Balance of payment

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BALANCE OF PAYMENTS AND NEED FOR INTERNATIONAL TRADE:

BALANCE OF PAYMENTS AND NEED FOR INTERNATIONAL TRADE Tanmayi Krishnaiah Kumar Ravi Tom Thomas Greshma Ann Deelip

OBJECTIVES:

OBJECTIVES International Trade Need for International Trade Trade determinants Balance Of Payments (BOP) Components, Uses, Crisis factors and causes Pre-Crisis The Crisis Post Crisis – Reforms and Impacts

INTERNATIONAL TRADE:

INTERNATIONAL TRADE Buying and selling goods and services from other countries The purchase of goods and services from abroad that leads to an outflow of currency– Imports (M) The sale of goods and services to buyers from other countries leading to an inflow of currency– Exports (X)

NEED FOR INTERNATIONAL TRADE:

NEED FOR INTERNATIONAL TRADE Trade allows each country to specialize in doing what it does best. Availability of an increased variety of goods. Lower costs through economies of scale It allows countries to get new ideas from one another It allows countries to obtain resources that they need It reduces the risk for one economy

TRADE DETERMINANTS:

TRADE DETERMINANTS The equilibrium without trade

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The world price and comparative advantage The gains and losses of an exporting country

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The gains and losses of an importing country

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The effects of a tariff

BOP- Balance Of Payments:

BOP- Balance Of Payments

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An accounting record of all monetary transactions between a country and the rest of the world. Summarises international transactions for a specific period, usually a year Prepared in a single currency, typically the domestic currency Indicator of economic and political stability Visible Items: All types of physical goods exported/imported Invisible Items: All types of services Capital transfers: Capital receipts/payments

COMPONENTS OF BOP:

COMPONENTS OF BOP CURRENT ACCOUNT Import and Export of goods Import and Export of services Financial capital and transfers CAP ITAL ACCOUNT Foreign Investment FDI & portfolio Investment Loans Commercial Borrowings, External Assistance & Banking Capital Transactions

OVERALL BALANCE OF PAYMENTS :

OVERALL BALANCE OF PAYMENTS CURRENT ACCOUNT BALANCE = Balance of Visible Trade(goods) + Balance of Invisible Trade(services) + Balance of Unilateral transfers CAPITAL ACCOUNT BALANCE = Inflow of foreign exchange – outflow of foreign exchange OFFICIAL RESERVES: The holdings of foreign reserves and gold by official institutions like the central bank OVERALL BALANCE OF PAYMENT = Current Account Balance+ Cap ital account balance+ Official Reserve Account

USES OF BOP ANALYSIS:

USES OF BOP ANALYSIS Overview of Macroeconomic and Monetary situations of the economy Study on prospects of direct investment to the nation Implications on the exchange rate of the currency Provides data for economic analysis Reveals changes in the composition & magnitude of foreign trade Provides indications of future repercussions of country’s past trade performances Reveals the weak and strong points of a country’s foreign trade relations

BOP CRISIS- FACTORS AND CAUSES:

BOP CRISIS- FACTORS AND CAUSES Economic factors Huge development expenditure owing to which there are large scale imports Business cycles in terms of recession, depression, recovery and boom High rate of inflation running up to large scale imports of essential goods Decline of import substitutes which would necessitate and increase in imports Change in cost structure of trading partners Political factors Political Instability leading to decline in FDI and FII Populism policies which may encourage imports Social factors Change in tastes and preferences leading to demand changes Cross border prejudices which may lead to expensive sources of imports

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PRE-CRISIS PERIOD

ECONOMIC INDICATORS-PRE CRISIS PERIOD:

ECONOMIC INDICATORS-PRE CRISIS PERIOD GDP growth rate: 5.5 % (3.3% on a per capita basis) Industrial Growth : 6.6% Agriculture: 3.6% Investments went from nearly 19% of GDP from to 1970s to 25% by end on 1980s Composition was predominantly primary sector which accounted for 32.8% of the GDP

Trends in Pre BOP crisis period:

Trends in Pre BOP crisis period Capital inflows mainly consisted of aid flows, commercial deposits and Non resident Indian deposits FDI was heavily restricted and foreign portfolio investments generally channelized to public sector issued bonds Gradual loss of for-ex reserves and deterioration of trade balance due to fixed nominal exchange rate which was declining over the 1980s

Trends… contd:

Trends… contd Sharp rise in imports due to growth orientation and ( petroleum imports rose by 40% from 1986-87 to 1989-90 ) Doubling of external debt from 1984-85 ($35 bn ) to 1990-91 ($69 bn ) Loss of investor confidence led to outflows being increasingly dependent on short term external debts. An unstable government and the gulf crisis further aggravated the situation

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THE CRISIS

BALANCE OF PAYMENTS: THE CRISIS:

BALANCE OF PAYMENTS: THE CRISIS Also known as the “Unfortunate period” of Indian Economy. Gulf crisis of 1990 – increase in oil import bill Deterioration of invisible account Increase in price of oil => overall current account deficit in 1990-91 : US $ 9.7 billion Important trading partners like US, Russia turned up to invest in India Export growth reduced to 4%

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World growth declined from 4.5% in 1988 to 2.5% in 1991 Political turmoil – VP Singh government overthrown, Rajiv Gandhi assassination – reduced credibility of India, investors lost interest and trust in India’s government.

BALANCE OF PAYMENTS: THE UNBALANCE:

BALANCE OF PAYMENTS: THE UNBALANCE Foreign reserves very low at $1.2 billion Overshot IMF SDR reserves Simultaneous outflow of NRI deposits Serious difficulties in rolling over of short term loans Current account deficit of $9.7 billion almost impossible to finance

DEVELOPMENTS IN 1991:

DEVELOPMENTS IN 1991 Current account deficit averaging 2.2% of the GDP hit hard by the Gulf war Triggers oil bill increased by $2 billion overseas markets for exports shrinked (West Asia, Soviet Union) Fall in remittances The Reserve Position in IMF of $660 million was drawn in full by September, 1990 to add to the reserves The international credit rating agencies placed India on the “watch list” in August 1990

What actually happened…..:

What actually happened….. Agreement with IMF for a drawing of $1,025 billion under its Compensatory and Contingency Financing Facility (CCFF) Drawings of $789 million from the first credit tranche made in Jan,1991 Despite the drawings, the situation was hardly under control. Between March 1991 and June 1991, there was a sharp withdrawal of non-resident deposits to the extent of $952 million leading to further drop in foreign exchange reserves

The Crisis:

The Crisis Despite low trade deficit ,the slide in foreign reserves continued unabated Essentially became a “crisis of confidence”

The Crisis (Contd.):

The Crisis (Contd.) Foreign exchange reserves fell below $1 b Barely enough to cover 2 weeks of imports Likely ramifications

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REFORMS & IMPACTS

BALANCING MECHANISM:

BALANCING MECHANISM Rebalancing by changing the exchange rate An upwards shift in the value of domestic currency relative to others will make exports less competitive and make imports cheaper and will tend to correct a current account surplus. Exchange rates can be adjusted by government in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance

BALANCE OF PAYMENTS: POLICIES:

BALANCE OF PAYMENTS: POLICIES Government allowed Reserve Bank of India to ship 47 tonnes of Gold to the Bank of England in July 1991. Short-term debt was reduced and strict controls put in place to prevent future expansion Foreign exchange reserves were consciously accumulated to provide greater insurance against external sector stresses and uncertainties

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Fiscal Correction: Abolishing export subsidies, increasing fertilizer prices, as well as by keeping non- plan expenditure in check. Budget projected a sharp decline in the budget deficit to Rs.7719 crore in 1991-92. Fiscal deficit was also projected to decline from Rs 43,331 crore in 1990-91 to Rs 37, 772 crore in 1991-92.

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Industrial Policy Reforms: 80 % of the industries were taken out from the licensing framework. Areas reserved for public sector was narrowed down and greater participation was permitted from the private sector.

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN The limit of foreign equity holders was raised from 40 to 51 % in the wide range of priority industries. Technology imports for priority industries are automatically approved for royalty payments upto 5 % of domestic sales and 8 % of export sales or for lumpsum payments of Rs 1 Crore .

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Results of Industrial Reforms: The number of investment approvals rise from 3335 in 1990 to 5538 in 1991. 505 foreign technology import agreements were also approved. In 1991, a total of 244 cases of foreign equity participation with the proposed equity investment of $ 504 million was approved.

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Public Sector Reforms: Government undertook a limited disinvestment of a part of public sector equity to the public through financial institutions and mutual funds in order to raise non- inflationary finance for development.

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Trade Policy Reforms: Large part of administered licensing of imports was replaced by import entitlements linked to export earnings. Advance licensing system for exports was simplified so as to improve exporters’ access to imported inputs at duty- free rates.

REFORMS UNDERTAKEN:

REFORMS UNDERTAKEN Anti-export bias in the trade and payments regime was also reduced substantially Effects of these reforms was to reduce the degree of licensing in import trade, to broaden, to enhance and harmonize export initiatives.