Balance of Payments
Balance of Payments (BOP) is the overall statement of a country’s economic and financial transactions with the rest of the world over a specific period—usually one year. In other words, the balance of payment of a country is a systematic record of all its economic transactions with the outside world in a given year. It includes all outflows and inflows (payments and receipts). The term ‘all transaction’ refers to transactions of the government as well as private. If financial outflows are more, it is a BOP deficit, and if inflows are more, it is a surplus. All global financial transactions of a country consist of two types:
a) Capital account (investment and borrowing)
b) Current account (rest of external transactions, which includes the balance of trade)
Balance of crisis of 1991
The beginning of the 1990s saw a major BOP crisis due to many factors like the Gulf war and cumulative problems of the Indian economy. India has been dependent on crude imports. International crude prices are very crucial for our BOP condition. When there was geopolitical disturbance due to the Iraq crisis, crude prices shot up, as did our import bill. Tourism dropped. It depleted our foreign exchange reserves. International rating agencies downgraded India. This fueled the crisis further as India’s creditworthiness plunged, and there were no ready international lenders. A substantial outflow of deposits held by Non-resident Indians during 1990–91 added to the crisis. Reserves declined to a low of $0.9 billion in January 1991. India had to pledge gold in May 1991 and again in July 1991 to avoid a default on its short-term debt servicing obligations. India borrowed foreign currency through India Development Bonds issued by the State Bank of India and the Foreign Exchange Immunity Scheme of the Government of India. The scheme was aimed at attracting back the illegal foreign currency stashed abroad by resident Indians. India came out of the crisis with an IMF-sponsored bailout. Over time, the Indian economy recovered, exports grew as the rupee was devalued, foreign inflows started to pick up, and we overcame the BOP pressures. The rupee was devalued and brought closer to the market value as earlier it was artificially overvalued. International investors saw in this reform progress towards market orientation. Indian exporters felt encouraged as their earnings in foreign currency would fetch them more rupees. Devaluation was a precursor to rupee convertibility. Structural reforms were taken up so that the economy is put on a competitive path— opening the economy to globalization.
Main causes of persistent deficit in the balance of payments
The causes of deficit in the balance of payments relate largely to a big increase in imports and a small growth in exports. To an extent, deficits on account of capital transactions have also contributed to the problem.
1. Sharp rise in imports: A rise in imports has been the most important factor resulting in big deficits. Most of these imports have, however, been in the nature of development goods. In the early stages, particularly during the second and third Plans, these imports consisted of capital goods. These were required to implement the heavy industry strategy of industrial development envisaged under the Mahalanobis Scheme. Therefore, a burdensome factor raising the imports has been an increase in the prices in imports. One such factor contributing to the rise in the value of imports has been the devaluation of the rupee and the slow depreciation in recent times. Another factor has been the rise in the prices of certain imports, in particular petroleum, fertilizers, etc. The results of all these factors are that imports grew at a fast rate.
2. Slow rise in export earnings: A rise in the value and volume of imports would not have been a source of trouble had exports increased simultaneously and substantially, if not equally. There has undoubtedly been a rise in exports, but it has not been sufficient to tone down the rigour or difficulty associated with big sized deficits. The exports have not been rising. Until recently, exports have fluctuated with ups and downs in the agricultural output for a country that has not until recently well-established itself in the industrial field, much less in the export of industrial goods in the world market. Later, when non-traditional items like engineering goods, iron and steel, iron ore, chemical and allied products, etc., start figuring in exports, some improvement in the situation did occur. However, the earnings from Invisibles have not proved of much help. The Invisibles did play a significant part in the early years in reducing deficits on trade account. But their contributions have declined in recent years, largely because a major part of earnings is being devoted to meet the rising interest payments on foreign debts.
3. Deficit on capital transactions: Another contributory factor in operation in recent years has been the growing deficits on account of capital transactions. Of its different components, namely private capital transactions, government capital transactions, amortization payments, purchase of rupees from IMF and banking capital, the major source of deficits has been the rising obligations to meet amortization payments. This has involved large sums on return of loans which became due, and the large interest payments thereon.
Measures adopted by the government of India to correct the balance of payments deficit:
To overcome the serious problem of deficits, the government undertook several measures. These may be described as under:
1. Crisis management: One set of measures adopted in the early years of the 1990s were those which could produce an immediate impact on the BoP situation. In this category fall four operations. One, the gold was used to acquire foreign currency to meet the payment obligation that had become due. The second measure consisted of a downward adjustment of the exchange rate of the rupee, described by some as devaluation. The third line of action was to compress imports to immediately reduce the need for foreign exchange. Finally, the fourth type of measure was to seek foreign exchange to meet the immediate and the future BoP needs and relax the curbs on imports.
2. Reform of the economy: To fully overcome the BoP problem on a durable basis, the Government undertook several measures to restructure the economy to make it efficient and competitive. As for the external sector is concerned, the objective is to ensure a broad-based, rapid and sustained growth of exports and an efficient import substitution. For this, radical policy changes have been introduced in the various sectors of the economy. In public finance, several measures for reducing growth in expenditure and raising revenues have been undertaken to reduce the fiscal deficit. Together with it, a contractionary monetary policy has been adopted to curb the rate of inflation. The aim is to reduce the demand for imports, stabilize the economy, and ensure a proper alignment of domestic prices with international prices.
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