreign investments—both direct as well as portfolio, non-residents deposits, and external commercial borrowings. Foreign direct investments (FDIs), simply put, are long-term investment by foreign entities in Indian companies or projects in which the foreign entities are interested in taking part in management.
Foreign portfolio investments (FPIs) are investments made through stock exchanges, in which investors are not interested in exercising management control.
Both FDIs and FPIs (which are also commonly known as FIIs inflow) have been onthe rise. In 2005-06, the total net foreign investment has been around $17 billion.
Net commercial borrowings and net non-residents depo-sits have been around $2.7 billion each.
On the whole, in 2005-06, the net capital account inflow has been around $24 billion, more than enough not only for completely wiping out our total forex deficit, but also for creating an overall surplus.
Johnny: Now I understand how the dollars are falling on our roof. But why do some people call it a problem of plenty? In my view, we should be happy that from the days of scarcity we have moved to days of abundance. I don’t know what’s the problem.
(The talk on the present subject will continue next week)
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at realsimple@livemint.com
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First Published: Sun, Jun 24 2007. 11 41 PM IST
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