Balance of Payments

Dr. Utpal Chattopadhyay

Asst. Professor, NITIE.
 Concepts
• Balance of payments (BoP) is a systematic record of all
economic transactions between the residents of a country and
the rest of the world.
• Like all double-entry book keeping accounts it always balances,
i.e. sum of credit entries equals sum of debit entries.
• There are two types of accounts in BoP, viz.
• Current Account
 It records transfers of goods and services i.e., merchandise
trade and net invisibles which includes services like travel,
transportation, insurance etc. and transfer payments.
• Capital Account
 It shows transfers of claims to money or titles to investment
between a country and the rest of the world. In includes
foreign investment inflows minus the foreign investment
outflows, loans including external assistance and external
commercial borrowings (inflow-outflow) and other forms of
capital.
• A current account deficit is financed through net inflow of
capital on the capital account and the changes in the Govt’s
foreign exchange reserve position.
India’s BoP : April-June 2008 (US$ million) Source: RBI Credit Debit Net
A.CURRENT ACCOUNT      
I. MERCHANDISE 43703 75277 -31574
II.INVISIBLES (a+b+c) 37730 16880 20850
a) Services 21969 11508 10461
b) Transfers 12188 666 11522
c) Income 3573 4706 -1133
Total Current Account (I+II) 81433 92157 -10724
B. CAPITAL ACCOUNT      
1. Foreign Investment 53161 47252 5909
2.Loans 13643 9560 4083
3. Banking Capital 19025 16290 2735
4. Rupee Debt Service - 30 -30
5. Other Capital 2585 2067 518
Total Capital Account (1to5) 88414 75199 13215
C. Errors & Omissions - 256 -256
D. Overall Balance 169847 167612 2235
(Total Capital Account, Current Account and Errors &
Omissions (A+B+C))      
E. Monetary Movements (i+ii) - 2235 -2235
i) I.M.F. - - -
ii) Foreign Exchange Reserves - 2235 -2235
 Trends in India’s BoP
• During 1950s & 1960s
 Prior to 1956-57, when India faced BoP crisis, the country
mostly had current account surplus.
 The BoP crisis of 1956-57 precipitated the imposition of
exchange controls which then became endemic to the import-
substitution regime.
 The BoP position deteriorated once again in 1966-67,
following Indo-Pak war in 1965 (USA suspended its aid).
 The Indian Rupee was devaluated (by 36.5%) in June 1966.
 Tariffs and export subsidies were simultaneously rationalized.
 BoP improved after 1966-67 largely due to decline in imports
(exports performed indifferently despite devaluation).
• During 1970s (A Decade of Comfort)
 During this period India’s BoP remained comfortable, mainly
due to buoyant exports, spurt in private transfer receipts and
inflow of aid.
 At the close of the decade the foreign exchange reserves
stood at US$ 7361 million sufficient for seven months’
imports.
 Trends in India’s BoP
• Upto 1981-82 ( A Period of Difficulties)
 During the eighties, issues relating to the balance of
payments came to occupy the centre stage in terms of
India’s macro-economic management.
 Between 1978-79 and 1981-82 , imports almost doubled
(the increase in POL imports accounted for a little over half
the increase in the overall imports).
 Export performance was depressed by the severe
international recession of 1980-83. (exports in vol. grew by
a little over 3% p.a.).
 Net invisible receipts continued to provide support to BoP
(tourism, private transfers played important role).
 However, growing merchandise trade deficits resulted in a
current account deficits to the tune of US$ 3166 million in
1981-82 (1.8% of GDP).
 Adjustments efforts consisted essentially of an Extended
Fund Facility negotiated with the IMF, although there was
also intensified efforts to improve domestic crude oil
production.
 Trends in India’s BoP
• During 1982-83 to 1984-85 (Easing of Pressure)
 A reprieve came during the period, mainly due to a decline in volume
growth of imports .
 Net oil imports declined substantially as domestic production spurted
by 1984-85.
 Exports, however, grew only at a moderate rate of 3.2% p.a.,
invisibles account deteriorated and private transfers stagnated.
 Current account deficits fell to US$ 2416 million in 1984-85.
 Commercial borrowings, non-resident deposits and external
assistance accounted for the majority of the financing requirements.
• During 1985-90 (The Build-up to the Crisis)
• Current account deficits remained at a high level in spite of robust
growth in exports (share of manufactured exports went up to 75% in
1989-90).
• The volume of POL trade almost doubled between 1985 and 1990.
• The non-POL rose sharply partly due to large imports of food grains.
Imports of capital goods also increased significantly.
• The current account deficit was high at 2.4% of GDP.
• The period also marked a deterioration in fiscal imbalances (GFD
rose to 8.2% of GDP).
• External debts doubled.
 Trends in India’s BoP
• BoP during 1990-92 (The Crisis)
• The 1985 Export-Import Policy led to a wave of
indiscriminate liberalization of imports.
• Import liberalization measures resulted in the emergence of
the huge deficits in the balance of trade (export promotion
has not been commensurate with the increase of imports).
• In 1991, India found itself in its worst balance of payments
crisis since 1947.
• Foreign currency reserves were depleted rapidly.
• Matters were made worse by an accompanying double-digit
inflation in 1990-91.
• The oil price increase resulting from Iraq’s invasion of
Kuwait in August 1990 reinforced the crisis-like situation in
India.
• A net outflow of NRI deposits commenced in Oct. 1990 and
continued during 1991.
• The crisis forced to opt for economic reforms programme. A
series of changes were introduced in the industrial policy
and trade policy with a view to improve efficiency,
productivity and international competitiveness of India’s
economy.
 Trends in India’s BoP

• BoP during 1993-94 & Beyond

• Initial response of the economy, especially exports, was very
good (exports grew by about 20% between 1993-94 and
1995-96).
• But the boom was short lived as India’s export performance
started declining since 1996.
• Deficit on trade account touched alarming level of US$ 1.6
billion in 1997-98.
• A current account surplus for the third consecutive year,
coupled with an expanding capital account reversed the
previous trend and by 2003-04 India had a foreign exchange
reserve of about US$ 31.4 billion.
• The year 2004-05 marked a significant departure with the
current account, after three consecutive years of surplus,
turned into a deficit.
 Trends in India’s BoP
• The current account has followed an inverted U shaped
pattern during the period 2001-02 to 2006-07, rising to a
surplus of over 2% of GDP in 2003-04. Thereafter it has
returned close to its post-1990s reform average, with
current account deficit of 1.2% (of GDP) in 2005-06 and
1.1% in 2006-07.
• Capital flows have been on a clear uptrend during the six
years 2001-02 to 2006-07.
• With capital inflows exceeding financing requirements,
foreign exchange reserve was on the rise.
• With continuous reforms in policies, FDI inflows has
accelerated in the recent years. On a gross basis, FDI
inflows into India has increased from US$ 6.2 billion in
2001-02 to US$ 23.0 billion in 2006-07.
 FDI
Inflows
 FDI
Outflows
 India’s Export & Import Performance

India’s Foreign Trade

( In US $ million)

250000
Year Exports Imports

200000
1990-91 18477 27915

2000-01 45452 57912

150000 2003-04 66285 80003

2004-05 85206 118908

100000
2005-06 105152 157056

50000
2006-07 128083 191254

0
1990-91 2000-01 2003-04 2004-05 2005-06 2006-07 Source: Economic Survey
Exports Imports
2007-08
 Balance of Trade
• Ever since the beginning of planning era in 1951,
India has continued to suffer from an unfavorable
balance of trade.
• The only exceptions to this trend have been the
years 1972-73 and 1976-77 when India had
positive trade balance.

• The gap between imports and exports though was

narrow at the beginning had widened over the
years.

• This has happened because exports from India

have not been able to keep pace with high growth
rate of imports.
 Growth in Exports & Imports

Annual per cent change in value (in US$ terms)

45 42.7

40

35 33.8
30.8
30 27.3
25.9
24.5
25 23.4
22.6 21.6
20.3 21.1
19.4
20

15
8.3
10 7.7

0
1990-91 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Exports Imports
 Causes of Unfavorable Trade Balance

• Large increase in Imports

• In terms of value India’s imports have increased sharply
since 1950-51 (e.g., import has jumped from 1,273 US$
million in 1950-51 to 1,85,747 US$ million in 2006-07).
• Some of the factors that have contributed to this massive
import growth are:
 Large increase in developmental imports: Under the planned
economic development programme there has been
continuous expansion in imports of capital goods, machinery
and raw materials.
 Large increase in import of petroleum: Petroleum, oils and
lubricants (POL) accounts for a major part of India’s imports.
Petroleum being the major source of energy and also a raw
material to some industries there has been massive increase
in its demand in the country. The domestic production always
fell short of demand and the gap was filled by imports.
 Import of Fertilizers.
 Commodity Composition of
Imports

Year (Figures in per cent)

Commodity 2000-01 2005-06 2006-07 2007-08

Food & allied pdts. 3.30 2.50 2.90 2.20

POL 31.30 29.50 30.60 31.00
Fertilizer 1.30 1.30 1.60 1.90
Capital Goods 10.50 15.80 15.40 13.20
Chemicals 5.90 5.70 5.20 5.20
Electronic Goods 7.00 8.90 8.60 8.90
Others 40.70 36.30 35.70 37.60
Total 100.00 100.00 100.00 100.00

Source: Economic Survey 2007-08

 Causes of Unfavorable Trade Balance
• Modest growth of exports
• The following external and internal factors can be
held responsible for this.
• External factors:
 Low world demand
 Low income and price elasticity of goods exported
 Import restrictions by foreign countries (tariff,
NTBs)
 Disintegration of the Soviet Union
• Internal factors:
 Increasing domestic demand
 Low quality and high cost of production.
Measures to Correct Deficits in Balance
of Trade

• The GOI has been adopting and implementing a number of

measures for restricting imports and promoting exports.
• Restriction on Import:
 Licensing of Imports (not a very import measure now a days)
 Tariff Restrictions
 QRs ( on the way out under WTO system)
• Export Promotion:
• Such measures include both monetary and non-monetary
measures. Some of the important measures are:
 Devaluation of Rupee
 Cash assistance to exporters to compensate them for
indirect taxes levied on the imported inputs.
 Income tax concessions (e.g. profits from exports are
exempted from IT).
 Measures to Correct Deficits in
Balance of Trade
 Concessional bank credit to exporters
 Import license to exporters
 Relaxation of controls on exports and simplification
of procedures
 Establishment of
 Export processing Zones (EPZs)
 Special Economic Zones (SEZs)
 Export Promotion Councils
 Specialized financial institution like Export Import
(Exim) Bank.