(Online Course) Contemporary Issues for IAS Mains 2012: Yojana Magazine - Balance of Payments In India

Foreign Trade - Balance of Payments In India

Q. What do you understand by Balance of Payments?

Answer: Balance of payments (BoP) accounts are the accounting record of all monetary transactions between a country and the rest of the world. In other words, it is a record of all transactions made between one particular country and all other countries during a specified period of time. If a country has received money, this is known as a credit. Similarly, if a country has paid or given money, the transaction is counted as a debit. Theoretically saying the BoP should always be zero, meaning that assets or credits and liabilities or debits should balance. But in practice this is rarely the case and, therefore, the BoP of a country usually has a deficit or a surplus. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Indian economy which is the ninth largest in the world in terms of nominal GDP and the fourth largest in terms of purchasing power parity was having very strong balance of payment figures during the early 2000s and the global financial crisis adversely affected the smooth growing of the overall BoP balance. The international BoP of a country reflects its economic strengths and weaknesses. A typical problem of the developing countries is of chronic deficit, India being no exception. It is therefore necessary to have a look at the overall BoP position of Indian economy which is adversely affected by the global financial crisis and the recent global economic developments.

Table 1: Annual Balance of Payment account of India

The large number of international transactions can be summarized into three categories such as Current Account transactions, Capital Account transactions and Official Settlements Balance transactions.
The Current Account tracks transactions that involve current transactions in goods and services.

The current account mainly consists of four types of transactions such as those given below.

• Overall Exports and imports of goods

• Exports and imports of services

• Interest payments on international investments.

• Unilateral transfers

The Capital Account primarily tracks transactions involving buying and selling of assets. The capital account consists primarily of the following three types of transactions. Purchase and sale of assets; Making and repaying loans; Changes in holdings of currency. An Official Settlements Balance transaction tracks transactions between official government authorities. It is used to make BoP in balance.

Q. Give an account of the trends in BoP of India.

Answer: The overall balance of payments account of India during the last decade is given in table 1. It can be found that the overall balance of country’s transaction with the rest of the world has been improving during the first three years of the decade. This positive progress can be attributed to the current as well as capital account surplus. From 2004-05 onwards the country witnessed increasing deficit in its current account signifying our imports (expenditure) larger than our exports (receipts). Despite a huge deficit in current account, the country could make improvements in its capital account until 2007-08. The capital account surplus resulted in
decade’s highest BOP balance i.e., Rs. 369689 crores during 2007-08. However, India’s BoP balance turned negative for the first time during the decade in 2008-09 (i.e., a huge deficit in overall BoP balance of Rs 97115 crores, the largest figure in the history). Though there could be seen a slight improvement in the overall balance during the last two financial years, the surplus still remains low almost equitant to that of 2001-02.

According to the statistics given by the Department of Commerce the share of Asia and the ASEAN region comprising South Asia, East Asia, Mid-Eastern and Gulf countries accounted for 53.5 percent of India’s total exports. The share of Europe and America in India’s exports stood at 20.2 percent and 16.5 percent respectively of which EU countries comprises 18.6 percent. Similarly, Asia and ASEAN accounted for 61.5 percent of India’s total imports during the period followed by European Union (17.3 percent) and America (10.2 percent). India’s major export items include gems and jewellery, petroleum products, cotton, machinery and instruments, drugs and pharmaceutics etc.

The import basket contains petroleum (crude and products), electronic goods, gold, machinery, organic chemicals, iron and steel etc. It is clear from the statistics that the European Union and US economy are significant partners of India’s foreign trade. Due to the same reason, the recent aggravating financial crisis in those developed economies and the crisis affected ASEAN economies adversely affected our international trade balance.

As a result, the current account balance worsened and capital account surplus narrowed down, particularly during the last three financial years.

Crude Oil speculators also have created havoc in emerging countries like India. Being the 10th largest oil importing nation in the world (oil imports are close to 70 percent of India’s crude oil requirements), a continued uptrend in prices is likely to have repercussions on India’s Balance of Payments. It has been estimated that with every US $1 bbl increase in oil prices is likely to increase our import bill by US $ 700mn. This would lead to a drawdown in reserves, current account deficits and much further currency weakening.

Q. Write a short notes on the effect of rupee depreciation.

Answer: The continuous depreciation of Indian rupee is emerging to be another major challenge so far as country’s internal and external sectors are concerned. Rupee has been depreciating against the dollar for the past few months and many analysts are predicting it that it will depreciate further. Rupee depreciation means that India’s currency has lost its value in comparison to US dollar. The main driver of rupee depreciation in the last  three months has been the withdrawal of funds by foreign institutional investors (FIIs) from domestic economy. The rather pessimistic view of FIIs is being governed by ongoing global developments. Other causes of depreciation can be attributed to strengthening of dollar, widening current account deficit, decline in other capital flows etc. Now the question is what will be the impact of rupee deprecation on the foreign sector of the country and its Balance of Payments position. A depreciation of the local currency naturally manifests in higher import costs for the domestic economy. The unavoidable import expense of petroleum products and the possible hike in domestic subsidy may cause fiscal slippage during the financial years to come. Indian corporate sector which imports raw materials from abroad will also be hit hard as they have to pay more for imports and therefore their profit margin will be narrowed. Small importers will also be in pain as they too have to pay more for dollar, which in turn would make some smaller importers to go out of business or may even lead to bankruptcy. It can be expected that exports would get a boost in case the domestic currency depreciates because exports become cheaper in international markets. However, given sluggish global conditions, only some sectors would tend to gain where our competitiveness will increase such as textiles, leather goods processed food products and gems and jewellery. In case imported raw material is used in these industries they would be adversely affected. Therefore, exports may not be able to leverage fully. Similarly, with the depreciating rupee, borrowing from abroad will also become less attractive. Rupee depreciation has more disadvantages than  advantages and if this fall is not controlled in time it can have serious effects on the Indian growth story and also it can lead to downgrading of Indian economy by rating agencies all over the world. It will further worsen the already crisis affected BOP balance of the country. Therefore, BoP management still remains a tightrope walk for policy makers, as now we are exposed to each and every change in the global economic scenario.

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