(Sample Material) IAS PRE GS Online Coaching : Economic & Social Development – External Sector

Subject: Economic & Social Development
Topic: External Sector

Ques. 1 : What do you understand by Balance of Payments?

Ans. The highlights of BoP developments during 2010-11
were higher expors, imports, invisibles, trade, CAD and capital flows in
absolute terms as compared to fiscal 2009-10. Both exports and imports showed
substantial growth of 37.3 per cent and 26.8 per cent respectively in 2010-11
over the previous year. The trade deficit increased by 10.5 per cent in 2010-11
over 2009-10. However, as a proportion of gross domestic product (GDP), it
improved to 7.8 per cent in 2010-11 (8.7 per cent in 2009-10) Net invisible
balances showed improvement, registering a 5.8 per cent increase in 2010-11. The
CAD widened to US$ 45.9 billion in 2010-11 from US$ 38.2 billion in 2009-10, but
improved marginally as a ratio of GDP to 2.7 per cent in 2010-11 vis-a-vis 2.8
per cent in 2009-10. Net capital flows at US$ 62.0 billion in 2010-11 were
higher by 20.1 per cent as against US$51.6 billion in 2009-10, mainly due to
higher inflows under ECBs, external assitance, short-term trade credit, NRi
deposits, and bank capital. In 2010-11, the CAD of US$45.9 billion and it
resulted in acretion to foreign exchange reserves to the tune of US$13.1 billion
(US$13.4 billion in 2009-10).

During the first half (H-1-April-September 2011) of 2011-12,
CAD in absolute terms was higher than in the corresponding period of the
previous year, mainly due to higher trade deficit. The net capital flows in
absolute terms were also higher during H1 of 2011-12 vis-a-vis the corresponding
period of 2010-11.

Balance of payments is an overall statement of a country’s
economic transactions with the rest of the world over some period- usually one
year. It includes all outflows and inflows (payments and receipts) Countries
have either balance of payment surplus or a balance of payment deficit. Balance
of payments is a way of listing receipts and payments in international
transactions of a country. Balance of payments can be broken down into balance
of trade (export & import of goods); balance of current account (includes the
balance of trade, the balance of services and remittances; and capital account
(investment and borrowing). Trade account is a part of the current account.
Capital account deals with investment and borrowings and the rest of the 130P is
the current account of which foreign trade is a part.

Balance of Payments in the l990s

The 1990s witnessed some major changes in India’s balance of
payments front. The decade began with a crisis caused both by the immediate Gulf
war and the cumulative problems of the Indian economy. It led to an IMF-sponsored
bail out. The response to the crisis also spurred a host of reforms which had a
significant bearing on the balance of payments The rupee was devalued
substantially, foreign portfolio investments were Welcomed and Indian companies
were allowed to raise capital from the international markets. Convertibility of
the rupee was gradually brought in from 1992-1993 budget onwards: India’s
foreign trade expanded as tariff and non-tariff barriers to trade dropped.

The Gulf crisis of 1990-91 and the subsequent rise in crude
prices rudely exposed the inadequacy of reserves. The consequent rise in India’s
import bill, depleted reserves. International rating agencies downgraded Indian.
This fuelled the crisis further as India’s credit worthiness plunged. A
substantial outflow of deposits held by Non-resident Indian during 1990-91 added
to the crisis. Reserves declined to a low of $0.9 billion in January 1991.

India had to pledge gold in May 1991 and again in July 1991
to avoid a default on its short term obligations. Further, in October 199i,
India forex through India Development Bonds and Foreign Exchange Immunity
Scheme.

Confidence building measures were taken up after a new
government was formed in June 1991. The rupee was devalued. The rupee was
partially freed in 1992, wherein 40 per cent of the foreign exchange earnings
were to he surrendered at the official exchange rate and the remaining 60 per
cent could be converted at market determined exchange rates.

The partial convertibility was extended to full
convertibility and rates were unified on trade account in 1993 and an effective
current account convertibility in 1994. In August 1994, India assumed
obligations under Article VIII of the International Monetary Fund, as a result
of which, India is committed to adopt current account convertibility.

The measures helped in international investors reposing faith in
India once again.