Business Environment

Project Work

BOP Development in India

Pankaj Kumar Bagre Roll No. 1006 PGDBM (MPE ) Batch 01 NMIMS Hyderabad

NMIMS-MPE/Pankaj Kumar Bagre

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Executive Summary
The Project Work attempts to study and analyze the various causes and factors that prompted the Balance of Payments Development in India various steps taken by the Government and Central bank to fight the BOP crisis occurred in 1991 and come out of it successfully on Development of BOP in context of India. The assignment begins with explaining the Balance of payments as a determinant of the economic s i t u a t i o n i n I n d i a a n d enumerates the various uses of Balance of payments in Indian Economy a n d i t s d e v e l o p m e n t p o s t crisis in 1991. This Project assignment also elaborates on the various contingency measures taken by the government and RBI in order to recover from the crisis. Also, the long term effects of such policy changes are evaluated. The project work is intended for good insights and learning as far as the BOP Development in India is concerned.

Introduction
1. Balance of Payments 1.1) Definition Balance of payments is an accounting record of all monetary transactions of a country with rest of the world which includes payments for exports and imports of goods, services, capital and financial transfers for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned. The transactions are presented in the form of double-entry book keeping. Reserve Bank of India defines Balance of payment as 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. 1.2) Deficits & Surplus Exports and receipts of loans and investments are recorded as surplus items. Imports or funds used to invest in foreign countries are recorded as deficit items. Generally surplus is recorded as positive and deficit is expressed as negative. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. A BOP surplus means a nation has more funds coming in than it pays out to other countries from trade and investments, which results in appreciation of its national currency versus currencies of other nations. A d e f i c i t i n t h e b a l a n c e o f p a y m e n t s h a s t h e
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o p p o s i t e e f f e c t : a n e x c e s s o f i m p o r t s o v e r e x p o r t s , d ependence on foreign investors, and an overvalued currency. Countries experiencing a payments deficit must make up the difference by exporting gold or Hard Currency reserves, such as the U.S. Dollar, that are accepted currencies for settlement of international debts. 1.3) Types of Accounts The balance of payments for any country is divided into two broad categories: The Current Account: It reports the various trades in import and export plus income derived from tourism, profits earned overseas, and payments of interest The capital account: It reports sum of bank deposits, private investments and debt securities sold by a central bank or official government agencies. The official reserve account It is a subdivision of the capital account which contains foreign currency and securities held by the government or the central bank, which is used to balance the payments from year to year. It is known as the balancing item and can be considered a "plug factor" for summing the balance of payments accounts to zero. Overall balance of payment = Current Account Balance+ Capital account b a l a n c e + O f f i c i a l Reserve Account

Justification
Development of BOP is measure of Economic Development of Nation and social Prosperity as well. Any kind of irrationality leads to BOP Crisis. A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived
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domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. These were the causes and factors that prompted the Balance of Payments crisis that occurred in India in 1991

Methods
The Reserve Bank of India (RBI) is responsible for compiling the balance of payments for India. The RBI obtains data on the balance of payments primarily as a by-product of the administration of the exchange control. In accordance with the Foreign Exchange Management Act (FEMA) of 1999, all foreign exchange transactions must be channeled through the banking system, and the banks that undertake foreign exchange transactions must submit various periodical returns and supporting documents prescribed under the FEMA. In respect of the transactions that are not routed through banking channels, information is obtained directly from the relevant government agencies, other concerned agencies, and other departments within the RBI. The information is also supplemented by data collected through various surveys conducted by the RBI. Data are prepared on a quarterly basis and are published in the Reserve Bank of India Bulletin. The data are compiled in crores of rupees (one crore is equal to 10 million) and are broadly in conformity with the recommendations of the BPM5. The data are also expressed in millions of U.S. dollars. Main Components of India's Balance of Payments 1. Trade Balance 2. Current Account 3. Invisible 4. Capital Account 5. Reserves

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Analysis & Evolution of Balance of Payment- India Perspective

The balance of payment situation started improving since 1992-93. There was a satisfactory balance of payment position in that period; the reasons are (i) High earnings from invisibles, (ii) Rise in external commercial borrowings, and (iii) Encouragement to foreign direct investment. The positive earnings from invisibles covered a substantial part of trade deficit and current account deficit reduced significantly. The external commercial borrowings were extensively used to finance the current account deficit. The net nonresident deposits were positive throughout the ten year period. There has been a growing strength in India's balance of payment position in the post reform period inspite of growing trade deficit and current account deficit. Analysis- India's Reform Mechanism post Crisis India adopted a more cautious approach to reforms and liberalization than most of the other emerging economies. The reforms program was undertaken in the face of a balance of payments crisis which forced the country to seek IMF financial assistance. To impart inherent competitive strength to the industrial economy, a program of structural reforms of trade, industrial and public sector policies was also initiated The objective was to evolve an industrial and trade policy framework would promote efficiency, reduce bias in favor of excessive capital-intensity and encourage an employment-oriented form of industrialization. The four major steps taken by the government to address the balance of payments and structural rigidities are discussed below: 1) Fiscal Correction The stabilization effort was the effort to restore fiscal discipline. Balance of payments and the persistent inflationary pressure were the result of large budgetary fiscal deficits year after year.1) Budget deficit reached Rs. 10,992 crore in 1989-90 and Rs. 10,772 crore in 1990-912) Reversal of the trend of fiscal expansion was necessary to restore balance in the economy3) Budget projected a sharp decline in the budget deficit to Rs. 7719 corer in 1991-924) Fiscal deficit which represents the overall resource gap of the government, projected a decline from Rs. 43,331 crore in 1990-91 to Rs. 37,772 in 1991-92These improvements in the fiscal performance was mainly due to the decision to - abolish export subsidies, to increase fertilizer prices and to keep non-plan expenditure in check. 2) Trade policy Reforms New initiatives were undertaken in trade policy that created an environment which would stimulate the exports and at the same time reduce the degree of regulation and licensing
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control on the foreign trade. The exchange rate was adjusted to 18% in the value of the rupee to stimulate exports The important trade policies introduced in 1991-92 were: a. A d m i n i s t e r e d l i c e n s i n g o f i m p o r t s w a s r e p l a c e d b y i m p o r t e n t i t l e m e n t s l i n k e d w i t h e x p o r t earning b. Import entitlements renamed as EximScrips, were freely tradeable and attracted a premium in the market. For exports at a uniform rate if 30% of Eximscrips was made applicable. c. The advanced licensing system for exports was simplified so as to improve exporters access to imported inputs at duty-free rates d. Permission was granted to import capital goods without clearance from the indigenous availability angle provided this import was covered by foreign equity or was up to 25% of the value of plant and machinery, subject to a maximum of Rs. 2 crore5) Trading houses were permitted a large range of imports including 51% in foreign equity e. Scope of canalization of both exports and imports was narrowed. 3) Industrial Policy Reforms To provide greater competitive stimulus to the domestic industry, a series of reforms were introduced in Industrial Policy. This policy reforms should be seen as being complementary to those undertaken in trade and fiscal policies and in the management of exchange rate and the financial sector. The central elements of this reform were as follows: a. I n d u s t r i a l l i c e n s i n g w a s a b o l i s h e d f o r a l l p r o j e c t s e x c e p t 1 8 i n d u s t r i e s w h e r e s t r a t e g i c o r environmental concerns are paramount or where the industries produce goods with exceptionally high import content. b. The MRTP Act was amended to eliminate the need for prior approval by large companies for capacity expansion and diversification c. Areas reserved for the public sector was narrowed down, and greater participation by private sector was permitted in core and basic industries. d. Government clearance for the location of projects was dispensed with except in the case of 23cities with a population of more than one million e. Small scale industries were given an option to offer 24% of their share-holding to large scale another industrial undertaking.

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Evolution- India's BOP Development an Deliverables of Impact Reform Mechanism post Crisis
The above reforms and number of policy initiatives has optimise gains emanating from the structural transformation of the economy as a whole and of the financial sector in particular. On the whole, despite some strains, the economy performed reasonably well with an overall growth of and the position in respect of the overall balance of payments outcome was also satisfactory with foreign exchange reserves reaching a record level of US $ 67,519 million (INR 3,276,417 Cr).

INDIA'S OVERALL BALANCE OF PAYMENTS

2009-10 PR Debit 6 (Rs. crore) April-June 2010 PR Credit Debit Net 8 9 10 143,977 88,680 40,918 2,879 41 457 -223 37,764 55,117 -4,941 -803 383 59,560 -256 59,816 -11,798 -10,612 -1,186 -55,297 33,846 12,834 26,928 16,941 9,668 319 -14,094

Item 1 A.CURRENT ACCOUNT I. MERCHANDISE II.INVISIBLES (a+b+c) a) Services i) Travel ii) Transportation iii) Insurance iv) G.n.i.e. v) Miscellaneous of which Software Services Business Services Financial Services Communication Services b) Transfers i) Official ii) Private c) Income i) Investment Income ii) Compensation of Employees Total Current Account (I+II) B. CAPITAL ACCOUNT 1. Foreign Investment (a+b) a) Foreign Direct Investment (i+ii) i. In India Equity Reinvested Earnings Other Capital ii. Abroad

Credit 5

Net 7 560,746 380,120 169,843 11,805 -3,496 1,496 -404 160,442 228,169 -31,563 -4,211 -549 248,277 1,164 247,113 -38,000 -34,280 -3,720 180,626 243,641 89,675 157,894 109,349 41,125 7,420 -68,219

862,333 774,512 453,246 56,045 52,902 7,598 2,083 334,618 235,161 53,749 17,716 5,858 259,244 3,403 255,841 62,022 57,689 4,333 1,636,845 943,447 183,186 179,723 129,326 41,125 9,272 3,463

1,423,079 394,392 283,403 44,240 56,398 6,102 2,487 174,176 6,992 85,312 21,927 6,407 10,967 2,239 8,728 100,022 91,969 8,053 1,817,471 699,806 93,511 21,829 19,977 1,852 71,682

256,660 194,062 118,281 13,460 14,340 1,871 429 88,181 57,740 21,987 5,603 1,483 62,754 269 62,485 13,027 11,991 1,036 450,722 239,829 38,773 37,432 27,335 9,668 429 1,341

400,637 105,382 77,363 10,581 14,299 1,414 652 50,417 2,623 26,928 6,406 1,100 3,194 525 2,669 24,825 22,603 2,222 506,019 205,983 25,939 10,504 10,394 110 15,435

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Equity Reinvested Earnings Other Capital b) Portfolio Investment i) In India of which FIIs GDRs/ADRs ii) Abroad 2.Loans (a+b+c) a) External Assistance i) By India ii) To India b) Commercial Borrowings i) By India ii) To India c) Short Term to India i) Supplier's Credit >180days & Buyers Credit ii) Supplier's Credit up to180days 3. Banking Capital (a+b) a) Commercial Banks i) Assets ii) Liabilities of which: Non-Resident Deposits b) Others 4. Rupee Debt Service 5. Other Capital Total Capital Account (1to5) C. Errors & Omissions D. Overall Balance

3,463 760,261 759,004 743,016 15,994 1,257 349,720 27,863 247 27,616 70,371 4,610 65,761 251,486 229,568 21,918 292,105 289,280 81,517 207,763 196,435 2,825 54,300 1,639,572 3,276,417

47,794 5,143 18,745 606,295 605,119 605,119 1,176 288,047 14,251 1,992 12,259 57,188 7,101 50,087 216,608 207,865 8,743 282,261 280,091 72,633 207,458 182,181 2,170 452 116,874 1,387,440 7,269 3,212,180

-44,331 -5,143 -18,745 153,966 153,885 137,897 15,994 81 61,673 13,612 -1,745 15,357 13,183 -2,491 15,674 34,878 21,703 13,175 9,844 9,189 8,884 305 14,254 655 -452 -62,574 252,132 -7,269 64,237

1,341 201,056 200,627 195,544 5,083 429 106,305 14,473 64 14,409 20,235 844 19,391 71,597 66,984 4,613 76,401 76,392 14,888 61,504 51,338 9 10,877 433,412 884,134

9,171 1,236 5,028 180,044 179,401 179,401 643 65,843 3,413 91 3,322 9,933 1,109 8,824 52,497 52,497 58,137 58,027 11,671 46,356 46,233 110 73 29,484 359,520 1,526 867,065

-7,830 -1,236 -5,028 21,012 21,226 16,143 5,083 -214 40,462 11,060 -27 11,087 10,302 -265 10,567 19,100 14,487 4,613 18,264 18,365 3,217 15,148 5,105 -101 -73 -18,607 73,892 -1,526 17,069

Conclusion
INDIAs trade deficit during the first nine months of fiscal 2009-10 on a balance of payments (BoP) basis was lower at US$ 89.51 bn compared with US$ 98.44 bn during the same period in fiscal 2008-09. The trade deficit on a BoP basis in Q3 (US$ 30.72 billion) was, however, less than that in Q3 of 2008-09 (US$ 34.04 billion). This is revealed in e report RBI. The key features of Indias BoP that emerged in Q3 of fiscal 2009-10 were:(i) Exports recorded a growth of 13.2 per cent during Q3 of 2009-10 over the corresponding quarter of the previous year, after consecutive declines in the last four quarters.(ii) Imports registered a growth of 2.6 per cent in Q3 of 2009-10 after recording consecutive declines in the last
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three quarters.(iii) Private transfer receipts remained robust during Q3 of 2009-10.(iv) Despite low trade deficit, the current account deficit was higher at US$ 12.0 billion during Q3 of 2009-10 mainly due to lower invisibles surplus.(v) The current account deficit during April-December 2009 was higher at US$ 30.3 billion as compared to US$ 27.5 billion during April-December 2008.(vi) Surplus in capital account increased sharply to US$ 43.2 billion during April-December 2009 (US$ 5.8 billion during April-December 2008) mainly on account of large inflows under FDI, Portfolio investment, NRI deposits and commercial loans.(vii) As the surplus in capital account exceeded the current account deficit, there was a net accretion to foreign exchange reserves of US$ 11.3 billion during April-December 2009 (as against a drawdown of US$ 20.4 billion during April-December 2008). From above, it is reflected that Fiscal & Monetary policies reforms post BOP Crisis of 1991 has substantially supported the BOP status of India.

References: 1. Internet Data 2. RBI Data 3. Work of various researchers available on Web

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