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BALANCE OF PAYMENTS

BOP or Balance of International Payments is the systematic and summary record of a countrys economic and financial transactions with the rest of the world over a period of time.

As per IMF:
BOP is a statistical statement for a given period showing: (a) transactions in goods & services and income between an economy and the rest of the world; (b) changes of ownership and other changes in that countrys monetary gold, SDRs, and claims on and liabilities to the rest of the world; and (c) unrequited transfers and counterpart entries that are needed to balance, in the accounting sense any entries for the foregoing transactions and changes which are not mutually offsetting. IMF, Balance of Payments Manual.
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Difference between BOP and BOT


Balance of Trade:

only exports and imports of merchandise or goods , i.e. only visibles. Hence does not show the services (shipping, insurance, payment of interest, royalties, tourist spendings, etc.)
BOP:

both visibles and invisibles.


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Nature of BOP accounting


Follows double entry book keeping system. Each transaction has a debit and credit Has to balance (if not : errors & omissions entry)

Components of BOP
Various entries grouped under 4 categories or accounts (parts) A) Current Account B) Capital Account C) Unilateral Payments Account D) Official Settlements Account.

Components of BOP
Balance of payment (BoP) comprises: current account, capital account, errors and omissions and changes in foreign exchange reserves.

Current Account
Is a summary record of a nations goods and invisibles transactions with the rest of the world. All transactions which give rise to or use up National Income. Includes 2 major items: Merchandise exports & imports Invisible exports & imports Exports = credit entry ( i.e. claims on foreigners) Imports = debit entry (i.e.claims on home country)

Invisibles
Invisibles include: a. non factor services:
travel, transportation, insurance, Government not included elsewhere (GNIE) and miscellaneous, (which includes communication, construction, financial, software, news agency, royalties, management and business services) b.income

c. private transfers ( NRI remittances, gifts ) and official transfers (Grants) ( for which no quid pro quo)

1.

2.

Non Factor Services include: export of software services travel and transportation (tourist spending, shipping etc,)
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Current account balance


Current account balance is synonymous with net foreign investment. A current account surplus means that:
The country has positive net foreign investment (i.e., the country is acting as a net lender to or investor in the rest of the world). The country is producing more ( and has more income from this production) than it is spending on goods and services. such a country is saving more than it is investing domestically A deficit = the nation is a net borrower or domestic savings are less than domestic investment.
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Capital Account
Shows the capital inflows and outflows. =Claims and liabilities which go to finance the deficit on current a/c or absorb its surplus.
Short Term Long Term

Capital Outflow = Debit ( eg. Indian inv in a foreign


country, inv in foreign securities, govt.loans to foreign countries)

Capital Inflow = Credit ( FDI by a foreign co. in


India, loans to Govt. from foreign countries, NRI deposits).

Also ST investments from abroad (incl FIIs).


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The interest on loans and dividends/profits received are current account; while the loan and FDI are capital account transactions.

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Capital Account components


Capital inflows can be classified by instrument (debt or equity) and maturity (short or long term). The main components of capital account include foreign investment, loans and banking capital. Foreign investment comprising foreign direct investment (FDI) and portfolio investment represents non-debt liabilities, while loans (external assistance, external commercial borrowings and trade credit) and banking capital including non-resident Indian (NRI) deposits are debt liabilities.

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Unilateral Transfer Account


= Gifts. No quid pro quo. One-sided transactions Include private remittances, govt grants, pension payments, disaster relief, etc. If received = credit; if paid = debit Now included in Other Receipts.

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Official Settlement Account


=Monetary Movement Official reserves represent the holdings by the Government (or official agencies) of the means of payment that are generally accepted for the settlement of international claims.

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Causes of BOP disequilibrium


Disequilibrium = there is surplus or deficit in BOP Deficit = demand for forex exceeds the supply Reasons:
Economic factors Political factors Sociological factors

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Economic factors
1. Development Disequilibrium: Large scale development expenditure = increase in purchasing power + increase in demand & prices. --Leads to huge imports (also of Capital Goods) --Hence adverse BOT adverse BOP.
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2. Capital Disequilibrium
Due to cyclical fluctuations in general business activity. If domestic economy experiences a boom, while the rest of the world not so --then more purchasing power & demand and higher prices --hence more imports But exports difficult because of slackness in world economy. Hence

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3. Secular Disequilibrium
If long term BOP problem, then it is due to some secular trends in the economy. If domestically: persistent high demand and high domestic prices (eg.USA) then imports will always be more than exports.
( if high production costs locally: but high disposable incomes and hence very high aggregate demand and high prices.)
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4.Structural Disequilibrium
Affects exports & imports Because of development of alternative sources of supply, discovery of better substitutes, exhaustion of productive resources, changes in transport routes and costs etc.

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II. Political factors


Continuous political instability, wars, etc., will lead to capital outflows and inadequacy of domestic investment and production Hence BOP problems.

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III. Social factors


Changes in tastes, preferences, fashions etc., will affect the exports and imports. Hence BOP

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Correction of Disequilibrium
Automatic Correction & Deliberate Measures Automatic: If adverse BOP fall in the external value of the domestic currency --So, exports will become cheaper and imports will become costlier --this will restore

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Deliberate Measures
1. Monetary Measures:
a) Contraction in money supply will reduce purchasing powerreduce demand -- so less imports
b) fall in prices cheaperso more exports

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Devaluation
Exports cheaper and imports costlier
E.g.: 1966 June: 4.76 to 7.50

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Exchange control
To conserve forex Only through ADs Central Bank

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Trade Measures
Export incentives High import duties and restrictions Canalisation

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Other Measures
Getting foreign loans Foreign assistance, Aid Development of tourism Export of services, BPOs, ITES, etc.

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BOP: INDIA
Because of the trade deficit, India has had BOP deficits in most of the years Though its effect has been mitigated to a great extent by invisible surplus. But this problem has increased the countrys dependence on external capital markets and increased its vulnerability to external shocks.
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During the I FYP: no BOP problem because of the huge sterling balances India had at the time of independence. In 1950-51: our forex reserves were equal to 158% of our merchandise imports. But by 1957-58 the reserves came down to about 1/3 of the level in 50-51 and resulted in shortage. So, we got aid from Aid India Consortium and drawals from IMF.also stringent import controls started. 1966 Re was devalued : to improve exports
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In 1972-73: we had a trade surplus of Rs.104 cr. But then came the I Oil Shock: 4 fold increase in international crude prices between Sept1973 and April, 74. But we managed somehow this and during 197677 to 1979-80: an improvement in BOP. In 1976-77, there was even a small trade surplus of Rs.72 cr. But the main reason for the improvement in BOP was the sharp increase in inflow of remittances from our emigrant workers,esp from Gulf.
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But then came the II Oil Shock in 1979-80: trade deficit shot up from Rs 2200cr in 78-79 to Rs 6,200 cr in 1980-81. Also a gradual decline in net receipts from invisibles, while the trade deficit widened. An important reason for the BOP problem in 1980s and since then is the change in source of financing the large current a/c deficit. --Until the beginning of the 80s; almost the entire deficit was financed thru inflows of concessional assistance (hence, debt-service burden low) --this was drastically replaced by commercial debtto pvt creditors, incl com banks and NRIs
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Invisible surpluses have traditionally financed a large part of Indias trade deficits --but there was a steep fall in this since 80s. In 1980-81: net invisibles financed nearly 73% of trade deficit. During 6th Plan(1980-85): it was on an average > 60%. But by 1990-91: it dropped to about 13% only. Hence, was forced to go for external (commercial) sources to meet our payments obligationscrisis.pledging gold.
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Made worse by the falling trend in net invisibles

Why:
Rise in invisibles payments: due to rising interest and service payments on foreign loans & credits. -- In 1990-91, the Debt service ratio was 35.3%. In 2000-01, it was 17.3% (now ,2004-05, only around 6.2%).
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Liberalisation and after

With the ec liberalisation: improvement Marked improvement in the coverage ratio i.e. ratio of export bill to import bill And inflow of invisibles In 1990-91 it was only 2.5 months (bare minimum norm =3 months of import). In July 1991 only 15 days ! now (04-05) more than 14.3 months. (in 03-04, it was 16.9) As a result, there was surplus in the Capital a/c of BOP (esp. during 1996-97 to 1998-99) So, comfortable BOP The debt creating flows as % of total capital flows which averaged 97% during the 7thPlan(85-90) declined to less than 18% by 94-95.
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Recent Trends
The year 2001- 02, which recorded a current account surplus for the first time in 23 years, is a landmark year in the history of the BOP of India. This resulted from the vibrant trends in respect of the invisibles over the past one decade or so.

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However
After 3 years of surplus, the current a/c reverted to the previous situation with a deficit or $5.4 bn in 2004-05. This was caused by a 147% increase in merchandise trade deficit which far outstripped the increase in invisible surplus. and continues to be in deficit.

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Remittances
Emigrant remittances, the single most important source of India's invisible earnings for long, exhibited a robust growth, registering a more than 6-fold growth from $ 2 billion at the start of 1990s to almost $ 13 billion by 2000-01, forming 2.7 per cent of GDP. Following the heavy inflow of invisible receipts, Indias Current a/c deficit narrowed down during the 90s and the nation enjoyed a current a/c surplus in 2001-02 when the merchandise deficit of $12.7bn was more than offset by the invisible surplus of over $14bn. Similarly, in 02, and 03.

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India continues to remain the highest remittance receiving country in the world.
In 2004, inward remittances into India were US$21.7 billion. (3% of our GDP) This made India the highest remittance receiving country in the world, followed by China (US$21.3 billion), Mexico (US$18.1 billion), France (US$12.7 billion) and Philippines (US$11.6 billion). Indias share in total global remittances of $225.8 billion in 2004, was almost 10 %. (Global Economic Prospects, 2006; World Bank). In 2007, India received $27bn (out of a total of $318 bn)as per World Banks Migration and Remittances Fact Book, 2008.
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Paradigm shift in services trade


While the period up to the 1980s was dominated by tourism earnings, the second half of the 1990s witnessed an unprecedented jump in India's earnings from newer activities like software service exports and other IT-related skill-intensive exports. Software services have shown spectacular growth while also emerging as the most important source of miscellaneous services earnings, increasing from $ 0.3 billion in 1993-94 to $ 7.2 billion in 2001-02, with its share rising from less than 3 % to over 20 % of total invisibles receipts during this period.
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The growth in receipts from information and communication related services (services relating to computer software, hardware, internet, e-commerce and telecommunication sector) experienced over the last decade was unprecedented. The ratio of invisible earnings to merchandise increased from 40 % in 1990-91 to almost 75 % in recent years reflecting the shifting comparative advantage of India in favour of services.
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With the shift in the competitiveness towards services, in particular the technology related services, India has emerged as one of the fastest growing exporters of services in the world. Reflecting this, gross invisible receipts (comprising services, transfers and income) increased from 29 %of total current receipts in 1990-91 to 44 % of total current receipts in 2001-02. Net invisible surplus grew by 35.2 per cent to reach US$ 31.7 billion in 2007-08 (April-September), equivalent of 6.1 per cent of GDP.

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Capital Account
The substantial increase in the foreign investment, as a result of the liberalization has been generating significant capital account surplus. Capital account surplus increased from less than $ 4 billion during the 1980s to US $ 8.6 billion during 1992-2002, resulting in a huge a accumulation of foreign exchange reserves. As a proportion of GDP, capital flows increased from 1.6 per cent during 1980s to 2.3 per cent during 1992-2002 and now it is around 2%.
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The trends in the capital flows over the


1990s reflects a shift in importance from debt to non-debt flows with the declining importance of external assistance and external commercial borrowings (ECBs) and the increased share of foreign investment - both direct and portfolio. FDI inflows (net) was $4.7 bn in 05-06 and of this 75.2% was in equity.
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The increase in capital inflows coupled with the improvement in the current account position resulted in a surplus in the overall BOP of India from 1993-94 onwards, excepting 1995-96. The surplus amounted to $ 26.2 billion in 2004-05 as against a deficit of US $ 0.6 billion in 1992-93. As a result India is one of the largest reserve-holding economies of the world.
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Causes of BOP problem in India


1. Large trade deficit 2. Fall in invisible surplus, caused by a) increase in invisibles payments (debt service) b) slackening of emigrants remittances and travel income. 3. Sensitive behaviour of foreign creditors and NRIs 4. Declining role of concessional external finance.

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2009-2010

BoP developments during 2009-10 indicate that despite lower trade deficit, current account deficit widened on account of slowdown in invisible receipts. There was also sharp increase in capital flows, which led to accretion in foreign exchange reserves. The current account deficit of 2.8 % of the GDP in 2009-10 vis-a-vis 2.3 % in 2008-09, however remained well within manageable limits. The net capital flows increased substantially to 3.8 % of GDP in 2009-10 as compared to 0.5 % in 2008-09. This led to net accretion of US$ 13.4 billion in foreign exchange reserves on BoP basis, as against the net outflow of US$ 20.1 billion in 2008-09.

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2009-10

Major determinants of BoP transactions such as external demand, international oil and commodity prices, pattern of capital flows and the exchange rate changed significantly during the course of the year. With the turnaround in exports and revival in capital flows, external sector concerns receded gradually in the second half of 2009-10.
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First half (H1 AprilSeptember 2010) of 2010-11


As per the latest data available, the highlights of BoP developments during the first half (H1 April-September 2010) of 2010-11 were higher trade and current account deficits as well as capital flows visa-vis the first half of 2009-10.

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Balance of Payments : Summary ($ million)

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CURRENT ACCOUNT: Merchandise trade

Indias current account position during 2009-10 continued to reflect the impact of the global economic downturn and deceleration in world trade. On a BoP basis, Indias merchandise exports of $ 182.2 billion during 2009-10 posted a decline of 3.6 %, as against $ 189.0 billion in 2008-09, which recorded a positive growth of 13.7 % over the exports of $ 166.2 billion in 2007-08. Similarly, import payments of $ 300.6 billion also recorded a decline of 2.6 % in 2009-10, as compared to $ 308.5 billion in 2008-09, which was 19.8 % higher than the imports of $ 257.6 billion in 2007-08.
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Merchandise trade

Though the decline in exports was relatively higher than that in imports, the merchandise trade deficit in absolute terms decreased marginally to $ 118.4 billion (8.6 % of GDP) during 2009-10 from $ 119.5 billion (9.8 % of GDP) in 2008-09.

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First half of 2010-11(April-September 2010)


Indias exports and imports growth momentum, which started during the second half of 2009-10, continued during the first half of 2010-11 also. During H1 of 2010-11, exports recorded a growth of 33.8 % as against negative growth of 25.7 % during the corresponding period of the previous year. Similarly, Imports posted a growth of 28.2 % during the first half of 2010-11, as compared to negative growth of 21.1 % during H1 of 2009-10. Despite the higher export growth compared to imports during April-September 2010-11, the trade deficit widened in absolute terms by 19.7 % to $ 66.9 billion in the first half of 2010-11, as compared to $ 55.9 billion during the same period last year.
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Invisibles

The invisibles account of BoP reflects the combined effect of transactions relating to international trade in services, income associated with non-resident assets and liabilities, labour, property and cross-border transfers, mainly workers remittances. Two components namely software services and workers remittances, continued to remain relatively resilient in 2009-10, as was the case in 2008-09, despite the global economic meltdown and were mainly responsible for the net invisible surplus.
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Invisibles receipts in 2009-10


Invisibles receipts of $ 163.4 billion in 2009-10 recorded a decline of 2.6 % over $ 167.8 billion in 2008-09 (as against an increase of 12.7 % in 2008-09 over $ 148.9 billion in 2007-08), mainly due to lower receipts under miscellaneous services such as business, financial, and communication services, together with lower investment income. Receipts under all the components of business services (such as trade related services, business and management consultancy services, architectural, engineering and other technical services, and services relating to maintenance of offices abroad) showed a decline during 2009-10 reflecting lagged impact of the global crisis. Receipts under investment income declined to $ 12.1 billion in 2009-10 from $ 13.5 billion in the previous year on account of significant decline in interest rates abroad.
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Invisibles receipts
Software receipts at $ 49.7 billion however, showed an increase of 7.4 % in 2009-10 (14.9 % a year earlier). Private transfer receipts, comprising mainly remittances from Indians working overseas also increased to $ 53.9 billion in 2009-10 (3.9 % of GDP) from $ 46.9 billion (3.8 % of GDP) in the previous year. Private transfer receipts constituted 15.6 % of current receipts in 2009-10 (13.1% in 2008-09).
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Invisible payments in 2009-10


Invisible payments increased by 9.4 % from $ 76.2 billion in 2008-09 to $ 83.4 billion in 2009-10 due to increase in payments under all the components except software services, transfers and investment income. As a result, the net invisible balance (receipts minus payments) of $ 80.0 billion (5.8 % of GDP) in 2009-10 posted a negative growth of 12.7 % over $ 91.6 billion (7.5 % of GDP) in 2008-09. The net receipts under the services component (travel, transportation, insurance, G.N.I.E. miscellaneous) went down by 33.8 % from $ 53.9 billion in 2008-09 to $ 35.7 billion in 2009-10. However, software services registered a positive growth of 10.3 % during the same period from $ 43.7 billion to $ 48.2 billion. The other component of invisibles which posted a positive growth was transfers (private as well as official). The net private transfers of US$ 52.1 billion in 2009-10 were higher by16.8 % from $ 44.6 billion in 2008-09.
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Current account balance


As a consequence of the decline in invisible surplus, despite the lower trade deficit, the current account deficit increased by 37.5 % in 2009-10 to $ 38.4 billion (2.8 % of GDP) from $ 27.9 billion (2.3 % of GDP) in 2008-09. Similarly, the lower invisible surplus combined with higher trade deficit during the first half of 2010-11 led to more than doubling of the current account deficit to $ 27.9 billion from $ 13.3 billion during April-September 2009-10
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CAPITAL ACCOUNT
Stronger recovery in India, ahead of the global recovery along with positive sentiments of global investors about Indias growth prospects, encouraged a revival in capital flows during 2009-10. The turnaround was mainly driven by large inflows under FIIs and short-term trade credits. The gross capital inflows at $ 345.7 billion during 200910 were 10.2 % higher than the $ 313.6 billion in 200809, while gross capital outflows at $ 292.3 billion were lower by 4.8 % from US$ 306.9 billion in 2008-09. As a result, net capital flows at $ 53.4 billion (3.8 % of GDP) were much higher during 2009-10 as compared to $ 6.8 billion (0.5 % of GDP) in 2008-09.
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FDI
Both inward as well as outward FDI showed declining trend in 2009-10 vis-a-vis 2008-09. The inward FDI declined by 12.4 per cent to $ 33.1 billion in 2009-10 from $ 37.8 billion in 2008-09. Similarly, outward FDI declined by 19.6 % from $ 17.9 billion in 2008-09 to $ 14.4 billion in 2009-10. Consequently, the net FDI (inward FDI minus outward FDI) was marginally lower at $ 18.8 billion in 2009-10, as compared with $ 19.8 billion in 2008-09. The FDI was channelled mainly into manufacturing followed by construction, financial services and the real estate sector.
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Portfolio investment
Portfolio investment witnessed net inflow of $ 32.4 billion in 2009-10 as against a net outflow of $ 14.0 billion in 2008-09. The attractive domestic market conditions facilitated net FII inflows of $ 29.0 billion in 2009-10 (as against net outflow of $ 15.0 billion in 2008-09). At $ 3.3 billion, the ADRs / GDRs remained at the same level in 2009-10 as in 2008-09. Net ECBs slowed down to $ 2.8 billion ($ 7.9 billion in 2008-09) mainly due to increased repayments.
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H1 of 2010-11
Net capital inflows increased significantly during H1 of 2010-11, mainly due to FII inflows, short term trade credits and ECBs.

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Reserve Use
In fiscal 2008-09, the widening of the CAD coupled with net capital outflows resulted in the drawdown of foreign exchange reserves of US$ 20.1 billion (excluding valuation) as against an accretion of US$ 92.2 billion in 2007-08.

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BALANCE OF PAYMENTS SUMMARY 2008-09


1. EXPORTS 2. IMPORTS 1,89,001 3,07,651 1,18,650 89,923 1,63,534 73,612

($ mn)

3. TRADE BALANCE
4. INVISIBLES (net) receipts payments

5. CURRENT ACCOUNT BALANCE 6. CAPITAL ACCOUNT TOTAL (net)


I. FOREIGN INVESTMENT (net)

-28,728 8,648

3,467

a. inflow b. outflow

164,915 161,448

II. EXTERNAL ASSISTANCE (net) 2,637 III COMMERCIAL BORROWING (net) 6,032 IV. Banking (net) -3,245 V. RUPEE DEBT SERVICE -100 VI.OTHER CAPITAL FLOWS (net) -1,545 VII. Errors & Omissions 1,402

7. Overall Balance (5+6) 8. RESERVE USE (- increase)

-20,080 20,080

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BALANCE OF PAYMENTS SUMMARY 2009-10


1. EXPORTS 2. IMPORTS 8,62,333 14,23,079 -5,60,746 3,80,120

(Rs.cr)

3. TRADE BALANCE
4. INVISIBLES (net) receipts 7,74,512 payments 3,94,392

5. CURRENT ACCOUNT BALANCE -1,80,626 6. CAPITAL ACCOUNT TOTAL (net) 2,44,861


I. FOREIGN INVESTMENT (net)

15,541

a. inflow b. outflow

9,43,447 6,99,806

II. EXTERNAL ASSISTANCE (net) 13,612 III COMMERCIAL BORROWING (net) 48,061 IV. Banking (net) 9,844 V. RUPEE DEBT SERVICE -452 VI.OTHER CAPITAL FLOWS (net) 62,574 VII. Errors & Omissions -7,271

7. Overall Balance (5+6) 8. RESERVE USE (- increase)

64,235 -64,235

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BALANCE OF PAYMENTS SUMMARY 2009-10


1. EXPORTS 2. IMPORTS 1,82,235 3,00,609 -1,18,374 79,991

($mn.)

3. TRADE BALANCE
4. INVISIBLES (net) receipts payments 1,63,404 83,413

5. CURRENT ACCOUNT BALANCE 6. CAPITAL ACCOUNT TOTAL (net)


I. FOREIGN INVESTMENT (net)

-38,383

51,824

51,167

a. inflow b. outflow

1,98,669 1,47,502

II. EXTERNAL ASSISTANCE (net) 2,893 III COMMERCIAL BORROWING (net) 10,366 IV. Banking (net) 2,084 V. RUPEE DEBT SERVICE -97 VI. OTHER CAPITAL FLOWS (net) -13,016 VII. Errors & Omissions -1,573

7. Overall Balance (5+6) 8. RESERVE USE (- increase)

13,441

-13,441
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SELECTED INDICATORS OF THE EXTERNAL SECTOR

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Foreign Exchange Reserves of selected countries

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Current account deficits (2009)


Country 1 2 3 4 5 6 7 Brazil China Germany UK USA Japan INDIA As % of GDP -1.5 5.9 5.0 -1.2 -2.7 2.8 -2.1
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Size of External Sector (2009)


Country 1 2 3 4 5 6 7 Brazil China Germany UK USA Japan INDIA As % of GDP Exports Imports 9.7 8.5 23.8 19.9 33.7 28.1 16.3 22.3 7.5 11.4 11.4 10.8 12.8 19.8

Indian economy is less vulnerable to global crises as its external sector is small relative to its GDP
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