BALANCE OF PAYMENTS

MACRO ECONOMICS

BALANCE OF PAYMENTSMACRO ECONOMICS PROJECT

What do you mean by Balance of payments? Analyse the trends in exports and imports (in value terms) with chart. Do you think Indias balance of payments condition is in adverse state? Discuss. How it can be sorted out? Discuss the government policies adopted by the government of India since 1950-51

ContentsBALANCE OF PAYMENTS AN INTRODUCTION3BALANCE OF CURRENT ACCOUNT4THE CAPITAL ACCOUNT5ACCOMMODATING & AUTONOMOUS CAPITAL FLOWS6BALANCE OF INVISIBLE TRADE6BALANCE OF VISIBLE TRADE6ERRORS AND OMISSIONS7UNILATERAL TRANSFERS7DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS7Other Accounts8TREND IN EXPORTS & IMPORTS - INDIA9Exports10Imports12INDIAS BALANCE OF PAYMENTS CONDITION13Measures to improve balance of payments18policies adopted by the government of India since 1950-5118DEFICIT IN THE BASIC BALANCE - DESIRABLE OR UNDESIRABLE!21

BALANCE OF PAYMENTS AN INTRODUCTIONThe balance of payments of a country is a systematic record of all economic transactions between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by theme on account of goods imported and services received from the capital transferred to non-residents or foreigners.- Reserve Bank of IndiaThe definition given by RBI needs to be clarified further for the following points:A. Economic TransactionsAn economic transaction is an exchange of value, typically an act in which there is transfer of title to an economic good the rendering of an economic service, or the transfer of title to assets from one economic agent (individual, business, government, etc) to another. An international economic transaction evidently involves such transfer of title or rendering of service from residents of one country to another. Such a transfer may be a requited transfer (the transferee gives something of an economic value to the transferor in return) or an unrequited transfer (a unilateral gift).B. ResidentThe term resident is not identical with citizen though normally there is a substantial overlap. As regards individuals, residents are those individuals whose general centre of interest can be said to rest in the given economy. They consume goods and services; participate in economic activity within the territory of the country on other than temporary basis. In general terms:The balance of payments (BOP) measures the Receipts & payments that flow between any individual country and all other countries over a period, normally over a financial year. It is used to summarize all international economic transactions including trade, services, debts, Investments for that country during the specified period. The BOP is determined by the balance of the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and liabilities from foreigners (credits). Balance of payments is one of the major indicators of a country's status in international trade, with net capital outflow.The balance, like other accounting statements, is prepared in the domestic currency. Foreign assets and flows are valued at the exchange rate prevailing at the time of the transaction.

The components of a BOP statement are:A. Current Account

B. Capital Account

C. IMF

D. SDR Allocation

E. Errors & Omissions

F. Reserves and Monetary Gold

BALANCE OF CURRENT ACCOUNTBOP on current account refers to the inclusion of three balances of namely Merchandise balance (Trade balance), Services balance (investment income, tourism, banking etc.) and Unilateral Transfer balance. In other words it reflects the net flow of goods, services and unilateral transfers (gifts, pensions, remittances etc.). The net value of the balances of visible trade and of invisible trade and of unilateral transfers defines the balance on current account. BOP on current account is also referred to as Net Foreign Investment because the sum represents the contribution of Foreign Trade to GNP.

THE CAPITAL ACCOUNTThe capital account records all international transactions that involve a resident of the country concerned changing either his assets with or his liabilities to a resident of another country. Transactions in the capital account reflect a change in a stock either assets or liabilities.It is often useful to make distinctions between various forms of capital account transactions:Direct investment is the act of purchasing an asset and the same time acquiring control of it (other than the ability to re-sell it). Such business transactions form the major part of private direct investment in other countries, multinational corporations being especially important. There are of course some examples of such transactions by individuals, like purchase of the second home in another country.

ACCOMMODATING & AUTONOMOUS CAPITAL FLOWSTransactions are said to Autonomous if their value is determined independently of the BOP. Accommodating capital flows on the other hand are determined by the net consequences of the autonomous items. An autonomous transaction is one undertaken for its own sake in response to the given configuration of prices, exchange rates, interest rates etc, usually in order to realise a profit or reduced costs. It does not take into account the situation elsewhere in the BOP. An accommodating transaction on the other hand is undertaken with the motive of settling the imbalance arising out of other transactions.BALANCE OF INVISIBLE TRADEJust as a country exports goods and imports goods a country also exports and imports what are called as services (invisibles). The service account records all the service exported and imported by a country in a year. Unlike goods which are tangible or visible services are intangible. Accordingly services transactions are regarded as invisible items in the BOP. They are invisible in the sense that service receipts and payments are not recorded at the port of entry or exit as in the case with the merchandise imports and exports receipts. Goods and services accounts together constitute the largest and economically the most significant components in the BOP of any country. The service transactions take various forms. They basically include 1) transportation, banking, and insurance receipts and payments from and to the foreign countries, 2) tourism, travel services and tourist purchases of goods and services received from foreign visitors to home country and paid out in foreign countries by home country citizens, 3) expenses of students studying abroad and receipts from foreign students studying in the home country, etc. Balance of Invisible Trade is a sum of all invisible service receipts and payments in which the sum could be positive or negative or zero. A positive sum is regarded as favourable to a country and a negative sum is considered as unfavourable. BALANCE OF VISIBLE TRADEBalance of visible trade is also known as balance of merchandise trade, and it covers all transactions related to movable goods. The valuation should be on F.O.B basis so that international freight and insurance are treated as distinct services and not merged with the value of goods themselves. Exports valued on F.O.B basis are the credit entries. Imports valued at C.I.F are the debit entries. The difference between the total of debits and credits appears in the Net column. This is the Balance of Visible Trade.In visible trade if the receipts from exports of goods happen to be equal to the payments for the imports of goods, we describe the situation as one of zero goods balance.

ERRORS AND OMISSIONSErrors and omissions is a statistical residue. It is used to balance the statement because in practice it is not possible to have complete and accurate data for reported items and because these cannot, therefore, ordinarily have equal entries for debits and credits. The entry for net errors and omissions often reflects unreported flows of private capital, although the conclusions that can be drawn from them vary a great deal from country to country, and even in the same country from time to time, depending on the reliability of the reported information. UNILATERAL TRANSFERSUnilateral transfers or unrequited receipts, are receipts which the residents of a country receive for free, without having to make any present or future payments in return. Receipts from abroad are entered as positive items, payments abroad as negative items. Thus the unilateral transfer account includes all gifts, grants and reparation receipts and payments to foreign countries. Unilateral transfer consist of two types of transfers: (a) government transfers (b) private transfers.DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTSA BOP statement (revised) includes the following sub accounts:ItemsCreditsDebitsNet

G. Current Account

1. Merchandise

a. Private

b. Government

2. Invisibles

a. Travel

b. Transportation

c. Insurance

d. Investment Income

e. Government (not included elsewhere)

f. Miscellaneous

3. Transfer Payments

a. Official

b. Private

Total Current Account (1+2+3)

H. Capital Account

2. Private

a. Long Term

b. Short Term

3. Banking

4. Official

a. Loans

b. Amortisation

c. Miscellaneous

Total Capital Account (1+2+3)

I. IMF

J. SDR Allocation

K. Capital Account, IMF & SDR Allocation (B+C+D)

L. Total Current Account, Capital Account, IMF & SDR Allocation (A+E)

M. Errors & Omissions

N. Reserves and Monetary Gold

Other AccountsThe IMF account contains purchases (credits) and repurchases (debits) from the IMF. SDRs Special Drawing Rights are a reserve asset created by the IMF and allocated from time to time to member countries. Within certain limitations it can be used to settle international payments between monetary authorities of member countries. An allocation is a credit while retirement is a debit. The Reserve and Monetary Gold account records increases (debits) and decreases (credits) in reserve assets. Reserve assets consist of RBIs holdings of gold and foreign exchange (in the form of balances with foreign central banks and investment in foreign government securities) and governments holding of SDRs. If the balance of payment is a double entry accounting record, then apart from errors and omissions, it must always balance. The imbalance must be interpreted in some sense as an economic disequilibrium.

TREND IN EXPORTS & IMPORTS - INDIAExports are the major focus of India's trade policy as it is important for addressing macroeconomic concerns. The incentives offered by the export promotion package are comparable to that of any other country. The focus remains on inducing the foreign investors to set up export oriented units in India. India offers a production base for foreign markets around the world for sourcing components and products manufactured at a low cost.India's strategic location, between Middle East and South East Asia, presents itself as a country with immense business opportunities. The countries labour advantage adds to this. India has vast reserves of technical and scientific manpower. India's skilled labour is in great demand in the world's premier organizations. Both skilled and unskilled labour is easy to find and wage rates are highly competitive compared to international levels. Language is not a barrier as the professional work force is conversant in English and the main transactions and procedures are done in the same language. The government also provides a number of incentives and facilities for exporters. India's rich resource and production base provides significant opportunities for investors to establish export units.Let us have a look at the import & export data for the last 20 years to analyze the trend for the same in Indian context:

Emerging destinationsIndias 21 emerging exporting countries have been listed in the table below. These countries have been growing strongly in the last five years and their share in Indias merchandise exports has gone up from 23.5% in FY02 to around 27.8% in FY07. Of all the 21 countries, Indias exports to Yemen Republic have seen the most impressive growth of more than 100% in FY07 as compared to last year. For instance, exports of mineral fuels, mineral oils and waxes (Under the HS Code 27) recorded a y-o-y growth of 55% and constituted almost 74% of Indias total exports to Yemen Republic. Even exports to Pakistan grew phenomenally at a y-o-y growth rate of almost 96%, driven by sugar, organic chemicals and cotton exports, which together constituted over 62% of the total exports to Pakistan.

The analysis of the trend in recent past throws up certain pointers which I have listed as below: Exports (i) The decline in exports which started since October 2008 continued during the first quarter of 2009-10. On a BoP basis, Indias merchandise exports recorded a decline of 21.0 per cent in Q1 of 2009-10 as against an increase of 43.0 per cent in Q1 of 2008-09.

(ii) As per the data released by the Directorate General of Commercial Intelligence and Statistics (DGCI&S), merchandise exports declined by 26.4 per cent in Q1 of 2009-10 as against a higher growth of 37.4 per cent in Q1 of 2008-09, reflecting fall in demand worldwide due to the global economic crisis.INDIAs cumulative value of exports for the period April- August, 2009 was Rs. 311715 crore as against Rs. 391841 crore registering a negative growth of 20.4 per cent in Rupee terms over the same period last year. Cumulative value of imports for the period April- August 2009 was Rs. 497108 crore as against Rs. 648041 crore registering a negative growth of 23.3 per cent in Rupee terms over the same period last year.Oil imports during April- August, 2009 were valued at US$ 28275 million which was 47.4 per cent lower than the oil imports of US $ 53742 million in the corresponding period last year. Non-oil imports during April- August, 2009 were valued at US$ 74024 million which was 25.9 per cent lower than the level of such imports valued at US$99949 million in April- August, 2008.The trade deficit for April- August, 2009 was estimated at US $38171 million which was lower than the deficit of US $ 60732 million during April-August, 2008.EXPORTS & IMPORTS (April-August, FY 2009-10)

In $ MillionIn Rs Crore

Exports including re-exports

2008-0992959391841

2009-1064129311715

Growth 2009-10/2008-2009 (percent)-31.0-20.4

Imports

2008-09153691648041

2009-10102300497108

Growth 2009-10/2008-2009 (percent)-33.4-23.3

Trade Balance

2008-09-60732-256200

2009-10-38171-185393

Figures for 2008-09 and 2009-10 are provisional

The trade deficit for April- June, 2009 was estimated at $ 15504 million which was lower than the deficit at $ 28642 million during April- June, 2008. Imports(i) Import payments, on a BoP basis, also continued its declining trend. Imports declined by 19.6 per cent in Q1 of 2009-10 as against a positive growth of 42.9 per cent in Q1 of 2008-09.

(ii) According to the data released by the DGCI&S, the decline in imports is mainly attributed to the sharp fall in oil import payments due to lower crude oil prices during Q1 of 2009-10 POL imports recorded a sharp decline of 56.9 per cent during Q1 of 2009-10 as against a sharp increase of 74.2 per cent during Q1 of 2008-09. (iii) According to the DGCI&S data, out of the total decline in imports of US$ 26.7 billion in Q1 of 2009-10 over the corresponding previous quarter, oil imports declined by US$ 16.8 billion, while non-oil imports decreased by US$ 9.8 billion Hence the trend we have seen in the recent past was the result of worldwide recession had. The affect of the same was seen throughout the economies. It did impact the export-based economies by a huge margin. But the situation is now towards the improving trend and the future presents a much improved scenario. Over the last five years, Indias merchandise exports underwent significant changes in terms of composition and destinations. During FY97 to FY07, Indias contribution to world trade has gone up considerably from 0.5% to around 1.1%, underlined by several milestones. Indias merchandise exports started accelerating since FY03 (in US dollar terms) and grew at a CAGR of 24.9% during FY04-08; in fact, this growth rate was much higher than the global merchandise export growth of 16.1%. The Indian government plans to raise its merchandise exports to US$ 200 billion by FY09 from US$ 155.5 billion in FY08, which translates into a growth of 28.6%.Indias exports are expected to accelerate in future, taking into account the growing numbers of approved, in-principle and notified SEZs in the country. As on March 27, 2008, there were 453 (of which 246 valid approvals) approved SEZs, 136 in-principle and 207 notified SEZs, which once operational are expected to boost Indias merchandise exports. It is to be noted that in FY07, exports from 19 functional SEZs stood at Rs 347.9 billion and during April-December 2007-08 they reached Rs 400 billion. It is estimated that exports from SEZs would reach Rs 1,246.8 billion by FY09.

INDIAS BALANCE OF PAYMENTS CONDITIONItemRupees croreUS $ million

2006-072007-08 PR2008-09 P2006-072007-08 PR2008-09 P

1234567

A. CURRENT ACCOUNT

1.Exports, f.o.b.5,82,8716,67,7577,98,9561,28,8881,66,1631,75,184

2.Imports, c.i.f.8,62,83310,36,28913,41,0691,90,6702,57,7892,94,587

3.Trade Balance-2,79,962-3,68,532-5,42,113-61,782-91,626-1,19,403

4.Invisibles, Net2,35,5792,99,6184,09,84252,21774,59289,586

a)Non-Factor Services1,33,0641,51,0592,28,77829,46937,56549,818

of which:

Software Services1,41,3561,62,0202,15,58831,30040,30047,000

b)Income-33,234-19,888-21,116-7,331-4,917-4,511

c)Private Transfers1,34,6081,67,4952,01,05029,82541,70544,047

d)Official Transfers1,1419521,130254239232

5.Current Account Balance-44,383-68,914-1,32,271-9,565-17,034-29,817

B. CAPITAL ACCOUNT

1.Foreign Investment, Net (a+b)66,7911,80,78811,76014,75344,9573,462

a)Direct Investment34,91061,79376,8227,69315,40117,496

of which:

i)In India1,02,6521,37,4341,58,57922,73934,23634,982

Equity73,9691,07,3201,25,36216,39426,75827,809

Re-invested Earnings26,37128,85929,7055,8287,1686,426

Other Capital2,3121,2553,512517310747

ii) Abroad-67,742-75,641-81,757-15,046-18,835-17,486

Equity-56,711-57,936-63,478-12,604-14,421-13,558

Re-invested Earnings-4,868-4,363-4,985-1,076-1,084-1,084

Other Capital-6,163-13,342-13,294-1,366-3,330-2,844

b)Portfolio Investment31,8811,18,995-65,0627,06029,556-14,034

In India31,6301,18,348-64,2067,00429,394-13,855

Abroad251647-85656162-179

2.External Assistance, Net7,9738,46512,4351,7752,1142,638

Disbursements16,97817,02223,5353,7674,2415,042

Amortisation-9,005-8,557-11,100-1,992-2,127-2,404

3.Commercial Borrowings, Net72,36591,18038,00916,10322,6338,158

Disbursements93,9321,22,27071,62620,88330,37615,382

Amortisation-21,567-31,090-33,617-4,780-7,743-7,224

4.Short Term Credit, Net30,09668,878-31,1606,61217,183-5,795

5.Banking Capital

of which:8,47747,148-19,8681,91311,757-3,397

NRI Deposits, Net19,57470620,4314,3211794,290

6.Rupee Debt Service-725-488-476-162-121-101

7.Other Capital, Net @18,69637,80221,6814,2099,4704,181

8.Total Capital Account2,03,6734,33,77332,38145,2031,07,9939,146

C. Errors & Omissions4,3444,8302,7759681,205591

D. Overall Balance [A(5)+B(8)+C]1,63,6343,69,689-97,11536,60692,164-20,080

E. Monetary Movements (F+G)-1,63,634-3,69,68997,115-36,606-92,16420,080

F.IMF, Net000000

G. Reserves and Monetary Gold-1,63,634-3,69,68997,115-36,606-92,16420,080

(Increase -, Decrease +)

INDIAs trade deficit during the first three months of current fiscal year (2009-10) on a balance of payments (BoP) basis was large due to the steeper decline in the pace of exports than that of imports. The trade deficit on a BoP basis in Q1 (US$ 26.0 billion) was, however, less than that in Q1 of 2008-09 (US$ 31.4 billion).

Table 3: Balance of payments (USD bn and % of GDP)

The key features of Indias BoP that emerged in Q1 of fiscal 2009-10 were:(i) The decline in exports which started since October 2008 continued during the first quarter of 2009-10. Import payments, on a BoP basis, also continued its declining trend mainly due to lower oil import bill(ii) Private transfer receipts remained buoyant and increased by 9.4 per cent to US$ 13.3 billion during Q1 of 2009-10. Exports of software services, however, declined during Q1 of 2009-10(iii) Despite net invisibles surplus at US$ 20.2 billion, the large trade deficit (US$ 26.0 billion) mainly on account of sharp decline in exports led to a current account deficit of US$ 5.8 billion in Q1 of 2009-10 (US$ 9.0 billion during Q1 of 2008-09(iv) With the revival in capital inflows to India, particularly foreign investments, the capital account showed a turnaround from a negative balance in last two quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10(v) Portfolio investment witnessed a sharp turnaround from net outflows of US$ 2.7 billion in Q4 of 2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-10(vi) NRI deposits also witnessed higher inflows reflecting the positive impact of the revisions in the ceiling interest rate on NRI deposits(vii) There was a marginal increase in reserves on BoP basis (i.e. excluding valuation) during Q1 of 2009-10. However, the foreign exchange reserves including valuation increased by US$ 13.2 billion during Q1 of 2009-10 implying that the increase in reserves during this period was mainly due to valuation gains as the US dollar has depreciated against major currencies.

Invisibles(i) During Q1 of 2009-10, in net terms, the invisibles balance at US$ 20.2 billion was lower than that in the corresponding period of the previous year (US$ 22.4 billion), though higher than that in Q4 of 2008-09 (US$ 19.3 billion). Invisibles Receipts(i) Invisibles receipts registered a marginal decline of 0.7 per cent in Q1 of 2009-10 (as against a higher growth of 30.3 per cent in Q1 of 2008-09) on account of a decline in almost all categories of services except insurance and financial services and a decline of 20.3 per cent in investment income receipts.(ii) Exports of software services declined by 11.5 per cent during Q1 of 2009-10 as against an increase of 37.6 per cent in Q1 of 2008-09(iii) Travel receipts at US$ 2.3 billion during Q1 of 2009-10 declined by 8.7 per cent as against an increase of 19.9 per cent in Q1 of 2008-09 reflecting a slowdown in tourist arrivals in the country since November 2008. Invisibles PaymentsInvisibles payments recorded a positive growth of 11.9 per cent in Q1 of 2009-10 (13.5 per cent in Q1 of 2008-09) mainly due to growth in payments under services and income account. In the services account, however, payments under travel, transportation, G.N.I.E. and software services recorded a negative growth in Q1 of 2009-10. Invisibles BalanceA combined effect of decline in invisibles receipts and increase in invisibles payments led to marginally lower net invisibles (invisibles receipts minus invisibles payments) at US$ 20.2 billion in Q1 of 2009-10 than that in the corresponding period of the previous year (US$ 22.4 billion) Current Account DeficitDespite net invisibles surplus, the large trade deficit mainly on account of sharp decline in exports led to a current account deficit of US$ 5.8 billion in Q1 of 2009-10 (US$ 9.0 billion during Q1 of 2008-09). Capital Account and Reservesi) The gross capital inflows to India revived during Q1 of 2009-10 as compared to the last two quarters of 2008-09 manifesting confidence in Indias long-term growth prospects. The gross inflows were, however, at US$ 78.5 billion as compared to US$ 90.9 billion in Q1 of 2008-09 mainly led by inflows under FIIs, FDI and NRI deposits. Gross capital outflows during Q1 of 2009-10 stood lower at US$ 71.8 billion as against US$ 79.7 billion in Q1 of 2008-09. ii) With the revival in capital inflows to India, particularly foreign investments, the capital account showed a turnaround from a negative balance in last two quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10 (US$ 11.1 billion in Q1 of 2008-09). iii) Net FDI inflows (net inward FDI minus net outward FDI) amounted to US$ 6.8 billion in Q1 of 2009-10 (US$ 9.0 billion in Q1 of 2008-09). Net inward FDI stood at US$ 9.5 billion during Q1 of 2009-10 (US$ 11.9 billion in Q1 of 2008-09). Net outward FDI stood at US$ 2.6 billion in Q1 of 2009-10 as compared with US$ 2.9 billion in Q1 of 2008-09.iv) During Q1 of 2009-10, FDI to India was channelled mainly into manufacturing sector (19.2 per cent), real estate activities (15.6 per cent), financial services (15.4 per cent), construction (12.2 per cent) and business services (11.7 per cent). Mauritius continued to be the major source of FDI during Q1 of 2009-10 with a share of 48.9 per cent followed by USA at 12.8 per cent. v) Portfolio investment primarily comprising foreign institutional investors (FIIs) investments and American Depository Receipts (ADRs)/Global Depository Receipts (GDRs) witnessed a sharp turnaround from net outflows of US$ 2.7 billion in Q4 of 2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-10.vi) The tightness in liquidity in the overseas markets continued during Q1 of 2009-10. The approvals of external commercial borrowings (ECBs) were very low in the first two months of 2009-10; however, it recovered during June 2009. vii) The gross disbursements of short-term trade credit was US$ 10.1 billion during Q1 of 2009-10 almost same in Q1 of 2008-09. The repayments of short-term trade credits, however, were very high at US$ 13.2 billion in Q1 of 2009-10 (US$ 7.8 billion in Q1 of 2008-09). As a result, there were net outflows of US$ 3.1 billion under short-term trade credit during Q1 of 2009-10 (inflows of US$ 2.4 billion in Q1 of 2008-09).viii) Banking capital mainly consists of foreign assets and liabilities of commercial banks. NRI deposits constitute major part of the foreign liabilities. Banking capital (net), including NRI deposits, were negative at US$ 3.4 billion during Q1 of 2009-10 as against a positive net inflow of US$ 2.7 billion during Q1 of 2008-09. ix) Other capital includes leads and lags in exports, funds held abroad, advances received pending for issue of shares under FDI and other capital not included elsewhere (n.i.e.). Other capital recorded net outflows of US$ 1.6 billion in Q1 of 2009-10. Hence from the description & facts given above we can see that the Indias Balance of Payment situation is not very good. The improvement in the Worlds economy would definitely boost the BOP position, but the Government too need to take some swift action to arrest the increase in deficit. Measures to improve balance of paymentsFew of the suggestions which we here make to improve the BOP condition are given as below: Reduce domestic Consumption-Domestic consumption in India is proving resilient as rest of world slips into recession. This is causing imports to rise faster than exports. Reducing consumer spending would reduce imports, but, it may be deemed inappropriate as economic growth may be more important than balance of payments.Encourage depreciation of Rupee-Depreciation in the Rupee would make Indian exports more competitive and imports more expensive. The problem is that with a global recession many other countries will want to help their exporters through encouraging a weaker currency.Structural improvements- Long term supply side policies aimed at increasing the competitiveness of exports should help improve the balance of payments for India. However, they will take a long time to work.The adverse balance of payments can be decreased in 3 ways:1) The foreign earnings should be increased by export led growth.2) The imports should be curtailed to essential items only.3) The expenditure on invisible imports should be minimized.policies adopted by the government of India since 1950-51India has a chronic deficit on current accounts. What bridges the gap between payments and receipts are mainly external aid (especially nonproject assistance), tourism earnings, and remittances from Indians working abroad. At the time of independence, higher imports and capital outflows, led by partition, resulted in significant deficit in the balance of payments necessitating running down of the accumulated sterling balances. As the country embarked upon the planned development in the fifties, rapid industrialization of the country through development of basic and heavy industries guided the industrial and trade policies during the First (1951-56) and the Second (1956-61) Five-Year Plans. 'Import substitution' was recognized as the appropriate strategy for rapid industrialization.Export pessimism permeated the policy stance throughout the early decades of our Planning. The inward looking industrialization strategy during the first three Plans resulted in higher rate of industrial growth. However, the signs of strain in the balance of payments were clearly visible in the Second Plan. As the import demand surged on account of development of heavy industries, current account deficit (CAD) in the Second Plan surged to 2.3 per cent of GDP. The Third Plan reflected the first signs of rethinking in the policy strategy by dedicating itself to self sustaining growth, which required domestic saving to progressively meet the demand of investment and for the balance of payment gap to be bridged over. Though the devaluation of 1966 brought to the fore the problems associated with the overvalued exchange rate, it did not bring immediate desired improvement in the balance of payments position. In fact, CAD-GDP ratio widened to 2.0 per cent during the Annual Plans (1966-69).Unlike the export pessimism of the earlier Plans, the Fourth Plan (1969- 74) visualized an aggressive approach to export growth for achieving self reliance. As a consequence, trade policy became the primary instrument for achieving a more dynamic concept of self reliance than what was prevalent in the earlier decades. However, it was in the Fifth Plan (1974-79) that self reliance was recognized as an explicit objective. In the Fifth Plan, invisibles surfaced as an important element of the current account with policy attention on tourism and shipping. Discovering the remittances from Indian workers as a new source of meeting the growing financing needs, the period witnessed new confidence in the external sector and prepared the ground work for takeoff to the exchange rate regime based on a basket arrangement initiated since 1975. The second oil price shock was the precursor of another phase of strain on India's balance of payments. However, emergence of rising invisible surplus in India's balance of payments helped neutralize the widening trade deficit. The Sixth Plan (1980-85) emphasized the strengthening of the impulses of modernization for the achievement of both economic and technological self reliance. The Seventh Plan (1985-90) noted the conditions under which the concept of self-reliance was defined earlier, particularly in the preceding Plan. It conceptualized self-reliance not merely in terms of reduced dependence on aid but also in terms of building up domestic capabilities and reducing import dependence in strategic materials. The weaknesses in the Indian economy were exposed by the Gulf crisis of 1990 and ensuing developments. The current account deficit rose to 3.1 per cent of GDP in 1990-91. Around the same time, credit rating of the country was lowered, restricting the countrys access to commercial borrowings and unwillingness on the part of normal banking channels to provide renewal of short-term credit to Indian banks abroad. The severity of the balance of payments crisis in the early 1990s could be gauged from the fact that Indias foreign currency assets depleted rapidly from US $ 3.1 billion in August 1990 to US $ 975 million on July 12, 1991. As a result of the crisis, a conscious decision was taken to honor all debt obligations without seeking any rescheduling and several steps were taken to tide over the crisis. The steps undertaken towards this objective included, among others, pledging our gold reserves, tightening of non-essential imports, accessing credit from the IMF and other multilateral and bilateral donors.After the Gulf crisis in 1991, the broad framework for reforms in the external sector was laid out in the Report of the High Level Committee on Balance of Payments, popularly known as Rangarajan Committee, former Governor of the Reserve Bank of India. After downward adjustment of the exchange rate in July 1991, following the recommendations of this Committee to move towards the market-determined exchange rate, we adopted the Liberalized Exchange Rate Management System (LERMS) in March 1992 involving dual exchange rate system in the interim period. The LERMS was essentially a transitional mechanism and a downward adjustment in the official exchange rate took place in early December 1992 and ultimate convergence of the dual rates was made effective from March 1, 1993, leading to the introduction of a market-determined exchange rate regime. The unification of the exchange rate of the Indian rupee was an important step towards current account convertibility, which was finally achieved in August 1994 by accepting Article VIII of the Articles of Agreement of the IMF. With the onset of structural reforms in 1991-92, accompanied initially by severe import compression measures and determined efforts to encourage repatriation of capital, there was a turnaround in the second half of 1991-92. Over the next two years (1993-95), mainly due to foreign investment flows, robust export growth and better invisible performance, the balance of payments situation turned comfortable and reserves surged by US $ 14 billion. In recent years the capital account has been dominated by flows in the form of portfolio investments including GDR issues, foreign direct investments and to a lesser extent, commercial borrowings and non-resident deposits, while traditionally, external aid was the only major component of the capital account. With significant opening up of the capital account, particularly on inflows, there were sustained foreign capital inflows since 1993-94. The net foreign assets of the Reserve Bank have also increased warranting open market operations involving sale of Government of India securities from the Reserve Banks portfolio and repo transactions - in order to offset the liquidity created by the purchases of foreign currency from the market; though use of cash reserve ratio is not uncommon. A Market Stabilization Scheme (MSS) was introduced in April 2004 wherein Government of India dated securities/Treasury Bills are issued to absorb liquidity. Proceeds of the MSS are immobilized in a separate identifiable cash account maintained and operated by the Reserve Bank, which is used only for redemption and/or buyback of MSS securities.DEFICIT IN THE BASIC BALANCE - DESIRABLE OR UNDESIRABLE!The basic balance was regarded as the best indicator of the economys position vis--vis other countries in the 1950s and the 1960s. It is defined as the sum of the BOP on current account and the net balance on long term capital, which were considered as the most stable elements in the balance of payments. A worsening of the basic balance [an increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit] is seen as an indication of deterioration in the [relative] state of the economy. Thus it is very much evident that a deficit in the basic balance is a clear indicator of worsening of the state of the countrys BOP position, and thus can be said to be undesirable at the very outset.However, on further thoughts, a deficit in the basic balance can also be understood to be desirable. This can be explained as follows: A deficit on the basic balance could come about in various ways, which are not mutually equivalent. E.g. suppose that the basic balance is in deficit because a current account deficit is accompanied by a deficit on the long term capital account. This deficit in long term capital account could be clearly observed in developing countries which might be investing heavily on capital goods for advancement on the agricultural and industrial fields. This long term capital outflow will, in the future, generate profits, dividends and interest payments which will improve the current account and so, ceteris paribus, will reduce or perhaps reduce the deficit.Thus a deficit in basic balance can be desirable as well as undesirable, as it clearly depends upon what is leading to a deficit in the long term capital account.

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