Introduction

A balance of payments is a strategy used to analyze the relationship between money that is
flowing into a country and money that is going out of that same country. Keeping this type of
record makes it possible for nations to determine if the current balance between imports and
exports is acceptable, or if some steps should be made to regulate the process in order to
achieve a trade balance that is more favourable. In most cases, a balance of payments is
compiled for either a calendar year or the fiscal year recognized by a particular national
government.
Just about every major type of commerce is included in the calculation of a balance of
payments. The movement of precious metals, such as gold and silver, are a key part.
Commodities like corn and wheat are also usually included. Imports and exports of petroleum
products are considered essential components in most countries. In nations where tourism is a
major source of revenue, the amount of money spent by tourists abroad and within the country
will also be accounted for.
The actual structure of a balance of payments is relatively simple. Using basic accounting
methods, receipts that come into the country from any source are identified as credits, or
positive numbers. Any revenue that flows out of the country is identified as a debit, and is
shown as a negative number. The balance of payments is determined by deducting the
negative numbers from the positive numbers, thus arriving at a single number that represents
that time period. Ideally, the comparison of the debits and credits for a given period will show
that the nation is taking in more revenue than it is spending outside its borders.

However, it is important to note that what is considered a healthy balance of payments may
vary from one country to another. This can be due to a number of factors, such as the amount
of natural resources found within the country, the importance of certain industries that operate
within the nation, and what goods and services are exported regularly. Local financial experts
can weigh all the relevant factors and determine what type of ratio between the debits and
credits is considered healthy for a particular nation.
Understanding the balance of payments for a given period of time can be very helpful when it
comes to planning for the needs of a nation over the next several years, or even the next
several decades. The process of calculating this balance can often call to attention various
trends that may or may not be favorable to the welfare of the nation at some point. By
analyzing all the available data and identifying these trends, it is possible to begin taking steps
to minimize their impact, and initiate various strategies that will help keep the countrys
economy in a relatively beneficial position.

Importance
India with a population of over 1 billion is a nation presently under going a profound change.
The pace of change for this impoverished nuclear armed country is rapid as it is transforming
from a socialist economy into a powerful free market economy. India began to implement free
market reforms and moved away from the protectionist policies of the past. Therefore it is a
matter of mandatory to examine the growth of Indias international trade with Import and
Export and the Balance of Payment position.

Statement of the problem

The domestic political developments and the Gulf crisis during 1990-91 in the context of a
fragile balance of payments situation culminated in a payments crisis of unprecedented
dimension in the first quarter of 1991-92. Its prime manifestations were difficulty in financing
current imports and in meeting debt service obligations together with the erosion of
confidence of short-term lenders and NRI depositors.
Short-term credits became difficult to obtain and inflows into non-resident deposits became
outflows of an alarming magnitude. This brought the country to a near default in July 1991.A
vibrant export performance is indispensable if the country has to achieve a sustainable
Balance of Payments. This requires sustained efforts to improve domestic production base of
a wide range of our 3 exports which have potential for growth and also to ensure adequate
profitability of exports. For a Government pursuing a strategy whose success is essentially
dependent on a massive spurt in exports.

Limitations
The divergence in trade data pertaining to international trade was a major limitation for any
study of this nature. There are two agencies for compiling merchandise trade data, namely,
Reserve Bank of India (RBI) and Directorate General of Commercial Intelligence and
Statistics (DGCI&S), Kolkata, Ministry of Commerce and Industry. This divergence is more
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pronounced in the case of imports. While the two agencies are recording the same
transactions, the scope, time period, definition, method and coverage of items of trade differ
considerably.

Objectives of the study

The study entitled ROLE OF IMPORTS AND EXPORTS IN INDIA`S BALANCE OF
PAYMENT POSITION is undertaken with the following objectives.
1. To know the Indias balance of payment position from 1990.
2. To appraise the character of Import in the Indias BoP position since 1990.
3. To evaluate the role of Export in the Indias BoP position since 1990.
4. To offer suggestions based on findings.

Composition Of Balance of Payment

BOP The two principal parts of the BOP accounts are the current account and the capital
account.
The current account shows the net amount a country is earning if it is in surplus, or spending
if it is in deficit. It is the sum of the balance of trade (net earnings on exports minus payments
for imports), factor income (earnings on foreign investments minus payments made to foreign
investors) and cash transfers. It is called the current account as it covers transactions in the
"here and now" those that don't give rise to future claims.
The Capital Account records the net change in ownership of foreign assets. It includes
the reserve account (the foreign exchange market operations of a nation's central bank), along
with loans and investments between the country and the rest of world (but not the future
regular repayments/dividends that the loans and investments yield; those are earnings and will
be recorded in the current account). The term "capital account" is also used in the narrower
sense that excludes central bank foreign exchange market operations: Sometimes the reserve
account is classified as "below the line" and so not reported as part of the capital account.
Expressed with the broader meaning for the capital account, the BOP identity assumes that
any current account surplus will be balanced by a capital account deficit of equal size or
alternatively a current account deficit will be balanced by a corresponding capital account
surplus:

The balancing item , which may be positive or negative, is simply an amount that accounts for
any statistical errors and assures that the current and capital accounts sum to zero. By the
principles of double entry accounting, an entry in the current account gives rise to an entry in
the capital account, and in aggregate the two accounts automatically balance. A balance isn't
always reflected in reported figures for the current and capital accounts, which might, for
example, report a surplus for both accounts, but when this happens it always means something
has been missed most commonly, the operations of the country's central bank and what
has been missed is recorded in the statistical discrepancy term (the balancing item).
An actual balance sheet will typically have numerous sub headings under the principal
divisions. For example, entries under Current account might include:
Trade buying and selling of goods and services
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Exports a credit entry

Imports a debit entry

Trade balance the sum of Exports and Imports

Factor income repayments and dividends from loans and investments

Factor earnings a credit entry

Factor payments a debit entry

Factor income balance the sum of earnings and payments.

Especially in older balance sheets, a common division was between visible and invisible
entries. Visible trade recorded imports and exports of physical goods (entries for trade in
physical goods excluding services is now often called the merchandise balance). Invisible
trade would record international buying and selling of services, and sometimes would be
grouped with transfer and factor income as invisible earnings.
The term "balance of payments surplus" (or deficit a deficit is simply a negative surplus)
refers to the sum of the surpluses in the current account and the narrowly defined capital
account (excluding changes in central bank reserves). Denoting the balance of payments
surplus as BOP surplus, the relevant identity is

Variations in the use of term "balance of payments"

Economics writer J. Orlin Grabbe warns the term balance of payments can be a source of
misunderstanding due to divergent expectations about what the term denotes. Grabbe says the
term is sometimes misused by people who aren't aware of the accepted meaning, not only in
general conversation but in financial publications and the economic literature.
A common source of confusion arises from whether or not the reserve account entry, part of
the capital account, is included in the BOP accounts. The reserve account records the activity
of the nation's central bank. If it is excluded, the BOP can be in surplus (which implies the
central bank is building up foreign exchange reserves) or in deficit (which implies the central
bank is running down its reserves or borrowing from abroad).
The term "balance of payments" is sometimes misused by non-economists to mean just
relatively narrow parts of the BOP such as the trade deficit, which means excluding parts of
the current account and the entire capital account.

Another cause of confusion is the different naming conventions in use. Before 1973 there was
no standard way to break down the BOP sheet, with the separation into invisible and visible
payments sometimes being the principal divisions. The IMF have their own standards for
BOP accounting which is equivalent to the standard definition but uses different
nomenclature, in particular with respect to the meaning given to the term capital account.

INDIA'S BALANCE OF PAYMENTS STATISTICS - ISSUES

AND RECOMMENDATIONS
The Reserve Bank of India (RBI) has been compiling and publishing Balance of Payments
(BoP) data for India since 1948. The articles on BoP published in the RBI Bulletin from time
to time carried the methodological changes introduced over the years in the construction of
Indias balance of payments. However, a need was felt for bringing out a publication that
would put together the methodological changes as well as provide general information on
various aspects of BoP such as concepts, main constituents and sources of data used.
Accordingly, Indias Balance of Payments Compilation Manual was brought out for the first
time by the RBI in 1987 in line with the Fourth Edition of the Balance of Payments Manual of
the IMF (BPM4, 1977). The Manual provided a conceptual framework and procedures for
compilation of India's balance of payments.
Since the publication of the First BoP Compilation Manual for India in 1987, several
developments have taken place both globally and domestically. Internationally, for example,
the size of financial markets grew multifold with innovations in the creation and packaging of
financial services; this gave birth to a new breed of financial instruments and cross-border
capital flows as well as the volume of international trade in services expanded exponentially.
To keep in step with the developments in international transactions, the IMF came out with
two editions of the BoP Manual, viz., the Fifth Edition of the Balance of Payments Manual
(BPM5, 1993) and the Sixth Edition of the Balance of Payments Manual (BPM6, 2009),
issuing guidelines to capture the developments in cross border transactions appropriately in
the BoP statistics. These Manuals, in essence, endeavoured to further improve the
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methodology of recording balance of payments transactions as well as to strengthen the

theoretical foundations of balance of payments accounting and linkages of external
transactions with other macroeconomic statistics. The Manuals also took into account
multifaceted developments in globalisation, for example, the formation of currency unions,
changes in cross-border production processes, evolving complex international company
structures, shifts in the flow of remittances and changing dimensions of the mobility of
international labour.
Domestically, during this period, the economy has moved from a restricted regime of external
payments, where many international transactions were regulated, to a more liberalised regime
with a rise in the volumes of both trade and financial flows across the border. A discernible
compositional shift has occurred over the years in India's BoP not only in relation to
magnitude but also in terms of destinations and sources of India's trade and financial flows.
Furthermore, several new financial instruments have been introduced and have gained
prominence in both domestic and international transactions. This has resulted in a greater
integration of Indias trade and financial market with the rest of the world.

The prominence of services in international trade as well as the flow of private transfers
gained ground in the wake of the increasing globalisation of the Indian economy. Significant
changes took place in production processes, company structures, methods of financing and
sourcing of funds. These developments necessitated a review and revision of compilation
methods as well as the coverage and presentation of BoP statistics.
Reflective of these developments, several changes and improvements in Indias BoP
compilation and presentation were gradually introduced since the publication of the first BoP
Compilation Manual in 1987. For example, retained earnings were estimated and included in
the preliminary balance of payments statistics from the beginning of the current decade.
Similarly, as software exports gained importance, they have been shown as a separate item
under service exports in the standard presentation of India's BoP since 2000-01. Data on
suppliers credit up to 180 days maturity have been estimated and incorporated in the capital
account under short-term trade credits since the first quarter of 2004-05. These improvements
in the coverage and compilation in balance of payments were discussed in the articles on
Indias balance of payments published in the RBI Bulletin from time to time. Nevertheless,
there is no explicit and comprehensive record of these developments in one place.
At present, though the methodology, coverage and presentation of Indias BoP statistics
conform, by and large, to the IMFs BPM5 guidelines, there exist certain differences with
respect to definitional issues and formats of presentation. For example, at present Indias BoP
statistics are presented under the current account and capital account, whereas, as per the
guidelines of the IMF, the capital account needs to be redefined as Capital and Financial
account with a clear distinction between capital account transactions (covering only capital
transfers and non-produced and non-financial assets) and financial account transactions
(covering transactions related to foreign investments, derivatives and other investments). The
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BPM6 has further suggested that not only capital account and financial account be
presented separately but also that capital account transactions be recorded on a gross basis,
while financial account transactions (which also include reserve assets) be shown on a net
basis.
At the same time, although significant disaggregation in services transactions has been
introduced in line with BPM5 and the Extended Balance of Payments Statistics (EBOPS) as
recommended by the IMF, there are still some gaps, especially regarding further
disaggregation under certain heads of services such as travel and transportation. Furthermore,
the latest manual (BPM6) has made a few additional recommendations in line with best
international practices improving the coverage, classification and presentation of BoP
statistics.

BALANCE OF PAYMENTS MANUAL FOR INDIA

Concept of Residence
The concept of residence is central to BoP compilation as it is a statistical statement
showing all economic transactions between residents of one economy and those of the rest of
the world (non-residents). In compiling BoP, it is, therefore, necessary to determine the
economic entities which are residents of an economy and those which are non-residents. For
this purpose, the IMF Manual has prescribed certain criteria. Besides, some conventions have
also evolved over the years.
In BoP, the concept of residence is not based on nationality or legal status, but is based on the
transactors centre of economic interest. Therefore, it is necessary to recognise the economic
territory of a country as the relevant geographical area to which the concept of residence is
applied. The concept of economic territory is defined as the area under the effective economic
control of a single government and, therefore, has both the dimensions of legal jurisdiction as
well as physical location, which decides the association of entities with a particular economic
territory.
According to the BPM6, an institutional unit is resident in an economic territory when there
exists, within the economic territory, some location, dwelling, place of production, or other
premises on which or from which the unit engages and intends to continue engaging, either
indefinitely or over a finite but long period of time, in economic activities and transactions on
a significant scale. Actual or intended location for one year or more is used as an operational
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criterion for the purpose of determining residence. Based on the above definition, each
institutional unit is a resident of one and only one economic territory determined by its centre
of predominant economic interest.

Households
The residence of an individual is determined by that of the household of which he is a part
and not by the place of his work. His status of residence continues till he acquires a centre of
predominant economic interest abroad. Normally, the predominant economic interest and,
therefore, the status of residence is said to have been acquired by staying or intending to do so
for one year or more in a territory. Students going abroad for full-time study (even for more
than one year) and patients going abroad for medical treatment even for a longer time
generally continue to be the residents of their home country. Similarly, crew of ships and
aircrafts, oil rigs, space stations, or other similar equipment that operate outside a territory or
across several territories are treated as residents in their home base territory. National
diplomats, peacekeeping and military personnel, and other civil servants employed abroad in
government enclaves, as well as members of their households are considered to be residents
of the economic territory of the employing government. Similarly, the staff of international
organisations are residents of their home country and not of the economy in which they
physically reside. Locally recruited staff of foreign embassies, consulates, military bases, etc.
are, however, treated as residents of the compiling economy. In the case of border workers,
seasonal workers, and other short-term workers, the residence of the persons concerned is
based on the principal dwelling rather than the territory of employment.

Enterprises
In contrast to individuals and households, where there is the possibility of inclusion in two or
more economies when they change their residence, enterprises are almost always connected to
a single economy. As a general principle, an enterprise is resident in an economic territory
where the enterprise is engaged in a significant amount of production of goods and/or
services. An enterprise is defined as an institutional unit engaged in production, which may
be a corporation or quasi-corporation, a non-profit institution, or an unincorporated enterprise
(part of the household sector).
Corporations and non-profit institutions are normally expected to have a centre of economic
interest in the economy in which they are legally constituted and registered. Corporations may
be resident in economies which are different from those to which their shareholders belong.
Similarly, subsidiaries may be resident in economies which are different from that where their
parent corporations are located. When a corporation or an unincorporated enterprise maintains
a branch, office or production site in another territory in order to engage in a significant
amount of production over a long period of time (usually one year or more) but without
creating a corporation for the purpose, the branch, office or site is considered to be a quasicorporation (that is, a separate institutional unit) resident in the territory in which it is located.

In the case of an enterprise using its location as a base to deliver services to other locations,
the residence of the enterprise is determined from its place of operations, rather than the point
of delivery or location of mobile equipment, unless the activities at the point of delivery are
sufficiently large to relate to a branch. This mode is used for transport (like operation of ships)
and delivery of some services like on-site repairs, short-term construction, and other business
services. For entities, such as special purpose entities, irrespective of the location, the
residence is determined by their place of incorporation.
When a non-resident has ownership of land and buildings, and natural resources other than
land, the assets are deemed to be owned by a notional resident institutional unit in the
economy of location, even if he does not engage in other economic activities or transactions
in the economy. All buildings, land and other natural resources are, therefore, owned by
residents.

Nature of Transactions
Transactions affecting international flows can be recorded in the BoP accounts, while
changes in external financial assets and liabilities are recorded in the account of International
Investment Position (IIP). A transaction is an interaction between two persons (residing in
different economies) or institutional units (located in different economies) that occurs by
mutual agreement or through the operation of the law and involves an exchange of value or a
transfer. In BoP parlance, there is a subtle difference between exchange and transfer. An
exchange involves providing something having economic value (for example, goods,
services, income, or a financial asset) in return for a corresponding item of economic value,
while transfers do not require such corresponding return of an item of economic value. In
other words, an exchange is called a transaction involving something for something in
return or a transaction with a quid pro quo, whereas a transfer is called a transaction
involving something for nothing in return or a transaction without a quid pro quo. Taxes,
debt forgiveness, grants and personal transfers are examples of transfers.
Transactions recorded in the BoP are economic interactions between a resident and a nonresident. Owing to the nature of international accounts, intra-unit transactions are not
recorded. The flows between the branch and its parent enterprise are shown as interactions
between institutional units, since a branch is recognised as a separate institutional unit (a
quasi-corporation). Similarly, when a notional enterprise (a quasi-corporation) is created for
holding land and associated buildings by non-resident owners, the flows between the nonresident owners and the notional enterprise are considered interactions between institutional
units and are, therefore, captured in the BoP. Any transactions between two resident
institutional units in external assets are treated as domestic transactions and are not recorded
in the BoP. Similarly, when financial instruments issued by residents are exchanged between
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non-residents, no transactions, other things being the same, are recorded in the BoP as there is
no change in overall external liabilities.
Some transactions are governed by mutual agreements involving three parties. For example,
guarantees involve the guarantor, the debtor, and the creditor. Transactions occurring between
any two parties (for example, between the guarantor and debtor, or between the guarantor and
creditor, or between the debtor and creditor) should always be identified. For one-off
guarantees, the activation of the guarantee gives rise to transactions and/or other flows
between each of the three pairs of the three parties. For each pair of parties, transactions in the
international accounts are recorded if one party is a resident and the other party is a nonresident.
Service activities may consist of one unit (an agent) arranging for a transaction to be carried
out between two other units in return for a fee from one or both parties to the transaction. In
such a case, the transaction is recorded exclusively in the accounts of the two parties engaging
in the transaction and not in the accounts of the agent facilitating the transaction.

Accounting System: Double-entry book-keeping

The basic principle involved in compilation of the BoP is the use of the internationally
accepted convention of double-entry recording system. The accounting system followed for
recording international transactions is guided by three broad book-keeping principles: (i)
vertical double-entry book-keeping, also simply known as double-entry book-keeping
involving corresponding entries (credit/debit); (ii) horizontal double-entry book-keeping
ensuring the consistency of recording for each transaction category by counterparties; and (iii)
quadruple-entry book-keeping involving the simultaneous application of both vertical and
horizontal book-keeping, which is the accounting system underlying the recording of
transactions in the national and international accounts.
An economys international accounts are required to be compiled on a vertical double-entry
book-keeping basis from the perspective of the residents of that economy. In principle, each
transaction in the BoP is recorded as consisting of two opposite entries with equal values: one
with a credit entry (signifying inflow) and the other with a debit entry (signifying outflow).
The accounting characteristics of transactions recorded in the BoP are as follows:
i. Credit (CR.): exports of goods and services, income receivable, unrequited transfer receipts,
reduction in foreign assets, or increase in foreign liabilities.
ii. Debit (DR.): imports of goods and services, income payable, unrequited transfer payments,
increase in foreign assets, or reduction in foreign liabilities.
Illustratively, under assets real or financial a positive figure (credit) represents a
decrease in assets, and a negative figure (debit) reflects an increase in assets. In contrast,
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under liabilities, a positive figure (credit) shows an increase in liabilities, and a negative
figure (debit) shows a decrease in liabilities. Similarly, in the case of services, a credit entry is
recorded when the services are provided to non-residents and a debit entry reflects receiving
services by residents from non-residents.
In the case of transfers (which are unilateral in nature), no good, service, or financial asset is
received in return from the counterpart. Nevertheless, the recording of a transfer gives rise to
two entries for each party to the transaction. Unilateral transfers are shown as credits or
debits, as the case may be, against the head transfers, with a contra entry either under
merchandise or financial assets/liabilities or reserves. For example, transfers received in kind
(e.g., gold) are recorded as a credit entry under transfers and the offsetting entry will be a
debit entry in imports. Similarly, transfers received in cash are shown as credit against
transfers under the current account, and the consequent increase in foreign currency holdings
is shown as debit under the foreign exchange assets of the banking system.

Under the system of vertical double-entry book-keeping, the total of all credit entries and that
of all debit entries become equal, which ensures consistency of accounts for a single unit.
More specifically, as each transaction involves two mutually offsetting entries, the difference
between the sum of credit entries and the sum of debit entries is conceptually zero in the BoP
statistics. Thus, in principle, the BoP accounts as a whole are in balance. In practice, however,
the accounts frequently do not balance. For example, the data for BoP are often drawn
independently from different sources; as a result, there may be a summary net credit or net
debit (i.e., net errors and omissions in the accounts). Net errors and omissions are derived by
subtracting the sum of net balance in the current account together with net balance in the
capital account from net borrowing/lending in the financial account (which includes
reserve assets). Errors and omissions with a negative sign indicate either understatement of
payments or overstatement of receipts or both. Conversely, positive errors and omissions
connote either understatement of receipts or overstatement of payments or both.

Basis of Recording
In deriving BoP aggregates, the current and capital account transactions are recorded on a
gross basis (i.e., showing full values) as credit and debit entries. In general, gross transactions
recorded in the current account often indicate the relative importance of particular item within
an economy. Recording the transactions on a gross basis also helps in measuring their global
share. On the other hand, the components of the financial account are recorded on a net basis
(i.e., as net changes, which are increases less reductions in the same type of transactions)
separately for each category/instrument of assets and liabilities on the same side of the
balance sheet, partly because gross data for transactions often are not available. Therefore, a

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positive change indicates a decrease in assets or an increase in liabilities (credit entry) and a
negative change indicates an increase in assets or a decrease in liabilities (debit entry).

Valuation
The BPM6 strengthens the basic principles followed by BPM5 in establishing a clear linkage
between flows (transactions) and the stock of external financial assets and liabilities, by
making a clear distinction between transactions and other changes in the accounts arising out
of valuation and other adjustments. For this purpose, a uniform system of valuation of
transactions in real resources and financial assets and liabilities and the stocks of assets and
liabilities, becomes necessary. Therefore, it is suggested that market prices be used as the
basis for valuation of both flows and stocks for compiling BoP and the International
Investment Position (IIP) to ensure consistency. This would also ensure international
comparability. Apart from linking flows and stocks, the role of valuation is important from the
perspective of ensuring internal consistency under the double-entry recording system of BoP.
Unless debit and credit entries for various transactions are valued at the same market price,
the sum of all debit and credit entries in the BoP statement will not be equal and, therefore,
will result in errors and omissions. Uniform valuation has to be followed, particularly because
the credit and debit aspects are often derived independently from separate sources. Second, in
the absence of a uniform valuation system, different items within the BoP cannot be compared
with each other.
In addition, BoP statements of different countries will not be comparable, unless the two
partner countries adopt uniform valuation principles for recording entries in their respective
BoP statistics. Ideally, the price at which the transaction is put through should be considered
for valuation. For BoP purposes, the BPM6 defines market prices for transactions as the
amounts of money that willing buyers pay to acquire something from willing sellers; when the
exchanges are made between independent parties and on the basis of commercial
considerations only. Thus, a market price refers only to the price for one specific transaction.
A market price defined in this way is to be clearly distinguished from a price quoted in the
market, a world market price, a going price, a fair market price, or any price that is intended
to express the generality of prices for a class of supposedly identical exchanges rather than a
price actually applying to a specific exchange.
In the case of merchandise trade, market price is the price payable by the buyer after taking
into account any rebates, refunds, adjustments, etc. from the seller. Imports and exports of
general merchandise are recorded at free on board (FOB) values, which take into account any
export taxes payable or any tax rebates receivable. However, transactions in financial assets
and liabilities should be recorded exclusive of any commissions, fees, and taxes whether
charged explicitly, included in the purchasers price, or deducted from the sellers proceeds,
and such charges should be shown separately under the appropriate categories. This is
because both debtors and creditors should record the same amount for the transaction in the
same financial instrument.

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In recording certain transactions, the conditions needed to establish a market price as defined
in the IMF Manual may not be present, such as barter transactions, provision of goods and
services without a charge, and goods under financial lease. In such cases, the BPM6
recommends that valuation based on market-price-equivalents be worked out as these provide
an approximation for market prices. Therefore, market prices of the same or similar items,
when such prices are quoted in the market, will provide a good proxy. In some other cases,
actual exchange values may not represent market prices, such as transactions involving
transfer pricing between affiliated enterprises, manipulative agreement with third parties and
certain non-commercial transactions, including concessional interest. In the case of affiliated
enterprises, the exchange of goods does not occur between independent parties (for example,
specialised components that are usable only when incorporated in a finished product) and,
therefore, prices may be under- or over-invoiced, necessitating adjustments to arrive at the
market equivalent price (with corresponding adjustments shown in the counterpart accounts).
Similarly, the exchange of services, such as management services and technical know-how,
may have no near equivalents in the types of transactions in services that usually take place
between independent parties. Thus, for valuing transactions between affiliated parties, one
may have no choice other than to accept valuations based on explicit costs incurred in
production or any other values assigned by the enterprise.
Another dimension to the valuation issue is that the values of real resources and financial
items are constantly subject to changes because (i) of alteration in terms of the currency in
which the price is quoted, and/or (ii) the exchange rate for the currency in which the price is
expressed may change in relation to the unit of account that is being used. In principle,
amounts denominated in foreign currencies are to be converted into domestic currency at
market rates of exchange prevailing at the time of the transaction. In principle, the actual
exchange rates applied for the currency conversion under a particular transaction should be
used for the purposes of BoP. However, at times it is not feasible to use the transaction rates.
Therefore, average rates for the shortest period are recommended, though daily average
exchange rates provide a good approximation. In this context, it may be noted that valuation
changes arising due to changes in exchange rates are not included in the BoP, which is a
flow concept, but are included in the IIP which represents stock position.

Timing
Generally, there are four broad principles to determine the time of recording transactions,
namely: the accrual basis, the due-for-payment basis, the commitment basis, and the cash
basis. Since BoP is compiled on an accrual basis, the accrual accounting principle governs the
time of recording for all transactions. Under accrual accounting, flows are recorded at the
time when economic value is created, transformed, exchanged, transferred, or extinguished.
Accordingly, a change of economic ownership is recorded when ownership changes, and
services are recorded when they are provided. The change of economic ownership is central in
determining the time of recording for transactions in goods, non-produced non-financial
assets, and financial assets on an accrual basis. When a change in economic ownership is not
obvious, the change is considered to have occurred at ( or is peroxide by) the time when the
14

parties to the transaction record it in their books or accounts. When services are provided
within a discrete period (e.g., transport or hotel services), there is no problem in determining
the timing of recording. However, when services are provided on a continuous basis over a
period of time (e.g., construction services, operating-leasing and insurance services), there
may be advance payments or settlements at later dates (freight, insurance, port services, etc.).
In such cases, the provision of services should be recorded on an accrual basis in each
accounting period, i.e., they should be recorded as they are rendered and not when payments
are made.
Distributive transactions (compensation of employees, social contributions, and interest and
dividend payments) are recorded at the moment when the related claims arise, i.e., when the
amounts payable accrue. For grants and other voluntary transfers, the time of recording is
determined by the time at which there is a change in the economic ownership of the resources
that corresponds to such transfers.
While the concept of change in economic ownership is generally the basis for time of
recording the transactions in financial assets/liabilities, there are certain financial claims/
liabilities (e.g., trade credit) which result from non-financial transactions. In such cases, the
financial claim is deemed to arise (i.e., the time of recording) at the time when the
corresponding non-financial transaction occurs.

Timing Adjustments
Timing adjustments may be necessary particularly in the case of merchandise trade as the
latter may not always reflect changes in economic ownership due to a time lag in the physical
movement of goods. Sometimes, the practices followed in customs statistics also may lead to
distortions requiring timing adjustments. When the process of importing or exporting involves
a lengthy voyage, a change in the economic ownership of goods can vary widely from the
time when the goods are recorded in trade statistics. In such cases timing adjustments should,
in principle, be applied to correct the trade statistics.
In brief, the timing of certain transactions in goods, services, and income may not coincide
with the corresponding payments for settling the transactions due to differences in procedure
followed for recording the same (cash and/or accrual basis). Therefore, alternative
information should be used routinely to verify and/or adjust selected transaction categories.
Therefore, compilers using an exchange record system should check each large settlement
transaction. Similarly, data on interest payments obtained from either the payment records or
debt service schedule may not be appropriate for accrual accounting. In such cases, other
possibilities for deriving interest accruals may be explored, such as using the information
contained in the loan agreements.

Applicability of IMF Guidelines

15

The IMFs Balance of Payments Manual provides guidance to its member countries on the
compilation of BoP and IIP and also serves as an international standard for the conceptual
framework for compiling statistics relating to external transactions. The IMFs Balance of
Payments Compilation Guide, which is brought out along with the Manual, provides detailed
information on standard concepts, definitions, coverage, classifications and conventions
followed in the construction of BoP and IIP statistics to enhance international comparability
of data. However, the Manual suggests that the principles and practices of BoP construction at
the country level should be based on country-specific circumstances keeping in view the
practical and legal constraints for data collection. The Manual provides a general framework
that is applicable for all countries ranging from small open economies and least developed
economies to the more advanced and complex economies. Therefore, it is recognised that not
all items are relevant in all cases.

It is for the national compilers to apply international guidelines in a way appropriate to their
specific circumstances. Factors to be taken into account when determining the items to be
collected and the techniques employed include the relative importance of disparate types of
economic activities, the diversity of institutions, range of instruments available in financial
markets and whether or not exchange controls exist. In addition, data collection for some
items of BoP may not be practical if the item is too small and the cost of collecting such data
is relatively high. Similarly, some countries may be interested in identifying certain other
items of economic transaction outside the general framework of BoP as recommended by the
IMF, which are of interest to their policymakers and analysts.

16

The External Crisis of Indias Balance of Payments:

The Political- Economic Background. The authorities talk of the impending crisis in
Indias balance of payments as if it had no history. They trace it to various immediate causes:
the alleged excess domestic demand generated by fiscal deficits, high international oil
prices, low domestic oil prices, the mysterious Indian fascination with gold, high domestic
inflation which drives Indian savers to buy gold, the slump in demand for Indias exports due
to the sluggish state of the world economy, and so on. In other words, the balance of payments
crisis is presented as a malady which is either amenable to a ready cure within the existing
policy framework (such as slashing Government spending and hiking domestic petroleum
product prices), or is self-limiting, and merely awaits a revival of the world economy (or even
limited windfalls such as a fall in international oil and gold prices). Leaving aside the
untenability of such explanations and remedies, what we need to note is that balance
of payments problems are not something new to India: they have been endemic to its post1947 history. And they have deep roots in the political economy of India. As with any
phenomenon, it helps to look into the history of Indias balance of payments to understand its
present.
Indias balance of payments crisis can be viewed as the expression of a contradiction. The
rulers, and the classes they represent, have always aspired to rapid growth without
confronting the institutional barriers to real development, i.e., the barriers inherent in the
prevailing social relations. Principal among these barriers have been the stifling and
retrogressive agrarian relations, which persist in modified forms to date. In the absence of any
reliable material base such as could be provided by transformed social relations, the rulers
have turned first to foreign aid, then to the 1981 IMF loan and external commercial
borrowings, and finally to all sorts of foreign investment, in order to boost growth. Their
efforts were not rewarded with much success in the first three decades of planning; but in the
era of globalisation and financialisation, large financial flows did succeed in triggering a
17

dramatic rise in Indias growth rate, at least for a spell. Side by side, the entire process has
resulted in the heightened domination of foreign capital over India.

The Colonial legacy

Before British rule, India had a traditional textile industry which produced fine fabrics for its
ruling elite; these fabrics also had a sizeable export market, which led to an inflow of bullion.
At the outset of British rule, the export of Indian textiles continued as one of the methods for
transferring colonial revenues home. Such colonial revenues made a very large contribution to
the industrialisation of Britain. Once a modern British textile industry emerged, however,
colonial policy destroyed Indias textile industry, and India became an importer of British
textiles. However, this destruction of Indias chief export industry left the colonial rulers with
a problem: How were they now to transfer their colonial extractions from India to Britain, in
terms of real resources? To meet this end, they promoted crops in India for export, such as
indigo, cotton, jute, and most of all opium (which they used indeed to penetrate and subjugate
China in the nineteenth century). To be able to pay land revenue, the peasant was forced to
grow these commercial crops. The British also exported food grains on a sizeable scale from
India, despite the widespread hunger and famines in this country. India always ran a (forced)
trade surplus under British rule. The British paid for this by, in effect, charging India for
being ruled by Great Britain (the so-called Home Charges). More bluntly, the continuous
trade surplus constituted a forced payment to Britain as a colonial tribute.
At the tail end of their rule, during World War II and the months immediately following it, the
British compulsorily took from India goods and services for their troops and even for their
civilian population, at the cost of millions of Indian lives. The deferred payment for these
acquisitions constituted a debt England owed to India, the sterling balances. The value of
these balances was in fact understated and then, in the period just before the transfer of power,
further written down (with the collaboration of Congress leaders). These were the foreign
assets with which India began its post-1947 journey. India was also saddled with foreign
liabilities, in the form of foreign investments in India which had been made under colonial
rule, which the post-colonial regime was not willing to expropriate.
18

At the time of the departure of the British, Indias exports were largely agricultural or
agriculture-related, demand for which was inelastic. Indias limited large-scale industry,
shaped by colonial policy, emerged without the development of a domestic machine industry,
and indeed without the capability or mind-set among the leading entrepreneurs to properly
assimilate imported technology. During World War II the profits of large industrial firms had
soared, but they now were desperate for imports of capital goods. Any drive for rapid
growth within the existing frame, therefore, promised to run not only an initial trade deficit,
but a persisting one.

Pressures for Growth

The First Plan (1951-56), hurriedly stitched together, was a puny one, consisting largely of
projects already under way, and it did not put much strain on the balance of payments; but it
also did not give much impetus to growth of the economy. Big business magnates dreamt of
rapid growth in their businesses, and wanted the Indian State to undertake certain large,
relatively low-profit or risky investments in order to facilitate the growth of the private sector.
The new rulers, for their part, entertained ambitions of becoming the leading power in Asia.
Meanwhile, the masses, having waged a struggle for independence, had high expectations
of national development under the new regime. Faced with these mass expectations, the new
rulers glanced nervously northward at the transformation taking place in China, and
considered how to prevent such developments taking place here. The Congress session at
Avadi , and later the Indian Parliament, adopted resolutions declaring that planning should be
directed towards the establishment of a socialist structure of society. For multiple reasons,
then, the Second Plan was thus greatly more ambitious than the First.

Barriers to Growth
However, India faced certain barriers to growth. Of these, the critical one was the agrarian
barrier; but the character of its monopolist business class also played a significant role. (Of
course, both can be viewed as aspects of a single phenomenon, i.e., the nature of class rule in
India.)
Retrogressive agrarian relations cast a pall over the prospects for industrial growth in several
ways: in terms of the market, sources of raw materials, the prices of wage goods, and the
social-economic environment. At an obvious level, agriculture was a crucial supplier of raw
materials to industry (cotton, jute, sugar, and foodstuffs), the constraints on agricultural
productivity were also constraints on growth of industries based on these raw materials.
Further, an important method of increasing the surplus in capitalist industry is the cheapening
19

of wage goods (thus indirectly reducing the share of wages); another constraint on the growth
of surpluses in industry was thus agricultures inability to ensure a growing supply to industry
of the principal wage good (food) on stable and favourable terms.
However, the most important of the shadows cast by the existing agrarian relations was the
appalling poverty of the semi-feudally exploited peasantry: Their widespread poverty clearly
narrowed the home market for industrial goods. In the immediate aftermath of the transfer of
power, land reform was therefore a staple of the rulers rhetoric.
There were also subtler effects of the agrarian barrier. The state of agrarian relations offered
multiple uses for capital other than productive industrial investment: among them, exploiting
fluctuations in production through speculative trade, and exploiting the helplessness of the
peasantry through usury. Last but not least, the agrarian conditions offered fertile ground for
the perpetuation of the caste system, which in turn contributed to the perpetuation of the
existing conditions. This cultural deadweight helped prevent the emergence of many
potentially dynamic social forces. It is worth noting that big business in India has long been
dominated by a few commercial castes, whose extensive community linkages help them
advance and form a barrier to other social groups. Though recent years have seen entrants into
the corporate sector from other castes, they too are very largely from the upper sections of the
caste hierarchy.

20

Emergence of Balance of Payments Difficulties

The new rulers were implacably opposed to any radical transformation of agrarian relations.
Nor were they willing to lay their hands on either the still sizeable foreign assets, or the assets
of the domestic monopolist class, in order to mobilise the resources for growth. What then
was to provide the impetus for growth? Within the existing social relations, it appeared that
impetus had to come from without.
The comfortable balance of payments witnessed during the First Plan period was short-lived.
Rapid industrial growth would involve large imports of capital goods and large foreign
exchange expenditure. (Apart from this, the countrys balance of payments was burdened with
sizeable food imports and the import-dependent consumer tastes of its elite.) Thus India ran
into foreign exchange difficulties hardly a year into the Second Plan. This led to some ad
hoc attempts at rationing foreign exchange, increasing drafts on IMF facilities, and the Plans
rapidly increasing dependence on foreign aid (much of it tied to imports from the aidgivers). Since that time, there has always been a strong undercurrent of balance of payments
difficulties, surfacing periodically in the form of crises.
Indias business magnates had emerged during British rule from prosperous mercantile
backgrounds, a strange premature form of monopoly capital, surrounded by a sea of small
producers. These domestic magnates, with interests spread over a bewildering range of
unrelated industries, had always excelled in mercantile activities, financial manipulations and
the rigging of Government policy and administrative mechanisms; these activities, rather than
the assimilation and further indigenous development of imported technology, absorbed
considerable energies of this class (and provided it handsome returns).
While no country has developed without significant initial imports of technology, the
Government of India did not systematically plan for and require assimilation and
development of that technology; this despite a potential technological workforce of engineers
and scientists (and notwithstanding certain central institutes of research). Thus it perpetuated
21

an uninterrupted reign of technological dependence. (By contrast, China, which had obtained
substantial Soviet technological and financial aid till 1960, managed by the mid-sixties to
achieve self-reliance in various fields and pay off all its foreign debt.)
Where Indias official policy stipulated the substitution of domestic production for imports,
that domestic production itself tended to be dependent on substantial imports and technology
fees, leading to little saving of foreign exchange, if any. This was all the more so in the case of
consumer industries catering to the upper segment of society, whose tastes were shaped by
imitation of the west; in such cases the attraction of the product was precisely the fact of its
being imported, or at most assembled locally. (This tendency has become an established, even
celebrated, feature in the Indian elites present accepted pattern of consumption, production
and distribution.)
Since the rulers wished to promote growth by any means other than confronting agrarian and
industrial monopolists, private foreign investment, too, was encouraged. The foreign owned
sector flourished and proved more profitable than Indian owned corporate firms, but it did not
necessarily bring in much capital. Rather, its holdings grew on the basis of profits earned here,
even as it continued to send out substantial sums on net imports, royalties, technology
payments, dividends and executive pay.
The Indian rulers had dreamt of big-power status even before the transfer of power, basing
their hopes perhaps on the size of their subject population and geographical spread rather than
on the countrys economic strength or social consolidation. The contradiction between this
shaky base and their outsize ambitions showed up in their disastrous 1962 China war. Defeat,
however, only spurred their wounded ambitions, and resulted in ever-larger arms imports, a
major contributor to foreign exchange expenditure whose very discussion is near-taboo. As
one writer pointed out tellingly in the mid-1960s, When development is in line with the
major political and social groups interests, the government can rapidly mobilize large sums
which may have seemed non-existent previously. Between 1960-61 and 1963-64, the
government was able to increase the defence budget by about 5.25 thousand million Rs. This
is a greater increase than has ever been known in the total of public and private investments.

22

Impasses of the Mid-Sixties

Despite the larger and larger components of foreign aid in the Plans, they did not actually
bring about the rapid growth desired by big business. GDP growth remained stuck at what
became referred to derisively as the Hindu rate of growth of 3.5 per cent per annum. Nor
did the Plans bring about the national development expected by the masses.
By the mid-sixties, the bankruptcy of the path of development pursued by the rulers was on
stark display. Two years of severe drought (1965-66) resulted in a sharp fall in food
production. Rather than impose systematic rationing on domestic food supplies to ensure the
minimum needs of the masses were met, the Government chose to make large food imports
from the US under PL-480. (As is well known, the US used this hold to twist the Indian
governments arm quite brazenly on foreign policy issues.) The food imports, however, did
not prevent a food crisis for the masses.
The other element of the mid-sixties crisis was the balance of payments. Even as the trade
deficit swelled, capital inflows were drying up (a condition aggravated by the temporary
suspension of foreign aid after the 1965 war with Pakistan). Seeing the foreign exchange
reserves dwindle, the Government devalued the rupee by a steep 36.5 per cent in 1966. The
period was marked by industrial stagnation, labour unrest, and finally major agrarian
upsurges. The once-unquestioned dominance of the Congress began its long decline. Against
this background, a number of studies appeared from the late 1960s to the early 1980s, devoted
to the question of long-term stagnation or structural retrogression in the Indian economy;
several of them pointed to its roots in the agrarian impasse, and reasserted the need for
fundamental agrarian transformation as the basis for making a breakthrough.

The Thrust Forward

The rulers, however, addressed these problems from their own class angle. Rather than
confront the agrarian barrier head-on and bring about a change in social-economic
institutions, they found a technological fix in the mid-sixties: This was to equip the viable
farmer in relatively well-endowed pockets of the country with high-yielding (high-input,
high-cost) varieties of a few crops, canal irrigation, power, subsidised chemical fertiliser, and
23

bank credit; and to procure the output at a remunerative price. The surpluses procured from
these pockets were to feed the country; the rest of agriculture was left to its own devices. This
shift finally buried the earlier pretensions to land reform. While food grain imports were
done away with for the time being (partly thanks to the reduction of per capita food grain), the
Green Revolution had a substantial, and more permanent, import content in terms of
chemical fertiliser, fertiliser manufacturing technology, agricultural machinery, pesticides and
diesel. Over the longer term, growth of production slowed, while costs to the peasant
continued to rise.
In the 1980s, particularly in the latter half, the rulers similarly addressed the problem of
industrial stagnation. The new strategy loosened industrial licensing, import restrictions, and
the regulation of foreign collaborations, all in the name of making domestic industry
efficient and competitive, and thus increasing exports. Industrialists took advantage of this
new dispensation to displace labour. However, since multinational firms then period jealously
guarded their markets worldwide from newcomer firms from the Third World, and since
foreign collaboration agreements with Indian industry generally included explicit or implicit
restrictions on exports from the Indian firm to foreign markets, this strategy served more as an
open door for capital goods imports rather than an effective boost to exports.
The basic question remained: that of the home market. Since the mass market lacked
purchasing power, the solution found by the rulers in the 1980s was to target what could be
called the viable consumer, i.e., the elite and the upper sections generally. As mass
consumption goods made up only a small portion of this segments consumption, the rapid
growth that occurred was concentrated around luxury consumption. And since the tastes of
this upper segment were shaped by the advertising campaigns of firms in the imperialist
countries, this strategy involved sizeable imports of goods and technology; often domestic
production consisted of mere assembly, or screw-driver technology.

24

Fresh Balance of Payments Crisis; Structural Adjustment

of 1991
The new strategy did succeed in raising the rates of industrial growth of this type for some
time, but for the above reasons, it also consumed foreign exchange on a large scale. The
difference was that, unlike in the past, foreign loans were now more easily available: first, in
the form of the 1981 IMF loan, and later, in the form of external commercial borrowings
(ECBs), which were now being pushed by banks of the developed world (which, flush with
deposits by oil-exporting countries, were looking for borrowers). The end result of this
strategy, however, was the doubling of Indias external debt, and a foreign exchange crisis,
forcing India to return to the IMF for a structural adjustment loan in 1991.
The structural adjustment of the early 1990s was supposed once more to make India
internationally competitive, and thus repair the perennial balance of payments problem. The
trade deficit did shrink for a few years, but began by the mid-1990s to expand once more, as
industrial production, particularly the production of import-intensive consumer durables,
boomed. The boom petered out quickly, however, and by the early 2000s the average rates of
growth of GDP and industrial production in the post-1991 period were in fact no better than in
the 1980s.

Growth and Crisis

It was in the post-2003 period that massive inflows of foreign capital at last triggered rapid
growth funding consumer debt, fueling luxury consumption, and sparking off investment by
a now-optimistic corporate sector. (Strikingly, however, despite all this growth, the share of
industry in either national income or employment has not changed much in all of post-1947
India. Rather, the services sector has grown in a distorted way.) These foreign inflows were
largely of the relatively footloose finance that is reigning globally. Foreign financial investors
now came to own sizeable shares in most of Indias top firms, rivaling promoter stakes. There
is no official figure of the current market value of the holdings of foreign direct investors, but
it is clear that these too have grown massively; and the opening of more and more sectors to
FDI continues. All this has amounted to a massive shift of Indian assets and sectors of the
Indian economy to foreign hands, with far-reaching consequences. For example, the opening
of the multi-brand retail sector to FDI may have drastic consequences at three stages not
only for the livelihoods of small retailers, but also for small producers, and even for
consumers.
25

Successive Indian governments have displayed neither the capability nor the will to stem
illicit outflows of capital, much of which are carried out through systematic mispricing of
trade. These sums can only be guessed at: Global Financial Integrity estimated the total
outflow from India very conservatively at $213 billion for 1948-2008. If the funds had earned
only the rates of return of US Treasury bonds, the present value would be $462 billion i.e.,
twice the size of Indias external debt in that year. According to GFI estimates, more than twothirds of this outflow took place in the period of liberalisation after 1991, and GFI finds a
statistical correlation between concentration of income in the hands of the top sections (High
Net Worth Individuals) and illicit transfers. Deregulation and trade liberalisation contributed
to/accelerated illicit transfers abroad.
Hidden within the figures of Indias exports of goods and services are huge real resourcetransfers. As Magdoff wrote, the prices at which international trade takes place, and the costs
that enter into those prices, are themselves the product of the social system and the current as
well as the congealed past power relations of that system. Remarkably, the share of low
value-added resource-based exports in Indias total merchandise exports rose from one-third
in 1990 to one-half in 2008. (These exports were of resources which may be needed for
Indias future development, and often have been extracted at terrible cost to the environment
and to the people living in those regions.) The overall conditions of agrarian misery and
stagnation of industrial employment ensure a steady flow of Indian workers to labour in
foreign lands at low wages; those wages are the private transfers in Indias balance of
payments. Indias exports of software depend on the huge wage differential between software
workers here and their counterparts in the developed world; behind that differential are the
low wages/incomes of those who produce goods and services consumed by Indian software
workers. And these low wages in turn are ensured by the skewed pattern of growth here. The
Indian education system, built with large public investment, produces a huge stream of lowcost software engineers, thereby subsidizing software exports so much so that the head of
Indias largest private engineering firm, L&T, complains the software export industry has
snatched away all the engineers. (Another giant resource transfer, which does not even figure
in our balance of payments, takes place as the best products of the publicly funded Indian
Institutes of Technology and other Government-funded institutes are systematically harvested
via the selective immigration policy of the US and other imperialist countries.) Further,
sizeable explicit and hidden subsidies are provided by the Indian government to export
industries, the most recent example being the special economic zones (SEZs).
Rapid GDP growth during 2003-08 also meant the rapid growth of imports, much faster than
the growth of exports. Even as export growth has fallen in the recent period, or even turned
negative, import growth has remained high. The growing current account gap has been funded
by ever-larger capital inflows (FDI, FII, and external debt), that is, additions to Indias foreign
liabilities. The servicing costs of these liabilities also rose steeply. Remarkably, even the post2008 slowdown did not lead to a sustained fall in imports, which underscores the fact that the
social sections who were responsible for the imports were certainly not those whose jobs and
spending were hit by that slowdown.
26

The slowdown can be seen as one expression of the deeper contradiction with which we
began, namely, between the ruling classes growth aspiration and its tenuous material base.
Another expression of that contradiction is the vast expansion of the trade deficit and current
account deficit in the last decade, requiring giant capital imports to bridge that gap. As pointed
out in another article in this issue of Aspects, the outcome of two decades of liberalisation and
globalisation is deepened dependence on foreign capital, increased foreign ownership of
Indian assets, and strengthened foreign dictation of Indias economic policy.

Perspectives on Indias Balance of Payments

In the recent years, Indias integration with the global economy has increased significantly.
This is reflected in our expanding volume of external trade and financial transactions. While
this process has several benefits arising from wider access to consumption and investment,
there is attendant cost of periodic instability. Over the last two years, the Reserve Bank has
been drawing attention to the widening current account deficit (CAD) in our balance of
payments (BoP).The risks to our BoP have increased both in the global and domestic context:
first, following the global financial crisis trade volumes have slumped and capital flows have
become volatile; second, slowing domestic growth coupled with a large fiscal deficit
alongside a high CAD poses twin deficit risks. In this context, I propose to capture the
evolution of Indias BoP in the historical context and trace how did we respond to risks to
external stability from time to time?
Let me start from the basics. What is BoP? It is our transaction account with the rest of the
world. It can be better appreciated in terms of the national income accounting identity:
GDP = C+G+I+X-M. In other words, domestic output (GDP) is equal to private consumption
(C), plus government consumption (G), plus domestic investment (I), plus net exports (X-M).
If net exports of goods and services (X-M) are negative, the domestic economy is absorbing
more than it can produce. In other words, absorption (C+G+I) by the domestic economy is
greater than domestic output (GDP). This is reflected in current account deficit (X-M) which
needs to be financed by external borrowings and/or investments. In normal times external
finance may not be a problem. However, it could be challenging if both the global and
domestic economic outlook are not very favourable. Against this background, my scheme of
presentation will be as follows: identify the key events those shaped Indias BoP since
independence; examine the changes in the composition of capital inflows; and in conclusion
highlight a few risks and make some suggestions to reinforce Indias BoP.
Indias BoP evolved reflecting both the changes in our development paradigm and exogenous
shocks from time to time. In the 60 year span, 195152 to 201112, six events had a lasting
impact on our BoP: (i) the devaluation in 1966; (ii) first and second oil shocks of 1973 and
1980; (iii) external payments crisis of 1991; (iv) the East Asian crisis of 1997;(v) the Y2K
event of 2000; and (vi) the global financial crisis of 2008. I will analyse the BoP trend in this
sequence.
The first phase can be considered from the 1950s through mid-1960s. In the early 1950s,India
was reasonably open. For example, in 195152, merchandise trade, exports plus imports,
accounted for 16 per cent of GDP. Overall current receipts plus payments were nearly 19 per
cent of GDP. Subsequently, the share of external sector in Indias GDP gradually declined
with the inward looking policy of import substitution. Moreover, Indian export basket
comprised mainly traditional items like tea, cotton textile and jute manufactures. Not only the
27

scope of world trade expansion in these commodities was less but additionally India had to
face competition from new emerging suppliers, such as Pakistan in jute manufactures and
Ceylon and East Africa in tea.
During this period, policy emphasis was on import saving rather than export promotion, and
priority was given to basic goods and capital goods sector. It was argued that investment in
heavy industries would bring in saving in foreign exchange, as output from such industries
would replace their imports in the long-run. Import-substituting strategies were expected to
gradually increase export competitiveness through efficiency-gains achieved in the domestic
economy. But this did not happen. Hence, exports remained modest. In fact our external
sector contracted in relation to GDP from the level observed in the early 1950s. By 196566,
merchandise trade was under 8 per cent of GDP and overall current receipts and payments
were below 10 per cent of GDP (Table 1).

Notwithstanding the contracting size of the external sector, as imports growth outstripped
Exports growth, there was persistent current account deficit (CAD). Emphasis on heavy
industrialisation in the second five year Plan led to a sharp increase in imports. On top of
this, the strains of Indo-China conflict of 1962, Indo-Pakistan war of 1965 and severe drought
of 196566 triggered a major BoP crisis. Indias international economic relations with
advanced countries came under stress during the Indo-Pak conflict. Withdrawal of foreign aid
by countries like the US and conditional resumption of aid by the Aid India Consortium led to
contraction in capital inflows. Given the low level of foreign exchange reserves and
burgeoning trade deficit, India had no option other than to devalue. Rupee was devalued
by36.5 per cent in June 1966.
Though Indias export basket was limited, the sharp devaluation clearly increased the
competitiveness of Indias exports. Concurrently, India had to undertake a number of trade
liberalising measures. Even though the net impact of devaluation was a contentious issue
among the leading economists,2 data show that exports growth, though modest, outpaced
imports growth (Chart 1).

28

In fact, the current account turned into a surplus in 197374 as not only the exports growth
was significant but invisible3 receipts also showed a sharp turnaround from deficit to surplus
mainly on account of official transfers which largely represented grants under the agreement
of February 1974 with the US Government on the disposition of PL 480 and other rupee
funds. Since surplus in current account balance (CAB) was used for repaying rupee loans
under the same agreement with the US, accretion to reserves was only marginal.
Surplus in Indias CAB was, however, short-lived as the first oil shock occurred by October
1973. Sharp rise in international oil prices was evident in higher imports growth in 197374
and 197475. The share of crude oil in Indias import bill rose from 11 per cent in 197273 to
26 per cent by 197475. As exports improved, particularly to oil producing Middle-East
countries, BoP recovered quickly from the first oil shock. By this time, the Indian rupee,
which was linked to a multi-currency basket with pound sterling as intervention currency,
depreciated against the US dollar (Chart 2).

29

Depreciating rupee along with other policy incentives to exporters acted as a supporting
factor for Indias exports. At the same time, invisible receipts grew sharply stemming from
workers remittances from the Middle East. Consequently, the current account balance
turned into surplus in 197677 and 197778 (Chart 3).

Thus, the private transfers added a new positive dimension to Indias BoP after the first oil
30

shock. Further, with the official exchange rate nearly converging to market exchange rate,
there was not much incentive for routing remittances through unofficial exchange brokers.
The rapid growth of private transfers reinforced the trade account adjustment to make the
current account situation much more comfortable (Chart 4).

During the 1980s, BoP again came under stress. The second oil shock led to a rapid increase
in imports in early 1980s. Oil imports increased to about two-fifths of Indias imports during
198083. At the same time, Indias external sector policy was changing towards greater
openness. Various measures were undertaken to promote exports and liberalise imports for
exporters during this period. However, several factors weighed against external stability. First,
despite a number of export promotion measures, the subdued growth conditions in the world
economy constrained exports growth. Second, the surplus on account of invisibles also
deteriorated due to moderation in private transfers. Third, the debt servicing had increased
with greater recourse to debt creating flows such as external commercial borrowings (ECBs)
and non-resident Indian (NRI) deposits. Fourth, deterioration is the fiscal position stemming
from rising expenditures accentuated the twin deficit risks.
Given the already emerging vulnerabilities in Indias BoP during the 1980s, the incipient
signs of stress were discernible which culminated in the BoP crisis in 1991 when the Gulf
War led to a sharp increase in the oil prices. On top of that, a slowdown in the world trade
following the recessionary conditions in industrialised countries and the economic disruption
in Eastern Europe including the erstwhile USSR had begun to affect Indias exports. A large
number of Indian workers employed in Kuwait had to be airlifted to India and their
remittances stopped. Foreign exchange reserves had already dwindled due to significant
drawdown for financing of CAD in earlier years. During 199091, at one point of time, the
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foreign currency assets had dipped below US$ 1.0 billion, covering barely two weeks of
imports. With increasing recourse to the borrowings on commercial terms in the previous
years, financing of CAD had also become more sensitive to creditors confidence in the
Indian economy.
Short-term credits began to dry up and the outflow of NRI deposits was also very substantial.
Downgrading of Indias credit rating below the investment grade also constrained Indias
access in the international markets for funds, especially ECBs and trade credit. Even though
the stress in Indias BoP was unprecedented, the Government decided to honour all debt
obligations without seeking any rescheduling (Reddy, 2006).
In response to the BoP crisis, a combination of standard and unorthodox policies for
stabilisation and structural change was undertaken to ensure that the crisis did not translate
into generalised financial instability. Such steps included pledging gold reserves, discouraging
of non-essential imports, accessing credit from the IMF and other multilateral and bilateral
donors. While dealing with the crisis through an IMF programme, a comprehensive
programme of structural reforms was undertaken simultaneously with special emphasis on the
external sector.
The broad approach to reform in the external sector was laid out in the Report of the High
Level Committee on Balance of Payments (Chairman: C. Rangarajan, 1993). Trade policies,
exchange rate policies and industrial policies were recognised as part of an integrated policy
framework so as to boost the overall productivity, competitiveness and efficiency of the
economy. In addition, to contain the trade and current account deficits and enhance export
competitiveness, the exchange rate of rupee was adjusted downwards in two stages on July
1 and July 3, 1991 by 9 per cent and 11 per cent, respectively. A dual exchange rate system
was introduced in March 1992 which was unified in March 1993. Subsequently, India moved
to current account convertibility in August 1994 by liberalising various transactions relating to
merchandise trade and invisibles.
The impact of policy changes was reflected in lower CAD and its comfortable financing in
subsequent years. India could manage the external shocks that emanated from the East Asian
crisis in 1997 and subsequently, the rise in international oil prices and bursting of dotcom
bubble in 19992000. Indeed, the Indian economy remained relatively insulated from
the East Asian crisis owing to the reforms undertaken in previous years and proactive and
timely policy measures initiated by the Reserve Bank to minimise the contagion effect.
Monetary tightening coupled with flexible exchange rate and steps to bolster reserves
through issuance of Resurgent India Bonds (RIBs) helped in stabilizing the BoP. The BoP
came under some stress again in the first half of 200001 due to a sharp rise in oil prices and
increase in interest rates in advanced countries. At the same time, Indias software exports got
a boost following the demands to address the Y2K challenges. This also encouraged migration
of Indian software engineers to the advanced countries. As a result, the surplus in the services
exports and remittance account of the BoP increased sharply which more than offset the
deficit in the trade account. Software exports rose from 0.9 percent of GDP in 19992000 to a
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peak of 3.8 per cent of GDP by 200809. Private remittances also rose from 2.7 per cent of
GDP to 3.8 per cent during this period. Thus, in the 2000 software exports and private
remittances emerged as two main financing items for the current account mitigating to a large
extent the merchandise trade deficit (Tables 2 & 3).
Owing to a combination of factors, in fact, the current account recorded a surplus during
200104. Subsequently, as international oil prices started rising and domestic growth picked
up, deficit in current account re-emerged during 200405 to 200708 albeit remained range
bound.

After a period of stability, Indias BoP came under stress in 200809 reflecting the impact of
global financial crisis. As capital inflows plummeted, India had to draw down its foreign
currency assets by US $ 20 billion during 200809. Stress since the collapse of Lehman
Brothers largely emanated from decline in Indias merchandise exports and deceleration in
growth in services exports. Though there was some improvement during 201011 on the back
of a strong pick-up in exports mainly led by diversification of trade in terms of composition as
well as direction, it proved to be short-lived. BoP again came under stress during 201112 as
slowdown in advanced economies spilled over to emerging and developing economies
(EDEs), and there was sharp increase in oil and gold imports. Let me now turn to the
financing aspects of the current account. Indias openness, both in terms of trade flows and
capital flows which increased in the 1990s accelerated in the 2000s (Chart 5). This was made
possible due to substantial liberalisation of the capital account and greater openness to private
capital.

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In the first three decades after the independence, CAD was mainly financed by external
assistance and drawdown of forex reserves. Since much of Indias planning strategy was
conceived in terms of a closed economy theoretical framework, private investment inflows
into the economy were not encouraged much. Therefore, foreign resources came primarily in
the form of official transfers. The private investment came mainly through technology
transfer, but played a minuscule role. During this period, the development efforts and stress
on BoP from time to time led India to tap diverse aid sources for specific projects. In the
1980s, as the traditional source of official concessional flows dried up there was a need to
access private capital. But, this came in the form of debt creating flows though costly external
commercial borrowings (ECBs) and NRI deposits. The limitations of financing CAD through
debt creating flows were exposed in the 1991 crisis. Subsequent reforms and opening up the
capital account to non-debt creating flows of foreign direct investment (FDI) and portfolio
equity flows not only completely transformed the sources of financing of the BoP but it also
resulted in substantial addition to reserves in the 2000s (Table 4 & Chart 6).

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35

Balance of Payments: Dependence on Volatile Flows Increases

The current account deficit has come in at 4.1% of the gross domestic product (GDP) for the
September quarter. Compared with the same quarter of the previous year, the merchandise
trade deficit increased, because export growth slowed while import growth remained strong.
While that was the main reason for the deficit, net invisibles, too, fell a bit, mainly because of
lower investment income from abroad and a slowdown in remittances. Edelweiss Capitals
Kapil Gupta hits the nail on the head when he writes that the widening current account deficit
reflects stronger economic activity domestically and relatively weaker growth abroad.
Stronger economic growth finds reflection in higher imports, while weaker growth abroad is
mirrored in weak exports, lack of growth in remittances and low interest rates leading to
lower returns on investments abroad.
The way the deficit was financed in the September quarter, however, has led to some
concerns. While the current account deficit in the quarter was $15.8 billion (Rs70,784 crore
today), portfolio inflows totalled $19.2 billion, more than adequately covering the deficit.
Commercial borrowings, both short- and long-term, have grown. On the other hand, the share
of net foreign direct investment (FDI) has fallen sharply, from $7.5 billion in the September
2009 quarter to $2.5 billion in the September 2010 quarter and $7.75 billion in the April-June
2010 quarter. The drop has been in inbound FDI and could reflect the lack of reforms and
overcapacity in the West. As a research note by Kotak Banks economic team starkly
underlines, net FII flows at $19.2 billion in 2Q FY11 were 94% of the total capital account

36

surplus for the quarter. In 1QFY10 the comparable figure was at around 50.0%. The dangers
of relying on volatile inflows to fund the current account deficit are well known.
Looking ahead, rising crude oil prices would exacerbate the current account deficit, although
a recovery in the West would also be good for exports. As the Kotak report points out, the
balance of payments is on a knife-edge, though foreign exchange reserves are high and there
are no immediate risks. Nevertheless, with the jury still out on whether the West has
recovered fully and especially with the situation in Europe remaining fragile, there could still
be bouts of risk aversion that could impact portfolio inflows and cause significant volatility in
the currency markets.

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Methodology
The researcher divided the study in two different compartments namely the role of import in
Indias BOP and the role of export in Indias BOP. The tables for the apparatus namely import,
export and trade balance prepared for analysis. The import section shows how different bulk
and non-bulk commodities have contributed to the values of import; the export section
exposed how the group of primary and manufactured commodities contributed to the growth
of exports; and finally in the trade balance section, it revealed how the growth of import and
export will affect the countrys trade balance.

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Conclusion
As India slowly marches towards globalization, with growing levels of trade and
investment flows, it would also become vulnerable to external developments like a
slowdown in industrial nations, volatility in international financial markets, swings in
exchange rates of major currencies, and unanticipated price movements such as in
the case of oil. The sustainability of foreign investment and other capital flows would
depend on Indias ability to curtail its excessive fiscal deficits and achieve higher
growth with price stability and raise Indias share of world exports.
Though Indias reserves are fairly comfortable, the Reserve Bank does not think that
there can be any complacency. The criterion is to keep reserves consistent with the
growth in the economy, the size of the current account deficit and of short-term
liabilities and the need to meet contingencies when external shocks occur. Overall,
the external side of the economy looks far more encouraging with the striking impact
of liberalisation policies of the 1990s.

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Bibliography

Library (Book Reading).

Encyclopaedia.
Wikipedia.
www.Google.com

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