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Emerald Group Publishing Limited
Foreign direct investment and current account deficit
Article Type: Editorial From: Journal of Advances in Management Research, Volume 11, Issue 2
Global economies are always in transition. Development and growth are moving targets for all economies of the world. Therefore, the related issues often give rise to new research areas. We discuss one such area in this editorial.
What are some of the issues that worry a government, particularly the finance ministers, most? One could say that governance in the modern times is a difficult task and there is always an inexhaustible list of problems to resolve. Be that as it may. Yet, one can enumerate the macro problems that the finance ministers have to grapple with all the time. These are: economic or GDP growth, reduction in unemployment, reduction in inflation and reduction of external imbalance.
Though all the four are interconnected, yet depending on the seriousness, one or the other of these issues becomes a cause of concern at different times. There are no universal solutions. Each country may have to respond differently taking into account the prevailing circumstances. For example, the external imbalance manifests in terms of current account deficit (CAD) and may require several steps to keep it at a reasonably low level.
Broadly, CAD means the amount by which the country's imports exceed its exports. This difference can further increase if a country has to meet large external debt service requirements. The short-term borrowings, if not sustainable, can cause havoc. Much of the Southeast Asian crisis of 1997 was caused due to the inability of the countries of this region to meet external debt service requirements. Their short-term payment needs exceeded their foreign exchange reserves. Consequently, they could not pay to the creditors and their currencies faced massive depreciation.
When the CAD is high, there are two possibilities. The country can meet this gap by depleting its exchange reserves, which is a risky proposition since it is not sustainable. The currency may become vulnerable. The other possibility is that the country attracts large capital inflows, especially in the form of foreign direct investment (FDI). They would provide a cushion to meet the CAD. Yet, the efficacy of the FDI inflows to solve the problem of CAD is not assured. The reverse is equally likely. The examination of empirical data shows that, in some periods, in a given country, large FDI inflows may increase imports much more than exports and therefore aggravate the problem of CAD rather than alleviating it!
So, what is the way out? There is no such thing as “the solution” or “the only solution”. Yet, a country can take several steps. For example, it can make efforts to increase exports of select products to select geographical areas in the world. It can judiciously cut down on some “non-essential” imports. For example, recently, India put some restriction on gold imports as it could not have done much to reduce its oil imports which consume the maximum foreign exchange. Another way is that a group of countries can come together to put in place a common fund to help each other in case of a specific short-term need. The group of countries called BRICS (Brazil, Russia, India, China and South Africa) has created a contingency fund of 100 billion dollars. Still another measure is to have imports invoiced in the home currency wherever possible, though chances of that happening are limited. A country can also issue long-term foreign bonds to increase reserves so as to better manage CAD. All these measures can serve to reduce the adverse impact of CAD, especially drastic depreciation of currency.
We all talk, incessantly, of global economic integration. It is happening in terms of increased trade and financial flows. But the true integration would mean the whole world becoming one single market with a single currency. A utopian idea!! Unless that happens, management of exchange rate and exchange reserves will remain a problem and, therefore, CAD will be one of the worries of finance ministers everywhere!
We believe that these are the potential research areas and academic world looks forward to research leading to development of new theories in them.
Surendra S. Yadav and Ravi Shankar