What are the Causes of India’s Balance of Payment?

Crisis in India’s BoP caused by several factors. The major causes are:

1. Ever Expanding Trade Gap:

Trade deficit is the result of trade gap, i.e., gap due to a big rise in imports against a small growth in exports of the country over the years.

As a matter of fact, eighties onwards country’s expenditure on imports has risen at an alarming rates due to the following reasons:

(i) Import Liberalisation:

Due to import liberalisation during the eighties there has been a quantum jump in imports of capital goods and modern technology. The new economic and trade policies of 1991 have favoured a further liberalisation of imports.

(ii) Increase in Import Intensity:

The pattern of industrial development and growth of national income during the seventh plan led to a higher propensity to import. There has been a growth in import demand for consumer durables.

(iii) Import of Oil:

Petroleum oil and lubricants (POL) has been the single most important item in India’s import bill. During seventies and eighties constituted nearly one-third of total imports of the country.

(iv) Import of Essential Items: Due to scarcity created by drought conditions, time to time, the country had to import essential items such as cereals and edible oils on a large scale.

(v) Rising Prices of Imports:

The country’s import bill has been rising due to rising prices of goods in. international markets. Especially, oil prices have been arbitrarily hiked by the oil supplying countries. For instance, in 1986, the average nominal price of crude oil was about US 13.8 a barrel. This had gone up to US 18 a barrel in 1987. Similarly, prices of fertilisers, etc., also have gone up.

(vi) Deterioration in the Exchange Rate of Rupee:

The external value of rupee in term of US dollar has continuously depreciated over the years. Rupee was devalued in 1991. As a result, the country had to pay high prices of imports in rupee terms.

Consequently, had the value of imports of the country gone up this would not have posed a problem as our exports would have kept an equal price. Actually, rate of growth imports was much faster than that of out exports. That is to say, our exports are not sufficient to finance our imports. On account of slow rise in export earnings of the country, the trade-gap has widened, consequently, trade-deficit has increased over the years.

2. Rising Current Account Deficit:

As a consequence of rising trend in trade deficit, India’s current account BoP deficit has also increased sharply from an average of 1.3 per cent of GDP in the Sixth Plan to 2.7 per cent of GDP in 1988-89.

The main factor contributing to the rising current account deficit is decline in the growth of net invisible earnings. The country’s earnings from invisibles declined sharply from Rs. 4311 crores in 1-980-81 to Rs. 1,025 crores in 1989-90. Net invisibles earnings financing only 24 per cent of trade deficit during the seventh plan as against financing over 60 per cent of trade deficit in the sixth plan.

In fact, net invisibles which financial over 90 per cent of trade deficit in 1978-79 financial only 14 per cent in 1989-90. Further owing to deterioration in the invisibles account the overall current deficit in 1990-91 at 7.3 billion was 1.4 billion higher than in the previous year.

Another factor decline is migrants’ remittance from abroad. Moreover, the country’s repayment obligation and debt servicing to the IMF and other sources of external public debt adds to current account BoP deficit.

In 1993-94, that current account deficit came down to $ 0.8 billion from $ 3.6 billion in 1992-93.

3. Deficits on Capital Transactions:

In recent years, there has been the growing deficit on capital account due to country’s rising obligations to meet amortisation payments. The situation is worsened due to a fall in the availability on concessional aid to finance the deficits and flattering out a private remittances.

Recently to ease the situation, the government has resorted to external commercial borrowings, assistance from IMF and MRI deposits, invitation to foreign capital and encouragement to direct foreign investment.

These constitute substantial future liabilities. Bimal Jalan, a noted economist, thus, writes that, the economy is plunged into a crisis when these sources of financing the BoP deficits dried up. To quote him “the roots of the crisis, therefore, do not lie in impart liberalisation per se but on overall framework of macroeconomic policies including fiscal policy, which permitted an expansion of internal demand for the home market without generating adequate exports.”

India’s balance of payment position was highly precarious in 1990-91. The country was caught in a vicious circle of low reserves, low credit rating and poor capacity to raise resources. The situation was no better in the beginning of 1991-92. To deal with the problem the government had to compress imports and also to find, sources of exceptional financing to meet the current account deficit.

4. Remedies and Suggestions:

Solution to the balance of payments problem requires a package deal of measures. The government of India took several steps for correcting the BoP in recent years. Important lines of action involved.

1. Acquisition of Foreign Currency:

In May 1991, for the first time, the government sold 20 tonnes of gold to a Swiss Bank for acquiring foreign currency, with the condition that it would be repurchased after six months. In July 1991, the RBI shipped about 47 tonnes of gold to the Bank of England as security to raise foreign currency from England and Japan. In short, by such gold transactions the government raised 600 million for foreign exchange crisis management in the mid- 1991.

2. Devaluation:

In July 1991, the government of India virtually devalued Indian rupee by a downward adjustment of its exchange rate by about-18.20 per cent in terms of major currencies such as US Dollar, UK Pound Sterling, German Mark, Japanese Yen, French Franc in two stages. The step was meant to boost exports and curb imports.

3. Compression of Imports:

To relieve the pressure of foreign exchange imports were compressed through certain monetary measures. The RBI imposed a each margin of 50 per cent on imports other than those of capital goods, in October 1990. In March 1991, the each margin was raised to 133.3 per cent. It was further enhanced to 200 per cent in April 1991. Besides, the RBI imposed a 25 per cent surcharge on interest on credit for imports, in May 1991.

4. Encouragement to Inflow of Funds from Abroad:

Since mid-seventies there has been a continuous flow of private remittances from abroad. But, as compared to other countries this has not been very significant in India’s case. The country has been getting foreign assistance at concessional rates from international institutions such as IMF, World Bank and IDA, and also from countries such as USA, the UK, France, Germany, USSR etc.

In recent years, however such concessional loans were not easily and adequately available. Hence, the government had to resort to high lost loans through external commercial borrowings and deposits of non-resident Indians (NRIs). In October 1991, the government introduced the Indian Development Bank Scheme and the Immunity Scheme for repatriation of funds hold abroad. These schemes are to encourage the inflow of capital funds in India. Under the new liberalised policy of 1991, the government also encourages the direct foreign investment.

To meet the BoP deficits in 1991, India approached the IMI for accommodation under the Compensator and Contingency Financing Facility (CCFF) and first credit trance. In March 1991, India drew 1.025 billion under the CCFF and 789 million under the first credit trance. In July 1991 and September 1991 further drawals were made. Besides, a steady arrangement was also negotiated.