India’s Balance of Payments

GROUP MEMBER’S -

SANDIP SHAH - KANCHAN KUMAR

- RISHABH SHARMA

The Balance of Payments of a country is a systematic record of all economic transactions between the ‘residents’ of a country and the rest of the world

carried out in a specified period of time.

-- Receipts on A/C of : - Goods Exported - Services Rendered - Capital received by residents

-- Payments made on A/C of : - Goods Imported - Services Received - Capital transfer to non-resident or foreigners

BALANCE OF PAYMENT

CURRENT A/C CAPITAL A/C

OMISSON AND ERRORS

MERCHANDISE

UNILATERAL AND UNREQUITED

TRANSFER

NON MONETARY GOLD MOVEMENT

INVISIBLES

BORROWING TO AND FROM ABROAD

INVESTMENT TO AND FROM ABROAD

CHANGE IN FOREIGN EXCHANGE RESERVE

Favorable Balance of Payment = Receipts – Payments > 0

Unfavorable Balance of Payment= Receipts-Payment < 0

Equilibrium Balance of Payment= Receipts =0

Bf =R-P > 0

Bu= R-P< 0

B = R-P =0

India’s Balance of Payment: THE PRE 1991 PERIOD• The Balance of Payments situation was satisfactory in the First

Plan as the deficit in current account was Rs. 42.3 crore.

Bimal Jalan classified has classified pre-1991 into 3 PERIODS

PERIOD-11956-57 to

1975-76

PERIOD-21976-77 to 1979-80,

There was a surplus on current a/c which stood 0.6% of GDP.

PERIOD-31980-81 to

1990-91

OVERALL BALANCE OF PAYMENT CONTINUED TO BE DIFFICULT IN

THESE TWO PERIODS.

PERIOD – 1 SECOND PLAN :

- Objective is to gave primary importance to the establishment and development of basic capital goods industries.

• This necessitated large scale import of capital equipments like machinery, technical know-how.

• Export become stagnant and value of import twice the value of export.

• As a result balance of trade deficit Rs2,613.3 crore and current a/c was reduced to Rs1,646.(receipts of invisible still positive).

THIRD PLAN : The overall balance of payment deficit rose to Rs1972 crore.

(increase by 326)

FORTH PLAN :It register in continuous increase in import mainly due to increase in international price.

OPEC (Organization of Petroleum Exporting Countries) raised price of crude oil per/barrel from $2.50 to $3.00 in middle of 1973 to $11.65 per/barrel in early 1974.

Price increase by 4 times.Deficit in current a/c during 4th plan was as high Rs 2,221 crore. FIFTH PLAN :The first 2 years of 5th plan (1974-75 to 1975-76) recorded a

deficit of Rs. 1,738 crore in current a/c.

PERIOD -2 (from 1976-77 to 1979-80)This brief 4 year period was GOLDEN PERIOD

• India had a small current a/c surplus of 0.6% during the period and foreign exchange reserves equivalent to 7 month’s import.

Comfortable Balance of Payment due to following factors are:-- First and foremost rapid increase in private remittances from

oil exporting countries. A large number of Indian workers temporarily migrated to the

oil richer middle east countries to work their as:- unskilled workers, skilled technicians, office assistance and

nurses etc. (they send their Net Earnings to their families in India)

- There was a strong growth of exports nearly31% In 1975-76 over 1974-75.

-There was substantial expansion in the activities of Indian firms in the oil exporting middle east countries. Indian firms were building roads, airport, housing estates, power stations and steel mills etc.

-Aid receipts were reasonably buoyant and India drew various IMF facilities during the year 1973-74 to 1975-76.

PERIOD-3 (1980-81 to 1990-91)• The period covering roughly the 6th plan (1980-81 to 1984-85)

and 7th plan (1985-86 to 1989-90) was marked by severe Balance of Payment difficulties.

• During first 4 years of 6th plan, the deficit in balance of trade was around Rs 6,000 crore per annum. In last year plan, this shot up to Rs 6,721 crore.

• The trade deficit in the first 3 years of 7th plan (1985-86 to 1987-88) exceeded Rs 9,000 crore per annum. And in 4th and 5th years (1988-89 t0 1989-90) exceeded Rs 12,000 crore per year.

• In 1990-91 the deficit touch astronomical figure of Rs. 16,934 crore.

• The current a/c deficit soared to Rs 17,369 crore.

ISSUE RELATED TO MANAGEMENT OF BALANCE OF PAYMENT

• Issue related to Trade strategy ( The Trade Policy Related Debate

OUTWARD ORIENTED is one in which the trade and industrial policies do not discriminate between production for domestic goods and foreign goods.

INWARD ORIENTED strategy is one in which trade and industrial incentives are biased in favor of domestic market over the export market.

TRADE STRATEGY

OUTWARD ORIENTED

INWARD ORIENTED

Import substitution Policy in India: Constraint to Growth

• India opted for strongly inward oriented strategy in early decades of economic planning

• Basic rationale to opt strategy was that it would help rapid industrialization through import substitution and save valuable foreign exchange.

• A no. of economist studies conducted all over the world that outward oriented have performed better while inward oriented constraint growth.

• World Development Report 1987 conducted a study of 41 countries which shows outward oriented economies performed better than inward oriented in all respect.

• Their growth rate of GDP is 7.7 percent in the period of 1973-85.

1991 economic crises: the causes of balance of payment crises-

• Iraq-Kuwait War: The Gulf crisis began with the invasion of Kuwait by Iraq at the beginning of August 1990. Crude oil prices rose rapidly thereafter–from USD 15 per barrel in July 1990 to USD 35 per barrel in October 1990.

• Slow Growth of Important Trading Partners: The deterioration of the current account was also induced by slow growth in economies of important trading partners. Export markets were weak in the period leading up to India’s crisis, as the world growth declined steadily from 4.5 percent in 1988 to 2.25 percent in 1991.

• Political Uncertainty and Instability: The period from November 1989 to May 1991 was marked with political uncertainty and instability in India. In fact, within a span of one and half years there were three coalition governments and three Prime Ministers. This led to delay in tackling the ongoing balance of payment crisis, and also led to a loss of investor confidence.

Fiscal Indiscipline: The Economic Survey (1991-92) had categorically remarked that:

“Throughout the eighties, all the important indicators of fiscal imbalances were on the rise. These were the conventional

budgetary deficit, the revenue deficit, the monetized deficit and gross fiscal deficit.

• Loss of Investors’ Confidence: The widening current account deficits and reserve losses contributed to low investor confidence, which was further weakened by political uncertainty. This was aggravated by the downgrade of India’s credit rating by credit rating agencies.

India’s Balance of Payments• India’s CAB has been negative from the days of independence

except some years, and this has posed persistent problem in the maintenance of external balance. From 1991-92, it has shown increasing trend up to the year 2012-13.

• The year 2011-12, India’s overall external sector balance has been in surplus, and boosted the international reserves of the country. This has been achieved through generating surplus in the capital account of BoP

Reasons for satisfactory balance of payments situation post – reform period

• High earnings from invisibles• Rise in external commercial borrowings• Non- resident deposits• Role of foreign investment

CAUSES OF UNFAVOURABLE BoP -Import of Machinery- to meet the need of industrialization India

import machinery on large scale. India import machinery from America, England, Germany, Japan and Russia.

- Import of War Equipments- India has top in list of largest weapons importing country in the world, accounting 14% of global imports.

Russia supplied -70% USA- 12%Israel- 7%-Foreign Competition in Export: India mainly exporter of Tea, Jute

and Textile in tea Bangladesh is a big rival of India, in jute Srilanka and Israel are big rival of India and in textile and cloths Pakistan, Bangladesh and Srilanka.

-Poor quality of Industrial Production: Back ward technology cause impediment and hindrance Indian traders to export.

- Population Growth: India’s population increase by faster pace to meet their needs, imports become essential.

- Natural Factors- Demonstration Effect- Negative Impact in Dollar Depreciation and

Rupee appreciation on exports

Meaning of currency convertible - Let us first explain what is exactly meant by currency convertibility. By

convertibility of a currency we mean currency of a country can be freely converted into foreign exchange at market determined rate of exchange that is, exchange rate as determined by demand for and supply of a currency.

- The exporters and others who receive US dollars, Pound Sterling etc. can go to these dealers which are generally banks and get their dollars exchanged for rupees at the market determined rates of exchange. Similarly, under currency convertibility, importers and other who require foreign exchange can go to these banks dealing in foreign exchange and get rupees converted into foreign exchange.

• A currency may be convertible on current account (that is, exports and imports of merchandise and invisibles) only.

Capital account transaction means cross border transactions in assets

Assets mean : Stocks, Bonds (or other debt instruments), Property, or mixture of these three

Full capital account convertibility means : 1) A foreign investor (person or institution) can convert foreign currency to Indian Rupee and invest in any asset in India without any restriction. This investor is also able to sell the investment without any restriction, convert the resulting Indian Rupee amount to a foreign currency and take it out of the country.

2) A domestic investor (person or institution) can convert Indian Rupee to foreign currency and invest in any asset abroad without any restriction. A domestic investor can also sell investments abroad and bring the proceeds back into India.

Convertibility of Indian Rupee:

• In the seventies and eighties many countries switched over to the free convertibility of their currencies into foreign exchange. By 1990, 70 countries of the world had introduced currency con vertibility on current account; another 10 countries joined them in 1991.

• As a part of new economic reforms initiated in 1991 rupee was made partly convertible from March 1992 under the “Liberalized Exchange Rate Management scheme in which 60 per cent of all receipts on current account (i.e., merchandise exports and invisible receipts) could be converted freely into rupees at market determined exchange rate quoted by authorized dealers, while 40 per cent of them was to be surrendered to Reserve Bank of India at the officially fixed exchange rate.

To be cont’d• This partial convertibility of rupee on current account was

adopted so that essential imports could be made available at lower exchange rate to ensure that their prices do not rise much. Further, full convertibility of rupees at that stage was considered to be risky in view of large deficit in balance of payments on current account.

• As even after partial convertibility of rupee foreign exchange value of rupee remained stable, full convertibility on current account was announced in the budget for 1993-94. From March 1993, rupee was made convertible for all trade in merchandise.

Advantages of Currency Convertibility:

• 1. Encouragement to exports: An important advantage of currency convertibility is that it

encourages exports by increasing their profitability. With convertibility profitability of exports increases because market foreign exchange rate is higher than the previous officially fixed exchange rate. This implies that from given exports, exporters can get more rupees against foreign exchange (e.g. US dollars) earned from exports.

• 2. Encouragement to import substitution: Since free or market determined exchange rate is higher than

the previous officially fixed exchange rate, imports become more expensive after convertibility of a currency. This discourages imports and gives boost to import substitution.

• 3. Incentive to send remittances from abroad: Thirdly, rupee convertibility provided greater incentives to send remittances

of foreign exchange by Indian workers living abroad and by NRI.

• Integration of World Economy: Finally, currency convertibility gives boost to the inte gration of the

world economy. As under currency convertibility there is easy access to foreign exchange, it greatly helps the growth of trade and capital flows between the countries. The expan sion in trade and capital flows between countries will ensure rapid economic growth in the econo mies of the world.

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