me term paper - group 3

8/3/2019 ME Term Paper - Group 3

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Group 3Group 3BhuvaneshwariBhuvaneshwari RR PGP 14/206PGP 14/206

ChaitraChaitra JJ PGPPGP 14/14/207207

Chandramohan Nayak MChandramohan Nayak M PGPPGP 14/14/209209

NeeluNeelu KK PGPPGP 14/14/216216

PragyaPragya PP PGPPGP 14/14/221221

MadhusudanaanMadhusudanaan NMNM PGPPGP 14/14/225225


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Overview of the crisis

Balance of Payments the machinery India before the crisis

Events leading to the crisis

The Crisis and recovery

Post Crisis India

Conclusion

Agenda


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Exchange rate was subjected to severe adjustment

Foreign exchange reserves were barely adequate for3 weeks of imports

Was on a brink of default

1990 What happened?

BALANCE OF PAYMENT CRISIS!!!


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An accounting record of all monetary transactions

between a country and the rest of the world

Sources of funds : positive or surplus item

Exports, receipts of loans and investments

Usage of funds : negative or deficit items

Imports or investment in foreign countries

All the components of a BoP sheet must balance: nooverall surplus/deficits.

BoP- An Introduction


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Two primary compositions of a BoP sheet:

Current account

Balance of trade + Factor payments + Cash transfers

Capital account

Reserves account along with the loans and investmentbetween the country and the RoW

BoP = Current account Capital account balancing items

Composition of BoP Sheet


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A visible trade deficit

A nation is importing more physicalgoods than it exports

An overall current account deficit

A basic deficit

Current account plus foreign directinvestment

Types of Deficits


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Rebalancing by changing the exchange rate

Rebalancing by adjusting internal prices anddemand

CA = NS NI

Rules based rebalancing mechanisms

Balancing Mechanisms


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Balance of PaymentsCrisis???


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Currency crisis / balance-of-payments crisis is a

speculative attack in the foreign exchange market

Speculative attack in the foreign exchange marketThe massive selling of a country's currency

assets by both domestic and foreign investors

Countries that utilize a fixed exchange rate are more

susceptible to a speculative attack than countriesutilizing a floating exchange rate because they havelarge amount of reserves necessary to hold the fixedexchange rate in place at that fixed level

What is BoP Crisis?


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But, if a government chooses to maintain a fixed

exchange rate during a speculative attack, they riskthe chance of severe economic depression orfinancial collapse, as illustrated by the Argentine andEast Asian financial crisis

What is BoP Crisis?


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An adaptation of Stephen Salant and Dale

Hendersons model of speculative attacks in gold

market

Sudden speculative attack on fixed exchange rate canbe a result from rational behavior by investors

Occurs when investors foresee that a government is

running an excessive deficit

First Generation Model


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The reason investors attack the currency is that they

expect other investors to attack is true

Second Generation Model


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Deal with how problems in the banking and financial

system interact with currency crisis

Suggests that "over borrowing" by banks to fund moralhazard lending is a form of hidden government debts

Suggests that self-fulfilling panics that hit the financialintermediaries, force liquidation of long run assets

Argues that a currency crisis may cause a banking crisis iflocal banks have debts denominated in foreign currency

Third Generation Model


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Comfortable during the 70s

1973-74 oil shocks aftermath saw increase inforeign aid, private transfers and booming exports

Global trade flourished exports increased

Price levels lower in India compared to othercountries depreciation of Rupee

Private transfers increased seven-fold

Decade of Comfort 70s


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Private transfers helped support 80% of trade deficit

Result : 1978-79 : Current account deficit was just 0.2% of GDP

Aid was higher than financial requirements for thedecade built up reserves

Close of decade: Foreign exchange reserves covering

7 months of imports!

Decade of Comfort 70s


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BO

P upto 1981-82 The second oil shock of 1979 was severe

Increase in POL imports

Exports were decreased due to internationalrecession

These factors led to a Current Account deficit


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BO

P upto 1981-82 During 1982-83 to 1984-85, there was a ease on

pressure on BOP due toDecline in volume growth of imports from an average

rate of 11% to 2%

NetOil imports declined substantially as domesticproduction spurted to 29 million tones after thediscovery of crude oil in Bombay High

Non-POL imports rose at an average rate of 3.6% indollar terms whereas exports increased at rate of3.2% in volume terms


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BO

P upto 1981-82 Invisibles Account deteriorated as interest payments

to service external borrowing acquired a rising trend

Commercial borrowings and non-resident depositsemerged as the important sources of finance

External assistance remained the major source offoreign capital inflow


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Build up to the crisis Second half of the eighties witnessed the building up

of strains on the BOP

Current Account Deficit remained high throughout

Trade deficit occurred despite a increase in exports

Manufactured exports increased during this period


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Build up to the crisis Heavy interest payments on foreign debts

Fiscal deficit 8.2% of GDP

Heavy borrowing from IMF debt-service ratioincreased -13.6% in 1984-85 to 30.9% in 89-90


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Build up to the crisis The genesis of the economic crisis in India, which

surfaced in 1991, lies in the large and persistent

macroeconomic imbalances that developed over the1980s.

The root cause of the crisis was the large andgrowing fiscal imbalance

Large fiscal deficits emerged as a result of mountinggovernment expenditures


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Build up to the crisis Fiscal deficits led to high levels of borrowing by the

government from RBI, with an expansionary impact

on money supply leading directly to high rate ofinflation

The gross fiscal deficit of the government rose from9.0% of GDP in 1980-81 to 10.4% in 1985-86 and to

12.7 % in 1990-91.


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Build up to the crisis These deficits had to be met by borrowings, the

internal debt of the government accumulated

rapidly, rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91

interest payments increased from 2% of GDP in 1980-81 to 4% in 1990-91


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Build up to the crisis The dynamic interrelationship between the fiscal and

trade deficits, resulted in large current account

deficits in the balance-of-payments In order to meet these large and persistent current

account deficits, large scale commercial borrowingswere undertaken along with contraction of

substantial short-term debt.


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Build up to the crisis The capital account of the balance-of-payments

began experiencing strains after 1986 with the

bunching of repayment obligations to the IMF andsome of the private creditors.


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Build up to the crisis

BOP Deficitleads to

Forex reservesDepletion

ExternalBorrowings

ReducedForeign

Investments

Debt Trap


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1990 1992 Ugly

Series of unfortunate events

Gulf crisis of 1990 increase in oil import bill

Burden of repatriating and rehabilitating of NRIsfrom West Asia

Deterioration of invisible account

Increase in price of oil => overall current accountdeficit in 1990-91 : US $ 9.7 billion

The Crisis


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Important trading partners grew weak US, Russia

World growth declined from 4.5% in 1988 to 2.5% in1991

Result : Export volume growth reduced to 4%

Political turmoil VP Singh governmentoverthrown, Rajiv Gandhi assassination reduced

credibility of India


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Capital Account

problems Foreign reserves very low at $1.2 billion

Overshot IMF SDR reserves

Only option commercial borrowing

Loss of investor confidence - Credit agenciesdowngraded India

Simultaneous outflow of NRI deposits

Serious difficulties in rolling over of short term loans

Current account deficit of $9.7 billion almostimpossible to finance


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Government 2 tasks

Compress imports

Find exceptional financing Unorthodox steps taken Pledging of gold

Adjustment in exchange rate

Structural reforms in trade, industrial and foreign

investment policies Loss of reserves stemmed by less imports

Result : 1991-92 ended with current account deficit ofless than 1% of GDP!

Revival


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Government deficit

Percentage of GDP


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Current Account trends


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Real exchange rate trends


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External debts As a

percentage of GDP


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Foreign exchange

reserves


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conscious policy of industrial de-regulation

exchange rate was devalued

system transformation from discretionary, basket-peggedsystem, to a market-determined, unified exchange rate,following a short intermediate period of dual rates

Anti-export bias in the trade and payments regime was

also reduced substantially A phased reduction in the exceptionally high customs tariffs

A phased elimination of quantitative restrictions on imports

Corrective Policies


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Policies were initiated to encourage both direct and

portfolio foreign investment

Short-term debt was reduced and strict controls put inplace to prevent future expansion Medium-term borrowing from private commercial

sources was made subject to annual caps and minimummaturity requirements

Growth of NRI deposits was moderated through

reduction of incentives Foreign exchange reserves were consciously accumulated

to provide greater insurance against external sectorstresses and uncertainties

Corrective Policies


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Trade and Investment Flows

Surge in exports

Significant rise in foreign direct investment and othercapital flows

Substantial increase in private transfers under thecategory of invisibles in balance of payments account

In ten years, 1991- 2001, Over 37 billion dollars of foreign investment flowed

18 billion $ was direct investment, i.e., an average of 2.2billion $ per year.

Effects ofL

iberalization


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Trade and Investment Flows

Private transfers grew to a level of 10-12 billiondollars in the latter half of 1990s.

Export growth momentum and the exchange ratereforms - the two major factors which helpedcontain the current account deficit in BOP to 1 to

1.5 per cent of GDP between 1991 and 2001

Effects ofL

iberalization


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Balance of Payment Surplus

NRI deposits with the banking system in India on the

rise from 13 billion dollars in 1991-92 to 23.8 billiondollars by March 2001

Balance of payments recorded an overall surplusconsecutively for five years from 1996-97

Indias foreign exchange reserves, barely one billion inthe pre-crisis year reached $ 40 billion (other than goldand SDR) - the average annual addition being 4.5billion dollars

Effects ofL

iberalization


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Balance of Payment Surplus

External sector - growth rates moving up to 11and 20% in the two years ended March 2001

India successfully withstood

the fall-out effects of the Asian financialturmoil in 1997

the economic sanctions imposed by USA andother countries following the nuclear tests inMay 1998t

the sharp rise in international oil prices since

the closing months of 1999.

Effects ofL

iberalization


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Transition from an onerous trade regime to a

market-friendly system encompassing both trade

and current payments Acceleration of GDP growth to 6.7 per cent in the

period 1992-97 was the highest India had everachieved over a five year period

Sum of external current payments and receipts as aratio to gross domestic product (GDP) doubled fromabout 19% in 199091 to around 40% by March 2001

Recovery of the 1990s


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Stabilization measures of 1991-93 restored

macroeconomic stability and fuelled one of the

swiftest recoveries of economic dynamism andbusiness environment seen anywhere in the world inrecent decades

GDP growth recovered to nearly 6 per cent in 1993-

94 and exceeded 7 per cent in each of the next threeyears

Manufacturing recorded average real growth of 11.3per cent in the four years 1993-94 to 1996-97



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Export growth in dollar terms averaged 20 per cent

in the three years 1994 1996 and the rates of

aggregate savings and investment in the economypeaked in 1995-96

Real fixed investment rose by nearly 40 %, led by amore than 50 % increase in industrial investment

Private investment showed an astounding averagegrowth of 16.3% per annum during 1992-96

Restoration of confidence and liberalization offoreign investment policies triggered a temporarysurge in foreign capital inflow



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External commercial

borrowings

-10 0 10 20 30 40 50

1980-81

1985-86

1986-87

1987-88

1988-89

1989-90

1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

10.9

25.2

48.1

20.1

36.7

31.8

26.8

30.6

-8.4

9.1

13.6

21

10.6

ECB/TC (%)

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91

1991-92 1992-93 1993-94 1994-95 1995-96 1996-97


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1993-94: Result of a concious government policy to

maintain a strict control over external indebtness and

resulted favourably in improving the credit rating ofIndia by international agencies.

1994-95: Some private sector power and petroleumcompanies finalizing their financing packages

1995-96: Large demand for borrowing with projectsin petroleum, oil exploration andtelecommunications.

External commercial

borrowings


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External Assistance

0

10

20

30

40

50

60

70

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

60.9

36.2 34.6

46.9

36.733.2

26.3

63.9

43.7

18.5 19

29.8

11.7

EXTERNAL ASSISTANCE/TC (%)

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91

1991-92 1992-93 1993-94 1994-95 1995-96 1996-97


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Advance release of funds to state governments

Disintermediation of loans to central public sector

units

Setting up of a Project Management Unit (PMU) aspart of the department of Economic Affairs tomonitor ,supervise and strengthen various projects.

In 1994-95 decided not to approach IMF for mediumterm funds.

Measures for utilization


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9

20.2 20.3

5.6 4.5

-3.9

11.6

20.4

-10

-5

0

5

10

15

20

25

1990-91 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00

AxisTitle

EXPORT GROWTH (%)

Export Growth


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14.4

10

21.6

12.1

4.6

-7.1

16.5

-10

-5

0

5

10

15

20

25

1990-91 1993-94 1995-96 1996-97 1997-98 1998-99 1999-00

AxisTitle

GROWTH OF IMPORTS (%)

Growth of Imports


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Can liberalized trade policies land us again in the

problems that we faced few years back?

Market determined exchange rate-lead us to nearlyequilibrium status

Market can provide advanced warning signals

POL imports needs special attention to protect from

external shocks Experts opinion: Maintain 15% annual exports

growth!

Conclusions


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me term paper - group 3

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