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I Aditya Harihar Iyer, Roll No. 35. Here by declares that the project titled A STUDY OF
BALANCE OF PAYMENTS IN INDIA is true and fair up to my knowledge. I have not copied
the entire project from direct source.

Date: -


ROLL NO.:-35

I take this opportunity to express my gratitude and acknowledge to all the individuals involved
both directly and indirectly for their valuable help and guidance.
This project has been an attempt to give information about the A STUDY OF BALANCE OF
I expressed my deep since of gratitude to founder and president of Vidya Prasarak Mandal. I
express my heartful thanks to our honourable Principal Dr. (Mrs.) Shakuntala Ajai Singh, for
her constant support and motivation.
I am also thankful to Mr. Deepak Murdeshwar Sir, co-ordination of self-financed courses for
giving us valuable guidance and information time to time.
I express special thanks to my guide Mrs. Kalpana Nayar, Mrs. Geetanjali Chiplunkar under
whose guidance the project conceived, planned, and executed.
I would also like to thank my family members for encouragement during this Endeavour.
Special thanks to Library staff for providing me various books as and when demanded.
Finally, I am thankful to all my friends without whom this project never had been possible.







Indias Balance Of Payment

International trade involves international means of payments. A country engaged in foreign trade receives
payments from countries to which it exports goods and services and requires making payments to those
nations from where it imports. Accordingly a country with foreign trade maintains an account of all its
receipts and payments from and to the rest of the world. Such an account is called balance of payments. It is
defined as a systematic record of all economic transactions between the residents of the reporting
country and residents of foreign countries during a given period of time.
The balance of payments account records all the transactions between the residents of reporting (domestic)
country and the residents of foreign countries (rest of the world). The transactions include sales and
purchases of all types of goods and services, financial assets and any other transactions which result in the
flow of money in and out of the country. The figures recorded are usually in domestic currency of the
reporting country. However, as and when necessary, they are also expressed in internationally accepted
currency like U.S. dollars.
There is no unique method of presenting balance of payments record. Below table presents a model balance
of payments accounts by incorporating all the transactions under major heads.


Receipts (Credits)
1) Export of goods

Payments (Debits)
1) Import of goods
Trade Account Balance
2) Exports of services
2) Imports of services
3) Interest, profits and dividends received
3) Interest, profits and dividends paid
4) Unilateral receipts
4) Unilateral payments
Current Account Balance (1 to 4)
5) Foreign investments
5) Investments abroad
6) Short term borrowing
6) Short term lending
7) Medium and long term borrowing
7) Medium and long term lending
Capital Account Balance (5 to 7)
Statistical discrepancy (Errors and Omissions)
8) Change in reserves (+)
8) Change in reserves (-)
Total Receipts = Total Payments
The balance of payments account in above table shoes all the receipts and payments grouped under major
accounting heads.
Current Account:
The current account includes all items which give rise to or use up national income. It consists of two major
items, i.e. Merchandise exports and imports, and Invisible exports and imports.
Merchandise Exports and Imports:

Item no.1 on both sides refers to the merchandise exports and imports. They are also referred as tangible
exports and imports as they include the exports and imports of tangible or visible items. The balance of
exports and imports of goods (Item No. 1) is referred as balance of trade or balance of visible trade or
balance of merchandise trade.
Invisible Exports and Imports:
They consist of items 2, 3 and 4. Item no. 2 on both sides constitutes exports and imports of services. The
major items included in this are shipping, International Airways, Insurance, Banking and other Financial
Services, Tourism and any other services including knowledge related Services.
The 3rd item relates to interest, profits and dividends received from and paid to. Investments, direct and
portfolio, give rise to interest and dividends. The share of this item has been slowly increasing in recent
years under the era of globalisation where movement of capital has become easier. Multinationals from rich
countries invest in developing countries. The advanced countries, to which these multinationals belong to,
receive substantial amount of profits. The poor countries, however, hardly have any such income. Their
outflow is much more than what they receive, if any, on this account.
Unilateral or unrequited payments and receipts shown in item no. 4 refers to those receipts and payments for
which there is no corresponding quod pro quo. They include remittances from migrant workers to their
families back home, the payment of pensions to foreign residents, foreign donations, gifts etc. For all these
receipts and payments there are no counter obligations. The receipts on this account lead to an increase in
income due to receipts from foreigners and are shown as credit. Similarly the payments to foreign countries
or residents results in decrease in income and thus recorded as debit.
All the receipts and payments on the items nos 1 to 4 are treated under current account and the balance
between them are called balance on current account. The current account in the balance of payments may
have a surplus or deficit. A surplus provides resource enabling the country to pay off past debts, if any, or to
import capital or consumer goods as per their requirement. A surplus increases a countrys stock of claims on
the rest of the world.
A deficit on this account is treated as a problem and calls for remedial measures. Deficit reduces a countrys
capacity to import, increases foreign debt burden and may lead to foreign debt trap and other international
financial problems.
Both surplus as well as deficit will no doubt pose a problem but the former is hardly considered to be one,
whereas the latter draws immediate attention and also the application of corrective measures.
The Capital Account:
The capital account transaction is concerned with the asset related flow as against current account which is
income related flow. All inflows which add to foreign claims by the reporting country are shown as credit
and all outflows which add to the domestic claims on foreign countries are recorded as debit.
Foreign Investment comes in the form of direct or portfolio investment. In terms of ownership it can be
private which includes both multinationals and banking or official that is from other governments or
international institutions. Direct investment is undertaken mostly by multinationals. Most of the investments

are in consumer goods industries. In recent years investment in capital goods industries and infrastructure
sector is also steadily increasing. There is also investment by individuals who acquire assets in the form of
houses in other countries.
Portfolio investment refers to the acquisition of financial assets in foreign countries. Purchases of shares of
a foreign company, bonds issued by a foreign government are some examples.
Short term Borrowing/Lending refers to borrowing for a period of one year or less. Credits are in the form
of loans secured from foreigners, advance payment on deferred credit exports and other miscellaneous
capital receipts. Borrowing includes commercial borrowing from the foreign commercial banks. Such
borrowing may go beyond short term that is may be for more than one year, making it a medium term
In a similar way all the lending, private and official to the residents of other countries, are shown as debit.
This item may hardly figure in the balance of payment of very poor countries. The figures may increase and
may appear prominently in case of advanced countries.
Medium and long term borrowing/lending:
The distinction of capital flow in and out of the economy as short, medium and long term capital is more on
nature of investment rather than time dimension. A bank deposit in a foreign country is considered a short
term investment though the deposit may remain for many years. A purchase of government bond usually
comes under long term. However, borrowing from the international institutions such as IMF, IBRD etc. can
clearly be marked as medium or long term based on the time period involved.
Acquiring of assets through direct or portfolio investment appear as a negative item in the capital account of
the balance of payments record of the reporting country and as a positive item in the capital account of the
other country. All capital outflows (investments or lending) appear as negative (payment or debits) items as
the money goes out of the economy. Similarly all capital inflows (foreign investments or borrowings from
other countries) are positive items though some of them may increase the liabilities of the receiving country.
To avoid any confusion it should be kept in mind that all capital inflows are recorded as credit.
Errors and Omissions (Statistical Discrepancy):
From the accounting sense the balance of payments always balances, that is, in the double entry recording
system the sum of credit should match the sum of debit entries for a given period. A surplus in current
account must be matched by the equal amount of deficit in capital account and vice-versa. However in
reality the entries in both sides may not, in fact, does not equal. The balancing amount which is required to
balance both the sides is called Errors and Omissions. Errors may arise as values of credit and debit may
not be identical or due to different procedures followed by different sources of information. Omissions may
occur as some entries might have escaped recording.
Statistical discrepancies are unavoidable components of any balance of payments statements; however, they
do not invalidate the reliability of a balance of payments statement. Errors and Omissions reflect the
difficulties involved in recording accurately numerous transactions that take place during a given period.

Errors and Omission amount equals to the number necessary to make both sides equal. It is equal to the
discrepancy in the foreign exchange reserve. The significance of this particular item is only from accounting
sense, that is, to make the difference between credits and debits equal to zero.
Item no. 9 in above table shows the foreign exchange reserves (Forex). They are held by the Central bank of
a country. They are used to finance deficits in other accounts and payments are made into these reserves
when there is a surplus in other items. Foreign exchange reserves are held in a number of forms such as
Financial claims on foreign governments or central banks;
Claims on the International Monetary Fund
iv. Internationally accepted currencies like U.S. dollar; German mark; Japanese Yen. Etc.
Change in foreign exchange reserves can be explained by an example of individuals holdings of cash. The
cash holdings increase when an individual has a surplus of income over expenditure. They decrease when
expenditure exceeds income. Similarly when there is surplus in the balance of payments (current and capital
account) it results in the increase in foreign exchange reserves and a deficit brings down its volume.
The changes in foreign exchange reserves are shown as plus (+) or minus (-) depending on where and in
what form the reserves are held. If India holds the reserves in USA or any country, with IMF or in the form
of any financial or other assets abroad then money flows out of the country and is thus recorded as minus.
Foreign exchange held at home by the RBI in any acceptable form involves inflow of foreign exchange,
accordingly it is recorded as plus.
In an economy with floating exchange rate the disequilibrium in balance of payments gets adjusted
automatically and there is no need for any reserves. Therefore with a clean float, the reserves by definition
are zero. In reality however, most of the economies practice a managed float therefore they do require
reserves for market intervention or other official settlement. Usually it is expected that a country must
possess reserves equal to three months import bill.
The Basic Balance:
The basic balance is the sum of the current account and capital account, when the two sides of the current
and capital accounts are equal i.e. when the difference between the two is equal to zero, the basic balance is
achieved. An increase in deficit or reduction in surplus or a move from surplus to deficit is considered
worsening of the basic balance. Basic balance as Bo Sodersten points out need not necessarily be a happy
state of affairs. A basic balance achieved through long term borrowing from abroad may lead to future
problems at the time of repayment. Similarly an outflow of capital may indicate a deficit but may earn
profits and dividends in the future which will help improve the current account balance.

Deficits and Surpluses

The balance of payments always balances in a technical or accounting sense. The balance in the balance of
payment implies that a net credit in any one of the items must have a counterpart net debit in another. When
the total credits and debits of all accounts balance, we say the balance of payments balances. A clear picture
of deficit or surplus is revealed when we examine the balance of payment statement splitting it vertically into
current account and capital account. It is the current account that the surplus or deficit becomes more
evident. A current account surplus is achieved when the exports of goods and services are greater than their
imports. A reverse situation results in deficit. If the current account deficit has to be corrected by
accommodating inflow of capital, the balance of payments is in deficit. In other words if the autonomous
receipts are less than the autonomous payments, the balance of payments is said to be in deficit. It is in
surplus when such receipts are more than the payments.
The balance of payments, also known as balance of international payments and abbreviated BP, of a
country is the record of all economic transactions between the residents of the country and the rest of the
world in a particular period (over a quarter of a year or more commonly over a year). These transactions are
made by individuals, firms and government bodies. Thus the balance of payments includes all external
visible and non-visible transactions of a country. It represents a summation of countrys current demand and
supply of the claims on foreign currencies and of foreign claims on its currency.
These transactions include payments for the countrys exports and imports of goods, services, financial
capital, and financial transfers. It is prepared in a single currency, typically the domestic currency for the
country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments,
are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries,
are recorded as negative or deficit items.
When all components of the BOP accounts are included they must sum to zero with no overall surplus or
deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the
shortfall will have to be counterbalanced in other ways such as by funds earned from its foreign
investments, by running down central bank reserves or by receiving loans from other countries.
While the overall BOP accounts will always balance when all types of payments are included, imbalances
are possible on individual elements of the BOP, such as the current account, the capital account excluding
the central banks reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus
countries accumulating wealth, while deficit nations become increasingly indebted. The term balance of
payments often refers to this sum: a countrys balance of payments is said to be in surplus (equivalently, the

balance of payments is positive) by a specific amount if sources of funds (such as export goods sold and
bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds
purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said
to be negative) if the former are less than the latter. A BOP surplus (or deficit) is accompanied by an
accumulation (or decumulation) of foreign exchange reserves by the central bank.
Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net
inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to
match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate
between the countrys currency and other currencies. Then the net change per year in the central banks
foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a
fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at
the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a
pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be
set by the market, and the central banks foreign exchange reserves do not change, and the balance of
payments is always zero.

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 dont give rise to future
The capital account records the net change in ownership of foreign assets. It includes the reserve account
(the foreign exchange market operations of a nations central bank), along with loans and investments
between the country and the rest of world (but not the future interest payments and dividends that the loans
and investments yield; those are earnings and will be recorded in the current account). If a country purchases
more foreign assets for cash than the assets it sells for cash to other countries, the capital account is said to
be negative or in deficit.
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 states 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 isnt 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 countrys 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

o Exports a credit entry
o Imports a debit entry
Trade balance the sum of Exports and Imports
Factor income repayments and dividends from loans and investments
o Factor earnings a credit entry
o 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


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 arent 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 nations 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 has 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.
The IMF definition of Balance of Payment
The International Monetary Fund (IMF) use a particular set of definitions for the BOP accounts, which is
also used by the Organization for Economic Co-operation and Development (OECD), and the United
Nations System of National Accounts (SNA).
The main difference in the IMFs terminology is that it uses the term financial account to capture
transactions that would under alternative definitions be recorded in the capital account. The IMF uses the
term capital account to designate a subset of transactions that, according to other usage, form a small part of
the overall capital account. The IMF separates these transactions out to form an additional top level division
of the BOP accounts. Expressed with the IMF definition, the BOP identity can be written:

The IMF uses the term current account with the same meaning as that used by other organizations, although
it has its own names for its three leading sub-divisions, which are:

The goods and services account (the overall trade balance)

The primary income account (factor income such as from loans and investments)
The secondary income account (transfer payments)

Balance of payments is also known as balance of international trade

While the BOP has to balance overall, surpluses or deficits on its individual elements can lead to imbalances
between countries. In general there is concern over deficits in the current account. Countries with deficits in
their current accounts will build up increasing debt and/or see increased foreign ownership of their assets.
The types of deficits that typically raise concern are

A visible trade deficit where a nation is importing more physical goods than it exports (even if this is

balanced by the other components of the current account.)

An overall current account deficit.
A basic deficit which is the current account plus foreign direct investment (but excluding other
elements of the capital account like short terms loans and the reserve account.)

As discussed in the history section below, the Washington Consensus period saw a swing of opinion towards
the view that there is no need to worry about imbalances. Opinion swung back in the opposite direction in
the wake of financial crisis of 20072009. Mainstream opinion expressed by the leading financial press and
economists, international bodies like the IMF as well as leaders of surplus and deficit countries has
returned to the view that large current account imbalances do matter. Some economists do, however, remain
relatively unconcerned about imbalances and there have been assertions, such as by Michael P. Dooley,
David Folkerts-Landau and Peter Garber, that nations need to avoid temptation to switch to protectionism as
a means to correct imbalances.
Current account surpluses are facing current account deficits of other countries, the indebtedness of which
towards abroad therefore increases. According to Balances Mechanics by Wolfgang Sttzel this is described
as surplus of expenses over the revenues. Increasing imbalances in foreign trade are critically discussed as a
possible cause of the financial crisis since 2007. Many Keynesian economists consider the existing
differences between the current accounts in the Eurozone to be the root cause of the Euro crisis, for instance
Heiner Flassbeck, Paul Krugman or Joseph Stiglitz.
Causes of BOP imbalances

There are conflicting views as to the primary cause of BOP imbalances, with much attention on the US
which currently has by far the biggest deficit. The conventional view is that current account factors are the
primary cause these include the exchange rate, the governments fiscal deficit, business competitiveness,
and private behavior such as the willingness of consumers to go into debt to finance extra consumption. An
alternative view, argued at length in a 2005 paper by Ben Bernanke, is that the primary driver is the capital
account, where a global savings glut caused by savers in surplus countries, runs ahead of the available
investment opportunities, and is pushed into the US resulting in excess consumption and asset price
Reserve asset
In the context of BOP and international monetary systems, the reserve asset is the currency or other store of
value that is primarily used by nations for their foreign reserves. BOP imbalances tend to manifest as hoards
of the reserve asset being amassed by surplus countries, with deficit countries building debts denominated in
the reserve asset or at least depleting their supply. Under a gold standard, the reserve asset for all members of
the standard is gold. In the Bretton Woods system, either gold or the U.S. dollar could serve as the reserve
asset, though its smooth operation depended on countries apart from the US choosing to keep most of their
holdings in dollars.
Following the ending of Bretton Woods, there has been no de jure reserve asset, but the US dollar has
remained by far the principal de facto reserve. Global reserves rose sharply in the first decade of the 21 st
century, partly as a result of the 1997 Asian Financial Crisis, where several nations ran out of foreign
currency needed for essential imports and thus had to accept deals on unfavorable terms. The International
Monetary Fund (IMF) estimates that between 2000 to mid-2009, official reserves rose from $1,900bn to
$6,800bn. Global reserves had peaked at about $7,500bn in mid-2008, then declined by about $430bn as
countries without their own reserve currency used them to shield themselves from the worst effects of the
financial crisis. From Feb 2009 global reserves began increasing again to reach close to $9,200bn by the end
of 2010.
As of 2009, approximately 65% of the worlds $6,800bn total is held in U.S. dollars and approximately 25%
in euros. The UK pound, Japanese yen, IMF special drawing rights (SDRs), and precious metals also play a
role. In 2009, Zhou Xiaochuan, governor of the Peoples Bank of China, proposed a gradual move towards
increased use of SDRs, and also for the national currencies backing SDRs to be expanded to include the
currencies of all major economies. Dr. Zhous proposal has been described as one of the most significant
ideas expressed in 2009.

While the current central role of the dollar does give the US some advantages, such as lower cost of
borrowings, it also contributes to the pressure causing the U.S. to run a current account deficit, due to the
Triffin dilemma. In a November 2009 article published in Foreign Affairs magazine, economist C. Fred
Bergsten argued that Dr. Zhous suggestion or a similar change to the international monetary system would
be in the United States best interests as well as the rest of the worlds. Since 2009 there has been a notable
increase in the number of new bilateral agreements which enable international trades to be transacted using a
currency that isnt a traditional reserve asset, such as the renminbi, as the Settlement currency.
Balance of payments crisis
A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or
service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected
nations currency. Crises are generally preceded by large capital inflows, which are associated at first with
rapid economic growth. However a point is reached where overseas investors become concerned about the
level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound
capital flows are associated with a rapid drop in the value of the affected nations currency. This causes
issues for firms of the affected nation who have received the inbound investments and loans, as the revenue
of those firms is typically mostly derived domestically but their debts are often denominated in a reserve
currency. Once the nations government has exhausted its foreign reserves trying to support the value of the
domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further
declines in the value of its currency, but while this can help those with debts denominated in foreign
currencies, it generally further depresses the local economy.

One of the three fundamental functions of an international monetary system is to provide mechanisms to
correct imbalances.
Broadly speaking, there are three possible methods to correct BOP imbalances, though in practice a mixture
including some degree of at least the first two methods tends to be used. These methods are adjustments of
exchange rates; adjustment of a nations internal price along with its levels of demand; and rules based
adjustment. Improving productivity and hence competitiveness can also help, as can increasing the
desirability of exports through other means, though it is generally assumed a nation is always trying to
develop and sell its products to the best of its abilities.
Rebalancing by changing the exchange rate

An upwards shift in the value of a nations currency relative to others will make a nations exports less
competitive and make imports cheaper and so will tend to correct a current account surplus. It also tends to
make investment flows into the capital account less attractive so will help with a surplus there too.
Conversely a downward shift in the value of a nations currency makes it more expensive for its citizens to
buy imports and increases the competitiveness of their exports, thus helping to correct a deficit (though the
solution often doesnt have a positive impact immediately due to the MarshallLerner condition).
Exchange rates can be adjusted by government in a rules based or managed currency regime, and when left
to float freely in the market they also tend to change in the direction that will restore balance. When a
country is selling more than it imports, the demand for its currency will tend to increase as other countries
ultimately need the selling countrys currency to make payments for the exports. The extra demand tends to
cause a rise of the currencys price relative to others. When a country is importing more than it exports, the
supply of its own currency on the international market tends to increase as it tries to exchange it for foreign
currency to pay for its imports, and this extra supply tends to cause the price to fall. BOP effects are not the
only market influence on exchange rates however; they are also influenced by differences in national interest
rates and by speculation.
Rebalancing by adjusting internal prices and demand
When exchange rates are fixed by a rigid gold standard, or when imbalances exist between members of a
currency union such as the Eurozone, the standard approach to correct imbalances is by making changes to
the domestic economy. To a large degree, the change is optional for the surplus country, but compulsory for
the deficit country. In the case of a gold standard, the mechanism is largely automatic. When a country has a
favorable trade balance, as a consequence of selling more than it buys it will experience a net inflow of gold.
The natural effect of this will be to increase the money supply, which leads to inflation and an increase in
prices, which then tends to make its goods less competitive and so will decrease its trade surplus. However
the nation has the option of taking the gold out of economy (sterilizing the inflationary effect) thus building
up a hoard of gold and retaining its favorable balance of payments. On the other hand, if a country has an
adverse BOP it will experience a net loss of gold, which will automatically have a deflationary effect, unless
it chooses to leave the gold standard. Prices will be reduced, making its exports more competitive, and thus
correcting the imbalance. While the gold standard is generally considered to have been successful up until
1914, correction by deflation to the degree required by the large imbalances that arose after WWI proved
painful, with deflationary policies contributing to prolonged unemployment but not re-establishing balance.
Apart from the US most former members had left the gold standard by the mid-1930s.

A possible method for surplus countries such as Germany to contribute to re-balancing efforts when
exchange rate adjustment is not suitable is to increase its level of internal demand (i.e. its spending on
goods). While a current account surplus is commonly understood as the excess of earnings over spending, an
alternative expression is that it is the excess of savings over investment. That is:

Where CA = current account, NS = national savings (private plus government sector), NI = national
If a nation is earning more than it spends the net effect will be to build up savings, except to the extent that
those savings are being used for investment. If consumers can be encouraged to spend more instead of
saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert
more of their profits to investment, then any current account surplus will tend to be reduced. However, in
2009 Germany amended its constitution to prohibit running a deficit greater than 0.35% of its GDP and calls
to reduce its surplus by increasing demand have not been welcome by officials, adding to fears that the
2010s will not be an easy decade for the Eurozone. In their April 2010 world economic outlook report, the
IMF presented a study showing how with the right choice of policy options governments can transition out
of a sustained current account surplus with no negative effect on growth and with a positive impact on
Rules based rebalancing mechanisms
Nations can agree to fix their exchange rates against each other, and then correct any imbalances that arise
by rules based and negotiated exchange rate changes and other methods. The Bretton Woods system of fixed
but adjustable exchange rates was an example of a rules based system. John Maynard Keynes, one of the
architects of the Bretton Woods system had wanted additional rules to encourage surplus countries to share
the burden of rebalancing, as he argued that they were in a stronger position to do so and as he regarded their
surpluses as negative externalities imposed on the global economy. Keynes suggested that traditional
balancing mechanisms should be supplemented by the threat of confiscation of a portion of excess revenue if
the surplus country did not choose to spend it on additional imports. However his ideas were not accepted by
the Americans at the time. In 2008 and 2009, American economist Paul Davidson had been promoting his
revamped form of Keyness plan as a possible solution to global imbalances which in his opinion would
expand growth all rounds without the downside risk of other rebalancing methods.


Historically, accurate balance of payments figures were not generally available. However, this did not
prevent a number of switches in opinion on questions relating to whether or not a nations government should
use policy to encourage a favorable balance.
Pre-1820: mercantilism
Up until the early 19th century, international trade was generally very small in comparison with national
output, and was often heavily regulated. In the middle Ages, European trade was typically regulated at
municipal level in the interests of security for local industry and for established merchants. From about the
16th century, mercantilism became the dominant economic theory influencing European rulers, which saw
local regulation replaced by national rules aiming to harness the countries economic output. Measures to
promote a trade surplus such as tariffs were generally favored. Power was associated with wealth, and with
low levels of growth, nations were best able to accumulate funds either by running trade surpluses or by
forcefully confiscating the wealth of others. Rulers sometimes strove to have their countries outsell
competitors and so build up a war chest of gold.
This era saw low levels of economic growth; average global per capita income is not considered to have
significantly risen in the whole 800 years leading up to 1820, and is estimated to have increased on average
by less than 0.1% per year between 1700 and 1820. With very low levels of financial integration between
nations and with international trade generally making up a low proportion of individual nations GDP, BOP
crises were very rare.
18201914: free trade
From the late 18th century, mercantilism was challenged by the ideas of Adam Smith and other economic
thinkers favoring free trade. After victory in the Napoleonic wars Great Britain began promoting free trade,
unilaterally reducing her trade tariffs. Hoarding of gold was no longer encouraged, and in fact Britain
exported more capital as a percentage of her national income than any other creditor nation has since. Great
Britains capital exports further helped to correct global imbalances as they tended to be counter cyclical,
rising when Britains economy went into recession, thus compensating other states for income lost from
export of goods.
According to historian Carroll Quigley, Great Britain could afford to act benevolently in the 19 th century due
to the advantages of her geographical location, its naval power and economic ascendancy as the first nation
to enjoy an industrial revolution. A view advanced by economists such as Barry Eichengreen is that the first
age of Globalization began with the laying of transatlantic cables in the 1860s, which facilitated a rapid
increase in the already growing trade between Britain and America.

Though Current Account controls were still widely used (in fact all industrial nations apart from Great
Britain and the Netherlands actually increased their tariffs and quotas in the decades leading up to 1914,
though this was motivated more by a desire to protect infant industries than to encourage a trade surplus),
capital controls were largely absent, and people were generally free to cross international borders without
requiring passports.
A gold standard enjoyed wide international participation especially from 1870, further contributing to close
economic integration between nations. The period saw substantial global growth, in particular for the volume
of international trade which grew tenfold between 1820 and 1870 and then by about 4% annually from 1870
to 1914. BOP crises began to occur, though less frequently than was to be the case for the remainder of the
20th century. From 1880 to 1914, there were approximately 8 BOP crises and 8 twin crises a twin crises
being a BOP crises that coincides with a banking crises.
19141945: delocalization
The favorable economic conditions that had prevailed up until 1914 were shattered by the First World War,
and efforts to re-establish them in the 1920s were not successful. Several countries rejoined the gold
standard around 1925. But surplus countries didnt play by the rules, sterilizing gold inflows to a much
greater degree than had been the case in the pre-war period. Deficit nations such as Great Britain found it
harder to adjust by deflation as workers were more enfranchised and unions in particular were able to resist
downwards pressure on wages. During the Great Depression most countries abandoned the gold standard,
but imbalances remained an issue and international trade declined sharply. There was a return to mercantilist
type beggar thy neighbor policies, with countries competitively devaluing their exchange rates, thus
effectively competing to export unemployment. There were approximately 16 BOP crises and 15 twin crises
(and a comparatively very high level of banking crises.)
19451971: Bretton Woods
Following World War II, the Bretton Woods institutions (the International Monetary Fund and World Bank)
were set up to support an international monetary system designed to encourage free trade while also offering
states options to correct imbalances without having to deflate their economies. Fixed but flexible exchange
rates were established, with the system anchored by the dollar which alone remained convertible into gold.
The Bretton Woods system ushered in a period of high global growth, known as the Golden Age of
Capitalism, however it came under pressure due to the inability or unwillingness of governments to maintain
effective capital controls and due to instabilities related to the central role of the dollar.

Imbalances caused gold to flow out of the US and a loss of confidence in the United States ability to supply
gold for all future claims by dollar holders resulted in escalating demands to convert dollars, ultimately
causing the US to end the convertibility of the dollar into gold, thus ending the Bretton Woods system. The
194571 eras saw approximately 24 BOP crises and no twin crises for advanced economies, with emerging
economies seeing 16 BOP crises and just one twin crises.
19712009: transition, Washington Consensus, Bretton Woods II
The Bretton Woods system came to an end between 1971 and 1973. There were attempts to repair the system
of fixed exchange rates over the next few years, but these were soon abandoned, as were determined efforts
for the U.S. to avoid BOP imbalances. Part of the reason was displacement of the previous dominant
economic paradigm Keynesianism by the Washington Consensus, with economists and economics
writers such as Murray Rothbard and Milton Friedman arguing that there was no great need to be concerned
about BOP issues.
In the immediate aftermath of the Bretton Woods collapse, countries generally tried to retain some control
over their exchange rate by independently managing it, or by intervening in the foreign exchange market as
part of a regional bloc, such as the Snake which formed in 1971. The Snake was a group of European
countries who tried to retain stable rates at least with each other; the group eventually evolved into the
European Exchange Rate Mechanism (ERM) by 1979. From the mid-1970s however, and especially in the
1980s and early 1990s, many other countries followed the US in liberalizing controls on both their capital
and current accounts, in adopting a somewhat relaxed attitude to their balance of payments and in allowing
the value of their currency to float relatively freely with exchange rates determined mostly by the market.
Developing countries that chose to allow the market to determine their exchange rates would often develop
sizeable current account deficits, financed by capital account inflows such as loans and investments, though
this often ended in crises when investors lost confidence. The frequency of crises was especially high for
developing economies in this era from 1973 to 1997 emerging economies suffered 57 BOP crises and 21
twin crises. Typically but not always the panic among foreign creditors and investors that preceded the crises
in this period was usually triggered by concerns over excess borrowing by the private sector, rather than by a
government deficit. For advanced economies, there were 30 BOP crises and 6 banking crises.
A turning point was the 1997 Asian BOP Crisis, where unsympathetic responses by western powers caused
policy makers in emerging economies to re-assess the wisdom of relying on the free market; by 1999 the
developing world as a whole stopped running current account deficits while the U.S. current account deficit
began to rise sharply. This new form of imbalance began to develop in part due to the increasing practice of

emerging economies, principally China, in pegging their currency against the dollar, rather than allowing the
value to freely float. The resulting state of affairs has been referred to as Bretton Woods II. According to
Alaistair Chan, At the heart of the imbalance is Chinas desire to keep the value of the yuan stable against
the dollar. Usually, a rising trade surplus leads to a rising value of the currency. A rising currency would
make exports more expensive, imports less so, and push the trade surplus towards balance. China
circumvents the process by intervening in exchange markets and keeping the value of the yuan depressed.
According to economics writer Martin Wolf, in the eight years leading up to 2007, three-quarters of the
foreign currency reserves accumulated since the beginning of time have been piled up. In contrast to the
changed approach within the emerging economies, US policy makers and economists remained relatively
unconcerned about BOP imbalances. In the early to mid-1990s, many free market economists and policy
makers such as U.S. Treasury secretary Paul ONeill and Fed Chairman Alan Greenspan went on record
suggesting the growing US deficit was not a major concern. While several emerging economies had
intervening to boost their reserves and assist their exporters from the late 1980s, they only began running a
net current account surplus after 1999. This was mirrored in the faster growth for the US current account
deficit from the same year, with surpluses, deficits and the associated buildup of reserves by the surplus
countries reaching record levels by the early 2000s and growing year by year. Some economists such as
Kenneth Rogoff and Maurice Obstfeld began warning that the record imbalances would soon need to be
addressed from as early as 2001, joined by Nouriel Roubini in 2004, but it was not until about 2007 that their
concerns began to be accepted by the majority of economists.
2009 and later: post Washington Consensus
Speaking after the 2009 G-20 London summit, Gordon Brown announced the Washington Consensus is
over. There is now broad agreement that large imbalances between different countries do matter; for
example mainstream U.S. economist C. Fred Bergsten has argued the U.S. deficit and the associated large
inbound capital flows into the U.S. was one of the causes of the financial crisis of 20072010. Since the
crisis, government intervention in BOP areas such as the imposition of capital controls or foreign exchange
market intervention has become more common and in general attracts less disapproval from economists,
international institutions like the IMF and other governments.
In 2007, when the crises began, the global total of yearly BOP imbalances was $1680 billion. On the credit
side, the biggest current account surplus was China with approx. $362 billion, followed by Japan at $213bn
and Germany at 185 billion, with oil producing countries such as Saudi Arabia also having large surpluses.
On the debit side, the US had the biggest current account deficit at over $1100 billion, with the UK, Spain
and Australia together accounting for close to a further $300 billion.

While there have been warnings of future cuts in public spending, deficit countries on the whole did not
make these in 2009, in fact the opposite happened with increased public spending contributing to recovery as
part of global efforts to increase demand. The emphases have instead been on the surplus countries, with the
IMF, EU and nations such as the U.S., Brazil and Russia asking them to assist with the adjustments to
correct the imbalances.
Economists such as Gregor Irwin and Philip R. Lane have suggested that increased use of pooled reserves
could help emerging economies not to require such large reserves and thus have less need for current account
surpluses. Writing for the FT in Jan 2009, Gillian Tett says she expects to see policy makers becoming
increasingly concerned about exchange rates over the coming year. In June 2009, Olivier Blanchard the chief
economist of the IMF wrote that rebalancing the world economy by reducing both sizeable surpluses and
deficits will be a requirement for sustained recovery.
In 2008 and 2009, there was some reduction in imbalances, but early indications towards the end of 2009
were that major imbalances such as the U.S. current account deficit are set to begin increasing again.
Japan had allowed her currency to appreciate through 2009, but has only limited scope to contribute to the
rebalancing efforts thanks in part to her aging population. The euro used by Germany is allowed to float
fairly freely in value, however further appreciation would be problematic for other members of the currency
union such as Spain, Greece and Ireland who run large deficits. Therefore, Germany has instead been asked
to contribute by further promoting internal demand, but this hasnt been welcomed by German officials.
China has been requested to allow the renminbi to appreciate but until 2010 had refused, the position
expressed by her premier Wen Jiabao being that by keeping the value of the renminbi stable against the
dollar China has been helping the global recovery, and that calls to let her currency rise in value have been
motivated by a desire to hold back Chinas development. After China reported favorable results for her
December 2009 exports however, the Financial Times reported that analysts are optimistic that China will
allow some appreciation of her currency around mid-2010.
In April 2010 a Chinese official signaled the government is considering allowing the renminbi to appreciate,
but by May analysts were widely reporting the appreciation would likely be delayed due to the falling value
of the Euro following the 2010 European sovereign debt crisis. China announced the end of the renminbis
peg to the dollar in June 2010; the move was widely welcomed by markets and helped defuse tension over
imbalances prior to the 2010 G-20 Toronto summit. However the renminbi remains managed and the new
flexibility mean it can move down as well as up in value; two months after the peg ended the renminbi had
only appreciated against the dollar by about 0.8%.

By January 2011, the renminbi had appreciated against the dollar by 3.7%, which means its on track to
appreciate in nominal terms by 6% per year. As this reflects a real appreciation of 10% when Chinas higher
inflation is accounted for, the U.S. Treasury once again declined to label China a currency manipulator in
their February 2011 report to Congress. However Treasury officials did advise the rate of appreciation was
still too slow for the best interests of the global economy.
In February 2011, Moodys analyst Alaistair Chan has predicted that despite a strong case for an upward
revaluation, an increased rate of appreciation against the dollar is unlikely in the short term. And as of
February 2012, Chinas currency had been continuing to appreciate for a year and a half, while drawing
remarkably little notice.
While some leading surplus countries including China have been taking steps to boost domestic demand,
these have not yet been sufficient to rebalance out of their current account surpluses. By June 2010, the U.S.
monthly current account deficit had risen back to $50 billion, a level not seen since mid-2008. With the US
currently suffering from high unemployment and concerned about taking on additional debt, fears are rising
that the US may resort to protectionist measures.
Competitive devaluation after 2009
By September 2010, international tensions relating to imbalances had further increased. Brazils finance
minister Guido Mantega declared that an international currency war has broken out, with countries
competitively trying to devalue their currency so as to boost exports. Brazil has been one of the few major
economies lacking a reserve currency to abstain from significant currency intervention, with the real rising
by 25% against the dollar since January 2009. Some economists such as Barry Eichengreen have argued that
competitive devaluation may be a good thing as the net result will effectively be equivalent to expansionary
global monetary policy. Others such as Martin Wolf saw risks of tensions further escalating and advocated
that coordinated action for addressing imbalances should be agreed on at the November G20 summit.
Commentators largely agreed that little substantive progress was made on imbalances at the November 2010
G20. An IMF report released after the summit warned that without additional progress there is a risk of
imbalances approximately doubling to reach pre-crises levels by 2014.


The Indias balance-of-payments (BoP) position improved dramatically in 2013-14, particularly in the last
three quarters. This owed in large part to measures taken by the government and the Reserve Bank of India
(RBI) and in some part to the overall macroeconomic slowdown that fed into the external sector. Current
account deficit (CAD) declined sharply from a record high of US$ 88.2 billion (4.7 per cent of gross
domestic product [GDP]) in 2012-13 to US$ 32.4 billion (1.7 per cent of GDP) in 2013-14. After staying at
perilously unsustainable levels of well over 4.0 per cent of GDP in 2011-12 and 2012-13, the improvement
in BoP position is a welcome relief, and there is need to sustain the position going forward. This is because
even as CAD came down, net capital flows moderated sharply from US$ 92.0 billion in 2012-13 to US$ 47.9
billion in 2013-14, that too after a special swap window of the RBI under the non-resident Indian (NRI)
scheme/overseas borrowings of banks alone yielded US$ 34.0 billion. This led to some increase in the level
of external debt, but it has remained at manageable levels. The large depreciation of the rupee during the
course of the year, notwithstanding sizeable accretion to reserves in 2013-14, could partly be attributed to
frictional forces and partly to the role of expectations in the forex market. The rupee has stabilized recently,
reflecting an overall sense of confidence in the forex market as in other financial markets of a change for
better economic prospects. There is a need to nurture and build upon this optimism through creation of an
enabling environment for investment inflows so as to sustain the external position in an as yet uncertain
global milieu.


A sharp improvement was seen in the outcome during 2013-14 with the CAD being contained at US$ 32.4
billion as against US$ 88.2 billion and US$ 78.2 billion respectively in 2012-13 and 2011-12. The stress in
Indias BoP, which was observed during 2011-12 as fallout of the euro zone crisis and inelastic domestic
demand for certain key imports, continued through 2012-13 and the first quarter of 2013-14. Capital flows
(net) to India, however, remained high and were sufficient to finance the elevated CAD in 2012-13, leading
to a small accretion to reserves of US$ 3.8 billion. A large part of the widening in the levels of the CAD in
2012-13 could be attributed to a rise in trade deficit arising from a weaker level of exports and a relatively
stable level of imports. The rise in imports owed to Indias dependence on crude petroleum oil imports and
elevated levels of gold imports since the onset of the global financial crisis. The levels of non-petroleum oil
lubricant (PoL) and non-gold and silver imports declined in 2012-13 and 2013-14.

Capital flows (net) moderated sharply from US$ 65.3 billion in 2011-12 and US$ 92.0 billion in 2012-13 to
US$ 47.9 billion in 2013-14. This moderation in levels essentially reflects a sharp slowdown in portfolio
investment and net outflow in short-term credit and other capital. However, there were large variations
within quarters in the last fiscal, which is explained partly by domestic and partly by external factors. In the
latter half of May 2013, the communication by US Fed about rolling back its programmed of asset purchases
was construed by markets as a sign of imminent action and funds began to be withdrawn from debt markets
worldwide, leading to a sharp depreciation in the currencies of EMEs. Those countries with large CADs saw
larger volumes of outflows and their currencies depreciated sharply. As India had a large trade deficit in the
first quarter, these negative market perceptions led to sharper outflows in the foreign institutional investors
(FIIs) investment debt segment leading to 13.0 per cent depreciation of the rupee between May 2013 and
August 2013.








Current account
















Trade balance







Invisibles (Net)



























Current account balance







Capital account


External assistance







External commercial borrowings







Short-term debt







Banking capital of which






Non-resident deposits







Foreign investment














Portfolio investment







Other flows






Capital account balance






Capital account (including errors &







Errors & omissions







Overall balance







Reserves change (-indicates increase,






+indicates decrease)
Source: Reserve Bank of India (RBI).
The government swiftly moved to correct the situation through restrictions in non-essential imports like
gold, customs duty hike in gold and silver to a peak of 10 per cent, and measures to augment capital flows
through quasi-sovereign bonds and liberalization of external commercial borrowings. The RBI also put in
place a special swap window for foreign currency non-resident deposit (banks) [(FCNR (B)] and banks
overseas borrowings through which US$ 34 billion was mobilized. Thus, excluding one-off receipts,
moderation in net capital inflows was that much greater in 2013-14. The one-off flows arrested the negative
market sentiments on the rupee and in tandem with improvements in the BoP position, led to a sharp
correction in the exchange rate and a net accretion to reserves of US$ 15.5 billion for 2013-14.


After registering strong growth in both imports and exports in 2011-12, merchandise trade (on BoP basis)
evidenced a slowdown in 2012-13 consisting of a decline in the levels of exports from US$ 309.8 billion in
2011-12 to US$ 306.6 billion and a modest rise in the level of imports to reach US$ 502.2 billion. This
resulted in a rise in trade deficit from US$ 189.8 billion in 2011-12 to US$ 195.7 billion in 2012-13. The
decline in exports owed largely to weak global demand arising from the slowdown in advanced economies
following the euro zone crisis, which could only be partly compensated by diversification of trade. Non-PoL
imports declined only marginally whereas PoL imports held up resulting in relatively stronger imports. Net
imports of PoL shot up to US$ 99.0 billion in 2011-12 initially on account of a spurt in crude oil prices
(Indian basket) and remained elevated at US$ 103.1 billion and US$ 102.4 billion in the next two years.
Similarly, gold and silver imports rose to a peak of US$ 61.6 billion in 2011-12 and moderated only
somewhat in 2012-13. Hence the wider and record high trade deficit in 2012-13.
With relatively static levels of net inflow under services and transfers, which are the two major components
(at about US$ 64 billion each), it was the net outflow in income (mainly investment income), which

explained the diminution in level of overall net invisibles balance. Net invisibles surplus was placed at US$
107.5 billion in 2012-13 as against US$ 111.6 billion in 2011-12. Software services continue to dominate the
non-factor services account and in 2012-13 grew by 4.2 per cent on net basis to yield US$ 63.5 billion with
other services broadly exhibiting no major shifts. In 2012-13, private transfers remained broadly at about the
same level as in 2011-12. Investment income which comprises repatriation of profits/interest, etc., booked as
outgo as per standard accounting practice, has been growing at a fast clip reflecting the large accumulation
of external financing of the CAD since 2011-12. Investment income (net) outgo constituted 25.4 per cent of
the CAD in 2012-13.
With trade deficit continuing to be elevated and widening somewhat and net invisibles balance going down,
the CAD widened from US$ 78.2 billion in 2011-12 to US$ 88.2 billion in 2012-13. As a proportion of GDP,
the CAD widened from 4.2 per cent in 2011-12 to a historic peak of 4.7 per cent in 2012-13. This rise also
owes to the fact that nominal GDP expressed in US dollar terms remained at broadly the same level of US$
1.8 trillion in both the years due to depreciation in the exchange rate of the rupee.


In terms of the major indicators, the broad trend witnessed since 2011-12 continued through to the first
quarter of 2013-14. With imports continuing to be at around US$ 120-130 billion per quarter for nine
quarters in a row and exports (except the last quarter of the two financial years) below US$ 80 billion for
most quarters, trade deficit remained elevated at around US$ 45 billion or higher per quarter for nine
quarters till April-June 2013. The widening of the trade deficit in the first quarter mainly owed to larger
imports of gold and silver in the first two months of 2013-14. In tandem with developments in the globe of a
market perception of imminence of tapering of asset purchases by the US Fed, the widening of the trade
deficit led to a sharp bout of depreciation in the rupee. This essentially reflected concerns about the
sustainability of the CAD in India. The government and RBI took a series of coordinated measures to
promote exports, curb imports particularly those of gold and non-essential goods, and enhance capital flows.
Consequently, there has been significant improvement on the external front. (The Mid-Year Economic
Analysis 2013-14 of the Ministry of Finance contains a detailed analysis of sustainability concerns and
measures taken.)
The measures taken led to a dramatic turnaround in the BoP position in the latter three quarters and for the
full fiscal 2013-14. There was significant pick-up in exports to about US$ 80 billion per quarter and
moderation in imports to US$ 114 billion per quarter in the latter three quarters. This led to significant
contraction in the trade deficit to US$ 30-33 billion per quarter in these three quarters. Overall this resulted

in an export performance of US$ 318.6 billion in 2013-14 as against US$ 306.6 billion in 2012-13; a
reduction in imports to US$ 466.2 billion from US$ 502.2 billion in 2012-13; and a reduction in trade deficit
to US$ 147.6 billion, which was lower by US$ 48 billion from the 2012-13 level. As a proportion of GDP,
trade deficit on BoP basis was 7.9 per cent of GDP in 2013-14 as against 10.5 per cent in 2012-13.
A decomposition of the performance of trade deficit in 2013- 14 vis--vis 2012-13 indicates that of the total
reduction of US$ 48.0 billion in trade deficit on BoP basis, reduction in imports of gold and silver
contributed approximately 47 per cent, reduction in non- PoL and non-gold imports constituted 40 per cent,
and change in exports constituted 25 per cent. Higher imports under PoL and non-DGCI&S (Directorate
General of Commercial Intelligence and Statistics) imports contributed negatively to the process of reduction
to the extent of 12 per cent in 2013-14 over 2012-13.
Net invisibles surplus remained stable at US$ 28-29 billion per quarter resulting in overall net surplus of
US$ 115.2 for 2013-14. Software services improved modestly from US$ 63.5 billion in 2012-13 to US$ 67.0
billion in 2013-14. Non-factor services however went up from US$ 64.9 billion in 2012-13 to US$ 73.0
billion partly on account of business services turning positive in all quarters with net inflows of US$ 1.3
billion in 2013-14 as against an outflow of US$ 1.9 billion in 2012-13. Business services have earlier been
positive in 2007-08 and 2008-09. Private transfers improved marginally to US$ 65.5 billion in 2013-14 from
US$ 64.3 billion in 2012-13. However, investment income outgo was placed at US$ 23.5 billion in 2013-14
as against US$ 22.4 billion in 2012-13. There has been an elevation in the levels of gross outflow in recent
quarters reflecting the large levels of net international investment position (IIP), which is an outcome of
elevated levels of net financing requirements in 2011-12 and 2012-13.
As an outcome of the foregoing development in the trade and invisibles accounts of the BoP, the CAD
moderated sharply in 2013-14 and was placed at US$ 32.4 billion as against US$ 88.2 billion in 2012-13. In
terms of quarterly outcome, the CAD was US$ 21.8 billion in April-June 2013 and moderated to around US$
5.2 billion in July-September 2013, US$ 4.1 billion in October-December 2013, and further to US$ 1.3
billion in January-March 2014. As a proportion of GDP, the CAD was 1.7 per cent in 2013-14, which when
adjusted for exchange rate depreciation compares favorably with the levels achieved in the pre-2008 crisis


In terms of macroeconomic identity, the resource expenditure imbalance in one sector needs to be financed
through recourse to borrowing from other sectors and the persistence of high CAD requires adequate net
capital/financial flows into India. Any imbalance in demand and supply of foreign exchange, even if

frictional or cyclical, would lead to a change in the exchange rate of the rupee. For analytical purposes, it
would be useful to classify these flows in a 2X2 scheme in terms of short-term and long-term, and debt and
non-debt flows. This scheme of classification can be analyzed in terms of the nature of flows as stable or
In the hierarchy of preference for financing stable investment flows like foreign direct investment (FDI) and
stable debt flows like external assistance, external commercial borrowings (ECBs), and NRI deposits which
entail rupee expenditure that is locally withdrawn rank high. The most volatile flow is the FII variety of
investment, followed by short-term debt and FCNR deposits. While FII on a net yearly basis has remained
more or less positive since the 2008 crisis, it has large cyclical swings and entails large volumes in terms of
gross flows to deliver one unit of net inflow. Given this, it can be seen that post-1990 and prior to the global
financial crisis, broadly the CAD remained at moderate levels and was easily financed. In fact the focus of
the RBI immediately prior to the crisis was on managing the exchange rate and mopping up excess capital
flows. Post-2008 crisis, the CAD has remained elevated at many times the pre-2008 levels.
In 2012-13, net capital inflows were placed at US$ 92.0 billion and were led by FII inflows (net) of US$
27.6 billion and short-term debt (net) of US$ 21.7 billion. There were, besides, large overseas borrowings by
banks together indicating the dependence on volatile sources of financing. On a yearly basis, FII (net) flows
remained at high levels post-2008 crisis on account of the fact that foreign investors had put faith in the
returns from emerging economies, which exhibited resilience to the global crisis in 2009. There was some
diminution in net inflows in 2011-12 on account of the euro zone crisis. On an intra-year basis, there was
significant change in FII flows due to perceptions of changing risks which had a knock-on effect on the
exchange rate of the rupee given the large financing need.
While the declining trend in net flows under ECB since 2010-11 continued in 2012-13, growing dependence
on trade credit for imports was reflected in a sharp rise in net trade credit availed to US$ 21.7 billion in
2012-13 from US$ 6.7 billion in 2011-12. In net terms, capital inflows increased significantly by 40.9 per
cent to US$ 92.0 billion (4.9 per cent of GDP) in 2012-13 as compared to US$ 65.3 billion (3.5 per cent of
GDP) during 2011-12. Capital inflows were adequate for financing the higher CAD and there was net
accretion to foreign exchange reserves to the extent of US$ 3.8 billion in 2012-13. However, intra-year in the
first three quarters, though there were higher flows quarter-on-quarter, the levels of net capital flows fell
short or were barely adequate for financing the CAD but in the fourth quarter while the levels of net capital
flows plummeted, the CAD moderated relatively more sharply leading to a reserve accretion of US$ 2.7


Outcomes in 2013-14 were a mixed bag. The higher CAD in the first quarter of 2013-14 was financed to a
large extent by capital flows; but the moderation observed in the fourth quarter of 2012-13 continued
through 2013-14. The communication by the US Fed in May 2013 about its intent to roll back its assets
purchases and market reaction thereto led to a sizeable capital outflow from forex markets around the world.
This was more pronounced in the debt segment of FII. In the event, even though there was a drastic fall in
the CAD in July-September 2013, net capital inflows became negative leading to a large reserve drawdown
of US$ 10.4 billion in that quarter. FDI net inflows continued to be buoyant with steady inflows into India
backed by low outgo of outward FDI in the first two quarters. In the third quarter, while there was
turnaround in the flows of FIIs and copious inflows under NRI deposits in response to the special swap
facility of the RBI and banks overseas borrowing programme, there was some diminution in the levels of
other flows. This led to a reserve accretion of US$ 19.1 billion in the third quarter notwithstanding that the
copious proceeds of the special swap windows of the RBI directly flowed to forex reserves of the RBI. In the
fourth quarter, while FDI inflow slowed, higher outflow on account of overseas FDI together with outflow of
short-term credit moderated the net capital inflows into India.
Thus for the year as a whole, net capital inflow was placed at US$ 47.9 billion as against US$ 92.0 billion in
the previous year. While net FDI was placed at US$ 21.6 billion, portfolio investment (mainly FII) at US$
4.8 billion, ECBs at US$ 11.8 billion, and NRI deposits at US$ 38.9 billion, there were significant outflows
on account of short-term credit at US$ 5.0 billion, banking capital assets at US$ 6.6 billion, and other capital
at US$ 10.8 billion. The net capital inflows in tandem with the level of CAD led to a reserve accretion of
US$ 15.5 billion on BoP basis in 2013-14. The accretion to reserves on BoP basis helped in increasing the
level of foreign exchange reserves above the US$ 300 billion mark at end March 2014.


Change in foreign exchange reserves can be decomposed into change in reserves on BoP basis and valuation
changes in the assets held by the RBI, which are denominated in US dollars. As against a reserve accretion
of US$ 15.5 billion on BoP basis as at end March 2014, foreign exchange reserves in nominal terms
increased by only US$ 12.2 billion as there was a valuation loss in the non-US dollar assets held owing to
cross-currency movements and the decline in gold prices. As at end May 2014, foreign exchange reserves
stood at US$ 312.2 billion.
Sl. No.

Year (at








in reserves on BoP basis

rease (-) in



Source: Reserve Bank of India (RBI).

in reserves over
previous year

reserves due to

valuation effect

Foreign exchange reserves were placed at US$ 304.2 billion at end March 2014 as against a level of US$
292.0 billion at end March 2013. Foreign currency assets are the main component of foreign exchange
reserves and were US$ 276.4 billion at end March 2014. A second major component of the reserves was gold
valued at US$ 21.6 billion at end March 2014, lower than at end March 2013. Special drawing rights (SDRs)
and the reserve tranche position in the IMF were at US$ 4.5 billion and US$ 1.8 billion respectively at end
March 2014.
India continues to be one of the countries that have sizeable foreign exchange reserves particularly
considering that some of the other major reserve holders are nations with large current account surpluses.
Intervention in the foreign exchange markets by the RBI so as to manage the exchange rate of the rupee and
guard against volatility without targeting a specific rate is behind the accumulation of reserves generally; in
the specific context of developments in 2013-14, the intervention was to provide a measure of comfort
against the elevated levels of vulnerability indicators which are expressed as proportions of reserves.

The vulnerability of the rupee as well as the currencies of other emerging market and developing economies
came to the fore in May 2013 as a result of the announcement by US Fed about tapering of its asset
purchases. While capital flows on a net basis continued to be broadly adequate at that time, the rupee
depreciated sharply on the vulnerability concerns affecting expectations on the rupee emanating from the
confluence of factors of elevated CAD and large withdrawal from the FII debt segment. However, the rupee
became resilient when the US Fed taper actually happened subsequently.
In 2013-14, the rupee started to depreciate on a month-on-month basis starting May 2013. This process of
depreciation was more pronounced in June 2013 and August 2013 when there were large depreciation in
excess of 5 per cent on a month-on-month basis. The average exchange rate of the rupee reached a peak in
September 2013 at ` 63.75 per US dollar. Thereafter, on the strength of the measures taken by the
government to reduce the CAD and the RBI and government to boost capital flows, the rupee rebounded to

reach an average level of ` 61.62 per US dollar in the month of October 2013. The rupee has subsequently
been range bound and stable in 2013-14.
The annual average exchange rate of the rupee went up from ` 45.56 per US dollar in 2010-11 to ` 47.92 per
US dollar in 2011-12 and further to ` 54.41 per US dollar in 2012-13. It rose to reach an average of ` 60.50
per US dollar in 2013-14. The intra-year levels of depreciation have been sharper in some months; but
exhibit two-way movements within the broad rising trend. While the depreciation could in part be explained
by the levels of CAD and its financing by net capital flows, the movement in monthly average exchange
rates in the latter half of 2013-14 also reflects the levels of intervention by the RBI to shore up its reserves,
which had been rundown in the initial parts of the year. The exchange rate in 2014-15 reflects the same
pattern as in the latter half of 2013-14 with a surge in FII flows impacting the foreign exchange and equity
markets favorably; but the rupee appreciation has been limited relative to the rise in equity indices. The
levels of the rupee exchange rate ought to reflect the fundamentals of the BoP as per the tenets of
equilibrium exchange rate and in this regard, real exchange rates are indicators that need to be looked at.
The real effective exchange rate (REER) is a measure of real exchange rate and is defined as a weighted
average (geometric mean) of nominal exchange rates adjusted for relative price differential between India
and its major trade partners. The REER is an indicator of the competitiveness of the country. Earlier, as there
was no single composite consumer price index (CPI) in the country, the RBI used the wholesale price index
(WPI) as the measure in the price ratio to publish the REER. With the CPI new series of the Central
Statistics Office (CSO) being made available, the RBI has used it to compute the REER indices of the Indian
The rupee is considered to be fairly valued if the REER is close to 100 or the base-year value. Other things
remaining same, higher domestic inflation vis--vis its trade partners will reflect in appreciation of the
REER and hence there is a view that the nominal exchange rate should depreciate to keep it at base-year
levels. As evident from movements in the REER (base 2004-05 = 100) based on the CPI, there is
overvaluation of the rupee even though there is a broad depreciating trend in the first half of the year. The
levels of overvaluation are much higher in terms of six-currency export-based weights. However, in terms of
the REER with base year 2012-13, there is depreciation and consequently the rupee is undervalued.
Therefore, the choice of base year and currencies used in the basket is important in the context of analysis of
the REER. A recent article in Business Standard (OP-Ed dated 23.6.2014) by Martin Kessler and Arvind
Subramanian applying the purchasing power parity (PPP) approach and using the latest PPP estimates of the
World Bank finds that the rupee is persistently undervalued in excess of 30 per cent of its equilibrium value.

As the net capital flows that were incentivized to shore up the exchange rate of the rupee were of the debt
variety, this had implications for the level of external debt.

Indias external debt has remained within manageable limits due to the external debt management policy
with prudential restrictions on debt varieties of capital inflows given the large interest differentials. Indias
external debt stock at end March 2013 stood at US$ 404.9 billion (` 2,200,410 crore), recording an increase
of US$ 44.1 billion (12.2 per cent) over the end March 2012 level of US$ 360.8 billion (` 1,844,167 crore).
External debt (both at end March 2013 and end March 2012) is higher than reported earlier in various
publications owing to the inclusion of securitized borrowings of banks as reported by the RBI in its external
debt statistics. Component-wise, long-term debt increased by 9.1 per cent to US$ 308.2 billion at end March
2013 from US$ 282.6 billion at end March 2012, while short-term debt (refers to such debt in terms of
original maturity unless otherwise stated) increased by 23.7 per cent to US$ 96.7 billion from US$ 78.2
billion at end March 2012, reflecting elevated levels of imports.
Indias external debt stock went up by about US$ 21.1 billion (5.2 per cent) over the end March 2013 levels
to reach US$ 426.0 billion at end December 2013. The rise in external debt is largely composed of long-term
debt, particularly NRI deposits. A sharp increase in NRI deposits reflected the fresh FCNR (B) deposits
mobilized under the swap scheme during September-November 2013 which has been detailed in earlier
sections of this chapter.
Indias external debt continues to preponderantly consist of long-term borrowings. Long-term external debt
at US$ 333.3 billion at end December 2013, accounted for 78.2 per cent of total external debt, the remaining
21.8 per cent being constituted of short-term debt. Long-term debt at end December 2013 increased by US$
25.1 billion (8.1 per cent) over the level at end March 2013, while short-term debt declined by US$ 4.0
billion (4.1 per cent), reflecting the fall in the levels of imports.
ECBs, NRI deposits, and multilateral borrowings, which are the major components of long-term debt,
accounted for 67.0 per cent of total external debt, while the other components (namely bilateral borrowings,
export credit, and IMF and rupee debt) accounted for 11.2 per cent. Thus long-term debt, all its components
taken together, accounted for 78.2 per cent of total external debt, while the remaining 21.8 per cent
comprised short-term debt at end December 2013.
The dominance of US dollar-denominated debt in the currency composition of Indias total external debt at
end December 2013 continued with such debt at 63.6 per cent of the total, followed by debt denominated in

Indian rupee (19.4 per cent), SDR (7.1 per cent), Japanese Yen (5.0 per cent), and Euro (3.1 per cent). The
currency composition of government (sovereign) external debt presents a different picture with
predominance of SDR-denominated debt (39.3 per cent), which is attributed to borrowing from the
International Development Association (IDA), the soft loan window of the World Bank under multilateral
agencies and SDR allocations by the IMF, followed by government debt denominated in US dollar (27.9 per
cent), Japanese yen (16.5 per cent), Indian rupee (12.4), and Euro (3.9). At end December 2013, government
(sovereign) external debt was US$ 76.4 billion, accounting for 17.9 per cent of Indias total external debt,
while non-government external debt was US$ 349.5 billion, accounting for 82.1 per cent of the total.
Over the years, Indias external debt stock has witnessed a structural change in composition. The share of
concessional in total debt has declined on account of the shrinking share of official creditors and government
debt and the surge in non-concessional private debt. The proportion of concessional debt in total debt
declined from 42.9 per cent (average) during the period 1991-2000 to 28.1 per cent in 2001-10 and further to
10.6 per cent at end December 2013. The increasing importance of non-government debt is evident from the
fact that such debt accounted for 65.6 per cent of total debt during the 2000s as against 45.3 per cent in the
1990s. Non-government debt accounted for over 70 per cent of total debt in the last five years and stood at
82.1 per cent as at end December 2013.
As there were renewed concerns about external vulnerabilities in the context of monetary policy action in
systemically important economies, it would be useful to look at some key external debt indicators, some of
which are traditional indicators and only provide a sense of comfort. Indias foreign exchange reserves
provided a cover of 69.0 per cent to the total external debt stock at end December 2013 vis--vis 72.1 per
cent at end March 2013. The ratio of short-term external debt to foreign exchange reserves was 31.5 per cent
at end December 2013 as compared to 33.1 per cent at end March 2013. The ratio of concessional debt to
total external debt declined steadily and was 10.6 per cent at end December 2013 against 11.2 per cent at end
March 2013.

A cross-country comparison of total external debt of the 20 most indebted developing countries, based on the
World Banks International Debt Statistics 2014 which contains data on external debt for the year 2012,
showed that Indias position was third in terms of absolute external debt stock, after China and Brazil. The
ratio of Indias external debt stock to gross national income (GNI) at 20.8 per cent was the fourth lowest
with China having the lowest ratio at 9.2 per cent. In terms of the cover of external debt provided by foreign
exchange reserves, Indias position was seventh at 71.4 per cent.


A country engaged in foreign trade receives payments from countries to which it exports goods and

services and requires making payments to those nations from where it imports.
The balance of payments account records all the transactions between the residents of reporting

(domestic) country and the residents of foreign countries (rest of the world).
The current account includes all items which give rise to or use up national income.
The balance of exports and imports of goods is referred as balance of trade or balance of visible trade

or balance of merchandise trade.

The capital account transaction is concerned with the asset related flow as against current account

which is income related flow.

Portfolio investment refers to the acquisition of financial assets in foreign countries.
Statistical discrepancies are unavoidable components of any balance of payments statements;

however, they do not invalidate the reliability of a balance of payments statement.

The basic balance is the sum of the current account and capital account, when the two sides of the
current and capital accounts are equal i.e. when the difference between the two is equal to zero, the

basic balance is achieved.

When all components of the BOP accounts are included they must sum to zero with no overall

surplus or deficit.
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.
There are conflicting views as to the primary cause of BOP imbalances, with much attention on the

US which currently has by far the biggest deficit.

On the credit side, the biggest current account surplus was China with approx.
A decomposition of the performance of trade deficit in 2013- 14 vis--vis 2012-13 indicates that of
the total reduction of US$ 48.0 billion in trade deficit on BoP basis, reduction in imports of gold and
silver contributed approximately 47 per cent, reduction in non- PoL and non-gold imports constituted
40 per cent, and change in exports constituted 25 per cent.

Some of the broad conclusions which can be derived from the present study are as follows:
1. In a broader sense, after independence for almost forty years or so India adopted inward - oriented
strategy with a view to achieve rapid industrialization through import substitution. This strategy
covers the period from First Five Year Plan (1951 56) to the Seventh Five Year Plan. (1985 90).
2. The growing fiscal imbalances in the Seventh Plan leading to high fiscal deficits and the spillover of
the same into high current account deficits led to CAD / GDP ratio of as high as 3.1 per cent resulted
into the balance of payments crisis of 1991. Besides this, the country had the problems of - high
inflation, low foreign exchange reserves, political uncertainty & instability, loss of investors
confidence, high level of external debt etc.
3. The balance of payments crisis of 1991 led the policy makers to review the trade strategy and as a
result outward oriented strategy was adopted. The government undertook several reforms in the
fiscal, financial, industrial and trade sectors.
4. The results of the reforms are reflected in the post reform period which covers the period from
Eighth Plan (1992 to 1997) to Tenth Plan (2002 07).
5. Some of the major achievements of trade sector reforms are: (a) increase in trade openness, (b)
satisfactory export performance, (c) maintaining a reasonable level of current account deficit, (d)
increase in non debt creating capital flows like foreign investment, (e) improvement in indicators of
reserve adequacy and external debt, (f) control of inflation, (g) satisfactory industrial and overall
Real GDP growth.
6. Besides this, considering the benefits and costs of capital account liberalization, the country has
followed a cautious approach towards capital account convertibility. Full capital account
convertibility is expected to be achieved in the years to come.
7. One of the major objectives of reforms was to achieve fiscal consolidation. The progress of fiscal
correction shows mixed result in 1990s. No doubt there was some reduction in fiscal deficit in the
first half of 1990s. But, in the second half of 1990s the process once again reversed due to industrial
slowdown and the impact of Fifth Pay Commissions award. Moreover, this fiscal consolidation was
achieved by cutting down capital expenditure instead of current expenditure.
8. One of the important developments which took place in the second half of 2007 which affected the
entire world was the US sub prime crisis, which subsequently became a global financial and
economic crisis. This global economic crisis started affecting India from the beginning of 2008. The
crisis led to rise in CAD / GDP ratio, rise in fiscal deficit, rise in inflation, rise in capital outflows,
etc. At the same time it led to fall in foreign investments, depreciation of rupee, and a reduction in
industrial growth rate. To overcome the crisis, both the Government of India and RBI undertook

several measures. For instance, the Government of India undertook a fiscal stimulus package and
RBI announced reduction in CRR, SLR and other key policy rates. However, it can be concluded that
three factors helped to manage the crisis. They were (a) a well-regulated financial sector, (b)
gradual and cautious opening up of capital account, and (c) the availability of large stock of foreign
exchange reserves.

In the context of present study the following policy measures are suggested
1. There are many structural weaknesses in the export sector such as low efficiency and productivity
in resource use, lack of modern technology, lack of proper planning, marketing and decision making.
Hence it is utmost important to remove the structural weaknesses in the export sector.
2. On the export front it is expected that textiles, engineering goods and processed food items will be
the major export drivers. Hence efforts should be mobilized to increase the production and exports of
these commodities.
3. Besides this there still exists a vast scope for exporting horticultural products such as fruits and
flowers. This can be done by developing appropriate infrastructure and technology which is required
for horticultural products.
4. Indian exports can be made more competitive by faster delivery of export consignments, post sale
services, strengthening infrastructure, etc.
5. People all over the world are becoming Quality conscious and governments are laying down rigid
Quality standards for all food items and fresh agricultural products. Hence, it is imperative that the
highest attention should be given to ensure quality of our agricultural products meeting domestic and
international standards. For this purpose, it is necessary to educate the farmers, food processors, etc.
through training programs, workshops, etc.
6. There are various incentive schemes which are available to exporters. All these schemes are very
cumbersome and time consuming, and various agencies are involved. These procedures should be
simplified with the use of information technology and policies to promote self certification by
export houses should be encouraged. Preferential treatment should be granted to exporters with a
good track record.
7. The incentive schemes to promote exports should be designed in such a way that which could
generate maximum growth of exports. Export incentives should be given to those items which have
achieved high growth rates for a period of ten years or so.
8. There is a scope to diversify Indian exports geographically. This can be done by increasing exports to
non traditional markets such as Africa, South Asia and South East Asia.
9. Import liberalization should be based on careful planning and should lead to growth and higher
productivity of Indian industry. The import substitution industries must be given sufficient
opportunity to improve their productive capacity and competitiveness.
10. Trade liberalization and tariff reforms have provided necessary access to Indian companies to acquire
best inputs available at competitive prices. Hence, it is necessary to continue with the tariff reforms
in future.

11. The level of capital flows in the post reform period suggests that some widening of CAD / GDP
ratio could be financed without much difficulty. However, a careful monitoring of this ratio is
necessary so that it should not once again reach to an unsustainable level of beyond 3.0 per cent of
12. The policy of encouraging non debt creating flows such as foreign investment and discouraging
debt creating flows such as external commercial borrowings and NRI deposits should be continued in
order to keep external debt within manageable levels.
13. In the post reform period, foreign investment is regarded as a source of capital, technology and
managerial skills. However, adequate steps are still necessary to enhance foreign direct investment
rather than portfolio investment. This is because it is the foreign direct investment which is expected
to increase employment and output in the country.
14. The fiscal consolidation in the post reform period has been achieved by reducing public
investment. However, public investment is still essential in sectors producing public goods and
services. Hence, the policy of reduction in public investment should be reversed.
15. Finally, steps should be undertaken to eventually achieve full capital account convertibility on the
basis of recommendations of the Tarapore Committee - II.



Economics of Global Trade and Finance Johnson, Mascarenhas