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India’s Balance Of Payments – Part I

The international Balance of Payments (BOP) of a country reflects its economic strengths and weaknesses. A typical problem of the developing countries is that of a chronic BOP deficit, India being no exception. Our country has been facing BOP disequilibrium right since independence, culminating into a disaster in 1990-91, the year of the acute BOP crisis. India then had foreign exchange reserve of mere 1 billion dollar, barely sufficient to finance a month’s import bill. The country was on the verge of defaulting. This crisis led to the massive changes in the country’s economic policy, popularly known as the Structural Adjustment Program or New Economic Policy (NEP) regime, focusing on liberalization and globalization of the economy.

We opted for a very cautious approach and today after having overcome the initial hiccups of a newly liberalized economy, we have a fairly comfortable BOP situation. Even though we have attained a comfortable BOP position reflecting a strong emerging economy, BOP management still remains a tightrope walk for policy makers, as now we are exposed to each and every change in the global economic scenario.

Trends & problems of India’s BOP – 1949-50 to 1999-2000

The disequilibrium in India’s BOP has been caused by both internal as well as external factors.

The need for development of such a big nation with a huge population is one of the main causes for the recurring BOP problem. The BOP always under pressure and had huge deficits due to high imports of food grains and capital goods, the heavy external borrowings and its payment and poor exports.

After achieving independence, the foremost challenge before India was of attaining economic growth with social justice.

India’s aim after attaining independence was to attain economic self- reliance. For this the country had to tap both the internal as well as the external resources. Not only was our technology backward then, there was food scarcity too. Large amounts of food grains had to be imported to feed the huge population.

Protectionist Policies

The main objective of the Second Five Year Plan (1956-57 to 1960-61) was to attain self reliance through industrialization. Self reliance was to be achieved through import substitution. For this basic industries had to be set up which required import of capital goods. Exports were expected to take-off on its own with industrialization. It was felt –“….It is only after industrialization has proceeded to some way that increased production at home will be reflected in larger export earnings.” The import substitution strategy was based on non-price, physical- interventionist policies like licensing, quotas and other physical restrictions on imports. Heavy capital goods were imported but other imports were severely restricted to shut off competition in order to promote domestic industries. All focus was on import substitution, with gross neglect of exports. Such inward looking protectionist policies did result in some self-reliance in the consumer goods industries, but the capital goods industries remained mostly import intensive.

The high degree of protection to Indian industries led to inefficiency and poor quality products due to lack of competition. The high cost of production further eroded our competitive strength.

Rising petroleum products demand, the two oil shocks, harvest failure, all put severe strain on the economy. The BOP situation remained weak throughout the 1980s, till it reached the crisis situation in 1990-91; When India was on the verge of defaulting due to heavy debt burden and constantly widening trade deficit.

External Debt

India had to resort to large scale foreign borrowings for its developmental efforts in the field of basic social and industrial infrastructure. The country’s resources were very much limited due to low per capita income and savings. The situation worsened because Government of India resorted to heavy foreign borrowings to correct the BOP situation in the short run out of panicky. By the Seventh Five Year Plan, the debt service obligations rose sharply because of harder average terms of external debt, involving commercial borrowing, repayments to the IMF and a fall in concessional aid flow.

Export Promotion

Although by the Sixth Five Year Plan we had done away with the need of food grain imports and some crude oil was being produced domestically, BOP position was still not comfortable due to low exports. The need for export promotion was felt during the 1960s. The Third Five Year Plan introduced certain export promotion policies like cash compensatory schemes, tax exemptions, duty drawbacks, Rupee devaluation etc. However our exports remained discouraging.

Indian exports depended largely on world trade situation.

We were mainly primary product exporters, the price of which fluctuated heavily with fluctuations in world market demand.

  • Primary products exporting countries have an unfavorable term of trade. The earnings from primary product exports were low and unstable.
  • Secondly, the quality of Indian products was not up to the world standards due to which we could not sustain markets.
  • Third, only residue products were mainly exported. The fact that export earnings also contribute to economic development was overlooked. Cumbersome procedures for license etc served as disincentives for exporters. Domestic inflation further reduced the competitiveness of India’s export.

Exchange Rate

The instability of the exchange value of the rupee was another problem. The constant devaluations (to promote exports) raised the amount of external debt. The value of rupee was managed by the central bank (fixed exchange rate). The gap between official and market exchange rate created problems for the exporters and importers. The strict foreign exchange controls also encouraged hawala trade.

India followed a strongly inward looking policy, laying stress on import substitution. Ideally, imports should be financed by export earnings. But because there was export pessimism, the deficit was financed either by the invisible earnings or by foreign aid or depletion of valuable foreign exchange reserve. Much import constraint to check trade deficit was also not possible because India’s imports were mainly ‘maintenance imports’. On one hand import reduction was not possible and on the other exports suffered due to the recession in the 1980s.

India’s BOP was thus beset with several problems. The process of liberalization began from the mid 1980s. Restriction on certain imports were removed, particularly those which were used as inputs for export production. But by then the situation was already bad and all the mismanagement ultimately led to the 1990-91 BOP crisis.

continue reading International Balance of Payments for India.

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  1. pls send me the article