In obsessing over portfolio inflows and the much desired foreign direct investment (FDI) inflows, analysts often overlook trends in our biggest source of dollar inflows — remittances. There could be reasons for this. For instance, unlike, say, portfolio flows on which there is daily data, quick numbers on remittances are not available. However, that doesn’t take away from the fact that the ebb and flow of transfers made by Indian expats is critical to the rupee.
For the last 10 years, India has been the world’s largest recipient of remittances and around half of India’s trade deficit every year has been funded through such flows. On a cumulative basis, while FDI, portfolio flows and external aid all put together have brought in $430 billion between 2008 and 2017, private transfers made by Indians working abroad have been to the tune of $570 billion.
Thus, it should worry our policymakers that this trend of robust and stable remittances seems to be reversing. Tepid global growth has pulled private transfers to developing countries down for the past two years and the pace of decline has been much faster for India. In 2016, when remittances to developing countries declined by 2.4 per cent, India saw a much sharper drop of 8.9 per cent, according to the World Bank.
Analysts expect that if the current trend continues, India could lose its top spot to China in 2017. The reasons for the slowdown in the flow of private transfers are somewhat obvious. India’s strong economic connection with the Gulf region tops the list. The region has been witnessing lower growth on account of subdued oil prices and cutting back on fiscal expenditure and that means both fewer jobs and lower wages for India workers.
Around 72 per cent of the worldwide Indian diaspora lives in the Gulf Cooperation Council (GCC) region (UAE, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait) and contributes to 50 per cent of the overall remittances to India. With low crude prices impacting the fortunes of oil exporters, the flow of money from Indians working in the Middle East is being hit.
The consensus among forecasters is that oil prices will remain subdued and the fiscal pinch on the GCC governments will intensify, forcing them to cut back more and more on public spending. The need to stabilise oil prices would also mean that they hold back on oil production and that would affect jobs in this sector. As the austerity measures and oil output cuts weigh on economic activity, gross domestic product (GDP) growth in the GCC region could slow to 0.9 per cent in 2017 from two per cent in 2016 (International Monetary Fund estimates).
Meanwhile, for other countries, which have a relatively diversified diaspora, the decline in remittances is unlikely to be substantial. China, which draws 50 per cent of the remittances from the euro zone, East Asia and Asean nations, could still see a rise. Unlike the Gulf region, the euro zone and Asean countries are expected to record higher (or stable) growth numbers in 2017.
In its annual report of 2016, the Reserve Bank of India highlighted the impact of low crude prices on remittances flow for India. Using annual data from 1982 to 2015, it concluded that the long-run elasticity of private transfers with respect to crude oil prices is about 0.7. Going by such estimates, if indeed oil prices decline by around 10 per cent in 2017, say, from the current levels of $51 per barrel to $45 per barrel, remittance flow to India could deteriorate by roughly seven per cent, a decline of $4 billion in absolute terms.
This could be a cause of concern for the rupee, especially if other sources of dollar funding become volatile. This risk will strengthen in 2018 as the global cycle of quantitative easing (ultra-loose monetary policy) tapers off. As the European Central Bank and the US Federal Reserve start shrinking balance sheets, capital flows driven by the sheer abundance of liquidity could tend to moderate. If remittances dry up faster than anticipated and things like FDI don’t materialise, the rupee could be back under some pressure — to depreciate this time for a change.
Abheek Barua is chief economist and Tushar Arora is senior economist, HDFC Bank