India's Balance of Payments

India’s Balance of Payments Overview

  • The chapter covers the following aspects of India’s balance of payments:

    • Definition and meaning of balance of payments

    • India’s balance of payments situation in the pre-reform period

    • Current balance of payments scenario since 1991

    • Issues related to management of balance of payments

Meaning of Balance of Payments

  • The balance of payments (BoP) is a comprehensive record of all economic transactions between residents of a country and the rest of the world within a specified time frame.

  • It includes:

    • Receipts from exports of goods, services, and capital

    • Payments for imports of goods, services, and capital

  • BoP is broader than the balance of trade, which only includes merchandise exports and imports.

Structure of the Balance of Payments

  • The BoP comprises two major accounts:

    1. Current Account:

    • Records transactions related to goods, services, and income.

    • Subdivided into merchandise trade and invisibles (services, investment income, and transfers).

    • For example, imports/exports of goods are recorded at free-on-board (f.o.b.) prices for exports and cost, insurance, and freight (c.i.f.) prices for imports.

    1. Capital Account:

    • Contains transactions concerning financial claims and liabilities.

    • Can be divided into private capital, banking capital, and official capital.

    • The balance of current and capital accounts helps determine overall BoP stability.

India’s Balance of Payments: Pre-1991 Period

Current Account Deficit in Balance of Payments

  • Period I (1956-76):

    • Characterized by persistent deficits due to wars, droughts, and oil shocks.

    • Heavy reliance on foreign assistance (92% of current account deficit financed).

    • Initially had a 'sterling balance' but saw increasing imports and stagnating exports post-independence.

    • Current account deficit averaged 1.8% of GDP.

  • Period II (1976-80):

    • Short-lived surplus (0.6% of GDP) due to rapid growth in remittances and favorable external conditions.

    • Contributed to improvements in trade balance before the second oil shock.

  • Period III (1980-91):

    • Severe balance of payments difficulties resulted in high trade deficits averaging around 6,000 crore annually.

    • Heavy reliance on non-concessional loans, leading to increased debt.

    • Current account deficits surged, culminating in a deficit of 16,934 crore by 1990-91.

Balance of Payments Situation Since 1991

  • Post-1991 liberalization improved the BoP situation.

  • 1992-93: Current account deficit returned to 1.7% of GDP with foreign reserves covering 4.9 months of imports.

  • Significant improvements observed in subsequent years (1993-94), where the current account deficit fell to 0.4% of GDP and reserves covered 8.5 months of imports.

  • Continued rise in imports due to industrial growth and decent export performance.

Management of Balance of Payments

Key Issues

  1. Fiscal-External Policy Linkages:

    • Fiscal deficits can lead to excessive absorption of resources, impacting the current account balance.

  2. Trade Strategy:

    • Suggested shift from inward-oriented (import substitution) to outward-oriented (export promotion) strategies to foster economic growth.

  3. Exchange Rate Management:

    • Transition towards managed float with periodic adjustments to stabilize the currency and support exports.

  4. Capital Account Issues:

    • Dependence on high-cost methods like external commercial borrowings and NRI deposits increases future financial liabilities.

  5. Foreign Currency Reserves:

    • Building adequate reserves to manage the current account deficit and external shocks is critical.

Conclusion

  • India’s balance of payments reflects complex dynamics influenced by domestic policies, external economic conditions, and fiscal management practices. Implementation of effective trade and monetary policies remains crucial for achieving a stable BoP position and economic growth.