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

1. by,
NEHA DOKANIA

2. PRE-CRISIS PERIOD
BOP 1991 CRISIS: CAUSES
BOP 1991 CRISIS: IMPACTS
REFORMS AND POLICIES
DEVELOPMENTS AFTER THE CRISIS
AGENDA

3. India’s BOP crisis

4. “The balance of payments of a country is a
systematic record of all economic transactions
between the residents of a country and the rest of
the world. It presents a classified record of all
receipts on account of goods exported, services
rendered and capital received by residents and
payments made by them on account of goods
imported and services received and capital
transferred to non-residents or foreigners.”
–Reserve Bank of India
Balance of payments (BOP)

5. Current Account
•Import and Export of goods
•Import and Export of services
•Unilateral transfers from one country to another
Capital Account
•Foreign Investment
•FDI & portfolio Investment
•Loans
•Commercial Borrowings, External Assistance & Banking Capital
Transactions
Components of BoP

6. 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
Overall Balance of payments

7. Overview of Macroeconomic and Monetary situations of the
economy
Study on prospects of direct investment to the nation
Implications on the exchange rate of the currency
Provides data for economic analysis
Reveals changes in the composition & magnitude of foreign
trade
Provides indications of future repercussions of country’s past
trade performances
Reveals the weak and strong points of a country’s foreign
trade relations
Uses of BoP Analysis

8. Economic 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 partners
Political factors
•Political Instability leading to decline in FDI and FII
•Populism policies which may encourage imports
Social factors
•Change in tastes and preferences leading to demand changes
•Cross border prejudices which may lead to expensive sources of imports
BoP crisis- Factors and causes

9. Pre-CRISIS PERIOD

10. GDP 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 to
1970s to 25% by end on 1980s
Composition was predominantly primary sector
which accounted for 32.8% of the GDP
Economic Indicators-pre Crisis period

12. Protectionist Policies- defined objective of self reliance through
industrialization and import substitution
Focus was on substituting imports and promoting domestic industries by heavy
intervention while a gross negligence on exports
External Debt- The development projects caused a large scale foreign
borrowing which created pressure on the government
Economic Policies

13. Export promotion- Indian exports were largely
dependent on world trade situation due to
predominance of primary goods in trade mix combined
with lower quality standards.
Exchange rate- Fixed exchange rate was followed and
constant devaluations by the central bank to promote
exports raised the amount of external debt.
Strong inward looking policy in all
Economic policies

14. Government Deficit and Current Account- Pre 1991 levels

15. Real and Nominal Exchange rates
Pre 1991 levels

16. External Debt and For-ex reserves-
Pre 1991 levels

17. Capital inflows mainly consisted of aid flows,
commercial deposits and Non resident Indian deposits
FDI was heavily restricted and foreign portfolio
investments generally channelized to public sector
issued bonds
Gradual loss of for-ex reserves and deterioration of
trade balance due to fixed nominal exchange rate
which was declining over the 1980s
Trends in Pre BOP crisis period

18. Trends in For-ex reserves-Figures

19. Sharp rise in imports due to growth orientation and
( petroleum imports rose by 40% from 1986-87 to
1989-90 )
Doubling of external debt from 1984-85 ($35 bn) to
1990-91 ($69 bn)
Loss of investor confidence led to outflows being
increasingly dependent on short term external debts.
An unstable government and the gulf crisis further
aggravated the situation
Trends… contd

20. Trends in trade deficit-Figures

21. High revenue deficits especially after 1986, for which the
government responded by creating a surplus capital account to
finance them
Trends….contd

22. THE CRISIS

23. Also known as the “Unfortunate period” of Indian
Economy.
Gulf crisis of 1990 – increase in oil import bill
Deterioration of invisible account
Increase in price of oil => overall current
account deficit in 1990-91 : US $ 9.7 billion
•Important trading partners like US, Russia turned
up to invest in India
•Export growth reduced to 4%
Balance of payments: The Crisis

24. World growth declined from 4.5% in 1988 to 2.5%
in 1991
Political turmoil – VP Singh government
overthrown, Rajiv Gandhi assassination – reduced
credibility of India, investors lost interest and trust
in India’s government.

25. Foreign reserves very low at $1.2 billion
Overshot IMF SDR reserves
Simultaneous outflow of NRI deposits
Serious difficulties in rolling over of short term
loans
Current account deficit of $9.7 billion almost
impossible to finance
Balance of payments: The Unbalance

26. Current account deficit averaging 2.2% of the GDP hit hard
by the Gulf war
Triggers
•oil bill increased by $2 billion
•overseas markets for exports shrinked (West Asia, Soviet
Union)
•Fall in remittances
The Reserve Position in IMF of $660 million was drawn in
full by September, 1990 to add to the reserves
The international credit rating agencies placed India on the
“watch list” in August 1990
Developments in 1991

27. Curb imports to reduce deficit
•Surcharge on oil imports
•Cash margin
Import compression
-20
-10
0
10
20
30
1989-90 1990-91 Apr-Sep 1991
% change

Import Trends
Bulk imports
Capital goods
Export related imports

28. -50
-40
-30
-20
-10
0
10
20
30
40
% change

IIP and Imports
IIP
Non -oil Imports
Import compression effects

29. Agreement with IMF for a drawing of $1,025 billion under
its Compensatory and Contingency Financing Facility
(CCFF)
Drawings of $789 million from the first credit tranche
made in Jan,1991
Despite the drawings, the situation was hardly under
control.
Between March 1991 and June 1991, there was a sharp
withdrawal of non-resident deposits to the extent of
$952 million leading to further drop in foreign exchange
reserves
What actually happened…..

30. Despite low trade deficit ,the slide in foreign reserves
continued unabated
Essentially became a “crisis of confidence”

The Crisis

31. Foreign exchange reserves fell below $1 b
Barely enough to cover 2 weeks of imports
Likely ramifications
The Crisis (Contd.)

32. Foreign exchange reserves

33. As a first step, in May 1991, the government leased
20 tonnes of confiscated gold to the State Bank of
India for $200 million
Later, RBI moved in four installments 47 tonnes of
the gold held by it to the vaults of the Bank of
England to raise a temporary loan of $405 million
jointly from the Bank of England and the Bank of
Japan
Loan repaid in Sep-Nov. and the pledged gold was
redeemed
New government assumed charge in June ,1991
The response

34. Two-step downward adjustment in the exchange rate of
rupee was effected on July 1 and 3, 1991
This effectively translated into devaluation of 18-19 per
cent against major international currencies
This was coupled with the liberalisation of the trade regime
and lower import tariffs
Besides exceptional financing arrangements with the World
Bank, Asian Development Bank and a few industrial
countries were also negotiated
Due to the currency devaluation the Rupee fell from 17.50
per dollar in 1991 to 26 per dollar in 1992
Short term Structural changes

35. A High Level Committee on Balance of Payments
was set up in December 1991
Liberalized Exchange Rate Management System
(LERMS) and move to a single market based
exchange rate system
This obviates the need for the RBI to determine the
rate daily
However, the need to monitor and watch the
movements in the markets assumes importance, as
foreign exchange markets tend to overshoot often
Long term Structural changes

36. Macroeconomic stabilization on four fronts to
basically 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
Long term Structural changes (Contd.)

37. REFORMS &
IMPACTS

38. Rebalancing by changing the exchange rate
An upwards shift in the value of domestic currency
relative to others will make exports less
competitive and make imports cheaper and will
tend to correct a current account surplus.
Exchange rates can be adjusted by government in
a rules based or managed currency regime, and
when left to float freely in the market they also
tend to change in the direction that will restore
balance
Balancing mechanism

39. Government allowed Reserve Bank of India to ship
47 tonnes of Gold to the Bank of England in July
1991.
Short-term debt was reduced and strict controls
put in place to prevent future expansion
Foreign exchange reserves were consciously
accumulated to provide greater insurance against
external sector stresses and uncertainties
Balance of Payments: Policies

40. Fiscal Correction:
Abolishing export subsidies, increasing fertilizer
prices, as well as by keeping non- plan expenditure
in check.
Budget projected a sharp decline in the budget
deficit to Rs.7719 crore in 1991-92.
Fiscal deficit was also projected to decline from Rs
43,331 crore in 1990-91 to Rs 37, 772 crore in 1991-
92.
Reforms Undertaken

41. Industrial Policy Reforms:
80 % of the industries were taken out from the
licensing framework.
MRTP Act was amended to eliminate the need for
prior approval by large companies for capacity
expansion or diversification.
Areas reserved for public sector was narrowed
down and greater participation was permitted
from the private sector.
Reforms Undertaken

42. The limit of foreign equity holders was raised from
40 to 51 % in the wide range of priority industries.
Technology imports for priority industries are
automatically approved for royalty payments upto
5 % of domestic sales and 8 % of export sales or for
lumpsum payments of Rs 1 Crore.
Reforms Undertaken

43. Results of Industrial Reforms:
The number of investment approvals rise from 3335
in 1990 to 5538 in 1991.
505 foreign technology import agreements were
also approved.
In 1991, a total of 244 cases of foreign equity
participation with the proposed equity investment
of $ 504 million was approved.
Reforms Undertaken

44. Public Sector Reforms:
Government undertook a limited disinvestment of
a part of public sector equity to the public through
financial institutions and mutual funds in order to
raise non- inflationary finance for development.
Sick Industrial Companies Act: To Bring public
sector undertakings also in purview.
Reforms Undertaken

45. Trade Policy Reforms:
Large part of administered licensing of imports was
replaced by import entitlements linked to export
earnings.
Advance licensing system for exports was
simplified so as to improve exporters’ access to
imported inputs at duty- free rates.
Scope of canalization for both exports and imports
was narrowed.
Reforms Undertaken

46. Anti-export bias in the trade and payments regime
was also reduced substantially
Effects of these reforms was to reduce the degree
of licensing in import trade, to broaden, to enhance
and harmonize export initiatives.
Reforms Undertaken

47. Foreign exchange reserves had been build up to
respectable level of $5.63 billion from a low of
$1.29 billion at the end of July 2001.
Introduction to LERMS( Liberalized exchange rate
management system)
Mobilization of external assistance from IMF, World
Bank , ADB and Bilateral donors to support the
BOP
Balance of Payments: 1992-93

48. Introduced, from March 1992, a dual exchange rate
system in the place of a single official rate.
One official rate for select government and private
transactions and the market-determined rate for
the others.
Treated current and capital transactions in
different ways.
Decision to permit gold imports was linked to
LERMS
LERMS

49. Despite the increase in imports to more normal
levels during 1992-93, it has been possible to
manage the BOP with the stable exchange rate
and comfortable foreign exchange reserves
throughout the year.
Contd..

50. BOP 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
Effects of Liberalization

51. Trade and Investments:
Rise in FDI’s and other capital flows
Under the category of “Invisibles”, a significant increase in
private transfers.
Private transfers grew to a level of 10-12 billion dollars in the
latter 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.
Effects of Liberalization

52. Acceleration of GDP growth to 6.7 per cent in the period
1992-97 was the highest India had ever achieved over a five
year period.
Sum of external current payments and receipts as a ratio to
gross domestic product (GDP) doubled from about 19% in
1990–91 to around 40% by March 2001
Manufacturing achieved average real growth of 11.3 per
cent in the four years 1993-94 to 1996-97
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 economy peaked in 1995-96
Developments in the next decade

53. Private Investments showed an high growth of 16.34 % per
annum during 1992-96.
Real fixed investment rose by nearly 40 %, led by a more
than 50 % increase in industrial investment
Developments in the next decade

54. External Commercial Borrowings

55. External Commercial Borrowings
1993-94:
1994-95:
1995-96:

56. External Assistance

57. PMU : Project Management Unit was introduced,as
part of the department of Economic Affairs to
monitor ,supervise and strengthen various
projects.
In 1994-95 decided not to approach IMF for
medium term funds.
Advance release of funds to state governments
Developments in the decade

58. Export Growth

59. Decline in world trade since the second half of 1997
Decline in export prices of some major items of
manufactured goods
Growing infrastructure bottlenecks
Appreciation of the rupee in real effective
exchange rate terms.
Decline of Growth in 1997

60. Growth of Imports

61. References