What are the trends and problems of Indias Balance Of Payments

Balance of Payments (BOP) of a country shows its economic strengths and weaknesses. Most of the developing countries are deficit in their Balance of Accounts, India being no exception. Since independence, India has been facing this deficit or disequilibrium in terms of BOP, largely observed as a disaster in 1990-91, the year of the severe BOP crisis. At that time, India had foreign exchange reserve of meager 1 billion dollar, hardly sufficient to finance a month’s import bill. The nation was on the edge of defaulting. This crisis resulted in large scale amendments in the country’s economic policy, particularly known as the Structural Adjustment Program or New Economic Policy (NEP) regime, center of attention being liberalization and globalization of the economy.

We opted for a very vigilant approach and at present after having surmounted the initial glitches of a newly liberalized economy, we have a somewhat comfortable BOP condition. Even though we have arrived at a comfortable BOP position showing signs of a strong rising economy, BOP management still remains a tough walk for policy makers for taking any discussion, as now we are uncovered to each and every change in the global economic set-up.

Trends & problems of India’s BOP – 1949-50 to 1999-2000

The disequilibrium in India’s BOP has been accounted to both internal as well as external factors.

The requirement for development of such a big nation with a large population is one of the main factors resulting in recurring BOP problem. The BOP is always under some pressure and had large deficits due to high level of imports of food grains and capital goods, the profound external borrowings, their payment and poor exports.

After independence, the primary challenge in front of the country was to attain economic growth with social justice.

India’s aim after accomplishing independence was to achieve economic self- reliance. For this the country had to strike both the internal as well as the external resources. Not only our technology but our food availability was also on the backward stage. Hefty amounts of food grains had to be imported to supply the demand of such a large population.

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Protectionist Policies

The main intention of the Second Five Year Plan (1956-57 to 1960-61) was to achieve self reliance through industrialization. Self reliance was to be realized through import substitution. For this, essential industries had to be established which required import of capital goods. Exports were anticipated to take-off by own with advent of industrialization. It was felt that with advent of industrialization, there will be an increase in production at home that will be reflected in greater export earnings.” The approach for import substitution was based on physical- interventionist, non-price policies like quotas, licensing and other physical ceilings on imports. Heavy capital goods were imported however other imports were relentlessly restricted to shut off competition for promoting domestic industries. Mainly focus was on import substitution, with gross disregard of exports. These inward looking protectionist policies did resulted in some self-reliance in the consumer goods industries, but most of the capital goods industries remained majorly import intensive.

The elevated degree of protection to Indian industries resulted in to inefficiency and poor quality products basically due to lack of competition. The high cost of production further wrinkled our competitive strength.

Rise in petroleum products demand, harvest failure, two oil shocks, all put acute strain on the economy. The BOP condition remained weak for the period of 1980s, till it arrived at the crisis situation in 1990-91; When India was on the brink of defaulting mainly due to intense debt burden and continually widening trade deficit.

External Debt

India had been an exercising choice to large scale foreign borrowings for its developmental activities in the field of fundamental social and industrial infrastructure. The country’s reserves were very much restricted due to low level of per capita income and savings. The situation aggravated because Government of India resorted to large amounts of foreign borrowings to rectify the BOP situation in the short run out of frightening condition. With Seventh Five Year Plan, the debt service obligations increased sharply due to stiffer average provisions of external debt, including repayments to the IMF, commercial borrowing, and a drop in concessional aid flow.

Export Promotion

Even though by the Sixth Five Year Plan we had overcome the need of food grain imports and some crude oil was also produced domestically, BOP position was still not at ease attributed to low exports. The essential need for promoting export was realized during the 1960s. The Third Five Year Plan commenced certain promotion policies pertaining to export like tax exemptions, duty drawbacks, cash compensatory schemes, Rupee devaluation etc. However it didn’t showed significant improvements in exports.

Indian exports depended largely on situation of world trade.

We were chiefly primary product exporters, for which fluctuations in prices are very high in entire world market demand.

Primary products exporting countries generally have unfavorable term of trade. The incomes from primary product exports were unstable and low.

Secondly, the Indian products were not up to the mark in terms of quality and standard to sustain in world market.

Third, mainly residue products were exported. The fact that export earnings contribute significantly to economic development was disregarded. Cumbersome procedures, rules and regulations for license etc served as disincentives for exporters. Domestic inflation further diminished the competitiveness of India’s export.

Exchange Rate

The fluctuation in the exchange value of the rupee was another posing problem. The steady devaluations (to promote exports) enhanced the amount of external debt. The value of rupee was administered by the central bank (fixed exchange rate). The considerable gap between official and market exchange rate generated difficulties for the exporters and importers. The stringent foreign exchange controls also persuaded Hawala trade.

Trends in India’s BOP (2000-2010)

The benefits of foreign trade were overlooked year after year. Indian entrepreneurs were withdrawing with low-priced, outdated technology and demolishing subsidies, generating a heavy national burden of large ailing public sector undertakings. Despite acting through an incentive based approach, government protection in fact damaged our industrial growth.

The New Economic Policy of the nineties targeted for opening up of the economy, to permit free trade and competition and condense the role of government considerably in foreign trade issues. Restrictions on international trade were detached, foreign investments were allowed and a completely new Liberalized Exchange Management System was brought in to garner the benefits of competition and offset the drawbacks of a closed, inward looking trade policy.

The alterations towards liberalization and globalization of the Indian economy were conceded out very vigilantly in phases.

Foreign Investment

India effectively attracted Foreign investors to the country with its earnest positive economic transforms like reduced cumbersome formalities and other paperwork. From a scanty US$103 million  net foreign investment in the year 1990-91, it has grown to us$ 8669 million  in 2008-09.

Foreign investments kept the country buoyant during the recent global meltdown period. Because the consequences of recession were worst in the developed countries, the investors turned to the less affected rising economies like China and India. While initially foreign investment in the country did slow down significantly due to risk repugnance in the phase of the recession, but it picked up over again because rising economies like India and China were quick to execute corrective procedures to fight recession, showing creditable elasticity to the recession which badly affected the much developed economies.

There was massive turn down in net capital flows from US $ 106.6 billion in 2007-2008 (8% of GDP) to US $ 7.2 billion (0.6 % of GDP) IN 2008-09.

The turn down was mainly due to net outflows under portfolio investment. Despite this, the FDI inflow remained floating at US $ 21.0 billion during Apr – Sept. 2009 as against US $ 20.7 billion in Apr.-Sept. 2008. FDI inflow has been primarily in communication services, manufacturing, and real estate sector.

Current Account of BOP

The current account of BOP consists of the merchandise trade (export and import) and the invisibles (services, transfers etc.). The liberalized policy and reasonably hassle free formalities for export and imports have provided a push to our export industries as well as industries catering to domestic demands. Exports and imports both witnessed double digit growth rate. India is now a principally manufactured goods and services exporter deriving benefits from a better term of trade, as compared to what it was earlier, primary goods exporter, prior to 1991. The contribution of India’s exports in world trade has increased from 0.7 % in 2000 to 1.2 % in 2008. Services too have extended to various fields catering to both domestic and international consumers.

The current account balance broadened in 2008-09 (-2.4 % of GDP) compared to that of 2007-08 (-1.3% of GDP) attributed to recession, but it was sustainable. The external demand shock resulted in to the decline of export growth from 57 % in April-June’08 to (-) 8.4 % in Oct- Dec’08 and further to (-) 20 % in January-March’09, a decline for the first time since 2001-02. Imports too turn downed similarly due to domestic industrial demand and sharp fall in international crude oil and some other primary commodity prices.

India’s net invisibles rose by 18.7% in 2008-09.

With the economy (domestic as well as global) getting its pace of momentum once again, there is hope of glare once again in the trade and financial world. India having cruised reasonably successful through the uneven scrap of recession can look further to garnering greater profit from world market, at least till the time the developed economies which were poorly affected by recession, revitalize fully. In short, the situation of BOP is quite well administered and contented. However, lessons from the occurrences of the financial crises taking place in various parts of the world from time to time, we are required to continue our vigilant approach towards BOP management. The country cannot meet the expense of a setback to its economic growth attained through large scale changes in national economic policies. India indeed has arrived a long way from the time of the days of the protectionist policies, but there is a lot to be accomplished yet, particularly in the sector of infrastructure, in order to become a strong economy.