INDIA’S

Balance

Of

Payments

Balance Of Payments - BOP

What Does Balance Of Payments - BOP Mean?A record of all transactions made between one particular country and all other countries during

a specified period of time. BOP compares the dollar difference of the amount of exports and

imports, including all financial exports and imports. A negative balance of payments means that

more money is flowing out of the country than coming in, and vice versa.

Balance Of Payments - BOPBalance of payments may be used as an indicator of economic and political stability. For

example, if a country has a consistently positive BOP, this could mean that there is significant

foreign investment within that country. It may also mean that the country does not export

much of its currency.

This is just another economic indicator of a country's relative value and, along with all other

indicators, should be used with caution. The BOP includes the trade balance, foreign

investments and investments by foreigners.

A balance of payments (BOP) sheet is 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, and financial capital, as well as financial

transfers. The BOP summarises international transactions for a specific period, usually a year,

and is prepared in a single currency, typically the domestic currency for the country concerned.

Sources of funds for a nation, such as exports or the receipts of loans and investments, are

recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign

countries, are recorded as a negative or deficit item.

When all components of the BOP sheet are included it must balance – that is, it must sum to

zero – there can be no overall surplus or deficit. For example, if a country is importing more

than it exports, its trade balance will be in deficit, but the shortfall will have to be counter

balanced in other ways – such as by funds earned from its foreign investments, by running

down reserves or by receiving loans from other countries.

While the overall BOP sheet will always balance when all types of payments are included,

imbalances are possible on individual elements of the BOP, such as the current account. This

can result in surplus countries accumulating hoards of wealth, while deficit nations become

increasingly indebted. Historically there have been different approaches to the question of how

to correct imbalances and debate on whether they are something governments should be

concerned about. With record imbalances held up as one of the contributing factors to the

financial crisis of 2007–2010, plans to address global imbalances are now high on the agenda of

policy makers for 2010.

Composition of the balance of payments sheet

Since 1974, the two principal divisions on the BOP have been the current account and the

capital account .

The 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 – payments for

imports) , factor income (earnings on foreign investments – payments made to foreign

investors) and cash transfers. Its called the current account as it covers transactions in the "here

and now" - those that don't give rise to future claims.

The capital account records the net change in ownership of foreign assets. It includes the

reserve account (the international operations of a nation's central bank), along with loans and

investments between the country and the rest of world (but not the future regular

repayments / dividends that the loans and investments yield, those are earnings and will be

recorded in the current account).

Expressed with the standard meaning for the capital account, the BOP identity is:

The balancing item is simply an amount that accounts for any statistical errors and make sure

the current and capital accounts sum to zero. At high level, by the principles of double entry

accounting, an entry in the current account gives rise to an entry in the capital account, and in

aggregate the two accounts should balance. A balance isn't always reflected in reported figures,

which might, for example, report a surplus for both accounts, but when this happens it always

means something has been missed—most commonly, the operations of the country's central

bank.[3]

An actual balance sheet will typically have numerous sub headings under the principal divisions.

For example, entries under Current account might include:

Trade – buying and selling of goods and services

o Exports – a credit entry

o Imports – a debit entry

Trade balance – the sum of Exports and Imports

Factor income – repayments and dividends from loans and investments

o Factor earnings – a credit entry

o Factor payments – a debit entry

Factor income balance – the sum of earnings and payments.

Especially in older balance sheets, a common division was between visible and invisible entries.

Visible trade recorded imports and exports of physical goods (entries for trade in physical goods

excluding services is now often called the merchandise balance). Invisible trade would record

international buying and selling of services, and sometimes would be grouped with transfer and

factor income as invisible earnings.

Discrepancies in the use of term "balance of payments"

According to economics writer J. Orlin Grabbe the term Balance of Payments is sometimes

misused by people who aren't aware of the accepted meaning, not only in general conversation

but in financial publications and the economic literature.

A common source of confusion is to exclude the reserve account entry which records the

activity of the nation's central bank. Once this is done, the BOP can be in surplus (which implies

the central bank is building up foreign exchange reserves) or in deficit (which implies the central

bank is running down its reserves or borrowing from abroad ) The term can also be misused to

mean just relatively narrow parts of the BOP such as the trade deficit, which means excluding

parts of the current account and the entire capital account. Another cause of confusion is the

different naming conventions in use. Before 1973 there was no standard way to break down

the BOP sheet, with the separation into invisible and visible payments sometimes being the

principal divisions. The IMF have their own standards for the BOP sheet, at high level it's the

same as the standard definition, but it has different nomenclature, in particular with respect to

the meaning given to the term capital account.

Balance of Payments: CRISIS 

The lead up to the crisis: 1990-91

I. Breakup of the Soviet Union: The Soviet Union had been one of the largest export

markets for India prior to its breakup in India. The Soviet breakup therefore negatively

affected India’s precarious trade balance, which slipped further into red.

II. The Gulf war: Current account deficit averaging 2.2% of the GDP hit hard by

the Gulf war .The Gulf war began in August 1990 with Iraq’s Invasion of Kuwait.

Both Iraq and Kuwait were among the largest suppliers of oil to India, especially Iraq

with whom India had long term arrangements .Due to the war many of these long

term contracts were hit, which forced the government to buy from the spot

market at high prices resulting in the oil bill ballooning to $2 billion in the latter half

of 1990.

III. Fall in remittances: The Gulf war also caused many Indian workers working in Kuwait

and Iraq to return, resulting in a fall in remittances. This was significant since NRI

remittances had been an important source of inflows to the country throughout the

eighties thus reducing the severity of the balance of payments. The situation was further

aggravated further with the government having to airlift Indian residents in Kuwait.

IV. Political uncertainty: The period between1990-91 was marked with high

political uncertainty at the central level with the country seeing three successive

government changes. This reduced the focus of the government on the looming

economic crisis as there was no clear policy to deal with the unexpected situation.

When a stable majority government did was setup in 1991, it was a little too late as the

damage had been done.

The Crisis: The rapid loss of foreign exchange reserves had prompted the government to take

steps to reduce the trade deficit, by restricting the imports .In October 1990; the RBI imposed a

cash margin of 25percent on all imports other than capital goods. Capital goods imports were

allowed only with foreign sources of credit. Additionally, a surcharge of 50 percent was

imposed on all Petroleum and oil imports except domestic gas. Along with increases in custom

duties, the above mentioned policies had the desired impact of controlling the imports, which

started falling in the latter half of 1991. By late of 1991, the decline of imports had reached a

stage where it was starting to affect the domestic production, which started declining (as

shown). Hence any further measured in this direction was ruled out.

India’s Export

India’s export was worth 1041.52 Billion USD in April of 2011 and it increased throughout the

year to march of 2012 with export worth 1421.73 Billion at the end of their FY 2011-2012.

Export growth has continued to be a major component supporting India's rapid economic

growth. Exports of goods and services constitute 24.64% of its GDP. India’s major exports are:

agriculture and allied products, ores and minerals, leather and manufactures, chemicals and

related products, engineering goods, textile Products, gems and jewellery, handicrafts

(excluding handmade carpets) & petroleum products. India’s largest exports markets are

European Union, United States, Hong Kong, Sri-Lanka and Singapore.

From the following graph, we can see that India’s exports are increasing from May 2011 and it was highest in March 2012.

Figure 1: Export of India in US$ Billion for year 2011-12

India’s Imports

India’s import was worth 1623.93 Billion USD in April of 2011. Then it increased gradually and

made highest import in January 2012. India’s main imports of commodities are: Petroleum,

Crude and Products, Consumption Goods and Capital Goods. India’s main imports partners are:

Germany, Belgium, USA, South Korea and Asian countries.

From the following graph, we can see that India imports are increasing from May 2011 to

March 2012.

Figure 2: Import of India in US$ Billion for year 2011-12.

India is still categorized under Developing Countries. In 1991 India's industrial system changed

from socialism to capitalism. As a result, India's economy started growing at 6% per year –

double the earlier rate. Later it started growing at 9% per year – triple the earlier rate. That is,

after adopting capitalism in 1991, India's rate of industrialization/modernization has now

tripled. India is now industrializing /modernizing thrice as fast as she was doing during the

period 1947–1991.

Balance of trade and current account balance

Historically India has been running current account deficits.

Trade deficit hit a record high of $184.9bn – or 9.9 per cent of GDP – for the fiscal

year 2011 compared to 7.1 percent of GDP in FY 2010

Oil imports soared 46.9 per cent to $155.6bn.

Exports grew 21 per cent, to $303.7bn, but imports surged 32.1 per cent over the

previous fiscal year, to $488.6bn.

India’s current account deficit is estimated to reach an all- time high of ~-4% of GDP

in F2012

The driver for this rise in current account deficit is savings declining faster than

investment.

Some investors have argued that gold imports are the key cause for the high current

account deficit and therefore the underlying current account deficit is not as bad as

it appears. But higher gold imports as a symptom of loose fiscal policy (high revenue

deficit and low productivity nature of government capital spending) keeping inflation

high relative to growth trend.

Foreign investment was insufficient to bridge a record current-account gap,

highlighting the fragile state of Asia's third-largest economy even as the government

takes steps to curb its spending and boost growth.

Strengths in Balance of Payments

Transfer account and services account are the strengths in the BOP, as India expects

to receive high remittance than other Asian countries.

India has wide natural resources like Coal, Iron, Oil, etc. Experts say that more of

these would be found out soon.

The country is agriculture based so if it can bring some local investment or FDI in the

agriculture processing industry than it can have a more favorable growth.

The country is self-sufficient in many areas and was endowed with fertile land, dense

forests, and swift rivers.

Risks in Balance of Payments:

The most important balance of payment risk is the dependence on agricultural

export products.

India imports more than three-fourths of the crude oil it requires, making this the

biggest driver of the trade gap.

Analysts blame the government's large fuel subsidy for keeping the demand for

fuel products artificially high and stoking the trade deficit.

Rising inflation can make export costlier and may induce more imports from other

countries of consumption goods.

Moreover, increasing population and income level will induce more imports which

will eventually lead to balance of trade deficit. But, as it is not optimum to reduce

consumption in consumer goods and goods for industrialization structural deficit is

to be found.

Capital Account

Although, over 2004-07, when global capital markets were buoyant and capital inflows

continued to be higher than India’s current account deficit funding needs, in the current

environment, when risk of systemic sudden stop in capital inflows is high, a wider current

account deficit means that balance of payment could be under stress.

Over the three years, out of total capital inflows of US$120 billion, about 60% have been

from non-FDI inflows. Over the last 12 months, as the portfolio equity inflows have slowed,

dependence on debt- creating inflows has shot up. The share of debt-creating inflows is

expected to increase to 65% in F2012 compared to 44% in the 10-year period of F2001-10.

Balance of payment stress will keep short-term cost of capital high and hurt growth:

The government’s desire to stimulate domestic demand with less-productive spending

at a time when productive private investment has been declining as % of GDP has been

the key driver behind the wider current account deficit. In particular, the current

account deficit could widen further, exposing India to even more volatility in global

capital inflows. If a slowdown in capital inflows were to occur, it would create

significant depreciation pressures on the rupee and increase market-oriented short-

term cost of capital and hurt growth.

Effect on various factors due to Deficit in BOP statement

Persistent deficit in the BOP statement of a country indicates a fundamental disequilibrium in

the economy. This may be the cumulative effect on the variety of factors such as

• Changes in consumer tastes in the country or abroad which reduces the country’s

exports and increases its imports

• Low competitive strength in world market which adversely affects exports

• Continuous fall in the country’s foreign exchange to reserves due to supply inelasticities

of exports, and excessive demand for foreign goods and services

• Inflationary pressures in the economy which make exports dearer

• Changes in the supply or direction of long-term capital flows

• GDP growth or decline which is likely to affect exports and imports of a country

Other Items In The BOP Statement

The Balance of Payments statement has three more items, namely

Errors and Omissions

Overall Balance(total of Current and Capital Accounts and Errors and Omissions)

Monetary Movements

IMF

Foreign exchange reserves(increase/decrease)

Errors and Omissions

The large volume of statistical data required for the presentation of the Balance of Payments

statement is collected partly from official records and partly on the basis of estimates. As a

result, the total credits and total debits are unlikely to match. There is likely to be some

statistical discrepancy in the BOP statement. This is recorded as “Errors and Omissions’’ in BOP

statement

Overall Balance

Overall balance is arrived at by summing up all the items in the current account , capital

account and the errors and omissions figures. It is the net balance between international

receipt and payments of the country. The Overall Balance may show deficit or surplus

depending on whether the total debits exceeds the total credits or vice versa

IMF

The IMF has created a reserve asset termed SDRs (Special Drawing Rights) which are allocated

to member countries. SDRs may be held as reserves by member countries and used for settling

international payments between countries. A countries facing overall deficit in the BOP

statement may purchase SDRs from the IMF for meeting the deficit

Foreign Excahange Reserves

Foreign exchange reserves of countries include different types of assests such as gold, foreign

currencies, deposits of foreign currencies in foreign central banks, investment in foreign

government securities and SDR holdings. These assests are held by the central bank for the

purpose of meeting intenational commitments arising from international transactions. So when

a country faces overall deficit in its BOP statement, it may use its foreign exchange resereves to

meet the deficits

Conclusion

The Indian economy is the third largest in the world in purchasing power parity and ninth

largest by nominal GDP criterion. .Goldman Sachs has predicted that by 2035, the Indian

economy will be the third largest, behind USA and China. The economy would be as large as

60% of US economy. In 2011, the per capita income was $ 3073, making it relatively a lower

middle class economy.

Since independence, India's balance of payments on its current account has been negative.

Since economic liberalization in the 1990s, precipitated by a balance of payment crisis, India's

exports rose consistently, covering 80.3% of its imports in 2002–03, up from 66.2% in 1990–91.

However, the global economic slump followed by a general deceleration in world trade saw the

exports as a percentage of imports drop to 61.4% in 2008–09. India's growing oil import bill is

seen as the main driver behind the large current account deficit, which rose to $118.7 billion, or

9.7% of GDP, in 2008–09. Between January and October 2010, India imported $82.1 billion

worth of crude oil.

Due to the global late-2000s recession, both Indian exports and imports declined by 29.2% and

39.2% respectively in June 2009. The steep decline was because countries hit hardest by the

global recession, such as United States and members of the European Union, account for more

than 60% of Indian exports. However, since the decline in imports was much sharper compared

to the decline in exports, India's trade deficit reduced to 25,250 crore (US$4.6 billion). As of

June 2011, exports and imports have both registered impressive growth with monthly exports

reaching $25.9 billion for the month of May 2011 and monthly imports reaching $40.9 billion

for the same month. This represents a year on year growth of 56.9% for exports and 54.1% for

imports.

India's reliance on external assistance and concessional debt has decreased since liberalization

of the economy, and the debt service ratio decreased from 35.3% in 1990–91 to 4.4% in 2008–

09. In India, External Commercial Borrowings (ECBs), or commercial loans from non-resident

lenders, are being permitted by the Government for providing an additional source of funds to

Indian corporate. The Ministry of Finance monitors and regulates them through ECB policy

guidelines issued by the Reserve Bank of India under the Foreign Exchange Management Act of

1999. India's foreign exchange reserves have steadily risen from $5.8 billion in March 1991 to

$283.5 billion in December 2009.

Bibliography

Website

www.rbi.org.in

www.tradingeconomics.com

www.federalreserve.gov

www.worldbank.org

www.adb.org

www.bangaladeshbangk.org

www.wikipedia.org

Book:

International Financial Management by Jeff Madura 9th Edition.