(IGP) GS Paper 1 - Economic & Social Development - "External Sector"

Subject - Economic and Social Development
Chapter - External Sector

Balance of Payments

Balance of payments is an overall statement of a country’s economic transactions with the rest of the world over some period- usually one year. It includes all outflows and inflows (payments and receipts) Countries have either balance of payment surplus or a balance of payment deficit. Balance of payments is a way of listing receipts and payments in international transactions of a country. Balance of payments can be broken down into balance of trade (export & import of goods); balance of current account (includes the balance of trade, the balance of services and remittances; and capital account (investment and borrowing)

Convertibility of Rupee

• Convertibility refers to the freedom of the holder of a currency to freely convert it into any other foreign currency. The larger the scope of convertibility that is permitted by a country, the stronger and the more resilient its economy is said to be. No country grants full convertibility but restricts it for certain purposes and excluding certain other purposes.
• For example, the trade account convertibility is confined to exports and imports and certain associated aspects like remittances (what Indians living abroad send to their friends and relatives in India) etc. Convertibility for investment and borrowing abroad comes under capital account convertibility.

Convertibility has three dimensions:

• Freedom to convert
• Convert at market rate and
• Removal of restrictions for conversion on current and capital account. That is, liberalization of flows. It means convertibility for more purposes (like FDI in retail); higher or no caps on existing convertibility regime (49% FDI in insurance etc) and Indians being allowed greater freedom to take their money abroad.

Current account convertibility:

It refers to freedom to convert domestic currency into foreign currency and vice versa for the following purposes:

• exports and imports
• payments due as interest or loans etc .
• moderate remittances for living expenses etc.

Capital Account:

It covers investment and borrowings. For example, foreign investment in India; how much Indian companies can borrow. Similarly, Indians to open bank accounts in foreign countries; invest abroad; hold assets abroad etc.

Prerequisites for fuller convertibility:

• Fiscal deficit should be minimal

• Forex reserves should be adequate

• NPAs of banks should be minimal

• Inflation and interest rates should be moderate

Unless these conditions are met, great steps towards fuller convertibility should be kept on hold.

Rupee Depreciation

Forex reserves and infrastructure

• India is currently facing the problem of plenty on the foreign exchange reserves front. The country ranks sixth after Japan, China, Taiwan, South Korea, and Hong Kong for highest foreign reserves. With the increase in quasi-fiscal costs of holding large reserves, and the need to increase the yield on current reserves, policymakers have advocated the use of the ‘excess’ reserves to augment the country’s physical infrastructural capacity, Another idea floated is to start a sovereign wealth fund.

• Monetary experts short down the idea of diversion of reserves for infrastructure as it may adversely impact on our credibility. These are reserves and not resources and need to be kept up for security reasons. Infrastructure can always be financed by other means. SWF can set up if there are opportunities.

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