ECONOMIC NOTES

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The Balance of Payments Situation

1991 and Now
R Krishnaswamy, K Kanagasabapathy

There is a fear that the current vulnerabilities on the balance of payments front signal another crisis as in 1991. This article analyses the factors underlying the current problems in the BoP and points out the key differences and also a few similarities between the state of the Indian economy then and now.

ndias current account decit (CAD) on the balance of payments (BoP), after touching a historic high of 6.7% of the gross domestic product (GDP) in October-December 2012, moderated to 3.6% of GDP in January-March 2013 on the back of an increase in exports and a marginal decline in imports. On an annualised basis, the CAD rose to 4.8% of GDP in 2012-13 from 4.2% of GDP in 2011-12, mainly on account of a widening trade decit. Indias relatively poor competitiveness in exports and high dependence on oil and gold imports (which account for virtually half of total imports) resulted in a widening of the trade decit in recent years. While a somewhat stronger capital account has helped so far prevent the emergence of a crisis, the fragility of the external sector is reected in a weakening currency, the dwindling foreign exchange reserves and the threat of sovereign downgrades. The Ministry of Finance seems to have realised, for the rst time, the need to boost merchandise exports through greater diversication across destinations and products to bridge the trade decit that has been behind the burgeoning CAD. This note attempts to track the recent developments that are pushing the CAD to unsustainable levels; it also traces the similarities between the present and the 1991 crisis. 1 Recent Developments in CAD The CAD in 2004-05 was $2.5 billion and ared up to $27.9 billion in 2008-09, the year of the global nancial turmoil and leaped even higher in the next four years to touch a high of $88.2 billion in 2012-13. The current-account position has worsened since 2008-09 on account of increasing oil imports (driven both by rising oil prices and expanding domestic

demand) and rising gold imports. The share of oil and gold imports in total imports rose from 37.6% in 2008-09 to 45.3% in 2012-13. The CAD-GDP ratio increased from 2.3% in 2008-09 to 4.8% in 2012-13. The Reserve Bank of Indias (RBI) own research shows that the economy can sustain a CAD of about 2.5% of GDP in a scenario of slow growth (RBI 2012). A global economy that is growing slowly and protracted high levels of unemployment in advanced economies make it difcult to boost services exports in the short run. Slow global growth also has an adverse impact on inward remittances. Hence, there is a need to reduce imports and boost merchandise exports to bring the CAD to sustainable levels. 1.1 Burgeoning Trade Decit The average annual growth rate of exports has surged to 19.7% for the decade ending 2012-13. Between 2008-09 and 2012-13, Indias export propensity, i e, the share of exports in GDP was relatively stable and range-bound between 13.3% and 16.6%, thereby indicating a growing vulnerability of exports to external shocks. On the other hand, imports, which have undergone signicant changes, grew at an annual average growth of 24.1% in the decade ending 2012-13. Indias marginal propensity to import (MPM) has been highly volatile and concurrent with Indias economic cycle. MPM denes the extent to which an economys imports are induced by changes in income. It is the ratio of a change in total imports to the change in GDP. In 2009-10, MPM was very low signifying that a rupee growth in the GDP induced hardly any growth in imports. In 2008-09, imports were $308.5 billion, it actually declined the next year, in 2009-10, to $300.6 billion. On the other hand, in 2011-12 and 2012-13, a growth of Re 1 in GDP brought about Re 0.61 and Re 0.30 growth in imports respectively (Shiraly and Pacheco 2013). Indias trade dependence or trade openness index, which was 28.3% in 2004-05, rose to 40.1% in 2008-09 and 43.9% in 2012-13. The merchandise trade decit
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R Krishnaswamy and K Kanagasabapathy are with the EPW Research Foundation, Mumbai.
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rose from $33.7 billion in 2004-05 to $119.5 billion in 2008-09 and further to $195.7 billion by 2012-13. A clear indication of the bourgeoning trade decit is to be found in the trend in Indias export-import coverage ratio. This ratio, which signies how much of the import bill is met by export revenue, was 0.72 in 2004-05, declined to 0.61 in 2008-09 and hovered around that number until 2012-13. India saw an enormous leap in its gold consumption after liberalisation from 200 tonnes to 500-600 tonnes a year (Shetty 2012). This situation forced the government and the RBI to initiate efforts to curb gold imports. Import duty on gold has been quadrupled in the past two years. The demand for gold is not strictly amenable to policy changes. If supply through organised channels is restricted by a hike in import duty, etc, then buyers may take recourse to unauthorised channels to buy gold (RBI 2012). Thus, the rising import bill together with a comparatively lower

export income, especially from 2007-08 onwards, resulted in the CAD widening to unsustainable levels. 1.2 Invisibles Cushion A surplus in the net invisibles account has emerged as the lifeline of the current account. Indias invisibles in the current account are divided into trade in non-factor services, and transfer incomes. While net receipts from services and transfers have been positive, a signicant growth in income payments over receipts during the last three years has somewhat reduced the cushion available from invisibles. The surplus in net invisibles account increased from $31.2 billion in 2004-05 to $91.6 billion in 2008-09; thereafter it declined in 2009-10 and 2010-11 and then registered a remarkable recovery to $111.6 billion in 2011-12. However, it declined marginally to $107.5 billion in 2012-13. The invisibles to GDP ratio was more than 5% in all the years since 2004-05, but after reaching 6% in 2011-12, it declined sharply to

3.5% in 2012-13. Thus, the importance of net invisibles appears to have declined over the years. 2 Financing the CAD In addition to the magnitude of ows needed to nance the CAD, it is important to ensure the steadiness of these ows by reducing overdependence on the highly volatile portfolio and shortterm debt ows. According to RBIs Financial Stability Report (2013), CAD and its non-disruptive nancing has become a major challenge from the perspective of macroeconomic stability. Non-disruptive nancing implies the extent to which CAD is nanced through normal capital ows, without dipping into the pool of foreign exchange reserves. Cross-border volatile capital ows have made India vulnerable to sudden stops and reversals following even the slightest hint of phasing out quantitative easing (QE) by the US Federal Reserve. The RBI has said India faces challenges to nance its recordhigh CAD given the risk of large-scale

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outows. The portfolio outow which was $32 billion during the second quarter of 2012-13 rose to $45 billion by the third quarter, though, on an annual basis the outow in 2012-13 at $148 billion was less than $168 billion in 2011-12. 2.1 Bulging External Debt The external debt grew by 12.9% in 201213 to touch $390 billion. At this level, it was about 21.2% of GDP. But what is more important is the share of short-term debt in total debt, which was about 4% in March 2001, grew to about 25% by March 2013. There has been a sizeable rise in stock of external commercial borrowing from $24.4 billion at end-March 2001 to $120.9 billion by end-March 2013. The outstanding short-term debt rose from $3.6 billion to $96.7 billion during the period. This substantial increase in shortterm debt is a cause for concern. 3 Similar to the 1990-91 Crisis? India faced a major BoP crisis in 1990-91 after the Gulf War due to a decline in net receipts from invisibles, especially from the shrinking net tourism earnings and net remittances, widening trade decit and the oil price shock after the Gulf crisis in 1990-91. Furthermore, there was rapid build-up of debt, especially the short-term kind, and a sudden erosion of non-resident Indian (NRI) deposits. CAD touched 3.0% of GDP in 1990-91. India had to mortgage its gold reserves to borrow foreign currency (Reddy 2006). To mitigate the BoP crisis, a combination of standard and unorthodox policies for stabilisation and structural change were undertaken to ensure that the crisis did not translate into generalised nancial instability. The steps included pledging gold reserves, discouraging non-essential imports, and accessing credit from International Monetary Fund (IMF) and other multilateral and bilateral donors. The domestic economy had posted a remarkable recovery in 1988-89 after the drought in 1987-88. However, strain on the BoP position intensied with the external payment position remaining difcult, mainly due to intensication of protectionist tendencies in international trade, bunching of repayment obligations
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to IMF and others, and an unfavourable in 1980-81, were able to nance only climate for concessional assistance. The about 57% of the trade decit in 1984situation was aggravated as the import 85, which further shrank to about 15% in bill surged, reecting a spillover of es- 1988-89. Though travel income and prisential imports necessitated by the pre- vate remittances were more than sufvious years drought. Moreover, with the cient to pay the rising interest payments strong recovery in 1988-89, import de- on foreign debt till 1989-90, these were mand had become buoyant. However, no longer sufcient in 1990-91 and net international prices of metals, chemicals invisibles receipts declined and were in and edible oils ared up in 1988. Thus, the negative zone. The net travel receipts the signs of stress were discernible, rose from $0.8 billion in 1983-84 to $1.1 which culminated in the BoP crisis, when billion in 1990-91, but private transfers the Gulf War led to a sharp increase in declined from $2.6 billion in 1983-84 to the oil prices. On top of that, a slowdown $2.1 billion in 1990-91. At the same time, in world trade following recessionary outgo due to interest payment and amconditions in industrialised countries, ortisation payments grew from $0.5 biland economic disruptions in eastern Eu- lion to $3.8 billion in 1990-91. Thus, net rope and the erstwhile Union of Soviet invisible earning had lost its buoyancy Socialist Republics (USSR) had affected on account of rising interest payment on export to a large extent. Foreign exchange foreign debt. Thus, capital inows have played an reserves had dwindled due to signicant drawdown for nancing of CAD in increasingly important role in nancing earlier years. During 1990-91, at one trade decit. This, in turn, has led to a point of time, foreign currency assets substantial build-up in external debt dipped below $1 billion covering barely and debt service obligations. But this two weeks of import. Increasing recourse was also found to be insufcient for the to borrowings on commercial terms in government to defray its nancial oblithe previous years also resulted in the gations, and it took recourse to drawdown of foreign exchange reserves and creditors becoming more sensitive. The CAD was $9.7 billion in 1990-91 accepted the IMF accommodation on a and was about 3.2% of GDP as against grand scale during the period. In 1990-91, 2.7% in 1988-89. The trade decit, the capital account was sufcient to which was 3% of GDP in 1983-84 after offset 74.1% of the CAD. The drawdown reaching 3.3% in 1985-86, was hovering on foreign exchange reserves amounted around that level till Chart 1: Current Account Deficit (as Percentage to GDP) 1990-91. On the other 3 hand, net invisibles 2 Period 2 (2003-04 to 2012-13) to GDP progressively 1 dipped from 1.6% to 0 -1 -0.1% in 1990-91. -2 Period 1 (1983-84 to 1992-93) Though there was -3 some easing of pres- -4 sure during 1989-90 -5 when CAD ratio dip- -6 1 2 3 4 5 6 7 8 9 10 ped to 2.3%, this comfortable position was short-lived to $1.3 billion and defrayed 13.2% of the as Iraq invaded Kuwait in August 1990 CAD, while the IMF accommodation and the Gulf crisis extended till Febru- defrayed the remaining 12.5% of the CAD. ary 1991. The oil prices shot up after that and the import bill touched 8.5% 4 Assessment of GDP in 1990-91 from 7.5% in 1983-84, while export earnings were only 5.7% of GDP in 1990-91 as against 4.4% in 1983-84. Invisibles earnings, which were nancing more than 72% of trade decit
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In sum, the following can be said: (i) The CAD widened over the years, both in the current period as well as during the gulf crisis period. The CAD-GDP ratio widened in both periods as illustrated in Chart 1. (ii) The burgeoning merchandise trade
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Table 1: Comparison between 1991 Crisis and Now
Gulf Crisis (1983-84 to 1992-93) Current Situation (2003-04 to 2012-13)

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1 Global prices 2 Domestic inflation

Oil and commodity prices went up and became more volatile after the first Gulf War. Inflation rate was more volatile and it was 7.1% in 1992-93.

Global commodity prices and crude have been more or less stable in the last couple of years. Inflation, though high in the last three years, is declining and was 5.7% in 2012-13. Growth is subdued at 6.9% and will go down going by current trends. Foreign exchange reserve is $279 billion as on 29 July 2013 sufficient for 6.8 months import. CAD has become unsustainable due to increasing import of petroleum products, gold and many other luxury items. Exports were able to pay for only 61% of imports mainly due to higher oil and gold imports. Net invisibles position is not bad at $107.8 billion and is able to cover about 55% of trade deficit. Debt payment (interest+amortisation ) has increased but was only 33.3% of remittances in 2012-13. Average growth was 12.9% during the period and it was US$64.3 billion in 2012-13.

3 Domestic GDP growth Growth picked up from 1992-93 due to many economic measures that were initiated. 4 Foreign exchange reserves 5 CAD In 1990-91 at one point of time it was only $1 billion, enough to finance barely two weeks of imports. CAD became unsustainable because global commodity prices increased, pushing up interest costs and amortisation, with a drying up of remittances, especially from Kuwait. Export income was able to meet 78% of import bill, which rose mainly due to an increase in global oil and commodity prices. Net invisibles declined from $3.5 billion in 1983-84 to $1.9 billion in 1992-93. Able to cover only 35% of trade deficit. Debt payment (interest+amortisation) increased and was equivalent to 88.8% of remittances in 1992-93. Average growth was 4.7% during the period and it was US$3.9 billion.

6 Trade deficit 7 Net invisibles 8 Debt payment (net income) 9 Private transfers (remittances) 10 Net capital receipts

Net capital receipts were not sufficient to defray the CAD and Net capital receipts more than sufficient to defray CAD and thus hence more and more recourse to drawdown from foreign exchange there was addition to foreign exchange reserve in most of the reserve and withdrawals from IMF to pay for the deficits. years except in 2008-09 and 2011-12. Foreign investment was insignificant during the period. Foreign investment flows sufficient to cover the deficit and has also added to foreign exchange reserves. However, overdependence, especially the volatile portfolio investment is dangerous. NRI deposits were 0.8% of GDP in 2012-13. Present position is much better than in 1991. Hence for the present recourse to IMF is not warranted. Measures which would constrict imports like imposing customs duty on gold while taking adequate measures to attract the more stable FDI can overcome the present difficult circumstances.

11 Foreign investment

12 NRI deposits 13 What ahead ?

Deposits were 0.1% of GDP in 1991-92 and then rose to 0.8% by 1992-93. Improved after 1992-93 as the governement adopted different economic and reform measures to improve the overall health of the economy.

Source: Prepared by EPWRF.

decit in both periods was due to shrinking exports and bulging imports due to the increasing oil and gold import bill. (iii) Unsustainability in both periods took place after some crisis, viz, the global crisis during the current period and the gulf crisis during the 1990s. (iv) The importance of net invisibles receipts as an offsetting factor eroded over the years in both periods due to shrinking private remittances in 1990s, and reducing private remittances and services exports (especially software exports) during the current period. Both periods also witnessed substantial outow due to interest and amortisation payments. (v) In both periods, insufcient net capital account receipts forced recourse to withdrawal from foreign exchange reserves that shrunk as a result. During the current year it is sufcient to nance only about six to seven months of imports; as against this, it was enough to nance just two weeks of imports around July
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1990-91. (vi) However, one main difference is that the international crude oil and commodity prices, which were high and very volatile in the early 1990s, are more stable in the current period and oil prices were around $100/bbl in the last couple of years, while commodity prices witnessed declines due to the global recession (Table 1 for comparison of various parameters).

References
RBI (2012): RBI Annual Report 2011-12, 14 August. (2013): Financial Stability Report, Issue No 7, June. Reddy, Y V (2006): Dynamics of BoP in India, Speech at the First Diamond Jubilee Lecture of the Department of Commerce, Osmania University on 16 December. Shetty, S L (2012): External Account: Distinct Signs of Discomfort on the Horizon, Economic & Political Weekly, 47(52). Shiraly, Priyanka and Manoel Pacheco (2013): Analyzing the Vulnerability of Indias Current Account, Rakshitra, CCIL, June.

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