VIVEKANANDA COLLEGE

THAKURPUKUR
KOLKATA-700063
NAAC ACCREDITED ‘A’ GRADE

Topic: India’s Foreign Trade and Balance of Payment

Course Title: Policies and Performance of Indian Foreign Trade

Paper: ECO-G-CC-4-4-TH/ ECO-GE-4-4-TH-TU

Unit: Unit 4

Semester: Semester - IV

Name of the Teacher: Pawan Subba

Name of the Department: Economics

INDIA’S FOREIGN TRADE AND BALANCE OF
PAYMENT(ভারতের বৈতেশিক ৈাশিজ্য ও লেনতেন ৈযাতেন্স )

INTRODUCTION
India is moving fast towards globalisation. Inter-dependence (পারস্পররক
অধীনতা) between the economies of the world has increased multi-fold (বহুগুন).
Foreign trade (ববদেরিক বারিজ্য) in the economy has gained prime importance. Both
exports and imports contribute to the production process (উৎপােন প্ররিয়া). Both of
these are effective instrument (কার্যকর উপকরি) in raising the income levels of the
people in a developing economy (উন্নয়নিীল অর্যনীরত). Apart from flow of goods,
increasing flows of services and capital (পররদেবাত্ ও মূলধন) between the nations
give rise to payments and receipts (অর্য প্রোন এবং প্রারি) in foreign exchange
(ববদেরিক রবরনময়) which, in turn, influence the Balance of Payment’s position (ললনদেন
বযাদলন্স অবস্থা).

TRADE AND ECONOMIC DEVELOPMENT (ৈাশনজ্য এৈং

অর্যননরতক উন্নয়ন)
Foreign trade has worked as an ‘engine of growth’ in the past (as witnessed
by Great Britain in the 19th century and Japan in the 20th, besides others), and even
in more recent times the “outward-oriented growth strategy” (বারি্র্ক রিরিক বৃরির
লকৌিল)adopted by the Newly Industrialising Economies( রিল্পায়ন অর্যনীরত) of Asia,
viz., Hong Kong, (now a special administered area of China), Singapore, Taiwan,
Malaysia, Thailand, and South Korea, has enabled them to overcome the constraints
of small resource-poor under-developed economies.

Contribution of Foreign Trade to Economic Development (অর্থ ননশেক উন্নয়তন

বৈতেশিক ৈাশনতজ্যর অৈোন)
Foreign trade contributes to economic development in a number of ways:
 It provides flow of technology (প্রর্ুরিরবেযা) which allows for increases in total
factor productivity (উতপােনিীলতা), and some short-run multiplier effects (গুনক
প্রিাব) for countries with unemployed labour (লবকার শ্ররমক).
 It generates pressure for dynamic change (গরতিীল পররবতয ন) through: (i)
competitive pressure from imports (আমোরন), (ii) pressure of competing for
export (রিারন)markets, and (iii) a better allocation (বণ্টন) of resources.
 Exports allow increased exploitation of economies of scale, separation of
production pattern from domestic demand (চারিো), and increasing familiarity
with absorption of new technologies.
  These, in turn, help increase the profitability (লািজ্নকতা) of the domestic
business without any corresponding increase in price.
 Foreign trade increases most workers’ welfare (কলযাি). It does so at least in
four ways: (i) larger exports translate into higher wages(মজ্ুরর); (ii) because
workers are also consumers(লিািা), trade brings them immediate gains
through cheaper imports; (iii) it enables most workers to become more
productive as the goods they produce increase in value(মান); and (iv) trade
increases technology transfers from industrial to under developed countries
(UDCs) and the transferred technology is biased in favour of skilled labour(েক্ষ
কমী).
 Increased openness to trade has been strongly associated (সংর্ুি)with the
reduction (কমাদনা)of poverty(েররদ্রতা) in most developing countries.

A proper analysis (সঠিক রবদেেি) of a country’s foreign trade can be attempted in

its three components (উপাোন), viz., (i) Volume of trade, (ii) Composition of trade,
and (iii) Direction of trade.

Volume of Trade (ৈাশিতজ্যর পশরমাি)

It relates to the size of international transactions. Since a large number of
commodities (পনয) enter in international transactions and their aggregate can be
found only by finding their money value (অর্যমূলয), the volume of trade can be
measured by finding the total value. The trends in the value of trade help to identify
the basic forces that may be operating at different periods (সময়কাদল) in the
economy. However, mere absolute (পরম) changes in the value of trade may not be
satisfactory guide, hence it is necessary to find the changes in the value of trade by
relating them to two variables, viz.,
 Share of exports/imports in GDP, and
 Share of exports/imports in world trade.
The share of exports/imports in GDP indicates the degree (মাত্রা) of outward-
orientation or openness of the economy in regard to the trade activity. This share
reflects in a broad way the nature of trade strategies adopted (গ্রিীত বারিজ্য লকৌিল)
in the country. The ratio of exports to GDP could be interpreted (বযাখ্যা করা) also to
mean supply capability (সরবরাি ক্ষমতা) of the economy in regard to exports. It can
be called as average propensity to export. The similar ratio between imports and
GDP gives the average propensity to import. Clearly, however, the appropriate share
of exports in output under an efficient allocation of resources will be less in bigger
economies than in smaller economies.
The share of exports in the world trade indicates the importance of the country as a
nation in the world economy. It reflects the market thrust (লখ্াোঁচা) that the country is
able to realise in presence of the various competitors in the world market. Changes
in this ratio (অনুপাত), thus, indicate the shift in the position of the comparative
advantage (তু লামূলক সরবধা) of the country.
Further, changes in the value of exports may be compared to the changes in
the value of imports. The relationship between these two variables is known as the
terms of trade (TT) (ৈাশিজ্য িেথাৈেী), i.e., the terms at which exports exchange for
imports; if the exports value in terms of imports value shows an increase, the TT are
said to be favourable. Favourable TT imply that for a given value of exports, the
country can produce more of imports. Conversely, if the TT are unfavourable a
country has to give up more exports to produce a given volume of imports.

Composition of Trade (ৈাশিজ্যর গঠন)

It is indicative of the structure and level of development of an economy. For
instance, most of the UDCs depend for their export earnings on a few primary
commodities (PCs) (প্রার্রমখ্ পনয); these countries export raw materials of agricultural
origin and import manufactured industrial products, thus, denying themselves the
benefits of value added. As an economy develops, its trade gets diversified. It no
more remains dependent on a few PCs. It begins to export more of manufactured
industrial goods and import industrial raw materials (কাচামাল), capital equipment
(উপকরি) and technical know-how. Manufactured exports create greater value
addition than PCs as they go through more stages of processing (প্ররিয়াকরি). The
manufacturing sector has greater linkages (লজ্াগসূত্র) with the rest of the economy
and, hence, the downstream effects on exports from these sectors are likely to be
greater than primary exports. The commodities entering trade could also be
classified by various other criteria such as value added per unit of output,
productivity of labour, capital intensity (তীব্রতা) in production, strength of backward
and forward linkages (রপরিদয় এবং এরগদয় সংদর্াগ), etc. The shifts in the commodity
composition of trade in these categories would bring out the nature of structural
(কাঠাদমাগত) changes in regard to income generation, employment effect and overall
industrialisation through linkages effects, etc.

Direction of Trade (ৈাশিজ্যর গশে)

It is indicative (রনদেয িক) of the structure and level of economic development.
As a country develops and its trade gets diversified (রবরবধ), it has to seek new
outlets for its exports. Its horizon of choice in terms of imports also gets widened.
The country begins to trade with an increasingly large number of countries. In this
regard, one could ask whether there has been a concentration (ঘনত্ব) or dispersion
(িরিদয় পিা) of the markets for exports and sources (সূত্র) of supply for imports.
It is in terms of these components that we have to study the trends in India’s
foreign trade during the course of economic planning (পররকল্পনা).
VOLUME OF INDIA’S FOREIGN TRADE (ভারতের বৈতেশিক
ৈাশিতজ্যর পশরমাি)
Prior to economic reforms (সংস্কার), promotion of import substitution (প্ররতস্থান)
and discouraging (রনরূত্সাি করা) of exports affected the nature and composition of
trade. Imports were largely of machinery, equipment and intermediates (অন্তবযতী বস্তু)
in production. As the Indian economy grew, imports of petroleum and petroleum-
products also grew. With the Green Revolution from the early 1970s and until India
set up its own fertilizer units, imports of fertilizer too were an important part of the
composition of imports. What was hugely missing from imports was consumer goods
of different types, including luxury consumer goods (রবলাস পনয) and consumer
durables (লিাগযপনয). Even before 1991, India’s exports were diversifying. Beginning
with an overwhelming agricultural composition of exports (tea, raw cotton) with the
diversifying industrial structure, promoted by import substitution, exports of
manufactures were growing. But the real push to increasing exports of
manufactures came with the reforms from mid-1980s to 1991. Table 18.1 shows
the growing role of India’s external trade, exports and imports. In the immediate
five-year period preceding the 1991 reforms, external trade formed only 13.40
per cent of the GDP. During the 1990s and the first decade of the current
century this share has been continuously rising as would be seen from Table
18.1.
Table 18.1: Share of exports and imports in India’s GDP (per cent)

In absolute terms, India’s foreign trade has grown to exports of $250 billion
and imports of $380 billion in 2010-11. But it is more useful to see trade volume
as a percentage of GDP. As shown in Table 18.1 the ratio of exports plus imports to
GDP has grown from 13.40 per cent in the five-year period 1985-90 to almost three
times that, being 37.7 per cent in 2010-11. If we add trade in services to trade in
goods, then the ratio goes up from 22.9 per cent in the 1990s to 49.0 per cent in
2010-11 (see Table 18.2). Trade clearly is a growing feature of the Indian
economy.
Table 18.2: Volume of India’s trade (in US billion $).

Looking at trade Table 18.2, some interesting points emerge. First is that
India has a large deficit in the classical trade in goods, such as agricultural
products, minerals, metals and manufactures. This large deficit is accounted
for by high imports of capital goods and of petroleum and its products. But
exports are clearly lagging behind the growth in imports.
However, the picture is changed by the role of what is called
‘invisibles’. This includes both services, mainly software services, export of which
has grown to $59 billion in 2010-11. Along with this, remittances from Indians
abroad at $53 billion in 2010-11 are almost as much. This brings the current account
deficit from $130 billion to $44. This deficit (ঘাটরত) is quite easily covered by the
capital account surplus (উদ্বৃি) of $59 billion in that year. However, the large current
account (চেশে শিসাৈ) in goods trade is a matter of concern and the government
has come up with a New Foreign Trade Policy (নীশে) to increase exports and
reduce the trade deficit. It must be acknowledged that India is a ‘big player’ only in
the field of IT service exports, but not in the crucial area of manufacturing exports.
We call manufacturing exports crucial because, unlike IT service, it can
generate a large volume of employment. However, in this area, India’s trade
policy has not been much of a success. There has been some success in
increasing the share of manufacturing, as we will see below. However, this is
nothing like the spectacular performance of China and South-east Asia which have
become the manufacturing centre of the world.

COMPOSITION OF INDIA’S FOREIGN TRADE (ভারতের

বৈতেশিক ৈাশিতজ্যর গঠন)
The composition of India’s external trade has been changing. In the
early decades after Independence, exports were mainly of primary goods, viz.
Agricultural commodities and raw materials, such as minerals. Over time, the
role of manufactures including engineering goods (প্রতকৌিে পিয) has been
increasing. Overall manufactured goods are as much as 66 per cent of total
exports, of which engineering goods contribute as much as 27 per cent of the
value of goods exported. These engineering goods include automobiles and
parts, agricultural machinery (যণ্ত্রপাশে), and electrical machinery. The exports
that have not grown as much as would be expected, given India’s status as a
labour abundant economy, are textiles and textile products, which include
garments (লপািাক) and leather (চামড়া) products. They still account for just a
little more than 10 per cent of India’s exports. In some cases, it is useful to
look at both imports and exports together. For instance, India imported
$106.06 billion of petroleum, mainly crude oil. This crude oil was refined and
turned into various petroleum products, such as lubricants, fiber, etc.
Similarly, gems and jewellery show a high value of $40.79 billion. Here too
there is a high import content, in the value of raw diamonds and precious
stones imported. In both cases, raw materials are imported, processed in India
and then exported. In petroleum products the processing is of a high-tech
variety, in refineries with high capital and low labour content. In jewellery, it is
mainly low-tech, with a high labour content in cutting and polishing of
precious stones. The above examples show up a problem with trade statistics
(পশরসংখ্যা) — we cannot take value of exports at face value. From this we
should deduct the value of the raw materials imported. This will then give a
better measure of the contribution (অৈোন) of that item to the Indian economy
– it will give the value added that is India’s gain.
Table 18.3: India’s Exports and Imports (US$ billion).
 It should be noted that we have used data of imports and exports, FDI (রবদেরি
রবরনদয়াগ), etc. in US $ terms. These data (তর্য) could also be given in Indian
Rupee terms. But with the exchange rate between the Indian Rupee and the US
Dollar fluctuating, an Indian Rupee figure will not be a good measure of the role of
these traded sectors in the Indian economy. The value of exports and imports are
better stated in international terms. Most international transactions (ললনদেন),
including for petroleum, are carried out in US dollar terms. Summarising (সংতেপ
করা) the role of the external or internationally traded goods sector, it can be
said that its role in the Indian economy has been growing steadily (অটেভাতৈ),
if not as rapidly (দ্রুেভাতৈ) as in the case of the East and South-east Asian
economies. At present imports and exports together account for up to 49 per
cent of India’s GDP, as against 18.8 per cent in over the decade of the 1990s.
For India, however, export earnings do not only come from sales of goods.
They also come from sales of services. These services are basically IT
software services and also what are called IT-enabled services (ITES). Together
they earned as much as $59 billion in 2010-11 (see Table 18.2), i.e. more than 20
per cent of India’s export earnings. These service exports are a combination of
high-tech customised software and low-tech office services, such as call
centers and customer service. Together their impact has been such that India
is known as the ‘Back office of the world’, just as China is now the ‘manufacturing
centre of the world’. These services comprise many types of functions such as
accounting, ticketing, provision of customised software to provide these services.
These functions are together known as Business Process Outsourcing (BPO).
India accounts for about 45 per cent of the world’s supply of such off-shore
services. The major Indian IT companies, TCS, Infosys and Wipro, initiated and
perfected the Global Services Delivery (GSD) model. In this used the differences
between Indian salaries of software engineers and technicians and, say, US salaries
of the same level of software engineers and technicians. The job of, say, providing
accounting for a bank, was divided into tasks that were performed onshore, at the
site of the client, and off-shore, in India. Using the time difference between the two
countries, and the differences in remuneration, the Indian companies were able to
deliver high IT services to clients, services that were both faster and even better.
Their ability to do this depended on the vast pool of Indian software engineers and
an even bigger pool of English-knowing staff for functions such as customer service.
The Indian Global Services Delivery (GSD) model has now been copied by many
other companies in many countries. Even major IT service providers, such as IBM
and Accenture, set up their own IT and call centres in India in order to be able to
compete with the Indian companies. With growing competition in the market for
providing these services and with rising Indian salaries for the staff, the Indian
companies have been forced to move up to higher value-added sections of services.
They have moved from BPO to Knowledge Process Outsourcing (KPO), which
involves providing services for R&D and to high-end consulting. The Indian IT
majors, however, are still striving to establish themselves in the highest end services.
DIRECTION OF INDIA’S FOREIGN TRADE (ভারতের বৈতেশিক
ৈাশিতজ্যর গশে)
In the world as a whole, the economic and trade balance is shifting
towards Asia, and what are called the rising powers or BRICS – Brazil, Russia,
India, China and South Africa. With rates of growth in these economies, China
and India, having been far in excess of those in the developed economies,
there has been a process of catching up or closing the gap in per capita
income (মার্াশপছু আয়). China is in the status of an upper-middle income country
(per capita income in excess of USD 3,000 per annum), while India is still a lower-
middle income country (per capital income of USD1,000 per annum). But the large
populations of these countries mean that these economies are very large. Even in
absolute (পরম)terms, China is now the second largest economy in the world after
the US, while India is the fifth largest economy in the world, after Japan and
Germany. The Asian economies together are now larger than the EU. Thus, the
weight of the world economy is shifting with Asia now much more prominent
than in the immediate post-colonial period of the 1950s. The direction of Indian
exports too has been changing. It is shifting away from the traditional markets of the
old industrialised countries. As the Table 18.4 shows the roles of the traditional
markets (EU, US and Japan) and Asia have virtually reversed over the last 10 years.
Whereas the traditional markets accounted for over 58 per cent of India’s
exports in 2000-01, they account for just about 30 per cent in 2010-11. On the
other hand, exports to Asia have gone up from 38.69 per cent in 2000-01 to
54.86 per cent in 2010-11. What is also interesting to note is that Africa’s share
of Indian exports has grown from 4 per cent to 6.72 per cent in the same
period. As mentioned in another section, Africa is also an area where Indian
businesses are seeking to both invest and gain markets.
Table 18.4: Changing destinations (গন্তৈয) of Indian exports.

India’s exports are clearly shifting to the growing economies of Asia and
also Africa. As Asia and Africa continue to grow faster than the rest of the
world, one can expect the direction of exports to change even further away
from the old, developed and now stagnant economies towards the emerging
powers (উেীয়মান িশি) of Asia and the rapidly-growing African economies
BALANCE OF PAYMENT (লেনতেন ৈযাতেন্স): CONCEPT
(ধারিা) AND USES (ৈযৈিার)
The principal tool for the analysis of the monetary aspects of international
trade is the balance of international payments settlement. This statement, also
simply known as the ‘balance of payments’ (BOP), is a systematic (পদ্ধশেগে)
record of all international economic transactions, visible and invisible, of a
country during a given period, usually a year. It is a device for recording all the
economy transactions within a given period between the residents of a country and
the residents of other countries. It simply results from the double entry book-
keeping procedure which is used to record the transactions. The analysis of the
BOP can be done in terms of its two major sub-divisions: (a) Current Account,
and (b) Capital Account.

Current Account
The Current Account can be broken down into two parts, viz., one,
balance of trade, and, two, balance on invisibles. The Balance of Trade (BOT)
deals only with exports and imports of merchandise (or visible items). The
Balance on Invisibles (BOI) shows net receipts on account of invisibles. These
include the remittances, net service payments, etc. It is not necessary that the BOT
should always balance; more often than not, it will show either a surplus or a deficit
on BOI. If the surplus on BOI equals the deficit on BOT, the current account will
show a net balance. But then there is no reason why these two balances should
always be equal, again, always in opposite directions. The balance on current
account can either show a deficit or a surplus. A surplus on current account leads to
an acquisition (অজ্যন) of assets (সম্পে) or repayment of debts (ঋি আোয়)
previously contracted, and a deficit involves withdrawal of previously accumulated
assets or is met by borrowings.

Capital Account
The capital Account presents transfers of money and other capital items and
changes in the country’s foreign assets and liabilities (োয়)resulting from the
transactions recorded in the current account. The deficit on the current account and
on account of capital transactions can be financed by external assistance (loans and
grants) drawing from the International Monetary Fund and allocation of the Special
Drawing Rights. The BOP accounts provide a link between the increase in gross
external debt and the portfolio and spending decisions of the economy.
Thus, increase in gross external debt =
Current account deficit (CAD)
– direct and long-term portfolio capital inflows
+ official reserve increases
+ other private capital outflows
The above equation shows that an increase in external debt can have three broad
sources: current account deficits not financed by long-term capital inflows,
borrowing to finance a reserve build-up or private outflows of capital.
Balance of Payments and Developing Economies
It is well-known in development economics that UDCs invariably start as
debtor economies. In the process of development itself, these economies have to
import a great deal of capital goods, consumer goods, food and raw materials and
spares and components. They also have to import some new technologies and,
hence, the total exchange outgo cannot be matched by export earnings. But, it is
expected that in a decade or two, as the new capital goods and technologies begin
to become effective and their products are directed towards exports, export goods
and services become competitive in cost and quality. In that case, the volume of
exports expands and, in due course, begins to overtake imports. A developing
economy then moves on from being a debtor economy to a balanced one in terms of
BOP and, finally becomes a creditor economy, exporting more than it imports and
giving credit to buyers. Thus, from being a net debtor in the beginning, it becomes a
net creditor in the end and, in fact, begins to invest abroad rather than have others
lending to and investing in it.

Current Account Deficit (CAD) (ৈেথমান শিসাৈ ঘাটশে): Boon or Bane (আিীৈথ াে ৈা
অশভিাপ)
The general belief is that high CADs are dangerous (সংকটময়). In general
(সাধারিিাদব), this is correct. But the converse (প্ররতদলাম) – that low CADs are good –
is not correct. A CAD is nothing but a measure of a country’s saving gap, i.e., the
excess of investment over savings. It represents the net transfer of resources from
the rest of the world to the country running the deficit. Therefore, in a developing
country, with huge needs for funds for investment, a CAD makes sense. It
allows it to finance investments that would have been well beyond what it could hope
to finance with its own savings. On the other side, CADs are to be financed by
foreign capital inflows. The capital flows are fickle, can be reversed, and have to
be serviced. The right CAD for any country, therefore, depends on its ability to
absorb and service capital inflows. If these resources can be deployed
productively and in ways that enhance its ability to repay, a high CAD to GDP ratio is
nothing to worry about. But if they cannot, then it is inviting trouble. Too high a ratio
can prove unsustainable (অরস্থরতিীল) in the long run as it did in East Asian
economies in 1998 and in Mexico earlier. To that extent, low ratio has its
advantages (সুশৈধাশে). But, very low ratio carries with it an opportunity cost (সুদয়াগ
বযয়) – of not being able to benefit from resources that could be drawn from outside.
TREND (প্রৈিো) IN INDIA’S BALANCE OF PAYMENTS
India had faced pressures on BOP from time to time either due to certain
domestic compulsions (বাধযতা) or due to external factors.
Some causes (কারি) of the adverse (প্রশেকূে) BOP situation in India were:
a) Import of food grains particularly in the years of drought.
b) Import of capital goods and raw materials for rapid industrialisation.
c) Import of consumer goods and raw materials for its manufacture.
d) Low quality (গুন) of exportable goods.
e) Increasing price of petroleum and fertilisers in the international market.
f) Domestic inflation (মুদ্রাস্ফীরত), which made the foreign goods cheaper
(সস্তা) in the domestic market and made the domestic goods expensive
(োমী) in the international market.
g) External debt and its payment with interests.
h) Imports in the defence (প্ররতরক্ষা) sector.

Steps taken to improve BOP in India:

a) Increase in exports (রিারন বৃৃ্রধ):: The steps taken by the government
for increasing the country’s exports are as follows:
i. Selection of probable export items (সম্ভাবনাপূিয রিারন দ্রবয রনবযাচন).
ii. Benefits for exports (রিারনকারীদের সুরবধা োন) like introduction of
Special Economic Zones (SEZ) and Export Processsing Zone.
iii. Establishment of various Institutions and Boards for export
promotion (প্ররতষ্ঠানগত সািার্য)
b) Decline in imports (আমোরন হ্রাস):-
i. Increase in the production of agricultural products (কৃ রেজ্াত দ্রদবযর
উৎপােন বৃরি) to reduce their imports.
ii. Promotion of manufacture of goods for import substitution.
iii. Loans from International institutions like the IMF
iv. Structural reforms were done where the Replenishment (REP)
Licence (আমোরনপূরি লাইদসন্স) policy was replaced with EXIM scrip
(রিারন-আমোরন সার্টযরিদকট).

The whole period, covering nearly six decades, can be divided into two sub-
periods, viz. (i) Before 1991, and (ii) since 1991.
i) Period I (Before 1991)
The entire period was very difficult for India’s BOP, partly because of slow
growth of exports in relation to import requirements (প্রদয়াজ্ন) and partly because of
adverse external factors. Foreign exchange reserves were at a low level, generally
less than necessary to cover three months’ imports. Almost the entire CAD (92 per
cent) was financed by inflows of external assistance (সািার্য).
Table 18.5: Key indicators (সূচক) of India’s Balance of Payments (As per cent
of GDP).

ii) After 1991

The prominent features of the BOP situation as it has emerged over the last
two decades can be briefly summarised as follows:
1) On the current account: (i) Trade deficits have been widening. Both exports
and imports have multiplied fast, but imports have risen at a faster rate than
exports. Expanding imports in turn reflect (a) the impact of liberalisation measures,
and (b) increasing manufacturing activity in the domestic economy.
(ii) There has been a phenomenal increase in net surplus on account of
invisibles. This, in turn, is principally due to (a) buoyancy in private transfers
(i.e., inward remittances), and fast expansion in exports of services, especially
software. India is unique among emerging economies to have a sizable invisible
surplus that substantially offsets the merchandise trade deficit. As a result, although
India has been running a current account deficit (except during 2002-04 when India
experienced a current account surplus), the deficit has been conveniently
manageable, largely because of huge surplus on capital account.
2) On the capital account, India has been running a big surplus. The size of
surplus has been much more than what is required to finance the current
account deficit. As a result, India has been rapidly building up its foreign
exchange reserves. The capital account demonstrates following features: (i) Both
inflows and outflows of capital have increased, especially since 2003. (ii) The
composition of capital flows is undergoing a change: (a) Official external assistance
has been gradually losing out its significance; (b) FDI and portfolio investment have
surged, and among the two, the inflows on account of FDI have been more than on
account of portfolio investment (except 2010-11 when the trend got reversed). (c)
With easing of controls, external commercial borrowings have been coming back into
prominence. Overall, India’s balance of payments (current account plus capital
account) has been in surplus (উদ্ৃ্ ত্ত ব ), resulting in rapid build-up of foreign
exchange reserves. This has been due largely to massive inflows of foreign
capital. Indeed, the acceleration in India’s growth momentum since 2003 owes
partly to the exceptionally easy global liquidity conditions that have increased risk-
taking and also amplified the volume of capital inflows into India.

ISSUES (সমসযা) RELATED TO BALANCE OF PAYMENT

SITUATION
Openness of Indian Economy
As the Table 18.5 shows, the Indian economy has been steadily becoming more
open. If we take the trade measures (rows 2 and 3 in the Table.18.6) then the Indian
economy is more than twice as open as in 1990-91. Similarly, if we take all foreign
receipts and payments, on both current and capital accounts, then its ratio to
GDP has gone up from 41.9 per cent in the 1990s to 109.3 per cent now. This
means, that the total foreign receipts and payments are now more than India’s
total GDP. This shows the extent of openness of the Indian economy to foreign
payments and receipts. What this also means is that monetary and fiscal
policy needs to be undertaken very carefully, taking account of possible
international effects. As the current problems of Greece and other EU economies
shows, no country can now be unmindful of the international consequences (প্রিাব)
of its fiscal deficits (রাজ্স্ব ঘাটরত). The lesson is not that there cannot be fiscal
deficits, but that international consequences need to be kept in mind. Does this make
the Indian economy much more vulnerable to the transmission of external shocks
(ধাক্কা), shocks emerging from other parts of the global (রবশ্ব) economy? A brief look
at the different impacts of India’s own crisis in 1991, the Asian crisis of the late 1990s
and the ongoing (2007 onwards) global financial crisis will show the differences in
impacts, and also the manner in which the Indian economy has been able to
withstand (প্ররতদরাধ করা) these shocks.
Table 18.6: Different measures of openness of the Indian Economy.
 Does this make the Indian economy much more vulnerable to the
transmission of external shocks, shocks emerging from other parts of the global
economy? A brief look at the different impacts of India’s own crisis in 1991, the Asian
crisis of the late 1990s and the ongoing (2007 onwards) global financial crisis will
show the differences in impacts, and also the manner in which the Indian economy
has been able to withstand these shocks.

External Debt
The Indian economy in 1991 was relatively closed, much more so than in the
late 1990s or now. Nevertheless, it experienced a severe shock, one which forced a
drastic change in trade and even development policy. What was the shock of 1991?
India had a negative trade balance, with imports much more than exports.
Foreign exchange balances at that time were just below $5 billion, enough to
cover just two weeks of imports. At the same time, India had built up large
external debts. In order to secure a roll-over of these debt payments, India had
to pledge its gold reserves, physically air-lifting some of it to London. It also
secured a loan from the IMF to tide over the immediate crisis. How did this
external crisis come about? The Indian economy in 1991 was not as open as it is
now, yet it faced an external crisis. To understand this crisis, one must turn to
the relation between the fiscal deficit and the external deficit. India had a high
fiscal deficit, more than 7 per cent of GDP. Its interest rates were high. In
national accounting terms an excess of spending over income gets reflected in
a balance of payments deficit. This deficit could be covered by foreign investment
or debt. But at some point the foreign debt has to be repaid. In the late 1980s a
substantial portion of external debt was of the short-term variety. Further, the
high government spending behind the fiscal deficit was not used to fund
investment — had that been so, it would had that resulted in a substantially higher
rate of growth, and then the economy would have grown and made it possible to
service the debt. But the fiscal deficit did not result in greater investment; rather
it was used in what is called non-plan (non-investment) expenditure. With that
the ratio of debt service to GDP went up and became a multiple of available
foreign exchange (see table below). The result was that in 1991 India had
reserves that were just sufficient to cover one week’s imports. The crisis was
averted by borrowing from the IMF and then undertaking reforms of both
external and domestic sectors of the economy.

Table 18.7: Key external debt indicators, 1990-91 to 2009-10.

The experience of 1991 should not lead to the conclusion that foreign debt
must be avoided at all costs. Rather, foreign borrowing is important to increase the
volume of funds available for investment in a developing economy. It allows the
economy to investment beyond its own savings. But it is also necessary that
the borrowed money be used for investment (other than in a situation of a dire
emergency, as in a serious drought) so that economy grows and is able to
repay the debt. Along with growth, there is a need for foreign earnings too to
increase so that the debt can be repaid. If we look at the last row of Table 18.6,
pertaining to 2009-10, it will be seen that India’s debt is now more than the level it
was at in 1990-91. But since the Indian economy has been growing at more than 6
per cent per annum in the 1990s and at more than 7 per cent per annum in the
2000s, the debt to GDP percentage has come down from 26.4 per cent in 1990-91 to
19.9 per cent in 2009-10. What is important the debt service ratio (DSR – which is
interest and principal repayments as a proportion of exports) has also come down
from 34.6 per cent in 1990-91 to just 5.5 per cent in 2009-10. The only worrying
aspect of the debt situation is the increase in the proportion (অনুপাে) of short-
term to total debt from 10.2 per cent in 1990-91 to 20.0 per cent in 2009-10. This
increase in the proportion of short-term debt is due to external borrowings by Indian
businesses. While the increase in short-term debt is not of a magnitude to affect the
macro situation of the economy, borrowing firms could be affected by exchange rate
fluctuations. For instance, in later 2011 the Indian rupee fell to a low of Rs. 59 to the
US$. Those companies that had borrowed at, say, Rs.45 to the US$ a year ago,
would have fond their liabilities suddenly increase. Of course, they could have
protected themselves by hedging their borrowings. Since 1991 India has built up
substantial foreign exchange reserves, now in excess of $350 billion. This is the fifth
largest foreign exchange reserve in the world, but it is very small in comparison to
China’s $2 trillion foreign exchange reserve. The Asian economies, in particular,
have been accumulating (সঁচায়ক) foreign exchange reserves after the late
1990s Asian financial crisis. In that crisis many Asian countries had to
approach the IMF for emergency loans. A flawed (ত্রুটিযুি) policy followed by
the IMF forced these countries to reduce government expenditures and have
balanced budgets (আয়ৈযয়ক). This resulted in a further contraction of the
South-east and East Asian economies, already hit by the Asian crisis. After
this experience of having to borrow and being forced to follow a policy of
contraction that negatively affected their economies, the Asian countries seem
to have drawn the lesson that it was important to build sufficient foreign exchanges
for any future crisis. India too has followed this policy. In a way, this is a policy of
self-insurance, which is not the best way to have insurance. But in an
uncertain world where power pressures are at play, countries do decide to
build their own defences against risks of downturns. Building up reserves
comes at the cost of growth, as the reserves could be invested to speed up
growth. But there is a trade off between growth and risk and countries seem to
have decided to reduce some growth in order to build their capacity to
withstand shocks. One of the factors that has helped India build reserves is
remittances. A large number of Indians work abroad. This includes not only
the high-profile Indian professionals (লপিাোরী), but also the millions of Indian
workers in West Asia and elsewhere. Remittances from migrants were as
much as $54 billion in 2009-10, and that amounted to 3.9 per cent of India’s
GDP. These remittances have financed a large portion of India’s balance of
trade deficit. Remittances are the most important source of external finance,
more than foreign investments or loans from foreign governments.
External Shocks (ৈাশিরাগে ধক্কা)
With growing openness of the Indian economy it becomes more susceptible
(প্রিারবত) to external shocks. There are two measures of openness. One is to
take the ratio (অনুপাে) of exports and imports of goods and services to GDP.
Openness = (Export+ Import)/GDP
This has been rising from about 30.8 per cent in 2002-03 to 46.4 per cent in
2007-08 and now more than 60 per cent in 2009-10. The above measure only
deals with trade. But there are also financial inflows on both current and
capital accounts. Taking that into account we get a measure of openness.
Openness= [(current receipts and gross capital inflows) + (current
payments and gross capital outflows)]/ GDP.
By this measure openness rose from 49 per cent during 1997-98 to 1991-2 to
an average of 80 per cent from 2002-03 to 2007-08. The ratio of gross inflows and
outflows to GDP was as high as 120 percent in 2007-08. This second measure
better expresses the degree of connections between India and the rest of the
world. A country is affected not only by trade flows but also by overall
financial flows, on both current and capital accounts. In a completely open
economy capital (মূলধন)flow in and out at will. When returns are high compared to
other countries, there could be a large inflow. This itself could be destabilising
in that there would be an increase in money supply, with the possibility of
inflation. On the other side, when returns fall below those in other countries,
then there could be a massive outflow of capital, again negatively impacting
the economy.
India has not followed such a policy of open capital markets. There are
controls on both inflows and outflows. This control on capital account used to be
criticised in many quarters. But after India better managed the shock from the global
economic crisis of 2008-10, there has been appreciation of India’s policy of only
gradually opening the capital sector. Along with this control on capital flows, India’s
banking sector too was restrained. It was restricted in the extent to which it could
move into non-bank financial sector, such as insurance. Thus, the Indian banking
system, unlike those in the developed countries, were not so exposed to the collapse
of non-bank sectors such as insurance. Their exposure to banking assets in other
countries were also limited. While monetary policies and banking guidelines played a
major role in not allowing the financial collapse in the developed countries to spread
to India, there was an impact on India’s exports of the contraction of developed
country markets. In addition, uncertainty in the economic scene led Indian
businesses too to postpone investment, even in sectors such as construction, which
had nothing to do with the external market. Overall investment fell by about four to
five percentage points. Export contraction and business uncertainty together led to a
fall in employment in sectors such as diamond cutting and construction. Here the
Government of India followed the standard Keynesian prescription of increasing the
size of the budget deficit to make up for the shortfall in private investment. Measures
like the MGNREGS, the rural employment guarantee scheme, which were already in
place, were automatically increased in size to provide employment to the urban
unemployed who returned to rural homes. Following the ongoing global slowdown,
there was a slow-down in the rate of growth of Indian exports, while the markets in
the industrialised countries contracted or remained stagnant. The government
announced a ‘New Export- Import Policy for 2009-14’. It included expected measures
of certain support, in the form of drawbacks, easier import of capital goods,
diversification of exports into new products. More important were the measures to
reduce transaction costs through reductions in procedures. What was new in the
new trade policy is the emphasis on seeking markets outside the major industrial
powers of the North Atlantic, Europe and Japan. The policy promised support to
expand exports to South America and to Africa too. An important problem in
increasing exports is the constraint of poor infrastructure in the country.

Conclusion
Under outward-oriented growth strategy, foreign trade is considered as engine of
growth. It contributes to economic development in a number of ways. The foreign
trade of any country can be analysed in terms of volume, composition and direction.
Taking goods and services together the ratio of exports and its importance to India’s
GDP has gone up from 23 per cent in 1990s to 49 per cent in 2010-11 marking trade
as a growing feature of Indian economy. However large current account deficit in
goods trade is a matter of concern. The composition of India’s external trade has
been changing from primary goods to manufacturing and engineering goods.
Similarly direction of India’s exports is shifting from away from the traditional markets
(EU, USA and Japan) to Asia. India’s balance of payment has been in surplus
resulting in rapid build-up of foreign exchange reserves largely due to massive
inflows of foreign capital. Indian economy has been steadily becoming more open
and hence international consequences need to be kept in mind by the policy makers.