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Indias BOP crisis

Balance of payments (BOP)

The balance of payments of a country is a systematic record of all economic transactions between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by them on account of goods imported and services received and capital transferred to non-residents or foreigners. Reserve Bank of India

An accounting record of all monetary transactions between a country and the rest of the world. Summarises international transactions for a specific period, usually a year Prepared in a single currency, typically the domestic currency Indicator of economic and political stability Visible Items: All types of physical goods exported/imported Invisible Items: All types of services Capital transfers: Capital receipts/payments

Components of BoP
Current Account
Import and Export of goods Import and Export of services Unilateral transfers from one country to another

Capital Account
Foreign Investment FDI & portfolio Investment Loans Commercial Borrowings, External Assistance & Banking Capital Transactions

Overall Balance of payments

Current Account Balance = Balance of Visible Trade(goods) + Balance of Invisible Trade(services) + Balance of Unilateral transfers Capital Account Balance = Inflow of foreign exchange outflow of foreign exchange Official Reserves: The holdings of foreign reserves and gold by official institutions like the central bank Overall Balance of Payment = Current Account Balance+ Capital account balance+ Official Reserve Account

Uses of BoP Analysis

Overview of Macroeconomic and Monetary situations of the economy Study on prospects of direct investment to the nation Implications on the exchange rate of the currency Provides data for economic analysis Reveals changes in the composition & magnitude of foreign trade Provides indications of future repercussions of countrys past trade performances Reveals the weak and strong points of a countrys foreign trade relations

BoP crisis- Factors and causes

Economic factors
Huge development expenditure owing to which there are large scale imports Business cycles in terms of recession, depression, recovery and boom High rate of inflation running up to large scale imports of essential goods Decline of import substitutes which would necessitate and increase in imports Change in cost structure of trading partners

Political factors
Political Instability leading to decline in FDI and FII Populism policies which may encourage imports

Social factors
Change in tastes and preferences leading to demand changes Cross border prejudices which may lead to expensive sources of imports


Economic Indicators-pre Crisis period

GDP growth rate: 5.5 % (3.3% on a per capita basis) Industrial Growth : 6.6% Agriculture: 3.6% Investments went from nearly 19% of GDP from to 1970s to 25% by end on 1980s Composition was predominantly primary sector which accounted for 32.8% of the GDP

Economic Policies
Protectionist Policies- defined objective of self reliance through industrialization and import substitution Focus was on substituting imports and promoting domestic industries by heavy intervention while a gross negligence on exports External Debt- The development projects caused a large scale foreign borrowing which created pressure on the government

Economic policies
Export promotion- Indian exports were largely dependent on world trade situation due to predominance of primary goods in trade mix combined with lower quality standards.

Exchange rate- Fixed exchange rate was followed and constant devaluations by the central bank to promote exports raised the amount of external debt. Strong inward looking policy in all

Government Deficit and Current Account- Pre 1991 levels

Real and Nominal Exchange rates Pre 1991 levels

External Debt and For-ex reservesPre 1991 levels

Trends in Pre BOP crisis period

Capital inflows mainly consisted of aid flows, commercial deposits and Non resident Indian deposits FDI was heavily restricted and foreign portfolio investments generally channelized to public sector issued bonds Gradual loss of for-ex reserves and deterioration of trade balance due to fixed nominal exchange rate which was declining over the 1980s

Trends in For-ex reserves-Figures

Trends contd
Sharp rise in imports due to growth orientation and ( petroleum imports rose by 40% from 1986-87 to 1989-90 ) Doubling of external debt from 1984-85 ($35 bn) to 1990-91 ($69 bn) Loss of investor confidence led to outflows being increasingly dependent on short term external debts. An unstable government and the gulf crisis further aggravated the situation

Trends in trade deficit-Figures

High revenue deficits especially after 1986, for which the government responded by creating a surplus capital account to finance them


Balance of payments: The Crisis

Also known as the Unfortunate period of Indian Economy. Gulf crisis of 1990 increase in oil import bill Deterioration of invisible account Increase in price of oil => overall current account deficit in 1990-91 : US $ 9.7 billion Important trading partners like US, Russia turned up to invest in India Export growth reduced to 4%

World growth declined from 4.5% in 1988 to 2.5% in 1991 Political turmoil VP Singh government overthrown, Rajiv Gandhi assassination reduced credibility of India, investors lost interest and trust in Indias government.

Balance of payments: The Unbalance

Foreign reserves very low at $1.2 billion

Overshot IMF SDR reserves

Simultaneous outflow of NRI deposits Serious difficulties in rolling over of short term loans Current account deficit of $9.7 billion almost impossible to finance

Developments in 1991
Current account deficit averaging 2.2% of the GDP hit hard by the Gulf war Triggers oil bill increased by $2 billion overseas markets for exports shrinked (West Asia, Soviet Union) Fall in remittances The Reserve Position in IMF of $660 million was drawn in full by September, 1990 to add to the reserves The international credit rating agencies placed India on the watch list in August 1990

Import compression
Curb imports to reduce deficit
Surcharge on oil imports Cash margin

Import Trends
30 20
% change


Bulk imports Capital goods Export related imports

0 -10 -20
1989-90 1990-91 Apr-Sep 1991

Import compression effects

IIP and Imports
40 30

% change

0 -10 -20 -30 -40


IIP Non -oil Imports

What actually happened..

Agreement with IMF for a drawing of $1,025 billion under its Compensatory and Contingency Financing Facility (CCFF) Drawings of $789 million from the first credit tranche made in Jan,1991 Despite the drawings, the situation was hardly under control. Between March 1991 and June 1991, there was a sharp withdrawal of non-resident deposits to the extent of $952 million leading to further drop in foreign exchange reserves

The Crisis
Despite low trade deficit ,the slide in foreign reserves continued unabated Essentially became a crisis of confidence
Expectatio n of default expected devaluation

Further drop in reserves

payments of imports & exports

withdrawal by foreigners

The Crisis (Contd.)

Foreign exchange reserves fell below $1 b

Barely enough to cover 2 weeks of imports

Likely ramifications

Credit unavailability, trade disruption Shortages, industry dislocation ,unemployment High inflation , instability

Foreign exchange reserves

The response
As a first step, in May 1991, the government leased 20 tonnes of confiscated gold to the State Bank of India for $200 million Later, RBI moved in four installments 47 tonnes of the gold held by it to the vaults of the Bank of England to raise a temporary loan of $405 million jointly from the Bank of England and the Bank of Japan Loan repaid in Sep-Nov. and the pledged gold was redeemed New government assumed charge in June ,1991

Short term Structural changes

Two-step downward adjustment in the exchange rate of rupee was effected on July 1 and 3, 1991 This effectively translated into devaluation of 18-19 per cent against major international currencies This was coupled with the liberalisation of the trade regime and lower import tariffs Besides exceptional financing arrangements with the World Bank, Asian Development Bank and a few industrial countries were also negotiated Due to the currency devaluation the Rupee fell from 17.50 per dollar in 1991 to 26 per dollar in 1992

Long term Structural changes

A High Level Committee on Balance of Payments was set up in December 1991 Liberalized Exchange Rate Management System (LERMS) and move to a single market based exchange rate system This obviates the need for the RBI to determine the rate daily

However, the need to monitor and watch the movements in the markets assumes importance, as foreign exchange markets tend to overshoot often

Long term Structural changes (Contd.)

Macroeconomic stabilization on four fronts to basically improve efficiency and spur exports Fiscal correction lowering of government spending Trade policy reforms eximscrips Industrial policy reforms end of license raj Public sector reforms autonomy and efficiency


Balancing mechanism
Rebalancing by changing the exchange rate

An upwards shift in the value of domestic currency relative to others will make exports less competitive and make imports cheaper and will tend to correct a current account surplus.
Exchange rates can be adjusted by government in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance

Balance of Payments: Policies

Government allowed Reserve Bank of India to ship 47 tonnes of Gold to the Bank of England in July 1991. Short-term debt was reduced and strict controls put in place to prevent future expansion Foreign exchange reserves were consciously accumulated to provide greater insurance against external sector stresses and uncertainties

Reforms Undertaken
Fiscal Correction:

Abolishing export subsidies, increasing fertilizer prices, as well as by keeping non- plan expenditure in check. Budget projected a sharp decline in the budget deficit to Rs.7719 crore in 1991-92.
Fiscal deficit was also projected to decline from Rs 43,331 crore in 1990-91 to Rs 37, 772 crore in 1991-92.

Reforms Undertaken
Industrial Policy Reforms:

80 % of the industries were taken out from the licensing framework.

MRTP Act was amended to eliminate the need for prior approval by large companies for capacity expansion or diversification. Areas reserved for public sector was narrowed down and greater participation was permitted from the private sector.

Reforms Undertaken
The limit of foreign equity holders was raised from 40 to 51 % in the wide range of priority industries. Technology imports for priority industries are automatically approved for royalty payments upto 5 % of domestic sales and 8 % of export sales or for lumpsum payments of Rs 1 Crore.

Reforms Undertaken
Results of Industrial Reforms:

The number of investment approvals rise from 3335 in 1990 to 5538 in 1991.
505 foreign technology import agreements were also approved. In 1991, a total of 244 cases of foreign equity participation with the proposed equity investment of $ 504 million was approved.

Reforms Undertaken
Public Sector Reforms:

Government undertook a limited disinvestment of a part of public sector equity to the public through financial institutions and mutual funds in order to raise non- inflationary finance for development.
Sick Industrial Companies Act: To Bring public sector undertakings also in purview.

Reforms Undertaken
Trade Policy Reforms:

Large part of administered licensing of imports was replaced by import entitlements linked to export earnings. Advance licensing system for exports was simplified so as to improve exporters access to imported inputs at duty- free rates. Scope of canalization for both exports and imports was narrowed.

Reforms Undertaken
Anti-export bias in the trade and payments regime was also reduced substantially Effects of these reforms was to reduce the degree of licensing in import trade, to broaden, to enhance and harmonize export initiatives.

Balance of Payments: 1992-93

Foreign exchange reserves had been build up to respectable level of $5.63 billion from a low of $1.29 billion at the end of July 2001. Introduction to LERMS( Liberalized exchange rate management system) Mobilization of external assistance from IMF, World Bank , ADB and Bilateral donors to support the BOP

Introduced, from March 1992, a dual exchange rate system in the place of a single official rate. One official rate for select government and private transactions and the market-determined rate for the others. Treated current and capital transactions in different ways.

Decision to permit gold imports was linked to LERMS

Despite the increase in imports to more normal levels during 1992-93, it has been possible to manage the BOP with the stable exchange rate and comfortable foreign exchange reserves throughout the year.

Effects of Liberalization
BOP Surplus: External sector - growth rates moving up to 11 and 20% in the two years ended March 2001 India successfully withstood the sharp rise in international oil prices since the closing months of 1999. NRI deposits with the banking system in India on the rise from 13 billion dollars in 1991-92 to 23.8 billion dollars by March 2001 BOP recorded an overall surplus consecutively for five years from 1996-97 Indias foreign exchange reserves, 1 billion in 1990 reached $ 40 billion the average annual addition being 4.5 billion dollars

Effects of Liberalization
Trade and Investments:

Rise in FDIs and other capital flows

Under the category of Invisibles, a significant increase in private transfers. Private transfers grew to a level of 10-12 billion dollars in the latter half of 1990s. Increase in exports level and exchange rate reforms : the major factors that helped contain the current account deficit in BOP to 1 to 1.5 per cent of GDP between 1991 and 2001 In ten years, 1991- 2001, Over 37 billion dollars of foreign investment flowed 18 billion $ was direct investment.

Developments in the next decade

Acceleration of GDP growth to 6.7 per cent in the period 1992-97 was the highest India had ever achieved over a five year period. Sum of external current payments and receipts as a ratio to gross domestic product (GDP) doubled from about 19% in 199091 to around 40% by March 2001 Manufacturing achieved average real growth of 11.3 per cent in the four years 1993-94 to 1996-97 Export growth in dollar terms averaged 20 per cent in the three years 1994 1996 and the rates of aggregate savings and investment in the economy peaked in 199596

Developments in the next decade

Private Investments showed an high growth of 16.34 % per annum during 1992-96. Real fixed investment rose by nearly 40 %, led by a more than 50 % increase in industrial investment

External Commercial Borrowings

ECB/TC (%)
1996-97 1995-96 1994-95 1993-94

10.6 21 13.6 9.1


1992-93 1991-92 1990-91 1989-90 1988-89 1987-88 1986-87 1985-86

30.6 26.8 31.8 36.7 20.1 48.1 25.2 10.9

0 10 20 30 40 50


1980-81 1991-92

1985-86 1992-93

1986-87 1993-94

1987-88 1994-95

1988-89 1995-96

1989-90 1996-97


External Commercial Borrowings


Result of a concious government policy to maintain a strict control over external indebtness and resulted favourably in improving the credit rating of India by international agencies.


Some private sector power and petroleum companies finalizing their financing packages


Large demand for borrowing with projects in petroleum, oil exploration and telecommunications.

External Assistance





36.2 34.6 36.7 33.2 29.8 26.3 18.5 19 11.7





0 1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1980-81 1991-92 1985-86 1992-93 1986-87 1993-94 1987-88 1994-95 1988-89 1995-96 1989-90 1996-97 1990-91

Developments in the decade

PMU : Project Management Unit was introduced,as part of the department of Economic Affairs to monitor ,supervise and strengthen various projects.

In 1994-95 decided not to approach IMF for medium term funds.

Advance release of funds to state governments

Export Growth





Axis Title 10


5.6 4.5

0 1990-91 -5 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00



Decline of Growth in 1997

Decline in world trade since the second half of 1997 Decline in export prices of some major items of manufactured goods

Growing infrastructure bottlenecks

Appreciation of the rupee in real effective exchange rate terms.

Growth of Imports



12.1 10

Axis Title



0 1990-91 -5 1993-94 1995-96 1996-97 1997-98 1998-99 1999-00