Balance of Payments -India

V. LEELA KISHAN MBA-CMU

GBE Assignment Rno: 11031E0119 School of Management Studies-JNTUH

Introduction
The Balance of Payments is the statistical record of a countrys international transactions over a certain period of time presented in the form of double-entry bookkeeping. Balance of payments accounting is based on the double entry principle with every item booked as a credit and a debit. Therefore, the overall result will be in balance and the equation for the balance of payments will be zero. Deficits and surpluses can only show up in the sub balances such as in the balances of trade, services, unilateral transfers and the capital and financial account. A typical Balance of Payments (BoP) contains three major sub balances:

1. Current account

2. Capital and financial account

3. Changes of reserves account

All items are registered as flows or as a change of stocks. The reserves account is seen as a form of compensatory financing and as such a net increase of the foreign exchange reserves receives a minus sign because it implicitly represents capital exports. A simple balance of payments equation is given by Bringing the change of reserves (R) to the right side, one gets This equation demonstrates that when a country's current account (CA) and its capital and financial account (CF) should not balance, the discrepancy will show up as a change in the country's foreign exchange reserve position (R). If a country's reserves are depleted (R = 0) or if a certain level of foreign exchange reserves must be maintained (R = 0) a current account deficit must fully be compensated by a net inflow of foreign capital. If the country can no longer obtain foreign financing, the burden of adaptation falls on foreign trade. On the other hand, a country will accumulate foreign exchange reserves when the sum of the current account (CA) and the capital and financial account (CF) are positive.

Below table presents the Balance of Payments of India (in US$ million) for the Financial years 2006-07 to 2010-11. 2006-07 2007-08 2008-09 2009-10 2010-11 Balance of Payments India Current Account 1 Exports 128888 166162 189001 182442 250468 2 Imports 190670 257629 308520 300644 381061 3 Trade balance -61782 -91467 -119519 -118202 -130593 4 Invisibles (net) 52217 75731 91604 80022 84647 services a Non-factor 29469 38853 53916 36016 48816 b Income -7331 -5068 -7110 -8038 -17309 c Transfers 30079 41945 44798 52045 53140 5 Goods & Services -32313 -52614 -65603 -82187 -81777 Balance 6 Current Account -9565 -15737 -27914 -38181 -45945 Balance Capital Account 1 Capital Account 45203 106585 7395 51634 61989 Balance i External assistance 1775 2114 2439 2890 4941 (NET) ii External commercial 16103 22609 7861 2000 12506 borrowings (net) iii Short-term Debt 6612 15930 -1985 7558 10990 iv Banking Capital 1913 11759 -3245 2083 4962 (net) of which Non-resident deposits (net) 4321 179 4290 2922 3238 v Foreign investment 14753 43326 8342 50362 39652 (net) of which a FDI (net) 7693 15893 22372 17966 9360 b Portfolio (net) 7060 27433 -14030 32396 30293 vi Rupee Debt service -162 -122 -100 -97 -68 vii Other flows (net) 4209 10969 -5916 -13162 -10994 III Errors and 968 1316 440 -12 -2993 omissions IV Overall balance 36606 92164 -20080 13441 13050 V Reserves [increase (-) / decrease (+)] 36606 92164 20080 13441 (-)13050

Indias balance of payments (BOP) in 2000-01 remained comfortable and the external sector experienced a distinct improvement. There were, however, some pressures on the BOP during the first half of the year on account of the significant hardening of international oil prices, the sharp downturn in international equity prices and successive increases in interest rates in the United States and Europe; but the situation eased with the mobilization of funds under the India Millennium Deposits, which helped to revert the declining trend in reserves and enhanced confidence in the strength of Indias external sector. As a result, the BOP situation experienced a turnaround in the second half of the year, 2000-01. Overall, the current account deficit in 2000-01 narrowed further to about 0.5 per cent of GDP from 1.1 per cent of GDP in the previous year. This improvement in current account deficit was made possible largely because of the dynamism in export performance, sustained buoyancy in invisible receipts, reflecting sharp increases in software service exports and private transfers, and partly due to the subdued non-oil import demand.

Exports, on BOP basis, registered strong growth of 19.6 per cent in US dollar terms in 2000-01, on the heels of a strong recovery of 9.5 per cent in the previous year. Total imports, on payment basis, recorded only a moderate growth of 7.0 per cent during 2000-01, much lower than the sharp increase of 16.5 per cent in 1999-2000. The moderate growth in total imports in 2000-01 was, in fact, largely because of a 24.1 per cent increase in the oil import bill, while non-oil import growth, on BOP basis, remaining subdued at only 2.0 per cent. Non-oil, non-gold imports, on customs basis, grew at a very high rate of about 20 per cent per annum, on an average, during 1992-93 to 199596.

The growth rate decelerated sharply to just about 3.5 per cent per annum during the next four years ended 1999-00. As expected, the growth of non-oil, non-gold imports tended to be moderate when the initial impact of trade liberalisation got absorbed, and the exchange rate providing reasonable incentives for cost-effective import substitution. This allays the fears that trade liberalisation would swamp the domestic market with cheaper imports.

In 2000-01, nonoil, non-gold imports recorded a negative growth of 6.7 per cent, mainly because of the continuous industrial slowdown in recent years and the resulting lack of demand for imports. 6.7 Reflecting the trends in exports and imports, the deficit on the trade account of BOP narrowed to US $14.37 billion or 3.1 per cent of GDP in 2000-01 from US $17.84 billion (4.0 per cent of GDP) in 1999-2000 (Table 6.2). The net inflow of invisibles, at US $11.79 billion, covered about 82 per cent of the deficit on the trade account in 2000-01, leaving a financing gap of only US $2.68 billion on the current account. This deficit on the current account represented 0.5 per cent of GDP, compared with the deficit of 1.1 per cent of GDP (US $4.70 billion) in 1999-2000. 6.8 The recovery in capital flows witnessed in 1999-2000, after some set back in 1998-99, which had been a consequence of the East-Asian crisis and partly due to the economic sanctions on India, was broadly maintained. Net inflows of capital (excluding IMF) on the capital account of BOP in 2000-01 were about US $9.02 billion, which were lower than such inflows of US $10.44 billion in the previous year.

This reduction is mainly accounted for some bunching of repayments of commercial borrowings and significant net outflows under banking capital. On the other hand, capital inflows in 2000-01 were bolstered by the mobilisation of funds of US $5.51 billion under India Millennium Deposits (IMD) in October/November 2000. Fresh inflows of funds for portfolio investments in India by FIIs in 2000-01 amounted to about US$1.85 billion, which was only slightly lower than the US $2.14 billion in 1999-2000. Net accretions to non-resident deposits during 2000-01 rose by over 50 per cent to US $2.32

billion. Gross disbursement of external assistance at US $2.94 billion was comparable with the normal trends in recent years. Gross borrowing on commercial terms, excluding IMD, at US $3.81 billion in 2000-01 was higher than such normal borrowings of US $3.19 billion in the previous year. The sharp reduction in current account deficit and the funds raised under IMD making up for the dip in overall net capital inflows through normal sources during 2000-01, as indicated above, resulted in a large accumulation of official foreign exchange reserves for the fifth year in succession. On BOP basis, reserves rose by a substantial US $5.83 billion. This was on top of an increase of US $6.14 billion in 1999 2000 and an increase of US $4.51 billion per year, on an average, during the previous three years, 1996-97 to 1998-99. Official BOP statistics, as compiled by the RBI, for the year 2001-02 are available so far only for the first half of the year. However, a tentative assessment of BOP outlook for the current year indicates that the current account deficit in 2001-02 might widen somewhat, but it is expected to remain within 1 per cent of GDP. The widening of current account deficit will be mainly due to the poor export performance. Export performance faltered in the current year, as is evident from the growth rate of about 0.6 per cent, in US dollar terms, recorded by the DGCI&S data for the first nine months of 2001- 02. On the other hand, the resulting pressure on trade account will be eased to a large extent on account of moderation in oil import bill, following softening of international oil prices after September 2001. The net inflow of invisibles, despite larger outflows on account of interest and dividend payments, is expected to remain broadly at last years level, supported by continued buoyancy in software service exports and private transfers. The widening of the current account deficit will, however, be more than matched by the expected net capital inflows from normal sources, resulting in large accretions to reserves. During the first ten months of current financial year (2001-02), the foreign currency assets of the RBI have increased by about US $7.01 billion from US $39.55 billion at end-March 2001 to US $46.56 billion at end-January, 2002.

FOREIGN EXCHANGE RESERVES

Indias foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights (SDRs), and reserve tranche position (RTP) in the International Monetary Fund (IMF). The level of foreign exchange reserves is largely the outcome of the RBIs intervention in the foreign exchange market to smoothen exchange rate volatility and valuation changes due to movement of the US dollar against other major currencies of the world. Foreign exchange reserves are accumulated when there is absorption of the excess foreign exchange flows by the RBI through intervention in the foreign exchange market, aid receipts, and interest receipts and funding from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA), etc. FCAs are maintained in major currencies like the US dollar, euro, pound sterling, Australian dollar, and Japanese yen. Both the US dollar and euro are intervention currencies; however, reserves are denominated and expressed in the US dollar only, which is the international numeraire for the purpose. The movement of the US dollar against other currencies in which FCAs are held therefore impacts the level of reserves in US dollar terms. The level of reserves declines when the US dollar appreciates against major international currencies and vice versa. The twin objectives of safety and liquidity have been the guiding principles of foreign exchange reserves management in India with return optimization being embedded strategy within this framework. Indias foreign exchange reserves

Beginning from a low level of US$ 5.8 billion at end March 1991, Indias foreign exchange reserves gradually increased to US$ 25.2 billion by end March 1995, US$ 38.0 billion by end March 2000, US$ 113.0 billion by end March 2004, and US$ 199.2 billion by end March 2007. The reserves stood at US$ 314.6 billion at end May 2008, before declining to US$ 252.0 billion at the end of March 2009. The decline in reserves in 2008-09 was inter alia a fallout of the global crisis and strengthening of the US dollar vis- vis other international currencies. During 2009-10, the level of foreign exchange reserves increased to US$ 279.1 billion at end March 2010, mainly

on account of valuation gain as the US dollar depreciated against most of the major international currencies. In fiscal 2010-11, foreign exchange reserves have shown an increasing trend and reached US$ 304.8 billion at end March 2011, up byUS$ 25.7 billion from the US$ 279.