MFM-103 Balance of Payment-Current Scenario

BALANCE OF PAYMENT
DEFINITION
Balance of payments is a statistical record of a countrys transactions with the rest of the world over a certain period of time presented in the form of double entry book keeping. Receipt from foreigners is recorded as a credit with a positive sign whereas payment to foreigners is recorded as a debit with a minus sign.

SIGNIFICANCE
The balance of payments provides detailed information about the demand and supply of a countrys currency. It signals its potential as a business partner for the rest of the world. A countrys balance of payments also reveals its competitive position in the world economy.

COMPONENTS
The international transactions of a country are grouped under Current account Capital account Official reserve account The current account presents export and import of goods and services whereas capital account includes all purchases and sales of assets (physical/financial). The official reserve account covers all purchases and sales of international reserve assets such as foreign exchange, gold and SDRs (Special Drawing Rights). As per the Balance of Payment Manual (Fifth Edition), BoP comprises current account, capital account, errors and omissions, and change in foreign exchange reserves. Under current account of the BoP, transactions are classified into merchandise (exports and imports) and invisibles. Invisible transactions are further classified into three categories. The first component is Services comprising travel, transportation, insurance, government not included elsewhere (GNIE), and miscellaneous. Miscellaneous services include communication, construction, financial, software, news agency, royalties, management, and business services. The second component of invisibles is income. Transfers (grants, gifts, remittances, etc.) which do not have any quid pro quo form the third category of invisibles. Under capital account, capital inflows can be classified by instrument (debt or equity) and maturity (short- or long-term). The main components of capital account include foreign investment, loans, and banking capital. Foreign investment comprising foreign direct investment (FDI) and portfolio investment consisting of foreign institutional investor (FIIs) investment and American depository receipts /global depository receipts (ADRs/GDRs) represents non-debt liabilities. Loans (external assistance, external commercial borrowings [ECB], and trade credit) and banking capital including nonresident Indian (NRI) deposits are debt liabilities.

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MFM-103 Balance of Payment-Current Scenario

BALANCE OF PAYMENT-CURRENT SCENARIO

No country in todays globalized world can be fully insulated from what happens in the global economy and India is no exception to the rule. As the country is increasingly integrated into the world, it cannot remain impervious to developments abroad. The unfolding of the euro zone crisis and uncertainty surrounding the global economy have impacted the Indian economy causing drop in growth, higher Current Account Deficit (CAD) and declining capital inflows. As in 2008, the transmission of the crisis has been mainly through the balance-of-payments (BoP) channel. Export growth has decelerated in the third quarter of fiscal 2011-12, while imports have remained high, partly because of continued high international oil prices. At the same time, foreign institutional investment flows have declined, straining the capital account and the rupee exchange rate that touched an all-time low of Rs. 54.23 per US dollar on 15 December 2011. The situation, however, is showing signs of improvement in 2012. The rupee has appreciated by 2.6 per cent in January 2012 due to Reserve Bank of India (RBI) intervention, measures to augment supply of foreign exchange in the domestic market, steps to curb speculative activities, and general improvement in India's economic outlook. FII inflows have resumed, lending support to the balance of payments and exchange rate. The global outlook, however, remains uncertain with the situation in Greece teetering on the brink and increasing risk that the contagion will spread to the Portuguese economy. Such a scenario could have serious repercussions for the Indian economy. The highlights of BoP developments during 2010-11 were higher exports, 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 increases 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 assistance, short-term trade credit, NRI deposits, and bank capital. In 2010-11, the CAD of US$ 45.9 billion was financed by the capital account surplus of US$ 62.0 billion and it resulted in accretion to foreign exchange reserves to the tune of US$ 13.1 billion (US$ 13.4 billion in 2009-10).

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MFM-103 Balance of Payment-Current Scenario

A summary of Balance of payment from 2006-07 to 2011-12 is given below; Table 1: Balance of Payments : Summary
Sl. No.

(US$ million)
2007-08 2008-09 2009-10 201011PR 2010-11 H1 (AprilSept. 2010)PR 107331 176213 -68883 39283 21517 -17309 26004 -47366 -29599 38950 3036 5674 2011-12 H1 (AprilSept. 2011)P 150909 236674 -85765 52923 31060 -9025 30887 -54705 -32842 41061 705 10592

Item

2006-07

I 1. 2. 3. 4.

5. 6. II 1.

III IV V

Current Account Exports Imports Trade balance Invisibles (net) a) Non-factor services b) Income c) Transfers Goods & services balance Current account balance Capital Account Capital account balance i. External assistance (net) ii. External commercial borrowings (net) iii. Short-term debt iv. Banking capital (net) of which Non-resident deposits (net) v. Foreign investment (net) of which a) FDI (net) b) Portfolio (net) vi. Rupee debt service vii. Other flows (net) Errors and omissions Overall balance Reserves [increase (-) / decrease (+)]

128888 190670 -61782 52217 29469 -7331 30079 -32313 -9565 45203 1775 16103

166162 257629 -91467 75731 38853 -5068 41945 -52614 -15737 106585 2114 22609

189001 308520 -119519 91604 53916 -7110 44798 -65603 -27914 7395 2439 7861

182442 300644 -118203 80022 36016 -8038 52045 -82187 -38181 51634 2890 2000

250468 381061 -130593 84647 48816 -8238 53140 -81777 -45945 61989 4941 12506

6612 1913 4321 14753

15930 11759 179 43326

-1985 -3245 4290 8342

7558 2083 2922 50362

10990 4962 3238 39652

6937 839 2163 30836

5940 19344 3937 13657

7693 7060 -162 4209 968 36606 (-)36606

15893 27433 -122 10969 1316 92164

22372 -14030 -100 -5916 440 -20080

17966 32396 -97 -13162 -12 13441

9360 30293 -68 -10994 -2993 13050

7040 23796 -16 -8356 -2320 7030 (-)7030

12311 1346 -32 -9145 -2500 5719 (-)5719

(-)92164 20080

(-)13441 (-)13050

Source: RBI. Notes: PR: Partially Revised. P: Preliminary.

During the first half (H1April-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

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MFM-103 Balance of Payment-Current Scenario

deficit. The net capital flows in absolute terms were also higher during H1 of 2011-12 vis-avis the corresponding period of 2010-11. CURRENT ACCOUNT Merchandise trade During 2010-11, exports crossed the US$ 200 billion mark for the first time, increasing by 37.3 per cent from US$ 182.4 billion in 2009-10 to US$ 250.5 billion. This increase was largely driven by engineering goods, petroleum products, gems and jewellery, and chemicals and related products. The improvement in exports was accompanied by a structural shift in the composition of the export basket from labour-intensive manufacture to higher value-added engineering and petroleum products. There was also a diversification of export destinations with developing countries becoming our largest export market in recent years. Like exports, imports also recorded a 26.8 per cent increase to US$ 381.1 billion in 2010-11 from US$ 300.6 billion in 2009-10. Oil imports showed an increase of 19.3 per cent in 2010-11 (as against a decline of 7.0 per cent a year ago) and accounted for 28.1 per cent of total imports (30.2 per cent in 2009-10). Growth in imports has primarily been led by petroleum and related products and pearls and semi-precious stones. The trade deficit increases by 10.5 per cent to US$ 130.6 billion as compared to US$ 118.2 billion in 2009-10. This was primarily on account of higher increase in imports relative to exports on the back of a robust domestic economic performance in 2010-11. In terms of GDP, however, the trade deficit improved from 8.7 per cent in 2009-10 to 7.8 per cent in 2010-11 due to relatively higher increase in GDP at market prices vis-a-vis trade deficit. The widening of Indias CAD during H1 of 2011-12 reflects the impact of growth asymmetry between India and the rest of the world. Indias export and import growth momentum, gained in 2010-11, continued during H1 of 2011-12. During H1 of 2011-12, exports increased from US$ 107.3 billion during H1 of 201011 to US$ 150.9 billion, registering a growth of 40.6 per cent as compared to 30 per cent in H1 of 2010-11 over H1 of 2009-10. Exports in 2011-12 were driven mainly by buoyancy in items such as engineering goods and petroleum products. The resilience in export performance appeared to have resulted from a supportive government policy, focusing on diversification in terms of higher value-added products in the engineering and petroleum sectors and destinations across developing economies. Trade policy is supporting exports through schemes like the Focus Market Scheme (FMS), Focus Product Scheme (FPS), and Duty Entitlement Passbook Scheme (DEPB). Imports of US$ 236.7 billion recorded an increase of 34.3 per cent during H1 of 201112 as against an increase of 27.3 per cent in H1 of 2010-11 over H1 of 2009-10. Rising crude oil prices, along with increase in gold and silver prices, have contributed significantly to the burgeoning import bill during H1 of 2011-12. The trade deficit widened by 24.5 per cent to US$ 85.8 billion (9.4 per cent of GDP) during H1 of 2011-12 vis-a-vis US$ 68.9 billion (8.9 per cent of GDP) in H1 of the previous year, despite the higher export growth compared with imports in H1 of 2011-12.

Invisibles The invisibles account of the BoP reflects the combined effect of transactions relating to international trade in services, income associated with non-resident assets and liabilities, labour and property, and cross-border transfers, mainly workers remittances.

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MFM-103 Balance of Payment-Current Scenario

In 2010-11, there was a sharp increase in both exports and imports of services. Services exports increased by 38.4 per cent from US$ 96.0 billion in 2009-10 to US$ 132.9 billion in 2010-11. Business services increased by 113.3 per cent from US$ 11.3 billion in 2009-10 to US$ 24.8 billion in 2010-11 and financial services by 75.7 per cent to US$ 6.5 billion in 2010-11 from US$ 3.7 billion in 2009-10. Receipts on account of software services also witnessed a rise, mainly on account of improved efficiency and diversified export destinations. Software receipts at US$ 55.5 billion, accounting for 41.8 per cent of total service receipts, showed an increase of 11.7 per cent in 2010-11 (7.3 per cent a year earlier). Software receipts were 12.4 per cent of total current receipts. Net service exports increased to US$ 48.8 billion in 2010-11 from 36.0 billion in 2009-10, registering 35.5 per cent increase. Invisible payments increased by 36.2 per cent from US$ 83.4 billion in 2009-10 to US$ 113.6 billion in 2010-11. The growth of 36.2 per cent in invisible payments outstripped the 21.3 per cent growth recorded in 2010-11. Increase in invisible payments was mainly attributed to business services, financial services, travel, and investment income. Even though the surplus on account of service-sector exports was significantly higher in 2010-11, growth in net receipts on account of transfers was moderate and net outflow of investment income increased during the same period. As a result, the net invisible balance (receipts minus payments) posted an increase of 5.5 per cent to US$ 84.6 billion in 2010-11 as against US$ 80.0 billion in 2009-10. As a proportion of GDP, net invisible balance declined from 5.9 per cent in 2009-10 to 5.0 per cent in 2010-11. At this level, the invisible surplus financed 64.8 per cent of trade deficit as against 67.7 per cent during 2009-10. During H1 of 2011-12, invisible receipts recorded an increase of 17.4 per cent to US$ 106.0 billion vis-a-vis US$ 90.3 billion during the corresponding period of 2010-11. All broad categories of invisibles, namely services, transfers, and income, showed increase. Growth in exports of services moderated to 17.1 per cent during H1 of 2011-12 as against 32.7 per cent during H1 of 2010-11, while growth in imports was substantially lower at 1.0 per cent during H1 of 2011-12 as against 48.3 per cent during H1 of 2010-11. Invisible payments of US$ 53.0 billion during H1 of 2011-12 recorded an increase of 3.9 per cent over US$ 51.0 billion in H1 of 2010-11. Net invisibles balance (receipts minus payments) recorded a 34.6 per cent increase to US$ 52.9 billion (5.8 per cent of GDP) in H1 of 2011-12 from US$ 39.3 billion (5.1 per cent of GDP) in H1 of the previous year. At this level, the invisibles surplus financed about 62.0 per cent of trade deficit during H1 of 2011, as against 57.0 per cent during the same period a year earlier. Goods and services deficit (i.e. trade balance plus services) decreased marginally to US$ 81.8 billion (4.9 per cent of GDP) during 2010- 11 as compared to US$ 82.2 billion (6.0 per cent of GDP) in 2009-10. In fiscal 2011-12, it widened to US$ 54.7 billion up to H1 as compared to US$ 47.4 billion during the corresponding period a year earlier on account of increase in trade deficit. However, as a ratio of GDP, it marginally declined to 6.0 per cent in 2011-12 (up to H1) from 6.1 per cent in 2010-11 (up to H1). Current Account Balance The CAD increased to US$ 45.9 billion in 2010-11 from US$ 38.2 billion in 2009-10, despite improvement in net invisibles, mainly on account of higher trade deficit. However, as a proportion of GDP, CAD marginally improved to 2.7 per cent in 2010-11 as compared to 2.8 per cent in 2009-10. The CAD increased to US$ 32.8 billion in H1 of 2011-12, as compared to US$ 29.6 billion during the corresponding period of 2010-11, mainly on account of higher trade deficit. As a proportion of GDP, it was marginally lower at 3.6 per cent during H1 of 2011-12 vis-avis 3.8 per cent in H1 of the preceding year.

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MFM-103 Balance of Payment-Current Scenario

As per the latest data available from the Ministry of Commerce, at US$ 242.8 billion during April 2011-January 2012, exports registered a growth of 23.5 per cent over exports of US$ 196.6 billion during the same period in 2010-11. At US$ 391.5 billion, imports recorded 29.4 per cent growth during April 2011-January 2012 over the figure of US$ 302.6 billion during the corresponding period of the previous year. Consequently, trade deficit increased by 40.3 per cent to US$ 148.7 billion during April 2011-January 2012 as compared to US$ 106 billion in April 2010-January 2011. CAPITAL ACCOUNT Capital inflows can be classified by instrument (debt or equity) and maturity (shortterm or longterm). The main components of capital account include foreign investment, loans, and banking capital. Foreign investment comprising FDI and portfolio investment represents non-debt liabilities, while loans (external assistance, ECBs, and trade credit) and banking capital including NRI deposits are debt liabilities. In India, FDI is preferred over portfolio flows as the FDI flows tend to be more stable than portfolio and other forms of capital flows. Rupee-denominated debt is preferred over foreign currency debt and mediumand long-term debt is preferred over short-term. Push and pull factors explain international capital flows. Push factors are external to an economy and inter alia include parameters like low interest rates, abundant liquidity, slow growth, or lack of investment opportunities in advanced economies. Pull factors like robust economic performance and improved investment climate as a result of economic reforms in emerging economies are internal to an economy. In 2010-11, both gross inflows of US$ 499.4 billion and outflows of US$ 437.4 billion under the capital account were higher than gross inflows of US$ 345.8 billion and outflows of US$ 294.1 billion in the preceding year. In net terms, capital inflows increased by 20.2 per cent to US$ 62.0 billion (3.7 per cent of GDP) in 2010-11 vis-a-vis US$ 51.6 billion (3.8 per cent of GDP) in 2009-10 mainly on account of trade credit and loans (ECBs and banking capital). In fiscal 2011-12 (up to H1), under the capital account both gross inflows of US$ 244.2 billion and outflows of US$ 203.1 billion were higher than the gross inflows of US$ 207.5 billion and outflows of US$ 168.5 billion during the same period a year ago. In net terms, capital inflows increased moderately to US$ 41.1 billion in H1 of 2011-12 as against US$ 39.0 billion in H1 of 2010-11.While net FDI was higher at US$ 12.3 billion in H1 of 2011-12 as against US$ 7 billion in H1 of 2010-11, net portfolio investment substantially declined from US$ 23.8 billion to US$ 1.3 billion during the same period. This was on account of a major decline in FII flows to US$ 0.9 billion in 2011-12 (up to H1) from US$ 22.3 billion in H1 of 2010-11. Other capital flows, including ECBs and banking capital, also substantially increased. Net capital inflow as a proportion of GDP has shown moderation from 5.0 per cent in H1 of 2010-11 to 4.5 per cent in H1 of 2011-12. Net accretion to reserves (on BoP basis) during H1 of 2011-12 was lower at US$ 5.7 billion as compared to US$ 7 billion in H1 of the previous year mainly due to widening of the CAD. As per the latest available information on capital inflows, FDI inflows were US$ 35.3 billion during April-December 2011 (US$ 16.0 billion in the corresponding period of the preceding year). Portfolio inflows fell sharply to US$ 3.3 billion during April-December 2011 from US$ 31.3 billion a year earlier mainly reflecting uncertainty and risk in the global economy on account of the euro zone crisis.

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MFM-103 Balance of Payment-Current Scenario

FOREIGN EXCHANGE RESERVES Indias foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights (SDRs), and reserve tranche position (RTP) in the International Monetary Fund (IMF). The level of foreign exchange reserves is largely the outcome of the RBIs intervention in the foreign exchange market to smoothen exchange rate volatility and valuation changes due to movement of the US dollar against other major currencies of the world. Foreign exchange reserves are accumulated when there is absorption of the excess foreign exchange flows by the RBI through intervention in the foreign exchange market, aid receipts, and interest receipts and funding from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA), etc. FCAs are maintained in major currencies like the US dollar, euro, pound sterling, Australian dollar, and Japanese yen. Both the US dollar and euro are intervention currencies; however, reserves are denominated and expressed in the US dollar only, which is the international numeraire for the purpose. The movement of the US dollar against other currencies in which FCAs are held therefore impacts the level of reserves in US dollar terms. The level of reserves declines when the US dollar appreciates against major international currencies and vice versa. The twin objectives of safety and liquidity have been the guiding principles of foreign exchange reserves management in India with return optimization being embedded strategy within this framework. Indias foreign exchange reserves Beginning from a low level of US$ 5.8 billion at end March 1991, Indias foreign exchange reserves gradually increased to US$ 25.2 billion by end March 1995, US$ 38.0 billion by end March 2000, US$ 113.0 billion by end March 2004, and US$ 199.2 billion by end March 2007. The reserves stood at US$ 314.6 billion at end May 2008, before declining to US$ 252.0 billion at the end of March 2009. The decline in reserves in 2008-09 was inter alia a fallout of the global crisis and strengthening of the US dollar vis--vis other international currencies. During 2009-10, the level of foreign exchange reserves increased to US$ 279.1 billion at end March 2010, mainly on account of valuation gain as the US dollar depreciated against most of the major international currencies. In fiscal 2010-11, foreign exchange reserves have shown an increasing trend and reached US$ 304.8 billion at end March 2011, up by US$ 25.7 billion from the US$ 279.1 billion level at end March 2010. Of the total increase in reserves, US$ 12.6 billion was on account of valuation gains arising out of depreciation of the US dollar against major currencies and the balance US$ 13.1 billion were on BoP basis. In 2011-12, the reserves increased by US$ 6.7 billion from US$ 304.8 billion at end March 2011 to US$ 311.5 billion at end September 2011. Out of this total increase, US$ 5.7 billion was on BoP basis and the balance US$ 1.0 billion was on account of valuation effect. In the current fiscal, on month-on-month basis, the foreign exchange reserves have shown twin trends. The reserves reached an all-time high level of US$ 322.0 billion at end August 2011. However, they declined to US$ 311.5 billion at end September 2011 before increasing to US$ 316.2 billion at end October 2011. In the months of November and December 2011, reserves again showed a declining trend. At end December 2011, they stood at US$ 296.7 billion, indicating a decline of US$ 8.1 billion from US$ 304.8 billion at end March 2011 (Figure 6.3). The decline in reserves is partly due to intervention by the RBI to stem the slide of the rupee against the US dollar. This level of reserves provides about eight months of import cover.

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MFM-103 Balance of Payment-Current Scenario

EXCHANGE RATE The exchange rate policy is guided by the broad principle of careful monitoring and management of exchange rates with flexibility, while allowing the underlying demand and supply conditions to determine exchange rate movements over a period in an orderly manner. Subject to this predominant objective, RBI intervention in the foreign exchange market is guided by the objectives of reducing excess volatility, preventing the emergence of destabilizing speculative activities, maintaining adequate level of reserves, and developing an orderly foreign exchange market. During 2010-11, the average monthly exchange rate of the rupee against the US dollar appreciated by 1.2 per cent from Rs 45.50 per US dollar in March 2010 to Rs 44.97 per US dollar in March 2011. Similarly, on point-to-point basis, the average exchange rate of the rupee [average of buying and selling rate of the Foreign Exchange Dealers Association of India (FEDAI)] appreciated by 1.1 per cent from Rs 45.14 per US dollar on 31 March 2010 to Rs 44.65 per US dollar on 31 March 2011. This was mainly on account of weakening of the US dollar in the international market in 2010-11. The monthly average exchange rate of the rupee vis-a-vis the pound sterling, euro, and Japanese yen, however, depreciated in 2010-11.The monthly average exchange rate of the rupee vis-a-vis the pound sterling depreciated by 5.9 per cent from Rs 68.44 per pound sterling in March 2010 to Rs 72.71 in March 2011. Similarly, against the euro and Japanese yen, the monthly average exchange rate of the rupee depreciated by 1.9 per cent from Rs 61.77 per euro in March 2010 to Rs 62.97 per euro in March 2011 and by 8.7 per cent from ` 50.18 per 100 Japanese yen in March 2010 to Rs 54.98 per 100 Japanese yen in March 2011. On an annual average basis, the rupee appreciated against major international currencies except the Japanese yen in fiscal 2010-11. The annual average exchange rate of the rupee was Rs 47.44 per US dollar in 2009-10, appreciating by 4.1 per cent to ` 45.56 per US dollar in 2010-11. Similarly, the annual average exchange rate of the rupee in 2009-10 was Rs 75.76 per pound sterling and Rs 67.03 per euro, which appreciated by 6.9 per cent and 11.3 per cent to Rs 70.87 per pound sterling and Rs 60.21 per euro respectively during 2010-11. The annual average exchange rate of the rupee per Japanese yen however depreciated by 4.1 per cent from Rs 51.11 per 100 Japanese yen in 2009-10 to Rs 53.27 per 100 Japanese yen in 2010-11. CONCLUSION A trade deficit of more than 8 per cent of GDP and CAD of more than 3 per cent is a sign of growing imbalance in the countrys balance of payments. There is scope therefore to discourage unproductive imports like gold and consumer goods to restore balance. In this respect, some weakening of the rupee is a positive development, as it improves trade balance in the long run by increasing export competitiveness and lowering imports. High trade and current account deficits, together with high share of volatile FII flows are making Indias BoP vulnerable to external shocks. Greater attention therefore has to be given to improving the composition of capital flows towards FDI.

REFERENCES: International Financial Management; H.R. Machiraju indiabudget.nic.in

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