Balance of Payments: The Weak Link Of Indian Economy

This article has been written by S. Mahavir Prasad Sahu. An aspiring CA and young IPCC student, Mahavir loves to discuss Tax and Finance.

Balance of Payment is one of the oldest and most important statistical statements for any Country. It is a Systematic record of all economic transaction between the resident of one country and the resident of the rest of the world in a year.

Balance Of Trade:  Balance of trade may be defined as the difference between the value of goods sold to foreigner by the residents and firms of the home country and the value of goods purchased by them from foreigners. If value of exports of goods is equal to the value of imports of goods, we say that there is a balance of trade deficit. But if the former exceeds the latter, i.e., if value of exports of goods is more than the value of imports of goods, we say there is surplus balance of trade.

Balance of Current Account:   Balance of current account is a broader concept than the balance of trade. It includes balance of services and balance of unilateral transfers (i.e., unrequited transfer) besides including balance of trade. Balance of service records all the services exported and imported by the country in a year. Unlike goods which are visible and tangible, services are invisible and are not tangible. The services transaction basically include : (i) Transportation, banking and insurance receipt and payments from and to the foreign countries, (ii) Tourism, travel services and tourist purchases of goods and services received from foreign visitor to home country and paid out in foreign country by home country citizens, (iii) Expense of  diplomatic and military personnel from overseas as well as receipts from similar personnel from overseas who are stationed in the home country, and (iv) interest, profits, dividends and royalties received and paid from and to the foreigners. Balance of service is the sum of all invisible service receipt and payments which could be zero, positive or negative. Balance of unrequited transfers includes all gifts, donation, grants and reparation, receipt and payments to foreign countries.

Balance of Payment on Capital Account:

Balance of payment on capital account includes balance of private direct investments, private portfolio investment and government loans to foreign governments. Balance of capital account basically deals with debts and claims of the country in question or we say it deals with borrowing or lending of the country in question.

Balance of Payments:

Overall balance of payment is the sum of balance of current account and balance of capital account. It includes all the international monetary transaction of the reporting country vis-a-vis the rest of the world. The balance of payments must always balance in a book keeping sense. This is because for any surplus (or deficit) in the overall balance of payments there must be a corresponding debit (or credit) entry in the net changes in external reserves. In other words, if there is a surplus it adds to external reserves of the country and if there is deficit, it reduces down the external reserves of the country.

Trends In Balance Of Payments Of India:

A country, like India, which is on the path of development generally experience a deficit in balance of payments situation. This is because such a country requires imported machines, technology and capital equipments in order to successfully launch and carry out the programme of industrialisation. Also, since initially it has only primary goods to offer as exports, it generally has an unfavourable balance of payments situation. As pace of development picks up it has to have ‘maintenance imports’ although it has now more sophisticated goods to offer for exports. But the situation remains the same i.e. deficit balance of payment.

This has exactly happened in India. Over the period of planning India’s balance of payment has generally remained unfavourable. However, deficit in balance of payments sharply increased after the fifth plan. During the whole of the fifth plan India experienced surplus in the balance of payment due to a sharp increase in the export surplus on account of invisible remittance.(Money sent by foreign worker to his home country) From 1979-80 onwards, India started experiencing very adverse balance of payments. This happened because growing trade deficits, which till then were offset by net receipts could not be made good by them.

The Sixth Plan characterise balance of payments position as ‘acute’.

The balance of payments continued to be under strain during seventh Plan. In early 1990-91, the already poor BOP position worsened because of Gulf War. In 1992-93, many important changes such as a new system of exchange rate management, liberalisation of import licensing and tariff reduction were introduced. India saw a remarkable turnaround from a foreign exchange constrained control regime to a more open, market driven and liberalised economy (Free Economy). The trade liberalisation and a shift to a market determined exchange rate regime have had a significant positive impact on the country’s BOP.

Recent Trend and Eleventh Plan:

We had a surplus for three successive years from 2001 to 2004. Buoyant invisible flows, particularly private transfer comprising remittance, along with software services exports, have been instrumental in creating sustaining surplus for India for the above period. However, since 2003-04 trade deficit has widened sharply, particularly in 2004-06, because of higher outgo on import of petroleum, oil and lubricants. As a result, current account surpluses have once again turned into deficit inspite of the fact that invisible flows have continued to swell. In the eleventh plan exports were projected to grow at about 20percent per year in US Dollar terms, the imports were projected to grow at 23 per cent, current account deficit could range between 1.2 per cent to 2per cent.

The 2008 Global finance crisis and subsequent slowdown in the world of economy has clearly demonstrated that tremor originating in one corner of the world can quickly reach the other parts among others via the trade channel. Mirroring the global trend, India’s exports which also had robust growth of 30.1 per cent in the five post crisis years(2009-10).

Foreign Exchange, Laws and Rights:

India’s foreign exchange reserves comprise exchange assets (FCA), gold, special drawing rights (SDRs) and reserve tranche position (RTP) in the International Monetary Fund(IMF). When there is volatility in exchange rate, the reserve bank of India (RBI) intervenes to smoothen it. This results in increase or decrease in the level of foreign exchange reserves depending upon the type of intervention. Exchange Market Intervention’ by RBI means the sale of rupee vis-a-vis on or more currencies. If there is too much demand for foreign currency (say Dollar), it will appreciate too much and Indian rupee will depreciate. At this point RBI intervenes by releasing the dollars (from its reserve) in the market to stabilize the exchange rate. If there is too less demand for foreign currency, it will depreciate and rupee will appreciate too much. At his point, the central bank will intervene by purchasing dollars from the market to stabilize the rate. 

Special drawing Rights:

The special drawing rights were created in 1969 by the IMF, to supplement a shortfall to preferred foreign exchange reserve assets, namely gold and the US Dollar. SDA, neither a currency, nor a claim on the IMF, Rather it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members, and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external position. The SDR today is redefined as a basket of currencies, consisting of the euro, Japanese Yen, pound sterling, and US Dollars. The Primary means of financing the international Monetary Fund is through members’ quotas. Each member of the IMF is assigned a quota, a part of which is payable in SDRs or specified usable currencies and part in the member’s own currency. The difference between a member’s quota and the IMFs holdings of its currency is a country’s Reserve Tranche Position (TRP). It is accounted among a country’s foreign exchange reserves.

Current Situation and Conclusion:

During Manmohan Singh’s regime as PM of India has seen both the fall from grace to absolute darkness to reaching a surplus balance of payments situation. For it the due credit has to go to Former PM Dr. Manmohan Singh who was one of the best economic brains of the country. The main reason behind the rise foreign trade in India is diversification of trade. Earlier, Europe and USA used to be main partners of India’s International trade. Now, Asia and ASEAN (Association of South East Asian Nations) have become India’s major trade partners. This has helped India weather the global crisis emanating from Europe and America.

India’s Balance of payments has been in check for a while but the ever changing trade scenario and IMF’s Ignorance to developing nation has India in a precarious situation. If India is to become a Developed nation one day, than the Balance of payment situation has to be absolute surplus (Surplus shouldn’t include foreign debt). But the ever fluctuating rupee and its fringe demand has left the most with one question, Will We be Able to Achieve an Absolute Surplus situation? Will we be able to achieve the goal in the next 5 years, or we still be waiting? Do let me know your thoughts.

Reference:

 http://www.imf.org/external/np/sta/bop/bop.htm/

 IMF Balance of Payments Manual, Chapter 2 “Overview of the Framework”, Paragraph 2.15 [1]

http://www.econlib.org/library/Enc/BalanceofPayments.html

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