Program & BatchPGDM 2014-16

Term:VI

Course Name:IFM

Name of the faculty:Prof. Alok Kastia

Topic/ Title :Indias balance of payment

Original or Revised Write-up:Original

Group Number:-

Contact No. and email of Group Coordinator:Ph no.Sharadrai.cse@gmail.com

Group Members:Sl.Roll No.Name

11301-408Sharad rai

Balance Of Payments Position in India

BALANCE OF PAYMENTSDefinition:Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers.In simple words, it is the method countries use to monitor all international monetary transactions at a specific period of time. Usually, the BOP is calculated every quarter and every calendar year. All trades conducted by both the private and public sectors are accounted for in the BOP in order to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit. Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice this is rarely the case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.In other words:The 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.Purpose: The BOP is an important indicator of pressure on a countrys foreign exchange rate, and thus on the potential for a firm trading with or investing in that country to experience foreign exchange gains or losses. Changes in the BOP may predict the imposition or removal of foreign exchange controls. Changes in a countrys BOP may signal the imposition or removal of controls over payment of dividends and interest, license fees, royalty fees, or other cash disbursements to foreign firms or investors. The BOP helps to forecast a countrys market potential, especially in the short run. A country experiencing a serious trade deficit is not likely to expand imports as it would if running a surplus. It may, however, welcome investments that increase its exports.The Various Components Of A BOP Statement A. Current Account

B. Capital Account

C. Errors & Omissions

Current AccountThe 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 don't give rise to future claims.It can be calculated by a formula:

Where,CA: current accountX and M: export and import of goods and services respectivelyNY: net income from abroadNCT: net current transfers.BALANCE OF CURRENT ACCOUNTBOP on current account refers to the inclusion of three balances of namely Merchandise balance, Services balance and Unilateral Transfer balance. In other words it reflects the net flow of goods, services and unilateral transfers (gifts). 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.Thus the BOP on current account includes imports and exports of merchandise (trade balances), military transactions and service transactions (invisibles). The service account includes investment income (interests and dividends), tourism, financial charges (banking and insurances) and transportation expenses (shipping and air travel). Unilateral transfers include pensions, remittances and other transfers for which no specific services are rendered.It is also worth remembering that BOP on current account covers all the receipts on account of earnings (or opposed to borrowings) and all the payments arising out of spending (as opposed to lending). There is no reverse flow entailed in the BOP on current account transactions.STRUCTURE OF CURRENT ACCOUNTTransactionsCreditDebitNet Balance

1. MerchandiseExportImport -

2. Foreign TravelEarning Payment-

3. TransportationEarningPayment-

4. Insurance (Premium)ReceiptPayment-

5. Investment IncomeDividend ReceiptDividend Payment-

6.Government (purchase of goods & services)ReceiptPayment-

Current A/C Balance--Surplus (+)Deficit (-)

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. The basic distinctions are between private and official transactions, between portfolio and direct investment and by the term of the investment (i.e. short or long term). The distinction between private and official transaction is fairly transparent, and need not concern us too much, except for noting that the bulk of foreign investment is private.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). The acquisition of a firm resident in one country by a firm resident in another is an example of such a transaction, as is the transfer of funds from the parent company in order that the subsidiary company may itself acquire assets in its own country. 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, the most obvious being the purchase of the second home in another country.Portfolio investment by contrast is the acquisition of an asset that does not give the purchaser control. An obvious example is the purchase of shares in a foreign company or of bonds issued by a foreign government. Loans made to foreign firms or governments come into the same broad category. Such portfolio investment is often distinguished by the period of the loan (short, medium or long are conventional distinctions, although in many cases only the short and long categories are used). The distinction between short term and long term investment is often confusing, but usually relates to the specification of the asset rather than to the length of time of which it is held. For example, a firm or individual that holds a bank account with another country and increases its balance in that account will be engaging in short term investment, even if its intention is to keep that money in that account for many years. On the other hand, an individual buying a long term government bond in another country will be making a long term investment, even if that bond has only one month to go before the maturity. Portfolio investments may also be identified as either private or official, according to the sector from which they originate.The purchase of an asset in another country, whether it is direct or portfolio investment, would appear as a negative item in the capital account for the purchasing firms country, and as a positive item in the capital account for the other country. That capital outflows appear as a negative item in a countrys balance of payments, and capital inflows as positive items, often causes confusions. One way of avoiding this is to consider that direction in which the payment would go (if made directly). The purchase of a foreign asset would then involve the transfer of money to the foreign country, as would the purchase of an (imported) good, and so must appear as a negative item in the balance of payments of the purchasers country (and as a positive item in the accounts of the sellers country).The net value of the balances of direct and portfolio investment defines the balance on capital account.Short term capital movement includes: Purchase of short term securities Speculative purchase of foreign currency Cash balances held by foreigners Net balance of current account Long term capital movement includes: Investments in shares, bonds, physical assets etc. Amortization of capitalCAPITAL ACCOUNT CONVERTIBILITY (CAC)While there is no formal definition of Capital Account Convertibility, the committee under the chairmanship of S.S. Tarapore has recommended a pragmatic working definition of CAC. Accordingly CAC refers to the freedom to convert local financial assets into foreign financial assets and vice a versa at market determined rates of exchange. It is associated with changes of ownership in foreign / domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world. CAC is coexistent with restrictions other than on external payments. It also does not preclude the imposition of monetary / fiscal measures relating to foreign exchange transactions, which are of prudential nature.Following are the prerequisites for CAC:1. Maintenance of domestic economic stability.2. Adequate foreign exchange reserves.3. Restrictions on inessential imports as long as the foreign exchange position is not very comfortable.4. Comfortable current account position.5. An appropriate industrial policy and a conducive investment climate.6. An outward oriented development strategy and sufficient incentives for export growth.DIFFERENCE BETWEEN CURRENT ACCOUNT AND CAPITAL ACCOUNTCURRENT ACCOUNTCAPITAL ACCOUNT

Indicates flow aspect of countrys national transactions Relates to goods , services and unrequited transfers Indicates changes in stock magnitudes Relates to all transactions constituting debts and transfer of ownership

STRUCTURE OF BALANCE OF PAYMENTS ACCOUNTCREDITSDEBITS

Current A/c: Exports of goods(Visible items) Exports of services (Invisibles) Unrequited receipts(gifts , remittances, indemnities, etc. from foreigners)Capital A/c: Capital receipts (Borrowings from abroad, capital repayments by, or sale of assets to foreigners, increase in stock of gold and reserves of foreign currency etc.)Current A/c: Imports of goods(Visible items) Imports of services(Invisibles) Unrequited payments( gifts, remittance, indemnities etc. to foreigners)Capital A/c: Capital payments (lending to, capital repayments to, or purchase of assets from foreigners, reduction in stock of gold and reserves of foreign currency etc.)

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. Developing countries, in particular, usually experience great difficulty in providing reliable information.Errors and omissions (or the balancing item) reflect the difficulties involved in recording accurately, if at all, a wide variety of transactions that occur within a given period of (usually 12 months). In some cases there is such large number of transactions that a sample is taken rather than recording each transaction, with the inevitable errors that occur when samples are used. In others problems may arise when one or other of the parts of a transaction takes more than one year: for example with a large export contract covering several years some payment may be received by the exporter before any deliveries are made, but the last payment will not made until the contract has been completed. Dishonesty may also play a part, as when goods are smuggled, in which case the merchandise side of the transaction is unreported although payment will be made somehow and will be reflected somewhere in the accounts. Similarly the desire to avoid taxes may lead to under-reporting of some items in order to reduce tax liabilities.Finally, there are changes in the reserves of the country whose balance of payments we are considering, and changes in that part of the reserves of other countries that is held in the country concerned. Reserves are held in three forms: in foreign currency, usually but always the US dollar, as gold, and as Special Deposit Receipts (SDRs) borrowed from the IMF. Note that reserves do not have to be held within the country. Indeed most countries hold a proportion of their reserves in accounts with foreign central banks.The changes in the countrys reserves must of course reflect the net value of all the other recorded items in the balance of payments. These changes will of course be recorded accurately, and it is the discrepancy between the changes in reserves and the net value of the other record items that allows us to identify the errors and omissions.Balance Of Payment in IndiaIndias balance of payment position was quite unfavorable during the time of countrys entry into liberalized trade regime. Two decades of economic reforms and free trade opened several opportunities that, of course, reflected in the balance of payments performance of the country.

Indias Balance of Payments picture since 1991Independent Indias external trade and performance had faced severe threats many a times. The most challenging one was that of 1991.The economic crisis of 1991 was primarily due to the large and growing fiscal imbalances over the 1980s. Indias balance of payments in 1990-91 also suffered from capital account problems due to a loss of investor confidence. The widening current account imbalances and reserve losses contributed to low investor confidence putting the external sector in deep dilemma. During 1990-91, the current account deficit steeply hiked to $- 9680 million while the capital account surplus was far below at $ 7188 million. This led to an ever time high deficit in BOP position of India.India initiated economic reforms to find the way out of the growing crisis. Structural measures emphasized accelerating the process of industrial and import delicensing and then shifted to further trade liberalization, financial sector reform and tax reform. Prior to 1991, capital flows to India predominately consisted of aid flows, commercial borrowings, and nonresident Indian deposits. Direct investment was restricted, foreign portfolio investment was channeled almost exclusively into a small number of public sector bond issues, and foreign equity holdings in Indian companies were not permitted (Chopra and others, 1995). However, this development strategy of both inward-looking and highly interventionist, consisting of import protection, complex industrial licensing requirements etc underwent radical changes with the liberalization policies of 1991.The post reform period really eased Indias struggles with regard to external sector. This is evident from the RBI data summarizing the BOP in current account and capital account. The current account which measures all transactions including exports and imports of goods and services, income receivable and payable abroad, and current transfers from and to abroad remained almost negative throughout the post reform period except for the three financial years.Until 2000-01, the current account deficit that comprises both trade balance and the invisible balance, remained stagnant and stood around $ 5000 million. However, for the first time since 1991, the current account recorded surplus in its account during three consecutive financial years from 2001-02. The deficit in current account continued to occur from 2004-05 onwards and the growth rate was comparatively faster. The recent crisis of 2008 affected the trade performance of India in a large way. Indian economy had been growing robustly at an annual average rate of 8.8 per cent for the period 2003-04 to 2007-08. Concerned by the inflationary pressures, Reserve Bank of India (RBI) increased the interest rates, which resulted in a slowdown of Indias trade flows prior to the Lehman crisis (Kumar and Alex, 2009). The trade flows, which are one of the important channels through which India was affected during the recent global crisis of 2008, started to collapse from late 2008. Merchandise trade, software exports and remittances declined in absolute terms in response to the exogenous external shock.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 a 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 f iscal, 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 programme 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 def icit 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.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.Current account developments in 2012-13After 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 def icit f rom 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 f lows. 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 def icit 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 years.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 volatile.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 billion.Capital/Finance account in 2013-14Outcomes 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 signif icant 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.

Indias BOP during 1990-91 to 2013-14 (value in US $ million)YearCurrent account balanceCapital Account balanceOverall Balance

1990-91-96807188-2492

1991-92-117837772599

1992-93-35262936-590

1993-94-115996948535

1994-95-336991565787

1995-96-59124690-1222

1996-97-4619114126793

1997-98-5499100104511

1998-99-403882604222

1999-00-4698111006402

2000-01-266685355868

2001-023400835711757

2002-0363451064016985

2003-04140831733831421

2004-05-24702862926159

2005-06-99022495415052

2006-07-95654617136606

2007-08-1573710790192164

2008-09-279157835-20079

2009-10-381805162213441

2010-11-459455899613050

2011-12-7815565324-12832

2012-13-8816391989-3826

2013-14-3239747905-15508

Source: Reserve Bank of India, www.rbi.org

BOP CRISIS IN INDIACrisis of 1956-57From 1947 till 1956-57, the India had a current account surplus. By the end of the first plan, the Trade deficit was Rs. 542 Crore and Net Invisibles was Rs. 500 Crore, thus giving a BoP deficit in Current Account worth Rs. 42 Crore. From this time onwards, the trade deficit increased from 3.8% of the GDP at market prices to 4.5% of GDP (at Market Prices). The result was an imposition of the exchange controls. This was the first BoP crisis, ever India faced, after independence.Crisis of 1966In 1965, when India was at War with Pakistan, the US responded by suspension of aid and refusal to renew its PL-480 agreement on a long term basis. The idea of US as well as World Bank was to induce India to adopt a new agricultural policy and devalue the rupee. Thus, the Rupee was devalued by 36.5% in June 1966. This was followed by a substantial rationalization of the tariffs and export subsidies in an expectation of inflow of the foreign aid. The BoP improved, but not because of inflow of foreign aid but because of the decline in imports.After the 1966-67, the BoP of India remained comfortable till 1970s. The first oil shock of 1973-74 was absorbed by the Indian Economy due to buoyant exports. After that there was an expansion of the international trade.Crisis of 1990-91:BoP crisis had its origin from the fiscal year 1979-80 onwards. By the end of the 6th plan, Indias BoP deficit (Current account) rose to Rs. 11384 crore. It was the mid of 1980s when the BoP issue occupied the centre position in Indias macroeconomic management policy. The second Oil shock of 1979 was more severe and the value of the imports of India became almost double between 1978-78 and 1981-82. From 1980 to 1983, there was global recession and Indias exports suffered during this time.The trade deficit was not been offset by the flow of the funds under net invisibles. Apart from the external assistance, India had to meet its colossal deficit in the current account through the withdrawal of SDR and borrowing from IMF under the extended facility arrangement. A large part of the accumulated foreign exchange fund was used to offset the BoP.During the 7th plan, between 1985-86 and 1989-90, Indias trade deficit amounted to Rs. 54, 204 Crore. The net invisible was Rs. 13157 Crore and Indias BoP was Rs. 41047 Crore. India was under a sever BoP crisis. In 1991, India found itself in her worst payment crisis since 1947. The things became worse by the 1990-91 Gulf war, which was accompanied by double digit inflation.Indias credit rating got downgraded. The country was on the verge of defaulting on its international commitments and was denied access to the external commercial credit markets. In October 1990, a Net Outflow of NRI deposits started and continued till 1991.The only option left to fulfil its international commitments was to borrow against the security of Indias Gold Reserves. The prime Minister of the country was Chandra Shekhar and Finance Minister was Yashwant Sinha. The immediate response of this Caretaker government was to secure an emergency loan of $2.2 billion from the International Monetary Fund by pledging 67 tons of Indias gold reserves as collateral. This triggered the wave of the national sentiments against the rulers of the country. India was called a Caged Tiger.On 21 May 1991, Rajiv Gandhi was assassinated in an election rally and this triggered a nationwide sympathy wave securing victory of the Congress.The new Prime Minister was P V Narsimha Rao, who was Minister of Planning in the Rajiv Gandhi Government and had been Deputy Chairman of the Planning Commission. He along with Finance Minister Manmohan Singh started several reforms which are collectively called Liberalization. This process brought the country back on the track and after that Indias Foreign Currency reserves have never touched such a brutal low.

In 1991, the following measures were taken:In 1991, Rupee was once again devaluated.Due to the currency devaluation the Indian Rupee fell from 17.50 per dollar in 1991 to 45 per dollar in 1992.The Value of Rupee was devaluated 23%.Industries were delicensed.Import tariffs were lowered and import restrictions were dismantled.Indian Economy was opened for foreign investments.Market Determined exchange rate system was introduced.LERMSIn the Union Budget 1992-93, a new system named LERMS was started. LERMS stands for Liberalized Exchange Rate Management. The LERMS was introduced from March 1, 1992 and under this, a system of double exchange rates was adopted.Under LERMS, the exporters could sell 60% of their foreign exchange earning to the authorized Foreign Exchange dealers in the open market at the open market exchange rate while the remaining 40% was to be sold compulsorily to RBI at the exchange rates decided by RBI.Another important features of LERMS was that the Government was providing the foreign exchange only for most essential imports. For less important imports, the importers had to arrange themselves from the open market.Thus, we see that LERMS was introduced with twin objectives of building up the Foreign Exchange Reserves and discourage imports. The Government was successful in this.

Rangarajan Panel for Correcting BoPThe Report of the High Level Committee on Balance of Payments, of which Dr. Rangarajan was the Chairman, was submitted in June 1993. The important recommendations of this panel were as follows:A realistic exchange rate and a gradual relaxation of the restrictions on the current account should go hand in hand.Current account deficit of 1.6% of GDP should be treated as a ceiling.Government should be cautious of extending concessions or facilities to the Foreign Investors. The concessions were more to the foreign investors than to the domestic players.All external debts should be pursued on a prioritized on the basis of the Use on which the debt is to be put.No approval should be accorded for a commercial loan which has a maturity of less than 5 years.There should be efforts so that Debt flows can be replaced by the equity flows.The High Level Committee on Balance of Payments, 1993, chaired by Dr. C. Rangarajan, recommended that the RBI should target a level of reserves that took into account liabilities that may arise for debt servicing, in addition to imports of three months.

Major Items of India's Balance of Payments

(US$ Billion)

Apr-Jun 2014 (P)Apr-Jun 2013 (PR)

CreditDebitNetCreditDebitNet

A. Current Account139.2147.0-7.8130.9152.7-21.8

1. Goods81.7116.4-34.673.9124.4-50.5

Of which:

POL15.840.8-25.014.239.2-25.0

2. Services37.620.517.136.519.716.9

3. Primary Income2.39.0-6.72.57.4-4.8

4. Secondary Income17.61.116.418.01.316.7

B. Capital Account and Financial Account147.3138.68.6135.1114.220.9

Of which:

Change in Reserve (Increase (-)/Decrease (+))11.2-11.20.30.3

C. Errors & Omissions (-) (A+B)-0.80.9

P: Preliminary; PR: Partially Revised

Note: Total of subcomponents may not tally with aggregate due to rounding off.

Measures of Correcting in Adverse Balance of Payment1. Trade Policy Measures: Expanding, Exports and Restraining Imports:Trade policy measures to improve the balance of payments refer to the measures adopted to promote exports and reduce imports. Exports may be encouraged by reducing or abolishing export duties and lowering the interest rate on credit used for financing exports. Exports are also encouraged by granting subsidies to manufacturers and exporters.Besides, on export earnings lower income tax can be levied to provide incentives to the exporters to produce and export more goods and services. By imposing lower excise duties, prices of exports can be reduced to make then competitive in the world markets.On the other hand, imports may be reduced by imposing or raising tariffs (i.e., import duties) on imports of goods. Imports may also be restricted through imposing import quotas, introducing licenses for imports. Imports of some inessential items may be totally prohibited.Before the economic reforms carried out since 1991 India had been following all the above policy measures to promote exports and restrict imports so as to improve its balance of payments position. But they had not achieved much success in their aim to correct balance of payments disequilibrium. Therefore, India had to face great difficulties with regard to balance of payments.At long last, economic crisis caused by persistent deficits in balance of payments forced India to introduce structural reforms to achieve a long-lasting solution of balance of payments problem.2. Expenditure-Reducing Policies:The important way to reduce imports and thereby reduce deficit in balance of payments is to adopt monetary and fiscal policies that aim at reducing aggregate expenditure in the economy. The fall in aggregate expenditure or aggregate demand in the economy works to reduce imports and help in solving the balance of payments problem.The two important tools of reducing aggregate expenditure are the use of:

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(1) Tight monetary policy and(2) Contractionary fiscal policy.

Tight Monetary Policy:Tight monetary is often used to check aggregate expenditure or demand by raising the cost of bank credit and restricting the availability of credit. For this bank rate is raised by the Central Bank of the country which leads to higher lending rates charged by the commercial banks.This discourages businessmen to borrow for investment and consumers to borrow for buying durable consumers goods. This therefore leads to the reduction in investment and consumption expenditure. Besides, availability of credit to lend for investment and consumption purposes is reduced by raising the cash reserve ratio (CRR) of the banks and also undertaking of open market operations (selling Government securities in the open market) by the Central Bank of the country.This also tends to lower aggregate expenditure or demand which will helps in reducing imports. But there are limitations of the successful use of monetary policy to check imports, especially in a developing country like India.This is because tight monetary policy adversely affects investment increase in which is necessary for accelerating economic growth. If a developing country is experiencing inflation, tight monetary policy is quite effective in curbing inflation by reducing aggregate demand.This will help in reducing aggregate expenditure and, depending on the income propensity to import, will curtail imports. Besides, tight monetary policy helps to reduce prices or lower the rate of inflation. Lower price level-or lower inflation rate will curb the tendency to import, both on the part of businessmen and consumers.But when a developing country like India is experiencing recession or slowdown in economic growth along with deficits in balance of payments, use of tight monetary policy that reduces aggregate expenditure or demand will not help much as it will adversely affect economic growth and deepen economic recession. Therefore, in a developing country, monetary policy has to be used along with other policies such as an appropriate fiscal policy and trade policy to tackle the problem of disequilibrium in the balance of payments.Contractionary Fiscal Policy:Appropriate fiscal policy is also an important means of reducing aggregate expenditure. An increase in direct taxes such as income tax will reduce aggregate expenditure. A part of reduction in expenditure may lead to decrease in imports. Increase in indirect taxes such as excise duties and sales tax will also cause reduction in expenditure.The other fiscal policy measure is to reduce Government expenditure, especially unproductive or non-developmental expenditure. The cut in Government expenditure will not only reduce expenditure directly but also indirectly through the operation of multiplier.It may be noted that if tight monetary and Contractionary fiscal policies succeed in lowering aggregate expenditure which causes reduction in prices or lowering the rate of inflation, they will work in two ways to improve the balance of payments.First, fall in domestic prices or lower rate of inflation will induce people to buy domestic products rather than imported goods.Second, lower domestic prices or lower rate of inflation will stimulate exports. Fall in imports and rise in exports will help in reducing deficit in balance of payments.However, it may be emphasized again that the method of reducing expenditure through Contractionary monetary and fiscal policies is not without limitations. If reduction in aggregate demand lowers investment, this will adversely affect economic growth.Thus, correction in balance of payments may be achieved at the expense of economic growth. Further, it is not easy to reduce substantially government expenditure and impose heavy taxes as they are likely to affect incentives to work and invest and invite public protest and opposition. We thus see that correcting the balance of payments through Contractionary fiscal policy is not an easy matter.3. Expenditure Switching Policies: Devaluation:A significant method which is quite often used to correct fundamental disequilibrium in balance of payments is the use of expenditure-switching policies. Expenditure switching policies work through changes in relative prices. Prices of imports are increased by making domestically produced goods relatively cheaper.Expenditure switching policies may lower the prices of exports which will encourage exports of a country. In this way by changing relative prices, expenditure-switching policies help in correcting disequilibrium in balance of payments.The important form of expenditure switching policy is the reduction in foreign exchange rate of the national currency, namely, devaluation. By devaluation we mean reducing the value or exchange rate of a national currency with respect to other foreign currencies. It should be remembered that devaluation is made when a country is under fixed exchange rate system and occasionally decides to lower the exchange rate of its currency to improve its balance of payments.However, even in the present flexible exchange rate system, the value of a currency or its exchange rate as determined by demand for and supply of it can fall. Fall in the value of a currency with respect to foreign currencies is described as depreciation. If a country permits its currency to depreciate without taking effective steps to check it, it will have the same effects as devaluation.As a result of reduction in the exchange rate of a currency with respect to foreign currencies, the prices of goods to be exported fall, whereas prices of imports go up. This encourages exports and discourages imports.With exports so stimulated and imports discouraged, the deficit in the balance of payments will tend to be reduced. Thus policy of devaluation is also referred to as expenditure switching policy since as a result of reduction of imports, people of a country switches their expenditure on imports to the domestically produced goods.It may be noted that as a result of the lowering of prices of exports, export earnings will increase if the demand for a countrys exports is price elastic (i.e., ep > 1). And also with the rise in prices of imports the value of imports will fall if a countrys demand for imports is elastic. If demand of a country for imports is inelastic, its expenditure on imports will rise instead of falling due to higher prices of imports.This is because the demand for bulk of our traditional exports was not very elastic and also we could not reduce our imports despite their higher prices. However devaluation of July 1991 proved quite successful as after it our exports grew at a rapid rate for some years and growth of imports remained within safe limits.4. Exchange Control:Finally, there is the method of exchange control. We know that deflation is dangerous; devaluation has a temporary effect and may provoke others also to devalue. Devaluation also hits the prestige of a country.These methods are, therefore, avoided and instead foreign exchange is controlled by the government. Under it, all the exporters are ordered to surrender their foreign exchange to the central bank of a country and it is then rationed out among the licensed importers. None else is allowed to import goods without a licence. The balance of payments is thus rectified by keeping the imports within limits.After the Second War World a new international institution International Monetary Fund (IMF) was set up for maintaining equilibrium in the balance of payments of member countries for a short term. IMF also advises member countries how to correct fundamental disequilibrium in the balance of Payments when it does arise. It may, however, be mentioned here that no country now needs to be forced into deflation (and so depression) to root out the causes underlying disequilibrium as had to be done under the gold standard. On the contrary, the IMF provides a mechanism by which changes in the rates of foreign exchange can be made in an orderly fashion.Current situation:India's balance of payments (BoP) turned negative in the second quarter of 2015 after a gap of seven quarters. As per Reserve Bank of India (RBI) data, the country witnessed $0.86 billion depletion of reserve assets, the depletion last seen in the September 2013 quarter of $10.4 billion, due to flight of foreign institutional investors (FIIs) and capital outflows on the loan account.FIIs were solely responsible for the depletion of reserves this quarter. India saw net FII outflows of $6.5 billion between July and September 2015. FII inflows had started surging from the beginning of the calendar year 2014 but turned negative in the June 2015 quarter. The situation worsened in Q2FY16. Net outflow of portfolio investments intensified to $6.5 billion from $2.6 billion in the June 2015 quarter. Unlike in April-June 2015, the September quarter saw a bulk of the outflows from the equity market.Net foreign direct investments (FDI) in India during July-September 2015 were at $6.6 billion, the lowest in the past six quarters. A major chunk of this investment flew in from Singapore and Mauritius and went into telecom, software, automobile, mining, construction and other services sectors.Other net investments in India during the September 2015 quarter amounted to $8.8 billion. Half of it came in the form of NRI deposits, while the other half was divided between external assistance, ECBs and banking capital.It is worth noting that although net other investments during July-September showed a big jump over the investments of mere $1.1 billion in the year-ago quarter, it is substantially lower than the investments seen on this account in the preceding three quarters.Overall, the country witnessed net capital inflows (excluding reserves) of $7.2 billion during July-September 2015, the lowest quarterly inflows in the past two years. These inflows were not sufficient to cover the country's current account deficit, which amounted to $8.2 billion.

References/Bibliography: en.wikipedia.org/wiki/Balance_of_payments/ www.investopedia.com/articles/03/060403.asp www.economicshelp.org/blog/glossary/balance-payments/ Economic Survey (2013-14), http://indiabudget.nic.in Reserve Bank of India, www.rbi.org Search Engine:- Google.com