bop crisis india and external policy issues

8/7/2019 BoP crisis India and external policy issues

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Causes of BOP crisis in India

and

Issues in external management


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The run up to the crisis

First half of eighties, the CAD was at 1.5% of GDP only

While exports were low, domestic production of oil was keepingimport bill in check

High proportion of concessional external financing kept debtservice low

Come 1985 and the M-substitution model replaced

gradually by X-promotion; CAD increased sharply

Exports grew but so did imports

Volume of petro imports grew 40% due to slowing in domesticproduction and consumption remaining strong


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In 2nd half of eighties, the CAD was much higher thanavailable external financing at concessional rates; the debtservice burden ballooned putting further pressure on CAD

In particular, borrowings on commercial terms ($3 bln to$13 bln from 1985 to 1991)and remittances ($3 bln to$10.5 bln) were relied on heavily

Implied reliance on higher cost short maturity financing and

vulnerability to shifts in creditor confidence

External debt doubled from $35 bln in 1985 to $69 bln in1990-91


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The immediate factors

In 1991, short term external debt was to the tune of $6 blnand the ratio of debt service to current receipts close to30%

The first external shock that precipitated the crisis: TheGulf War 1991

Led to a hike in oil prices

Import volume increased sharply too

The oil import bill hiked by $2 bln to become $5.7 bln in1991


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Further, conditions in the Gulf disturbed conditions in SovietRussia, one of Indias key trading partners, thereby slowing ourexports

Also led to a slowdown from workers remittances

Second, world growth indicators were weak, GR deteriorated from4.5% in 1988 to 2.25% in 1991, thereby affecting Indian exports

US growth slowed from 3.9% in 1988 to 0% in 1990 and -1% in

1991: This was Indias biggest export destination

As a result of all these factors, Indian exports volume slowed to4% in 1991.


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Rising political uncertainty

Congress lost the 1989 elections and the JanataDal came to power

Riots involving caste politics forced V P Singh toresign in December 1990

Caretaker Government appointed till May 1991,

when re elections would happen

Rajiv Gandhi assassinated in May 1991


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Widening CAD, reserve losses and political certainties led tolowering of investor confidence

Indias credit rating was lowered by major rating agencies

Creditors became increasingly reluctant to roll overmaturing loans

Previously strong NRI deposits turned to net outflows in1990

A sudden run on reserves resulted in FOREX positionweakening to an extent that the RBI declared that we werein a BoP crisis episode


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Correction in the disequilibrium

Correction effected by a 2-step devaluation of 9.6% and12.8% in July 1991

From March 1992 to March 1993, system of dual exchangerates

40% of current receipts to be exchanged at official or RBIdeclared rate and 60% at market rates

Advantage of dual rates is that they help in preventinghikes in import bills of essentials such as oil

But these are always stop gap since they penalize exports

Unified rate adopted in March 1993


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Trends upto 2003

From 1993 to 2003, the Rupee has depreciated35% against the dollar from Rs. 38.52 to Rs.48.73

Has depreciated 31.3% in NEER but only 2.1% inREER in the same time period

Exchange rate policy of RBI in post-reformsperiod has been majorly one of keeping the Re.dollar exchange rate as realistic as possiblewithout unduly depreciating or appreciating theRupee


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Appreciation in 2003

The BoP surplus recorded with India up from $5.8 bln in2000-01 to $ 11.8 in 2001-02

Persistent increase inFOREX reserves had to be taken careof by allowing the Re. to appreciate

From Rs. 48.13 in January 2003, the Re. fell to Rs. 44.93 inMarch 2004; FOREX rose from $68 bln to $113 bln


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Rupee becomes stronger: 2003 to 2007

Despite BoT deficit in 2003-04, the current account surplusincreased from $2.9 bln to $3.2 bln on account of strongsoftware exports

But the capital account inflows have been truly exceptional

A bullish stock market and relatively undervalued stocksattracted record FII levels

The PSU disinvestment program was offering blue chipequities in some of the best managed PSUs; new issues toothus created lot of excitement

FII investment in PSU disinvestment was quite high


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RBI does a tight rope walk

The BoP surplus, Rupee appreciation and FOREX build upobviously put pressure on the RBI

2002-03 showed a KAS of Rs. 12.1 bln that increased to$17.1 bln next fiscal

In the same period, FOREX reserved jumped 49% (i.e. by$35 bln) to $113 bln

This alone would have caused M3 expansion to the tune ofRs. 1,60,000 crores on a base of Rs. 17,25,222 crores i.e

an increase of 9.6% in money supply

But total money supply grew 14.6% in 2003-04 comparedto 15% in earlier year


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Sterilization of FOREX

The RBI carried out record sterilization ofFOREX exercises,reducing its holdings of G-secs to the tune of Rs. 87,541crores

Thus, from Rs. 114998 crores worth of G-secs, the RBI heldas on March 2004, G-secs worth Rs. 27457 crores only

In addition, the creeping appreciation also slowed thegrowth in FOREX somewhat

The Rupee appreciated 8.1% against the dollar in 2003-04

Thus, money supply growth, Rupee appreciation and FOREXgrowth were all judiciously managed


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The Market Stabilization Scheme

By 2004, the RBI was becoming seriously constrained in itssterilization exercise by the seriously diminishing quantityof G-secs that it was holding

The Govt. introduced dated securities and T-Bills under thenew Market Stabilization Scheme, using which the RBI nowcarries out sterilization

Hence the RBI carries out sterilization ofFOREX reserves onthe basis of borrowed assets, claims Arvind Panagariya


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bop crisis india and external policy issues

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