43593417 indias balance of payments crisis and its impacts 121126075853 phpapp01

8/12/2019 43593417 Indias Balance of Payments Crisis and Its Impacts 121126075853 Phpapp01

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by,

NEHA DOKANIA


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PRE-CRISIS PERIOD

BOP 1991 CRISIS: CAUSES

BOP 1991 CRISIS: IMPACTS

REFORMS AND POLICIES

DEVELOPMENTS AFTER THE CRISIS

AGENDA


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Indias BOP crisis


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The balance of payments of a country is a systematic record of all economic transactionsbetween the residents of a country and the rest of

the world. It presents a classified record of all

receipts on account of goods exported, servicesrendered and capital received by residents andpayments 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)


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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


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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 bankOverall Balance of Payment =

Current Account Balance+ Capital account balance+

Official Reserve Account

Overall Balance of payments


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Overview of Macroeconomic and Monetary situations ofthe 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 foreigntrade

Provides indications of future repercussions of countryspast trade performances

Reveals the weak and strong points of a countrys foreigntrade relations

Uses of BoP Analysis


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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 inimports

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


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Pre-CRISIS PERIOD


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GDP growth rate: 5.5 % (3.3% on a per capitabasis)

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 sectorwhich accounted for 32.8% of the GDP

Economic Indicators-pre Crisis period


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Protectionist Policies- defined objective of self reliance throughindustrialization and import substitution

Focus was on substituting imports and promoting domestic industries byheavy intervention while a gross negligence on exports

External Debt- The development projects caused a large scale foreignborrowing which created pressure on the government

Economic Policies


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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 andconstant devaluations by the central bank to promote

exports raised the amount of external debt.Strong inward looking policy in all

Economic policies


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Government Deficit and Current Account- Pre 1991 levels

R l d N i l E h t


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Real and Nominal Exchange ratesPre 1991 levels

l b d


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External Debt and For-ex reserves-

Pre 1991 levels


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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 oftrade balance due to fixed nominal exchange rate

which was declining over the 1980s

Trends in Pre BOP crisis period


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Trends in For-ex reserves-Figures


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Sharp 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 being

increasingly dependent on short term external debts.An unstable government and the gulf crisis furtheraggravated the situation

Trends contd


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Trends in trade deficit-Figures


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High revenue deficits especially after 1986, for which thegovernment responded by creating a surplus capital accountto finance them

Trends.contd


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THE CRISIS


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Also known as the Unfortunate period of IndianEconomy.

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 turnedup to invest in India

Export growth reduced to 4%

Balance of payments: The Crisis


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World growth declined from 4.5% in 1988 to 2.5%in 1991

Political turmoil VP Singh government

overthrown, Rajiv Gandhi assassination reducedcredibility of India, investors lost interest andtrust in Indias government.


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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


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Current account deficit averaging 2.2% of the GDP hithard by the Gulf war

Triggers

oil bill increased by $2 billion

overseas markets for exports shrinked (West Asia, SovietUnion)

Fall in remittances

The Reserve Position in IMF of $660 million was drawn infull by September, 1990 to add to the reserves

The international credit rating agencies placed India onthe watch list in August 1990

Developments in 1991


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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


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-50

-40

-30

-20

-10

0

10

20

30

40

%c

hange

IIP and Imports

IIP

Non -oil Imports

Import compression effects


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Agreement with IMF for a drawing of $1,025 billionunder its Compensatory and Contingency FinancingFacility (CCFF)

Drawings of $789 million from the first credit tranchemade in Jan,1991

Despite 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

What actually happened..


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Despite low trade deficit ,the slide in foreign reservescontinued unabated

Essentially became a crisis of confidence

The Crisis

expected

devaluation

paymentsof imports& exports

withdrawalby

foreigners

Furtherdrop in

reserves

Expectatio

n of default


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Foreign exchange reserves fell below $1 b

Barely enough to cover 2 weeks of imports

Likely ramifications

The Crisis (Contd.)

Credit unavailability, tradedisruption

Shortages, industrydislocation ,unemployment

High inflation , instability


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Foreign exchange reserves


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As a first step, in May 1991, the governmentleased 20 tonnes of confiscated gold to the StateBank of India for $200 million

Later, 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 million

jointly from the Bank of England and the Bank of

JapanLoan repaid in Sep-Nov. and the pledged gold

was redeemed

New government assumed charge in June ,1991

The response


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Two-step downward adjustment in the exchange rate ofrupee was effected on July 1 and 3, 1991

This effectively translated into devaluation of 18-19 percent against major international currencies

This was coupled with the liberalisation of the traderegime and lower import tariffs

Besides exceptional financing arrangements with the

World Bank, Asian Development Bank and a few industrialcountries were also negotiated

Due to the currency devaluation the Rupee fell from 17.50per dollar in 1991 to 26 per dollar in 1992

Short term Structural changes


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A High Level Committee on Balance of Paymentswas set up in December 1991

Liberalized Exchange Rate Management System

(LERMS) and move to a single market basedexchange rate system

This obviates the need for the RBI to determine

the rate daily

However, the need to monitor and watch themovements in the markets assumes importance,

as foreign exchange markets tend to overshoot

often

Long term Structural changes


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Macroeconomic stabilization on four fronts tobasically improve efficiency and spur exports

Fiscal correction lowering of government

spendingTrade policy reforms eximscrips

Industrial policy reforms end of license raj

Public sector reforms autonomy and efficiency

Long term Structural changes (Contd.)


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REFORMS &

IMPACTS


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Rebalancing by changing the exchange rate

An upwards shift in the value of domesticcurrency relative to others will make exports less

competitive and make imports cheaper and willtend 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 alsotend to change in the direction that will restore

balance

Balancing mechanism


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Government allowed Reserve Bank of India toship 47 tonnes of Gold to the Bank of England inJuly 1991.

Short-term debt was reduced and strict controlsput 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


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Fiscal Correction:

Abolishing export subsidies, increasing fertilizerprices, as well as by keeping non- plan

expenditure in check.

Budget projected a sharp decline in the budgetdeficit 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 in1991-92.

Reforms Undertaken


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Industrial 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 narrowed

down and greater participation was permittedfrom the private sector.

Reforms Undertaken


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The limit of foreign equity holders was raisedfrom 40 to 51 % in the wide range of priorityindustries.

Technology imports for priority industries areautomatically approved for royalty paymentsupto 5 % of domestic sales and 8 % of export

sales or for lumpsum payments of Rs 1 Crore.

Reforms Undertaken


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Results of Industrial Reforms:

The number of investment approvals rise from3335 in 1990 to 5538 in 1991.

505 foreign technology import agreements werealso approved.

In 1991, a total of 244 cases of foreign equity

participation with the proposed equity

investment of $ 504 million was approved.

Reforms Undertaken


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Public Sector Reforms:

Government undertook a limited disinvestmentof a part of public sector equity to the public

through financial institutions and mutual funds in

order to raise non- inflationary finance fordevelopment.

Sick Industrial Companies Act: To Bring public

sector undertakings also in purview.

Reforms Undertaken


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Trade Policy Reforms:

Large part of administered licensing of importswas replaced by import entitlements linked to

export earnings.

Advance licensing system for exports wassimplified so as to improve exporters access to

imported inputs at duty- free rates.

Scope of canalization for both exports andimports was narrowed.

Reforms Undertaken


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Anti-export bias in the trade and paymentsregime was also reduced substantially

Effects of these reforms was to reduce the degree

of licensing in import trade, to broaden, toenhance and harmonize export initiatives.

Reforms Undertaken


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Foreign 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,

World Bank , ADB and Bilateral donors to support

the BOP

Balance of Payments: 1992-93


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Introduced, from March 1992, a dual exchangerate system in the place of a single official rate.

One official rate for select government and

private transactions and the market-determinedrate for the others.

Treated current and capital transactions in

different ways.

Decision to permit gold imports was linked toLERMS

LERMS

Contd


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Despite the increase in imports to more normallevels during 1992-93, it has been possible tomanage the BOP with the stable exchange rate

and comfortable foreign exchange reserves

throughout the year.

Contd..


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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 byMarch 2001

BOP recorded an overall surplus consecutively for fiveyears from 1996-97

Indias foreign exchange reserves, 1 billion in 1990reached $ 40 billion the average annual addition being

4.5 billion dollars

Effects of L iberal ization


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Trade and Investments:

Rise in FDIs 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 1990s.

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 L iberal ization


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Acceleration of GDP growth to 6.7 per cent in the period1992-97 was the highest India had ever achieved over afive year period.

Sum of external current payments and receipts as a ratioto gross domestic product (GDP) doubled from about 19%in 199091 to around 40% by March 2001

Manufacturing achieved average real growth of 11.3 percent in the four years 1993-94 to 1996-97

Export growth in dollar terms averaged 20 per cent in thethree years 1994 1996 and the rates of aggregatesavings and investment in the economy peaked in 1995-96

Developments in the next decade


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Private Investments showed an high growth of 16.34 %per annum during 1992-96.

Real fixed investment rose by nearly 40 %, led by a morethan 50 % increase in industrial investment

Developments in the next decade


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-10 0 10 20 30 40 50

1980-81

1985-86

1986-87

1987-88

1988-89

1989-90

1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

10.9

25.2

48.1

20.1

36.7

31.8

26.8

30.6

-8.4

9.1

13.6

21

10.6

ECB/TC (%)

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91

1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

External Commercial Borrowings


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Result of a concious government policy tomaintain a strict control over external indebtnessand resulted favourably in improving the creditrating of India by international agencies.

Some private sector power and petroleumcompanies finalizing their financing packages

Large demand for borrowing with projects inpetroleum, oil exploration andtelecommunications.

External Commercial Borrowings

1993-94:

1994-95:

1995-96:


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0

10

20

30

40

50

60

70

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

60.9

36.234.6

46.9

36.733.2

26.3

63.9

43.7

18.5 19

29.8

11.7

EXTERNAL ASSISTANCE/TC (%)

1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91

1991-92 1992-93 1993-94 1994-95 1995-96 1996-97

External Assistance


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PMU : Project Management Unit wasintroduced,as part of the department ofEconomic Affairs to monitor ,supervise and

strengthen various projects.

In 1994-95 decided not to approach IMF formedium term funds.

Advance release of funds to state governments

Developments in the decade


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9

20.2 20.3

5.64.5

-3.9

11.6

20.4

-10

-5

0

5

10

15

20

25

1990-91 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00

AxisTitle

EXPORT GROWTH (%)

Export Growth


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Decline in world trade since the second half of1997

Decline in export prices of some major items of

manufactured goodsGrowing infrastructure bottlenecks

Appreciation of the rupee in real effective

exchange rate terms.

Decline of Growth in 1997


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14.4

10

21.6

12.1

4.6

-7.1

16.5

-10

-5

0

5

10

15

20

25

1990-91 1993-94 1995-96 1996-97 1997-98 1998-99 1999-00

AxisTitle

GROWTH OF IMPORTS (%)

Growth of Imports


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References

43593417 indias balance of payments crisis and its impacts 121126075853 phpapp01

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