India’s Balance of Payments on Current Account

India’s Balance of Payments on Current Account

Before analyzing India’s balance of payments position over different plan period and there is a need to have knowledge on analyzing the Current Account.

Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.

A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.

So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.

As we have read in the above that the current account shows whether a country has favorable balance or deficit balance of payments in any given year. For example, the surplus or deficit of the current account are reflected in the capital account, through the changes of in the foreign exchange reserves of country, which are an index of the current strength or weakness of a country’s international payments position, are also included in the capital account.

The following discussion details India’s balance of payments on current account, over five year planning periods (see Table):

The First Plan Period

India had been experiencing persistent trade deficit, but she had a surplus in net invisibles, accordingly India’s adverse balance of payments during the First plan was only ` 42 crores. However, the overall picture of India’s balance of payments position was quite satisfactory.

The Second Plan Period

The prime feature of the Second Plan period was the highest (` 2,339 crores) trade deficit in the balance of payment. Net invisibles in this period was recorded at ` 614 crores, and covering a part of trade deficit. Balance of payments in this period recorded unfavorable, at ` 1,725 crores. The unfavorable balance of payment in the Second Plan was due to heavy imports of capital goods to develop heavy and basic industries, the failure of agricultural production to raise to meet the growing demand for food and raw materials from a rapidly growing population and expanding industry, the inability of the economy to increase exports, and the necessity of making minimum ‘maintenance imports’ for a developing economy. This led to foreign exchange reserves sharply declined and the country was left with no choice to think of ways and means to restrict imports and exports.

The Third Plan and Annual Plans

Third plan period resembles the features of the Second plan with ` 1, 951 crores unfavorable balance of payments. But the reasons for this state of affaire were different from the Second Plan. Unfavorable balance of payments in this period was primarily because of expanding imports under the impact of defense and development and to overcome domestic shortages (for example imports of food grains) and sluggish exports and failed to match imports. Loans from foreign countries, PL480 and PL665 funds, loans from the World Bank and withdrawals from IMF financed the current account deficit. In spite of all these there was some depletion of foreign exchange reserves of the country.

The higher unfavorable balance of payment that started in the beginning of the Second Plan continued throughout the Plan and also continued persistently during the Third and Annual Plans. During this period, huge amount was used to pay interest on the loans contracted earlier. This has reduced the invisibles balance. Consequently, balance of payment deficit was negligible.

The Fourth Plan Period

In this Plan period India’s current account balance was recorded favorable at ` 100 cores, it was due to the objectives of the Plan. The objectives of the Plan are self-reliance i.e., import substitution of certain critical commodities (that are key importance for the Indian economy), export promotion, so as to try to match raising import bill. Government had succeeded in finding substitutes for imports and succeeded in export promotion. The trade deficit in this period has come down from ` 2,067 crores in Annual Plans to ` 1,564 cores by the end of Fourth Plan period. The net current account balance was favorable for the first time in India.

The Fifth Plan Period

In the Fifth Plan period India’s trade deficit had increased from ` 3,179 crores to ` 3,374 crores by the end of Fifth Plan period. It was due persistent increase in imports and inadequate increases in exports due to relative decline in export prices were made the revival of deficit trade balance. Sharp increase in invisible is another outstanding feature of Fifth Plan period.

The prime factors responsible for this increase are stringent measures taken against smuggling and illegal payment of transactions, relative stability in the external value of rupee at a time when major international currencies were experiencing sizable fluctuations, increase in earnings from tourists, the growth earnings from technical, consultancy and contracting services, and increase in the number of Indian nationals going abroad for employment and larger remittances nest by them to India. Net invisibles were more than the trade balance deficit, thus India’s current account balance was favorable at ` 3,082 crores, which was comfortable for the first time in planning period started.

The Sixth - Plan Period

There has been a sea change in India’s current account balance since 1979-80, as against favorable balance experienced by the economy the whole of the Fifth Plan; India started experiencing unfavorably balance of payments from 1979-1980 onwards. In other words, trade deficit widen from 1978-79 onwards. In this period the trade deficit was recorded at ` 3, 374 crores, it was due to terrific growth of imports and very low growth rate of exports. This trade deficit was completely eaten the net invisibles and left current account deficit. For meeting this deficit India had taken external assistance, withdrawals of SDR, and borrowing from IMF under the extended facility arrangement. Apart from these, India used a part of its accumulated foreign exchange reserves to meet its balance of payments.

The Seventh Plan Period

During this period the total trade deficit increased to ` 54,204 crores. The net invisibles recorded a positive balance at ` 16, 157 crores. After adjusting the positive balance of net invisibles, the current account balance was registered at ` 41, 047 crores, which was the cause for serious concern, it was due to the larger imports. The increase in imports was due to import liberalization, promotion of industrial development, and the relative steep depreciation of the rupee vis-avis other currencies. The ultimate solution has to be found in controlling imports to the unavoidable minimum and promoting exports to the maximum.

Professor Sukhmoy Chakravarty in his work “Development Planning – the Indian Experience (1987)”, questioning the policy of liberal imports wrote: “In my judgment, India’s balance of payments is likely to come under pressure unless we carry out a policy of import substitution in certain crucial sectors. These sectors include energy, edible oil and nitrogenous fertilizers. In all these sectors, except fertilizers, India is getting increasingly dependent on imports resulting in a volatile balance of payments situation”.

In the year 1990-91 net invisible recorded a negative balance of ` 433 crores, which was the first time during last 40 years. It was largely the consequence of a net outflow of investment income of the order of ` 6, 732 crores in 1990-91 as against ` 4, 875 crores in 1989-90- as increase by 38 per cent. Thus, the cushion available through positive net invisibles to partly neutralize the trade deficit was removed.

The Eighth Plan Period

During 1992-03 to 1996-97 the trade deficit had continuously increased except 1992-03, and is was threefold increase from the year 1990-91. The total trade deficit for the Plan period was recorded at ` 1, 49,004 crores. Net invisibles also increased from a positive balance ` 4,259 in the year 1991-92 to a positive balance of ` 86, 090 crores by the end of the Plan period. It was good support for India. Despite this, the current account balance was recorded a negative balance in all the years and the total deficit was recorded at ` 62,914 crores.

The Ninth Plan Period

In this planning period the highest trade deficit was recorded in the year 1999-2000 with ` 77, 359 crores. Net invisibles had increased continuously in all the years of the plan except 2001-02, and the total net invisibles recorded at ` 2,52,995 crores. However, India’s current account balance was registered negatively at ` 53,175 crores.

On an overall the current account deficit was high in the year 1997-98 but the deficit had come down to ` 16, 426 crores, it was due to heavy receipts on account of invisibles amounting to ` 71, 381 crores, not only wiped of trade deficit, they also created a surplus balance in current account with ` 16, 426 crores.

The Tenth Plan Period

During the first two (2002-03, and 2003-04) years of the Tenth Plan, the current account balance was recorded a positive balance of ` 30,660 crores and ` 63, 983 crores respectively. It was due to heavy surplus on invisibles. India’s current account balance over the 2001-02 to 2003-04 year showed a favorable balance of payments. However, in the year 2004-05, there was a huge trade deficit (provisional) of ` 1, 64,542 crores on account of unexpected increase in imports, although there huge jump in our exports. Net invisibles shown as positive balance of ` 1, 39,756 crores, but it is just enough to cover 85 per cent of trade deficit. Consequently, a current account deficit of ` 24, 786 crores was recorded, which is an unhealthy development. It may further worsen if India follows reckless policy of import liberalization.