India’s balance of payments and the exchange rate

India’s Balance of Payments and the Exchange Rate in

the 2000sAvadhoot Nadkarni

Department of EconomicsUniversity of Mumbai

)

Sr. No. Receipts Payments Balance 1. Merchandise BOTM2. Services BOTS2A Non-Factor S2B Income3. Transfers BOTR4. Invisibles 2+35. Current A/C CAB=1+46. Capital Flows KAB

6Ai Investment6Aii Loans6Aiii Banking6Aiv Other7. Overall Bal OB=5+68. Change in R - OB

Balance of Payments: Definition

Balance of Payments (BOP) is a statement of transactions entered into by the residents of a country with the rest of the world (ROW), set out over a period of time, usually a year. The transactions include transactions in goods and services, as also in assets. They also include transfer payments.

Components of BOP

Current AccountCapital AccountReserve Changes AccountThe difference between the receipts and

payments on each of these accounts defines the balance on the account

The sum of the balances on these three accounts is zero reflecting the statement that BOPs always balance in the accounting sense

Components of the Current Account

Current Account◦Merchandise Trade Account◦Invisibles Account

Non-Factor Services Account Income Account Transfer Payments

Components of the Capital Account 1

Foreign Investment◦Direct◦Portfolio

Loans◦External Assistance◦Commercial Borrowings

Banking Capital including changes in NRI deposits

Components of the Capital Account 2

Rupee Debt ServiceOther Capital including trade creditsErrors and Omissions

Components of Reserve Changes Account

IMF Transactions – Purchases, Repurchases & Net

Increase (-) or Decrease (+) in ReservesTotal reserve Movement

Trade Balance

Trade deficits are increasing in absolute terms mainly due to POL imports

X as percent of M increased initially to 83% in 2002-03 (from 66% in 1990-91), but is again decreasing now to 60% in 2008-09

Trade balance need not be necessarily positive

Balance on the Invisibles

Invisibles Balance has been positive due to ◦ITES exports◦Transfer receipts

However the balance on invisibles has not been able to outweigh the negative trade balance has been negative in most years except 2001-02 to 2003-04

Current A/C Balance 1

The CAB has been negative for most years, since the positive invisible balance has not been able to outweigh the negative trade balance, except 2001-02 to 2003-04.

For a developing country the CAB needs to be negative as this provides additional resources that can be used for investment: X-M=(S-I)+(T-G)

CAB 2

Yet the implied positive KAB means that the debt has to be serviced if capital inflows are of debt-creating kind – too much of deficit can easily become non-sustainable

The optimum CAD for India seems to be 2% of GDP

The CAD in India has been around 1.5% of GDP in recent years, except in 2008-09when it increased to 2.5%

Financing of Trade Deficits

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

-150.00

-100.00

-50.00

0.00

50.00

100.00

150.00

Trade BalInv Net

Financing of CAD by Capital A/C Surplus

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

-40.00

-20.00

0.00

20.00

40.00

60.00

80.00

100.00

120.00

Cur A/CCap A/C

KAB

KAB has been positive and at times more positive than the negative CAB leading to increase in reserves

This has happened with many Asian countries – reflects the huge CAD of the US

We are following the policy of non-debt creating K inflows: FDI & FPI

Composition of Net K Flows 1

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

-10.00 0.00 10.00 20.00 30.00 40.00 50.00

Bank KLoansFor I

Composition of Net K Flows 2

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

-20.00 0.00 20.00 40.00 60.00 80.00 100.00 120.00

For ILoansBank K

Composition of Net K Flows 3

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

For ILoansBank K

Exchange Rate Policy 1

India follows a managed floating exchange rate regime

The avowed exchange rate policy of the RBI is that the rate is basically determined by the market, but since the market-determined rate tends to be volatile, the RBI manages the rate to avoid excess volatility in the market

This implicitly means that the RBI does not influence the level of the rate

Exchange Rate Policy 2

Yet the Real Effective Exchange Rate of the rupee has been relatively stable over the entire period

It can be said that volatility is being avoided not only in the short run, but also in the long run!

Apparently, the nominal rate is being managed to maintain the real rate in the face of higher domestic inflation compared to the trading partners

NEER vs. REER (6 Countries)

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0.00

20.00

40.00

60.00

80.00

100.00

120.00

NEER-6REER-6

NEER vs. REER (36 Countries)

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0.00

20.00

40.00

60.00

80.00

100.00

120.00

NEER-36REER-36

NEER-6 vs. NEER-36

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0.00

20.00

40.00

60.00

80.00

100.00

120.00

NEER-6NEER-36

REER-6 vs. REER-36

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0.00

20.00

40.00

60.00

80.00

100.00

120.00

REER-6REER-36