India's balance of payments: The alarm bells are ringing

ASHOAK UPADHYAY
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India's troubles mount because of a sluggish global trading environment and slipping capital flows.
May 27, 2012: However much India's policymakers may want the external sector to behave the way they want it to, it is clear that the sector's patterns of behaviour are no longer simply the outcome of domestic policies but of the whims and caprices of international trade and finance movements. That seems to be the case today, more than ever before, when we consider India's balance of payments position in the light of the fluctuating fortunes in India's most important destinations and sources of trade and capital respectively. Domestic policies work most effectively when the external environment is by and large favourable to trade. When the environment encourages the free flow of goods and services then for policymakers to take a more laid back position may prevent exporters from exploiting the advantages available in the situation. That had been the case when India's capital controls and forex restrictions had not allowed exporters the elbow room needed to evolve strategies for exports. Then it changed for the better and India was able to ride the horse to its advantage because its policies segued into the environment for trade The end-of-century turnaround in India's exports and balance of payments came because of services exports and specifically IT exports. India's telecommunication policy changes, that ushered in the most effective changes in communications ever, created the grounds for India's growing IT sector to become global. That event, with the top five Indian companies becoming known names in IT throughout the world, had wide repercussions on the overall organised economy, boosting demand for goods and services of other sectors such as manufacturing. This in turn boosted capacities, encouraging a re-engineering of extant practices to align with global ones.
GOLDEN AGE'

The period between 2002 and 2008 can be considered India's golden age of global trade when the current account deficit declined to 1.2 per cent of GDP on the back of a surge of exports and capital flows. Needless to say, services exports in particular ITES exports led the way with the latter increasing its share from around four per cent in 1998 to 25 per cent a decade later. More than domestic policies it was the international environment that favoured India's export surge. Till the crash of 2008 world demand was buoyant and sustained the export drive of most emerging economies including India. Four years after September 2008 the world has changed for the worse. India's exports have been slipping ever since as demand dries up in the West what with the US still weak in its recovery and Europe tackling rather ineffectively its slide into recession in many parts of the Euro Zone. Not surprisingly services exports have been slipping and the latest data from the RBI bear this out vividly.

Last fiscal (March end) saw the slowest growth in services exports at four per cent for three quarters with the slide evident after the first quarter when such exports grew at a healthy rate of 25 per cent. The star of services exports software also did poorly at 9.4 per cent after sliding from 21 per cent in the first quarter. The problem was not with services alone. As the RBI notes in its report on India's balance of payments, export growth decelerated in October-December 2011 while imports continued to rise largely due to high international commodity prices and inelastic demand for gold and silver. Here it is important to remember and the RBI reminds us that the advanced economies of the West still shape India's export-fortunes; so while the Commerce Ministry and commentators may appear innovative in seeking new markets for India's exports, the fact remains that the largest part of export earnings come from the US and Europe and other major western economies. India's BoP during the third quarter of 2011-12, according to the RBI that releases the data with a lag of one quarter, bears testimony to how the storms and stress of the global economy can affect growth potential and more disconcertingly, the country's capital position. As the RBI observes, India's trade deficit widened, while capital inflows fell far short of financing requirement resulting in significant drawdown of foreign exchange reserves. The trade deficit it notes rose by more than 50 per cent. Just how dramatic the fall is can be seen from the facts: On a BoP basis, merchandise exports recorded a growth of 7.9 per cent, year-on-year, during Q3 of 2011-12 compared with 39.9 per cent during the corresponding quarter of 2010-11. Imports, however, expanded 22.0 per cent during Q3 of 2011-12 compared with 24.7 per cent in the corresponding quarter of the preceding year; so the trade deficit widened more because of the great fall in exports than a significant rise in imports. On other counts too the fall was steep namely in relation to capital flows that could have mitigated the decline in the trade account. As a result, the current account deficit (CAD) widened to $19.6 billion in Q3 of 2011-12 ($10.1 billion in Q3 of 2010-11). At this stage this would work out to 4.3 per cent of GDP compared with 2.3 per cent of GDP in Q3 of 2010-11. At this point a little history helps. All through the 1980s, India's current account deficit hovered at 3.2 of GDP; given the policy environment at the time it became difficult to finance such a huge deficit and sure enough in 1991 the cumulative result showed in the country having only a billion dollars in reserves. With a CAD of 4.3 per cent today alarm bells should be ringing; all through the recent growth period India's CAD has not risen above 1.2 per cent of GDP. In its report the RBI notes a huge drawdown on forex reserves: $12.8 billion (excluding valuation) during Q3 of 2011-12 as against an increase of $4.0 billion in the corresponding quarter of 2010-11. Given the state of the world today, that should be worrying. Keywords: balance of payments, sluggish global trading environment, slipping capital flows

Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. BoP positions indicate various signals to businesses. BoP comprises current account, capital account and financial account. and services, income and current transfers. In the capital account, transactions of capital transfers, capital acquisition and non-produced non-financial assets like buildings and patents are included, while in the financial account, transactions relating to financial assets and liabilities like portfolio investments and foreign exchange reserves are included. However, the BoP account of most countries still classify transactions under two heads only capital account and current account. In such a case, financial and capital accounts are treated as one. Transactions in BoP are recorded on a double-entry bookkeeping system that is, a transaction is recorded on each side debit and credit of the BoP account. There are many signals that the BoP account of a country gives out. For example, large current account transactions indicate towards openness of an economy. This was the case with India as reduction in trade restrictions and duties led to increase in both exports and imports after 1991. Also large capital account transactions may indicate well-developed capital markets of an economy.

Capital and current account balances for India were quite stable between 1991 and 2001. After 2001, primarily because of increased exports of IT services and transfers, current account balance went into surplus. But due to increasing imports and an increasing oil bill, it started deteriorating after 2004 and went into deficit. Sound fundamentals and a large untapped market coupled with a deregulated regime allowed foreign investors to invest in India, thereby increasing capital inflows after 2000. However, the global meltdown has led to an outflow of capital, which has led to a sudden fall in the capital account balance after 2007. Reserves were built up over the years mainly because of capital inflows. But a recent deficit in current account and capital outflow led to a fall in 2008-09. Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and among investors. However, healthy BoP positions may be different for different countries. For example, surplus in current

account is often more important for developed countries than surplus in capital account as most of them have sufficient capital to fund their investments. On the other hand, developing countries like India may place more importance on capital account as reserves and funding for investment is crucial for them at present. Large balances often attract foreign investors into an economy, thus bringing in precious foreign exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to businesses. Businesses can make predictions about exchange rates by studying BoP positions. A healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to engage in future contracts accordingly. Also, the BoP position influences the decisions of policy makers, which are crucial for any business. How does BoP influence economic policy? The policies of a nation are highly affected and determined by the position and status of its BoP. While formulating or deciding any economic policy, BoP position and policy effect on BoP is given special consideration. While all the policies affect BoP, policies like tariff policy, those related to foreign flows etc affect it in greater magnitude. Earlier, trade-related policies used to have special focus. But over the years the share of current account transactions in total BoP transactions has decreased. For example, in India its share was almost 60% in 1991-92, but reduced to around 44% in 2007-08. Also, mismatch has been much greater in capital account in recent years, which gave rise to Indias foreign exchange reserves. Over the years, these trends have forced policy makers to make policies keeping in mind foreign flows (capital) and effects of policies on them. However, policies at the same time could be held responsible for such flows. To improve BoP positions countries have lately often leaned towards the capital account side. The trend has shifted from import substituting policies, that is, policies in which imports are discouraged by way of tariffs, quotas toward more of foreign inflows enhancing policies in the belief that such inflows may make a country crisis-proof and lead to investments that would increase productive capacity and also may increase exports that would earn foreign exchange in future. However, BoP position in itself affects decisions of policy makers. Often, a deteriorating current account is supported by capital or financial account. A healthy BoP position often allows countries to open up their trade and to appropriate gains from it. Indias BoP India presently has a deficit in its current account of BoP, which has increased substantially after reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in 1991, Indias position of merchandise trade (exports and imports of goods) kept on deteriorating, but its position on invisibles (services, current transfers etc) improved during the period. However, one of the major factors for increasing current account deficit in the last few years has been a rising oil import bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK have deficits. India has done fairly well on the capital account side. In 2007-08 it had a capital account surplus of $108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million, which provided stability to the economy. Foreign investments have increased manifold since 1991, peaking in 2007-08 to $44,806 million. Indias overall current account and capital account deficit is $20,380 million for AprilDecember 2008, which is expected to rise to a figure between $25 and 30 billion by the year ending March 31, 2009. There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in March 2009. Reasons for this are portfolio flows from foreign institutional investors and the appreciation of the US dollar. But this may not pose a significant threat to the Indian economy and businesses because of large pool of reserves that are still providing enough cushion. However, some businesses like those related to equities and realty are hit when outflows from these

sectors occur. Not only is there fall in asset prices and erosion of investment value, but economic activity also gets reduced in these sectors. However, recent profitability/growth numbers have indicated signs of a revival. Also political change and expected stability might bring in foreign exchange and may improve Indias capital account position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters and importers accordingly. At the same time, reserves infuse stability into the system, which in turn has positive effects on businesses and investments.

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written by Learning , September 06, 2009

well recent trends in BOP i mean if we consider 2008-09 ,to get a better view how country is performing in terms of its international transactions and trade activities its better if you analyse BOP half yearly,the first half shows healthy BOP whereas the second half shows the impact of the global crisis via transmission channels like trade and capital flows ...exports and imports declined impressively but due to starker fall in imports the trade deficit was not high..and stating that picture is improving for sure is not right at all if you track the monthly performance of exports and imports and calculate the year on year growth for this fiscal year you will see heavy deceleration in exports of about 30-34% and around 30% for imports ..and also if you track the various confidence indices (( see RBI monetary policy review )) then also the way ahead is hazy..and given the dismal performance of monsoon..agriculture performance is bound to be affected too... and if farm output declines by 5% then affect on GDP will be around 0.5-1% so just stating that way ahead is bright is not right ... report abuse vote down vote up
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