CAD: Unless India reverses sustainably, net foreign assets may stay negative

The Financial Express

Unless it reverses sustainably, India’s net foreign assets are expected to remain negative
India’s financial relationship with the world has two large components: (1) a large trade account deficit balanced by services exports and remittances which still leaves a meaningful CAD financed by (2) large net inward flows of foreign capital.
India’s large and consistent current account deficit (CAD) shows up in its changing net international investment position (NIIP). Data released by the Reserve Bank of India shows that as of March 2016 foreigners own $361 billion of assets in India more than what Indians own abroad (17.4% of India’s FY16 GDP), up from $165 billion in June 2010 (11.3% of the then annual GDP). A negative NIIP is the balance sheet corollary of running a persistent CAD: the valuation impacts of NIIP in an uncertain world can in turn impact CAD.
Look beyond P&L to balance sheet
India’s financial relationship with the world has two large components: (1) a large trade account deficit balanced by services exports and remittances which still leaves a meaningful CAD financed by (2) large net inward flows of foreign capital. As India has persistently run CADs, it has progressively liberalised its foreign direct investment (FDI) and foreign portfolio investment (FPI) regulations to make it easier for foreigners to invest in India, both in equity and debt. Many Indian companies have also invested abroad. These changes show up in the NIIP data released by the RBI every quarter.
NIIP data shows the assets owned by foreigners in India and the assets owned by Indians abroad: netting off these two numbers shows the net international investment position of India. Foreigners own $912 billion of Indian assets as of March 2016 and Indians (including the forex reserves that the central bank has) own $550 billion of foreign assets. This implies that the NIIP of India is (-)$362 billion (17.4% of FY2016 GDP). These numbers were $559 billion, $393 billion and hence (-)$165 billion (11.3%) respectively in June 2010, when the data were first released. India is a large ‘exporter’ of ‘human capital’: even as such people send large remittances back to India (~3.5% of its GDP), such human capital is not accounted for in the NIIP.
Over the six year period, FY10-16, India has run a cumulative CAD of $282 billion. As noted above, the NIIP, over the same period has changed by $196 billion. Changes in CAD are reasonably closely reflected in the changes in NIIP. NIIP incorporates mark-to-market changes as far as possible: for this reason the cumulative changes in NIIP do not necessarily equate with cumulative CAD.
How should we think about NIIP in an uncertain world?
NIIP represents the international financial exposures that a country has with the world and in the case of India, the liabilities exceed the assets. The valuation of NIIP changes due to (1) the mix of assets and liabilities in terms of instruments like debt and equity and (2) currencies in which assets and liabilities are held.
If, for example, Indians own, say African assets but have taken dollar denominated external commercial borrowings, the changes in the respective currencies and the valuations of the underlying instruments impact the NIIP. As the NIIP becomes a larger proportion of India’s GDP (both in gross and net terms) changes in its valuation and the cash flows from such investments (dividend, interest, etc.) will become significant enough to start having a material impact on India’s current account. It should be highlighted that for a negative NIIP country, a depreciation of the local currency is typically negative unless its liabilities are more ‘equity-like’.
The colour of money is green
Lest this note, with its focus on ownership of India’s assets by foreigners be viewed as protectionist, we hasten to clarify that this outcome is merely the corollary of India running a high current account deficit. Unless CADs sustainably reverse (or if the investments that Indians make abroad deliver spectacular returns), India’s NIIP is expected to remain negative and indeed grow from current levels. We reiterate what we highlighted in our previous article ‘How should India prepare for $100 oil?’: India needs to continue (1) deepening its export base in its traditionally strong industries, (2) creating success in the Make-in-India initiative, and (3) maintain its strength of the services export industry and remittances.
Tilotia is author of The Making of India–GameChanging Transitions and is an associate director with Kotak Institutional Equities

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