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Trends and Challenges of Indias Balance of Payments

Dr Jomon Mathew
University College Trivandrum, Kerala, India

30. September 2013

Online at http://mpra.ub.uni-muenchen.de/51167/ MPRA Paper No. 51167, posted 4. November 2013 14:49 UTC

Trends and Challenges of Indias Balance of Payments

Dr. Jomon Mathew1 -------------------------------------------------------------------------------------------------------------------Introduction Balance of Payments (BoP), being a record of the monetary transactions over a period with the rest of the world, reflects all payments and liabilities to foreigners and all payments and obligations received from foreigners. In this sense, the balance of payments is one of the major indicators of a country's status in international trade. BoP accounting serves to highlight a country's competitive strengths and wea nesses and helps in achieving balanced economic! growth. It can significantly affect the economic policies of a government and the economy itself. "herefore, every country strives to a have a favorable balance of payments and maintains its long run sustainability. India#s balance of payment position was $uite unfavorable during the time of country#s entry into liberali%ed trade regime. "wo decades of economic reforms and free trade opened several opportunities that, of course, reflected in the balance of payments performance of the country. "his paper, therefore, attempts to evaluate the trends and emerging challenges of India#s Balance of Payments. "he discussion is broadly classified into four parts vi%. i) India#s balance of payments picture since &''&, ii) emerging role of invisibles and software services in balance of payments iii) unhealthy trends in ()I and iv) the vulnerability and challenges ahead. a) Indias Balance of Payments picture since 1991 Independent India#s e*ternal trade and performance had faced severe threats many a times. "he most challenging one was that of &''&."he economic crisis of &''& was primarily due to the large and growing fiscal imbalances over the &'+,s. India#s balance of payments in &'',!'& also
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Assistant Professor of Economics, University College Trivandr m, !erala, "ndia#$%&'()

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suffered from capital account problems due to a loss of investor confidence. "he widening current account imbalances and reserve losses contributed to low investor confidence putting the e*ternal sector in deep dilemma. )uring &'',!'&, the current account deficit steeply hi ed to -! '.+, million while the capital account surplus was far below at - /&++ million. "his led to an ever time high deficit in BoP position of India. India initiated economic reforms to find the way out of the growing crisis. 0tructural measures emphasi%ed accelerating the process of industrial and import delicensing and then shifted to further trade liberali%ation, financial sector reform and ta* reform. Prior to &''&, capital flows to India predominately consisted of aid flows, commercial borrowings, and nonresident Indian deposits. )irect investment was restricted, foreign portfolio investment was channeled almost e*clusively into a small number of public sector bond issues, and foreign e$uity holdings in Indian companies were not permitted (1hopra and others, &''2). 3owever, this development strategy of both inward!loo ing and highly interventionist, consisting of import protection, comple* industrial licensing re$uirements etc underwent radical changes with the liberali%ation policies of &''&. "he post reform period really eased India#s struggles with regard to e*ternal sector. "his is evident from the 4BI data summari%ing the B5P in current account and capital account. "he current account which measures all transactions including e*ports and imports of goods and services, income receivable and payable abroad, and current transfers from and to abroad remained almost negative throughout the post reform period e*cept for the three financial years. 6ntil 7,,,!,&, the current account deficit that comprises both trade balance and the invisible balance, remained stagnant and stood around - 2,,, million. 3owever, for the first time since &''&, the current account recorded surplus in its account during three consecutive financial years

from 7,,&!,7. "he deficit in current account continued to occur from 7,,8!,2 onwards and the growth rate was comparatively faster. 0urprisingly, the current account deficit grew li e

anything since 7,,/!,+, the period witnessed financial crisis. "he current account balance of India during 7,&&!&7 is recorded to be - ! /+&22 million, signifying a deficit eight times that of the figures of 7,,/!,+. 3uge negative debits and comparatively low positive credits cause d for this negative value in current account. 9nother notable feature of current account balance is that the deficit was mounting during the previous years. "wo major items of current account are merchandise and the invisibles. "hese two items generate the value of current account balance of the country. "he net merchandise has been always found to be huge negative figure. )uring 7,&&!&7 it was recorded to be - ! &+'/2' million. )uring the same period, our total merchandise credit was - :,'//8 million while our merchandise debit was - 8''2:: million. "his is a common feature of India#s merchandise figures during all the years. "he recent crisis of 7,,+ affected the trade performance of India in a large way. Indian economy had been growing robustly at an annual average rate of +.+ per cent for the period 7,,:!,8 to 7,,/!,+. 1oncerned by the inflationary pressures, 4eserve Ban of India (4BI) increased the interest rates, which resulted in a slowdown of India#s trade flows prior to the ;ehman crisis (<umar and 9le*, 7,,'). "he trade flows, which are one of the important channels through which India was affected during the recent global crisis of 7,,+, started to collapse from late 7,,+. =erchandise trade, software e*ports and remittances declined in absolute terms in response to the e*ogenous e*ternal shoc .

"able &
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India#s B5P during &'',!'& to 7,&&!&7 (values in 60 - million)

Year 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Current account balance -9680 -1178 -3526 -1159 -3369 -5912 -4619 -5499 -4038 -4698 -2666 3400 6345 14083 -2470 -9902 -9565 -15737 -27915 -38180 -45945 -78155 Capital account balance 7188 3777 2936 9694 9156 4690 11412 10010 8260 11100 8535 8357 10640 17338 28629 24954 46171 107901 7835 51622 58996 65324 Overall balance -2492 2599 -590 8535 5787 -1222 6793 4511 4222 6402 5868 11757 16985 31421 26159 15052 36606 92164 -20079 13441 13050 -12832

0ource> 4eserve Ban of India, www.rbi.org

(igure & "rend of India#s B5P during &'',!'&to 7,&&!&7

"he growing trade deficit since 7,,+ can be attributed to destination wise collapse of India#s e*ports. "rade with 60, ?6 and 9sia (India#s most important trading partners) fell considerably during the year 7,,', with the least being in case of 9sia. 9s a result, the value of e*port reduced from - &+',,& million during 7,,+!,' to - &+'887 million during 7,,'!&,.

)uring the same period of economic crisis our import bill too declined from - :,+27, million to - :,,.88 million. "his fact certifies the phenomenon that Indian trade flows was hit by the global crisis, but with a lag. 3owever, Indian economy could find way out of the crisis driven path to the recovery as a result of various measures implemented by the 4eserve Ban of India.

b) Emerging role of in isibles and soft!are ser ices in Balance of Payments

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India#s balance of payments, which is built up of a large trade deficit sustained by large positive invisible inflows, is truly a miracle of the new service!oriented global economy. "he liberali%ed environment has made India's services attractive to the new I" dependent sector of the developed countries. "he trade deficit is financed largely by net invisible earnings consisting of remittances from e*patriates and software. "he importance of invisibles in the BoP is increasing in the post reform period. 9 notable development found in the performance of India#s current account is the growing contribution of the invisibles. 9mong the three components such as services, transfers and income, the largest surplus is generated by the services followed by transfers while income flow is greater from India adding net deficit in the BoP account. "he net invisible to the current account was deficit during &'',!'& worth - 787 million. 3owever, the post reform period witnessed rapid growth in this category contributing a large surplus to India#s BoP account. "his surplus though not enough to eliminate the merchandise deficit, could contribute significantly to neutrali%e the magnitude of the impact of the huge deficit. (rom 7,,&!,7 onwards, the growth of invisibles was at very high rate. Interestingly, it grew from - &8'/8 million during 7,,&!,7 to '&.,2 million during 7,,+!,'. "he very ne*t two consecutive years, global crisis affected the net flow of invisibles as the surplus from it declined to - +,,77 million and - +8.8+ million respectively. 3owever, 7,&&!&7 figures show that net invisibles in the current account is positive and very high in value i.e. - &&&.,8 million. It can be found that value has almost doubled within a gap of just . years. "he mounting share from software services shows another optimistic e*ternal sector picture. 0oftware services include the software related services offered by Indian I" professional to foreigners including those done by the I" par s. @otable feature is that the credit from this
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item is very huge say for instance, during 7,&&!&7, it stood at - .77&7 million while the debit i.e., the amount we pay out for foreign software services was only a meager figure ! - &72. million only. "he growth of India#s I" sector especially during the period of globali%ation turned favorably. "he growth of software services earnings is a recent development in the reform period. India possesses huge manpower professionally e$uipped with software services potentials who find the way in earning foreign e*change by e*porting the services. "he @90015= data e*hibits the growing share of software services in India#s current account balance. "he "otal software services e*ports was only -/28 million during &''2!'.. "he total software e*port contribution increased unbelievably in the years of economic liberali%ation. "he earnings from software services multiplied several times within a decade of time i.e., it increased from - /22. million during 7,,&!,7 to - .,'2. million during 7,&&!&7. "he growth rate was steady and above &, percent during every year despite the global challenges put forward by the so called financial crisis. Interestingly the debit in this item is very narrow say - &72. million during 7,&&!&7 that declined from -77./ million during 7,,.!,/. 6nited 0tates remained the major destination for software services e*ports from India.

c) "nhealthy trends in #oreign $irect In estment (oreign direct investment (()I) has played an important role in the process of globali%ation during the past two decades. "he rapid e*pansion in ()I by multinational
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enterprises since the mid!eighties may be attributed to significant changes in technologies, greater liberali%ation of trade and investment regimes, and deregulation and privati%ation of mar ets in many countries including developing countries li e India. "he widening gap of deficit in India#s current account is always compensated by the surplus accumulated in capital account. =ajor components in the capital account are foreign investment and borrowings. "here are several studies revealing the relevance of ()I in the economy. 0ome of the literature reviews are worth mentioning at this moment. ()I plays a multidimensional role in the overall development of host economies. It is widely discussed in the literature that, besides capital flows, ()I generates considerable benefits. "hese include employment generation, the ac$uisition of new technology and nowledge, human capital

development, contribution to international trade integration, creation of a more competitive business environment and enhanced localAdomestic enterprise development, flows of ideas and global best practice standards and increased ta* revenues from corporate profits generated by ()I (<lein et al., 7,,&B"ambunan, 7,,2) ()I in manufacturing is generally believed to have a positive and significant effect on a country#s economic growth(9lfaro, 7,,:). "otal ()I inflows into India during &''&!'7 were only - &7' million. "here was gradual increase in inflows during that decade and it reached - .&:, million during 7,,&!,7. "hough the inflow fluctuated during first part of 7,,,s the year 7,,.!,/ witnessed &28 percent hi e in inflow which is treated as the highest in the last two decades. 3owever, during the global recession the inflow was negatively affected showing negative growth during 7,,'!&, and 7,&,! &&. "he Indian economy regained confidence of the foreign investors during 7,&&!&7 attracting -

8',,/ million. "he huge sum of ()I inflow is contributing significantly in reducing the deficit in India#s current account and maintaining surplus in overall balance of payment account. "able 7 ()I inflow into India (60 - million) Cear ()I inflow 9nnual growth rate of 7,,,!,& 7,,&!,7 7,,7!,: 7,,:!,8 7,,8!,2 7,,2!,. 7,,.!,/ 7,,/!,+ 7,,+!,' 7,,'!&, 7,&,!&& 7,&&!&7 8,7' .&:, 2,:2 8:77 .,2& +'.& 77+7. :++88 8&',: :+8+8 :28.8 8',,/ ()I inflow !!! 27.& !&/.' !&8.7 8,., 8+.& &28./ /,.7 /.+ !+.7 !/.' :+.7
()I outflow +7' &8', &+'7 7,/. 7:,' .,+: &2+'/ 7&87' 7,.:8 7,2&+ 7.&,8 7.'8/

9nnual growth rate of ()I outflow

!!! +, 7/ &, && &.: &.& :2 !8 !& 7/ :

0ource> 4eserve Ban of India (7,&7)

9long with mounting credits in foreign investment account, there is growing debits in it in the form of capital outflow. It can be noted that the total outflow of ()I from India was only +7' million during 7,,,!,&. 6ntil 7,,8!,2, the growth rate of outflow was moderate but thereafter, the ()I outflow increased significantly. )uring last five years, the outflow stood above - 7,,,, million which seems unhealthy for India capital account is concerned. "he logic behind this trend is that Indian companies are reaching overseas destinations to tap new mar ets
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and ac$uire technologies. 9c$uisitions bring with them major benefits such as e*isting customers, a foothold in the destination mar et and the niche technologies they re$uire. )ue to the rapid growth in Indian companies# =D9 activity, Indian companies are ac$uiring international firms in an effort to ac$uire new mar ets and maintain their growth momentum, buy cutting!edge technology, develop new product mi*es, improve operating margins and efficiencies, and ta e worldwide competition head!on. It is noted that inflow of ()I has got very favorable impact on India#s BoP balance. 3owever, the danger alarmingly growing on the other side of the coin is in the form of outflow of ()I from India and massive withdrawal of foreign funds from the domestic economy.

d) %ulnerability and challenges ahead Post &''& crisis, Indian economists have managed to reduce the e*ternal debt through various strategies. "hey have succeeded as India withstood the global 7,,+ downturn well. But now, troubles are looming large over our emerging economy. 9fter the 7,,+ downturn of global economy, the vulnerability of India#s e*ternal sector has increased. "he latest report from 4eserve Ban of India about the rising e*ternal debt is a case of worry for the government. 9ccording to the data given by the 4eserve Ban of India, India#s e*ternal debt stood at -:', billion as of =arch 7,&:, which was up by &7.' E from its previous year figure. ?*ternal debt is a cumulative sum of ?*ternal 1ommercial Borrowings (?1Bs), (oreign 1urrency 1onvertible Bonds ((11Bs) and trade bill of the country. 9ny country#s inability to repay the e*ternal debt may lead to a crisis situation and worsen our balance of payment sustainability in near future. Cet another challenge to BoP emerges today in the form of rupee depreciation. "he Indian 4upee has been losing its value against the 60 )ollar mar ing a new ris for Indian
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economy. Frim global economic outloo along with high inflation, widening current account deficit and (II outflows have contributed to this fall. "hough 4BI has responded with timely interventions by selling dollars intermittently, in times of global uncertainty, investors prefer 60) as a safe haven. "o attract investments, 4BI can ease capital controls by increasing the (II limit on investment in government and corporate debt instruments and introduce higher ceilings in ?1B#s, which may ultimately attract BoP burden on the economy. Fovernment can create a stable political and economic environment. "he depreciation of the rupee was brought about by the adverse e*ternal trade position and the depreciation of regional currencies. It was an inevitable response to the balance of payments difficulties caused by a huge trade deficit. The deterioration in Indias current account and thereby overall BoP has led to a series of debates in the policy arena relating to sustainability, the importance of exchange rates in influencing the trade balance, and the role of high and rising inflation. 9ppropriate e*change rate policies, monetary policies and fiscal policies are vital to ensure economic stability and growth. "he depreciation of the currency is one of the means of correcting the trade deficit to manageable proportion. 3igher interest rates, containment of the fiscal deficit and control public e*penditure that restrains imports are crucial to containing the trade deficit. "his is especially so with respect to oil imports that is the single most import e*penditure. 9 depreciating rupee is not the only concern that Indian economy is striving to retrieve for the moment. "he bigger challenge is to reduce e*ternal sector vulnerability. Boosting investor confidence remains the ey to attracting capital flows. (iscal consolidation, reducing inflation and further careful liberali%ation of capital inflow could all contribute towards creating an environment conducive to domestic and foreign investors. 0ustainability and strength of

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Balance of Payments, being the symptoms of economy#s strength and competitiveness in the global scene, need to be maintained using every tough measure possible. &eferences
&. 9lfaro, ;aura (7,,:). *oreign Direct "nvestment and growth+ Does the sector matter, (3arvard 7. :. 8. 2. .. Business 0chool Gor ing Paper). 3arvard, 609. 1hopra, 9jai, 1harles 1ollyns, 4ichard 3emming, <aren Par er, Goosi 1hu, and 5liver )epartment of 1ommerce (9nnual report,) www.commerce.nic.in )epartment of 1ommerce (9nnual report,) www.commerce.nic.in ?conomic 0urvey (7,&,!&&), http>AAindiabudget.nic.in <lein, =ichael, 1arl 9aron and Bita 3adjimichael (7,,&). *oreign Direct "nvestment. (Policy

4esearch Gor ing Paper 7.&:). Gashington, ).1.> "he Gorld Ban . /. <umar, 4ajiv., =athew Hoseph, )ony 9le*, Pan aj Iashisht and )ebosree Banerjee, (7,,'), Indian ?conomic 5utloo > 7,,+!,' and 7,,'!&,., I14I?4 Gor ing Paper @o. 7:8, I14I?4, @ew )elhi +. 4eserve Ban of India (7,,+). -and.oo/ of 0tatistics on "ndian Economy 12''34.=umbai '. 4eserve Ban of India, www.rbi.org &,. "ambunan, "ulus (7,,2, =ay). The im5act of *oreign Direct "nvestment on 5overty red ction+ A s rvey of literat re and a tem5orary finding from "ndonesia. Paper presented at consultative meeting on (oreign )irect Investment and Policy 1hanges> 9reas for @ew 4esearch, 6nited @ations 1onference 1entre, Bang o , "hailand.

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