The changing Balance of Payment Situation in India

Submitted by: Amrit Preet Singh 2011057 Dushyant Chaturvedi 2011070 Esheeta Ghosh 2011071 Gavaksh Kumar Mangla 2011080 Abdullah - 2011244

What is Balance of Payment

Balance of payments is an accounting record of all monetary transactions of a country with rest of the world for an year Is a systematic record of all economic transactions between the residents of a country and the rest of the world.

What does BOP Surplus and Deficit mean

A BOP surplus means a nation has more funds coming in than it pays out to other countries from trade and investments, which results in appreciation of its national currency versus currencies of other nations. A deficit is an excess of imports over exports, a dependence on foreign investors, and an overvalued currency.

Types of Accounts
The balance of payments for any country is divided into two broad categories: The Current Account: It reports the various trades in import and export plus income derived from tourism, profits earned overseas, and payments of interest The capital account: It reports sum of bank deposits, private investments and debt securities sold by a central bank or official government agencies. The official reserve account: It is a subdivision of the capital account which contains foreign currency and securities held by the government or the central bank, which is used to balance the payments from year to year.

Overall balance of payment

Overall balance of payment = Current Account Balance + Capital account balance + Official Reserve Account

Indian Economy: Pre-Crisis Period 1980-89

From FY 1980 to FY 1989, the economy grew at an annual rate of 5.5 percent. Industry grew at an annual rate of 6.6 percent and agriculture at a rate of 3.6 percent. Investment went from about 19 percent of GDP in the early 1970s to nearly 25 percent in the early 1980s. Private savings financed most of India's investment, but by the mid-1980s further growth in private savings was difficult because they were already at quite a high level. As a result, during the late 1980s India relied increasingly on borrowing from foreign countries.

Economic Policies during 1980-89

Protectionist Policies : The Government had a defined objective of attaining self reliance through industrialization, i.e. Import substitution and export promotion. This actually was only effective in case of substitution of consumer goods while the capital goods industries were still import intensive. The high cost of production due to inadequate technical knowhow further aggravated the situation. All this led to an eventual decline in the exports and a widened trade deficit of the country along with a heavy debt burden. Exchange Rate: The instability in exchange rate also posed a great threat to economic stability of India. The constant devaluations of the rupee increased the amount of external debt. The inflation rates remained higher towards the end of the decade and hence it was imminent on the central bank to change the exchange rates accordingly

Economic Policies during 1980-89

External Debt : India had a very limited resource base due to lower per capita income and savings. Hence Government resorted to heavy foreign borrowing for the developmental efforts and also to correct the BoP situation in the short run.

Export promotion: Indian exports were mainly constituted of primary products, the prices of which fluctuated heavily with the fluctuations in the global market demand. The licensing and other disruptive policies were proving cumbersome for exporters and hence dis-incentivised them from export promotion. The earnings from such primary products were relatively low and the primary product exporting countries were always put in unfavorable terms of trade.

Economic Policies during 1980-89 Government Deficit

As its evident from the graph the government deficits have shown a steady increase from the beginning of 1980s and peaks during the 1985-86 period.

Economic Policies during 1980-89 Current Account

The graph above shows the position of the current account in the pre crisis period. We can see that the current account balance declined sharply during the end of the decade.

Economic Policies during 1980-89 Capital Account and For-ex reserves

The capital inflows to India mainly consisted of aid flows, commercial deposits and deposits from Non resident Indians. The heavy restriction on FDIs in almost all sectors was a main limiting factor in the economy to attract enough foreign investments for its development projects in infrastructure sectors. The situation worsened when India was gradually losing out its forex reserves due to constant devaluations of the rupee against dollar and widening trade deficit. The forex reserves fell from a comfortable $8151 mm in 1987 to $ 5331mm in 1990 and further to $ 1877mm by 1991.

Economic Policies during 1980-89 External Debt

The external debt of India doubled from 1984-85 ($35 bn) to 1990-91 ($69 bn). The investor confidence declined rapidly due to the economic situation of India and hence it resulted in the outflows being increasingly dependent on short term external debts.

Balance of Payment crisis-The build up

Break up of the Soviet Union The Soviet Union had been one of the largest export markets for India prior to its breakup in India. The Soviet breakup therefore negatively affected Indias precarious trade balance, which slipped further into red. The Gulf war Iraq and Kuwait were among the largest suppliers of oil to India, especially Iraq with whom India had long term arrangements .Due to the war many of these long term contracts were hit, which forced the government to buy from the spot market at high prices resulting in the oil bill ballooning to $2 billion in the latter half of 1990.

Balance of Payment crisis-The build up

Fall in remittances The Gulf war also caused many Indian workers working in Kuwait and Iraq to return, resulting in a fall in remittances. This was significant since NRI remittances had been an important source of inflows to the country throughout the eighties thus reducing the severity of the balance of payments. The situation was further aggravated further with the government having to airlift Indian residents in Kuwait. Political uncertainty The period between1990-91 was marked with high political uncertainty at the central level with the country seeing three successive government changes. This reduced the focus of the government on the looming economic crisis as there was no clear policy to deal with the unexpected situation. When a stable majority government was setup in 1991, it was a little too late as the damage had been done.

The CRISIS
The rapid loss of foreign exchange reserves had prompted the government to take steps to reduce the trade deficit, by restricting the imports By late 1991, the decline of imports had reached a stage where it was starting to affect the domestic production, which started declining . Hence any further measures in this direction was ruled out.

The CRISIS

The CRISIS
By the end of 1990 and the beginning of 1991 it was clear that Trade deficit was not the deciding factor , as it had come down to $382 million in Jan-Feb 1991 and further to $172 million in May 1991 . One reason for the drastic fall in reserves was due to the withdrawal of foreign currency non-resident deposits (FCNR), which accelerated from $59 million in Oct-Dec 1990, to $76 million in Jan-Mar 1991 and finally to 310 million in June 1991. The foreign investors fearing devaluation of the currency withdrew their deposits from the country. Further, in expectation of devaluation import receipts were forwarded and export receipts were postponed .

The CRISIS
In June 1991, Foreign exchange reserves fell below $1billion barely enough to cover 2 weeks of imports During this time the government took a number of steps starting with an agreement with IMF for a withdrawal of $1,025 billion under its Compensatory and Contingency Financing Facility In May 1991, the government leased 20 tones of gold to State bank of India to sell it abroad Further in July 1991, the government allowed the RBI to ship 47 tons of Gold to the Bank of England and Bank of Japan which allowed RBI to raise $600 million.

The CRISIS
It was against this background that a two-step downward adjustment process in the exchange rate of rupee was put into effect on July 1 and 3, 1991, which resulted in devaluation of rupee of around 18 per cent against major international currencies

Current state
The balance of payments position can be reflected from : Trade balance Current account balance Capital account balance Foreign exchange reserves

Trade balance
Trade balance has been in deficit since imports have always exceeded exports. The following are the trade deficit figures : 1990-91: us $ 9438 million 2000-01 : us $ 12460 million 2008-09 : us $ 118650 million

Current Account Balance

Our current account balance has also always shown deficit except years 2001-02, 2002-03 & 2003-04 In case of merchandise trade, the demand for imported goods continues to outstrip demand for Indian goods abroad which causes a huge deficit However, earnings from non-factor services have played a vital role in bringing down the current account deficit

Capital Account Balance

In BOP, the deficit in the current account balance is offset by capital account receipts External assistance like repayment of loans to IMF have finally become nil, though commercial borrowings are on an increase The foreign investment in the form of FDI and FIIs have consistently been positive 1990-91 us $ 103 million 2007-08 : us $ 43326 million 2008-09 : us $ 3467 million

Capital Account Balance

The net capital account balance has been positive throughout and after covering the current account deficit , the excess is added to the foreign exchange reserves However, when current account deficits are larger than capital account surpluses, foreign exchange reserves are also used to cover these deficits

Foreign Exchange Reserves

Indias foreign exchange reserves are held in the form of foreign currency assets (FCAs), gold, special drawing rights (SDR)and reserve tranche position (RTP) in the International Monetary fund(IMF) Foreign currency assets are maintained in the form of us dollar, pound, euro, yen, etc. However, foreign exchange reserves are expressed in us dollar only Foreign exchange reserves were as follows : 1991 : $ 5.8 billion 1995 : $ 25.2 billion 2009 : $ 283.5 billion

External Debt
India's external debt increased from US$ 261.0 billion at endMarch 2010 to US$ 305.9 billion at end-March 2011, showing a rise of 17.2 per cent during the year External debt to GDP ratio 2011 - 17.3 per cent 2000 22.5 per cent 1991 - 38.7 per cent Has been under control because of prudent measures by the government of India like monitoring long and short-term debt, raising sovereign loans on concessional terms with longer maturities and regulating external commercial borrowings

A few issues
Current account imbalance Rise of imports greater than the rise in exports At the end of March 2011, the import cover declined to 9.6 months from 11.1 months at end-March 2010 (2.5 months 1991)

Conclusion
Our reserves are comfortable ($ 295 Bn 2012), exchange rate is competitive, service sector exports are also bouyant and capital inflow through FDI is also encouraging In short, the BOP situation is quite well managed and comfortable