Causes of balance of payment crisisi in india 1991

8/7/2019 Causes of balance of payment crisisi in india 1991

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Group 1

Arjun Singh 2010052

Bipul Megotia 2010063

Gaurav Kataria 2010074

Jaya Dadlani 2010084

Kartik Mathur 2010094

Ankit Arora 2010261


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` Sudden downturn brought on by a financial crisis.

` Results in falling GDP, a drying up of liquidity andrising/falling prices due to inflation/deflation.


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` A record of alltransactions madebetween one particularcountry and all other

countries duringa specified period of time.

` The BOP includesthe trade balance, foreigninvestments andinvestments byforeigners.


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` A negative balance of payments means that moremoney is flowing out of the country than comingin, and vice versa.

` If a country has a consistently positive BOP,this could mean that there is significant foreigninvestment within that country. It may also mean

that the country does not export much of itscurrency.


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` Current Account

` Capital Account

` Balancing Item


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` Break-up of Soviet Bloc

` Iraq-Kuwait War

` Political uncertainty

` Confidence


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Middle East crisis (Gulf War)

Break up of Soviet Bloc


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Reserve tranche(RT)Rs.1177 Cr (US$600 million)

Compensatory andContingency financing facility(CCFF)Rs. 1884 Cr(1.025 billion $)

First credit tranche (FC Rs 1450 Cr ($78 millio


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BOP problem started from the year 1985 itself

Rajiv gandhi government-gradual relaxation of the license Raj and appointmentof V.P singh as the finance minister.

Some of the steps by V.P Singh

Extraordinary powers to enforcement Directorate

To control tax evasion.

Controlled smuggling by reducing the tax.

Whip on smugglers

Raids all over the nation on suspected evaders including the premises ofAmitabh Bacchan and Dhirubhai ambani.

Transferred to defense ministry but was made to quit when he tried to fall on theirregularities of bofors deal.

Later he formed his own government to could not sustain due to whip on Basbrimasjid agitators.


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` The caretaker government with Yashwant singh as the financedminister took the decision to ship the gold.

` National sentiments were outraged. The government had to give up.

` Assassination of Rajiv Gandhi led to worsening of the situation.

` P.V.Narasimha Rao government with Dr. Manmohan singh took overto control the situation and create the history.


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Blacklisted by Standard & Poor's, Moody's.

one Indian rupee fetched just 0.002 US dollars.

The government was unstable. Rajiv Gandhi, a former prime minister,had just been assassinated

Finance Minister Manmohan Singh pulled the trigger and sold about$200 million worth of confiscated smuggled gold .


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` pledging the RBI's gold was the only savior

` A country that worshipped gold as an auspicious item, now had toship it away to save itself.


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` The RBI used gold to save the country from spiraling debt.

` The decision by Finance minister Yashwant Singh was at the timewhen all other Asian countries were defaulting.

` And since 1991, India has gone on to receive an investment grade

rating by Moody's, and the stock market is up nearly 400%.` India now has a healthy trade surplus of $31 billion and owes the

International Monetary Fund absolutely no money.


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Come Back the financial crisis the people of India have a colossalhoard of gold

to fall back upon.

Why Indians Hoard Gold???????

Hide the wealth from taxmen. Worshipped as goddess of wealth.

Ornamental value.


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` Indian stock market is not very accessible to thecommon man.

` Investment vehicles are few and only available to thewealthy.

` Remote villages with no banks or safe-deposit boxes


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Fiscal deficit rose from 3.5% of GDP in 1971 to 7.8% in 1990.

Evidences of crowding out effect could be seen.

The inflation rate was 9.3% per annum during the first half of

the eighties and fell to 6.7% per annum during the second half

of the eighties.Some of the policy reforms were more helpful as fiscal deficitwould have raised the prices.

Current account deficit was also on an upward trend.

Such fiscal deficit and current account deficit were too high to

be sustainable and consequently the BOP crisis was a disasterwaiting to happen


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` Dichotomy in discussions about the external sector inIndia

` One set of discussions used to take place in the contextof economic planning, where the focus was on savings

gap

` The second set of discussions was related to externalaid and other means of financing the current accountdeficit


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` The explicit or implicit policy recommendation was thatthe problem required a halt to further import de-controlor perhaps even a reversal.

` The BOP data for the full decade tends to supportthese arguments, as imports rose much faster thanexports during the eighties.


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`

The limited loosening of import controls (primarily forexporters) during the eighties (along with some industrialde-licensing) also had other positive effects.

` The former included a much easier regime for import ofcapital goods by exporters along with lower import dutiessubject to export commitments

` Even though the initial liberalization was in capital goodsfor use of exporters, the rules were flexible enough for theireffect to be felt in the domestic economy. This is one likelyexplanation of the growth acceleration during the eighties.


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` The declining invisible surplus was driven by theincome deficit, which was rising up to the crisis year .

` The rising debt-GDP ratio led to rising interestpayments.

`

The cost of national borrowing was rising faster thanthe returns from the investment made . This waslinked to the low productivity of governmentexpenditure


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` Not enough incentive to generate external resourcesin line with the rising cost.

` Thus the issue of sustainability of the current accountwas closely linked with the sustainability of the overallfiscal situation, of which the rising fiscal deficit was a

visible symptom


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` Widening current A/C deficit Due to import of Aircrafts and defense equipment

` Current A/C deficit reached a new low of 3.0%,

when a deficit of 1.8% 2.2% was considered tobe healthy.

` Current a/c deficit of $9.7 billion almostimpossible to finance


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` This 0.8% increase in current a/c was financedthrough 0.3% External Commercial Borrowing (ECB)

0.3% NRI Deposits

0.3% other capital

` The problem arose when this external debt wasfunneled into financing the Government's deficit.

` Serious difficulties in rolling over of short term

loans


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` Foreign exchange reserve touched a new low of$1.2 billion, even not enough to sustain twoweeks import bill

` Simultaneous outflow of NRI Deposits


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` As per Mundell-Fleming model Expansive fiscal or monetary policyin the case of

a country such as India with limited capital mobility

causes a balance of payments deficit and nominal exchange

rate depreciation.

With sluggish prices, the real exchange rate alsodepreciates.


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` Severe exchange rate depreciation on July 1 and 3.Rupee devalued by 22%. Rupee- Dollar rate depreciatedfrom Rs.21.20 to Rs.25.80

` High inflation in India (1985/86 1990/91) relative to its

trading partners put further downward pressure on thenominal exchange rate.


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` Despite low trade deficit, the slide in foreignreserves continued unabated

` Essentially became a crisis of confidence

Expectation ofdefault

Expecteddevaluation

Payments

of import &exports

Withdrawal by

foreigners

Furtherdrop in

reserves


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` The RBI refused further credit to Gov.t

` The caretaker Gov.t had to pledge 67 tones of

gold as collateral to secure a loan of $2.2 billion.


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Causes of balance of payment crisisi in india 1991