India’s-balance-of-payments-crisis-and-it’s-impacts

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  • 1. by,NEHA DOKANIA
  • 2. AGENDAPRE-CRISIS PERIODBOP 1991 CRISIS: CAUSESBOP 1991 CRISIS: IMPACTSREFORMS AND POLICIESDEVELOPMENTS AFTER THE CRISIS
  • 3. India’s BOP crisis
  • 4. Balance of payments (BOP)“The balance of payments of a country is asystematic record of all economic transactionsbetween the residents of a country and the rest ofthe world. It presents a classified record of allreceipts on account of goods exported, servicesrendered and capital received by residents andpayments made by them on account of goodsimported and services received and capitaltransferred to non-residents or foreigners.” –Reserve Bank of India
  • 5. Components of BoPCurrent Account• Import and Export of goods• Import and Export of services• Unilateral transfers from one country to anotherCapital Account• Foreign Investment • FDI & portfolio Investment• Loans • Commercial Borrowings, External Assistance & Banking Capital Transactions
  • 6. Overall Balance of payments Current Account Balance = Balance of Visible Trade(goods) + Balance of Invisible Trade(services) + Balance of Unilateral transfers Capital Account Balance = Inflow of foreign exchange – outflow of foreign exchange Official Reserves: The holdings of foreign reserves and gold by official institutions like the central bank Overall Balance of Payment = Current Account Balance+ Capital account balance+ Official Reserve Account
  • 7. Uses of BoP AnalysisOverview of Macroeconomic and Monetary situations of theeconomyStudy on prospects of direct investment to the nationImplications on the exchange rate of the currencyProvides data for economic analysisReveals changes in the composition & magnitude of foreigntradeProvides indications of future repercussions of country’s pasttrade performancesReveals the weak and strong points of a country’s foreigntrade relations
  • 8. BoP crisis- Factors and causesEconomic factors• Huge development expenditure owing to which there are large scale imports• Business cycles in terms of recession, depression, recovery and boom• High rate of inflation running up to large scale imports of essential goods• Decline of import substitutes which would necessitate and increase in imports• Change in cost structure of trading partnersPolitical factors• Political Instability leading to decline in FDI and FII• Populism policies which may encourage importsSocial factors• Change in tastes and preferences leading to demand changes• Cross border prejudices which may lead to expensive sources of imports
  • 9. Pre-CRISIS PERIOD
  • 10. Economic Indicators-pre Crisis periodGDP growth rate: 5.5 % (3.3% on a per capita basis)Industrial Growth : 6.6%Agriculture: 3.6%Investments went from nearly 19% of GDP from to1970s to 25% by end on 1980sComposition was predominantly primary sectorwhich accounted for 32.8% of the GDP
  • 11. Economic PoliciesProtectionist Policies- defined objective of self reliance throughindustrialization and import substitutionFocus was on substituting imports and promoting domestic industries by heavyintervention while a gross negligence on exportsExternal Debt- The development projects caused a large scale foreignborrowing which created pressure on the government
  • 12. Economic policiesExport promotion- Indian exports were largelydependent on world trade situation due topredominance of primary goods in trade mix combinedwith lower quality standards.Exchange rate- Fixed exchange rate was followed andconstant devaluations by the central bank to promoteexports raised the amount of external debt.Strong inward looking policy in all
  • 13. Government Deficit and Current Account- Pre 1991 levels
  • 14. Real and Nominal Exchange ratesPre 1991 levels
  • 15. External Debt and For-ex reserves-Pre 1991 levels
  • 16. Trends in Pre BOP crisis periodCapital inflows mainly consisted of aid flows,commercial deposits and Non resident Indian depositsFDI was heavily restricted and foreign portfolioinvestments generally channelized to public sectorissued bondsGradual loss of for-ex reserves and deterioration oftrade balance due to fixed nominal exchange ratewhich was declining over the 1980s
  • 17. Trends in For-ex reserves-Figures
  • 18. Trends… contdSharp rise in imports due to growth orientation and( petroleum imports rose by 40% from 1986-87 to1989-90 )Doubling of external debt from 1984-85 ($35 bn) to1990-91 ($69 bn)Loss of investor confidence led to outflows beingincreasingly dependent on short term external debts.An unstable government and the gulf crisis furtheraggravated the situation
  • 19. Trends in trade deficit-Figures
  • 20. Trends….contdHigh revenue deficits especially after 1986, for which thegovernment responded by creating a surplus capital account tofinance them
  • 21. THE CRISIS
  • 22. Balance of payments: The CrisisAlso known as the “Unfortunate period” of IndianEconomy.Gulf crisis of 1990 – increase in oil import billDeterioration of invisible account Increase in price of oil => overall currentaccount deficit in 1990-91 : US $ 9.7 billion•Important trading partners like US, Russia turnedup to invest in India•Export growth reduced to 4%
  • 23. World growth declined from 4.5% in 1988 to 2.5%in 1991Political turmoil – VP Singh governmentoverthrown, Rajiv Gandhi assassination – reducedcredibility of India, investors lost interest and trustin India’s government.
  • 24. Balance of payments: The UnbalanceForeign reserves very low at $1.2 billionOvershot IMF SDR reservesSimultaneous outflow of NRI depositsSerious difficulties in rolling over of short termloansCurrent account deficit of $9.7 billion almostimpossible to finance
  • 25. Developments in 1991Current account deficit averaging 2.2% of the GDP hit hardby the Gulf warTriggers• oil bill increased by $2 billion• overseas markets for exports shrinked (West Asia, Soviet Union)• Fall in remittancesThe Reserve Position in IMF of $660 million was drawn infull by September, 1990 to add to the reservesThe international credit rating agencies placed India on the“watch list” in August 1990
  • 26. Import compressionCurb imports to reduce deficit• Surcharge on oil imports• Cash margin Import Trends 30 20 10 Bulk imports Capital goods 0 Export related imports%nheagc 1989-90 1990-91 Apr-Sep 1991 -10 -20
  • 27. Import compression effects IIP and Imports 40 30 20 10 0 IIP -10 Non -oil Imports % n h e a g c -20 -30 -40 -50
  • 28. What actually happened…..Agreement with IMF for a drawing of $1,025 billion underits Compensatory and Contingency Financing Facility(CCFF)Drawings of $789 million from the first credit tranchemade in Jan,1991Despite the drawings, the situation was hardly undercontrol.Between March 1991 and June 1991, there was a sharpwithdrawal of non-resident deposits to the extent of$952 million leading to further drop in foreign exchangereserves
  • 29. The CrisisDespite low trade deficit ,the slide in foreign reservescontinued unabatedEssentially became a “crisis of confidence”
  • 30. The Crisis (Contd.)Foreign exchange reserves fell below $1 bBarely enough to cover 2 weeks of importsLikely ramifications
  • 31. Foreign exchange reserves
  • 32. The responseAs a first step, in May 1991, the government leased20 tonnes of confiscated gold to the State Bank ofIndia for $200 millionLater, RBI moved in four installments 47 tonnes ofthe gold held by it to the vaults of the Bank ofEngland to raise a temporary loan of $405 millionjointly from the Bank of England and the Bank ofJapanLoan repaid in Sep-Nov. and the pledged gold wasredeemedNew government assumed charge in June ,1991
  • 33. Short term Structural changesTwo-step downward adjustment in the exchange rate ofrupee was effected on July 1 and 3, 1991This effectively translated into devaluation of 18-19 percent against major international currenciesThis was coupled with the liberalisation of the trade regimeand lower import tariffsBesides exceptional financing arrangements with the WorldBank, Asian Development Bank and a few industrialcountries were also negotiatedDue to the currency devaluation the Rupee fell from 17.50per dollar in 1991 to 26 per dollar in 1992
  • 34. Long term Structural changesA High Level Committee on Balance of Paymentswas set up in December 1991Liberalized Exchange Rate Management System(LERMS) and move to a single market basedexchange rate systemThis obviates the need for the RBI to determine therate dailyHowever, the need to monitor and watch themovements in the markets assumes importance, asforeign exchange markets tend to overshoot often
  • 35. Long term Structural changes (Contd.)Macroeconomic stabilization on four fronts tobasically improve efficiency and spur exports• Fiscal correction – lowering of government spending• Trade policy reforms – eximscrips• Industrial policy reforms – end of “license raj”• Public sector reforms – autonomy and efficiency
  • 36. REFORMS &IMPACTS
  • 37. Balancing mechanismRebalancing by changing the exchange rateAn upwards shift in the value of domestic currencyrelative to others will make exports lesscompetitive and make imports cheaper and willtend to correct a current account surplus.Exchange rates can be adjusted by government ina rules based or managed currency regime, andwhen left to float freely in the market they alsotend to change in the direction that will restorebalance
  • 38. Balance of Payments: PoliciesGovernment allowed Reserve Bank of India to ship47 tonnes of Gold to the Bank of England in July1991.Short-term debt was reduced and strict controlsput in place to prevent future expansionForeign exchange reserves were consciouslyaccumulated to provide greater insurance againstexternal sector stresses and uncertainties
  • 39. Reforms UndertakenFiscal Correction:Abolishing export subsidies, increasing fertilizerprices, as well as by keeping non- plan expenditurein check.Budget projected a sharp decline in the budgetdeficit to Rs.7719 crore in 1991-92.Fiscal deficit was also projected to decline from Rs43,331 crore in 1990-91 to Rs 37, 772 crore in 1991-92.
  • 40. Reforms UndertakenIndustrial Policy Reforms:80 % of the industries were taken out from thelicensing framework.MRTP Act was amended to eliminate the need forprior approval by large companies for capacityexpansion or diversification.Areas reserved for public sector was narroweddown and greater participation was permittedfrom the private sector.
  • 41. Reforms UndertakenThe limit of foreign equity holders was raised from40 to 51 % in the wide range of priority industries.Technology imports for priority industries areautomatically approved for royalty payments upto5 % of domestic sales and 8 % of export sales or forlumpsum payments of Rs 1 Crore.
  • 42. Reforms UndertakenResults of Industrial Reforms:The number of investment approvals rise from 3335in 1990 to 5538 in 1991.505 foreign technology import agreements werealso approved.In 1991, a total of 244 cases of foreign equityparticipation with the proposed equity investmentof $ 504 million was approved.
  • 43. Reforms UndertakenPublic Sector Reforms:Government undertook a limited disinvestment ofa part of public sector equity to the public throughfinancial institutions and mutual funds in order toraise non- inflationary finance for development.Sick Industrial Companies Act: To Bring publicsector undertakings also in purview.
  • 44. Reforms UndertakenTrade Policy Reforms:Large part of administered licensing of imports wasreplaced by import entitlements linked to exportearnings.Advance licensing system for exports wassimplified so as to improve exporters’ access toimported inputs at duty- free rates.Scope of canalization for both exports and importswas narrowed.
  • 45. Reforms UndertakenAnti-export bias in the trade and payments regimewas also reduced substantiallyEffects of these reforms was to reduce the degreeof licensing in import trade, to broaden, to enhanceand harmonize export initiatives.
  • 46. Balance of Payments: 1992-93Foreign exchange reserves had been build up torespectable level of $5.63 billion from a low of$1.29 billion at the end of July 2001.Introduction to LERMS( Liberalized exchange ratemanagement system)Mobilization of external assistance from IMF, WorldBank , ADB and Bilateral donors to support theBOP
  • 47. LERMSIntroduced, from March 1992, a dual exchange ratesystem in the place of a single official rate.One official rate for select government and privatetransactions and the market-determined rate forthe others.Treated current and capital transactions indifferent ways.Decision to permit gold imports was linked toLERMS
  • 48. Contd..Despite the increase in imports to more normallevels during 1992-93, it has been possible tomanage the BOP with the stable exchange rateand comfortable foreign exchange reservesthroughout the year.
  • 49. Effects of LiberalizationBOP Surplus:• External sector - growth rates moving up to 11 and 20% in the two years ended March 2001• India successfully withstood the sharp rise in international oil prices since the closing months of 1999.• NRI deposits with the banking system in India on the rise from 13 billion dollars in 1991-92 to 23.8 billion dollars by March 2001• BOP recorded an overall surplus consecutively for five years from 1996-97• India’s foreign exchange reserves, 1 billion in 1990 reached $ 40 billion the average annual addition being 4.5 billion dollars
  • 50. Effects of LiberalizationTrade and Investments:Rise in FDI’s and other capital flowsUnder the category of “Invisibles”, a significant increase inprivate transfers.Private transfers grew to a level of 10-12 billion dollars in thelatter half of 1990’s.• Increase in exports level and exchange rate reforms : the major factors that helped contain the current account deficit in BOP to 1 to 1.5 per cent of GDP between 1991 and 2001• In ten years, 1991- 2001, • Over 37 billion dollars of foreign investment flowed • 18 billion $ was direct investment.
  • 51. Developments in the next decadeAcceleration of GDP growth to 6.7 per cent in the period1992-97 was the highest India had ever achieved over a fiveyear period.Sum of external current payments and receipts as a ratio togross domestic product (GDP) doubled from about 19% in1990–91 to around 40% by March 2001Manufacturing achieved average real growth of 11.3 percent in the four years 1993-94 to 1996-97Export growth in dollar terms averaged 20 per cent in thethree years 1994 – 1996 and the rates of aggregate savingsand investment in the economy peaked in 1995-96
  • 52. Developments in the next decadePrivate Investments showed an high growth of 16.34 % perannum during 1992-96.Real fixed investment rose by nearly 40 %, led by a morethan 50 % increase in industrial investment
  • 53. External Commercial Borrowings
  • 54. External Commercial Borrowings 1993-94: 1994-95: 1995-96:
  • 55. External Assistance
  • 56. Developments in the decadePMU : Project Management Unit was introduced,aspart of the department of Economic Affairs tomonitor ,supervise and strengthen variousprojects.In 1994-95 decided not to approach IMF formedium term funds.Advance release of funds to state governments
  • 57. Export Growth
  • 58. Decline of Growth in 1997Decline in world trade since the second half of 1997Decline in export prices of some major items ofmanufactured goodsGrowing infrastructure bottlenecksAppreciation of the rupee in real effectiveexchange rate terms.
  • 59. Growth of Imports
  • 60. References