Unit 3
India’s Foreign Trade and Balance of Payment
Q1) What is the role of foreign trade in economic development of countries?
A1) Importance/Role of foreign trade in economic development of countries
Following points explain the need and importance of foreign trade to a nation:
1. Division of labour and specialization – Foreign trade results in division of labour and specialization at the world level. Some countries have abundant natural resources thus they should export raw materials and import finished goods from countries which are advanced in skilled manpower. Thus, foreign trade gives benefits to all or any the countries and thereby leading to division of labour and specialization.
2. Optimum allocation and utilization of resources – due to specialization, unproductive lines can be eliminated and wastage of resources are often minimized or avoided. In other words, resources are channelized for the production of only those goods which would give highest returns. Thus, there's rational allocation and utilization of resources at the international level thanks to foreign trade.
3. Equality of prices – Prices is often stabilized by foreign trade. It helps to keep the demand and supply position stable, which successively stabilizes the prices.
4. Availability of multiple choices – Foreign trade helps in providing a better option to the consumers. It helps in making available new varieties to consumers all over the world, thus giving the consumers a wide variety of options to settle on from.
5. Ensures quality and standard goods – Foreign trade is highly competitive so as to take care of and increase the demand for goods, the exporting countries have to continue the quality of goods. Thus, foreign trade ensures that the quality and standardized goods are produced
6. Raises Standard of Living of the people – Imports can facilitate standard of living of the people. This is because people can have a choice of new and better kinds of goods and services. By consuming new and better sorts of goods, people can improve their standard of living.
7. Generate employment opportunities – Foreign trade helps in generating employment opportunities, by increasing the mobility of labour and resources. It generates direct employment in import sector and indirect employment in other sector of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication), etc.
8. Facilitate economic development – Imports facilitate economic development of a nation. This is often because with the import of capital goods and technology, a country can generate growth in all sectors of the economy, i.e., agriculture, industry and service sector.
9. Assistance during natural calamities – During natural calamities such as earthquakes, floods, famines, etc., the affected countries face the problem of shortage of essential goods. Foreign trade enables a rustic to import food grains and medicines from other countries to help the affected people.
10. Maintains balance of payment position – Every country has to maintain its balance of payment position. Since every country has got to import which ends up in outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.
11. Brings reputation and helps earn goodwill – a country which is involved in exports earns goodwill within the international market. For e.g., Japan has earned a lot of goodwill in foreign markets because of its exports of quality electronic goods.
12. Promotes World Peace – Foreign trade brings countries closer. It facilitates transfer of technology and other assistance from developed countries to developing countries. It brings different countries closer because of economic relations arising out of trade agreements. Thus, foreign trade creates a friendly atmosphere for avoiding wars and conflicts. It promotes world peace as such countries try to maintain friendly relations among themselves.
Q2) Explain India’s foreign trade since 2001.
A2) Over the last 25 years since India’s liberalisation, its foreign trade has expanded multi fold and seen significant structural shifts in product as well as geographic composition. The easing of quantitative restrictions as well as significant reduction in tariff levels across product lines has aided the growth of foreign trade in the first two decades post liberalisation. In-fact, the share of foreign trade (both exports and imports) in India’s GDP stood at over 43 percent during 2011-13 as against 13 -15 percent during early nineties. However, over the last few years there has been a marked deceleration in India’s foreign trade, both exports as well as imports, primarily on account of subdued global demand and dip in global commodity prices. This article presents a detailed analysis of India’s foreign trade trends, assessing the performance of key export commodities in current challenging global environment.
During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q3) What do you mean by EXIM policy?
A3) EXIM Policy, a synonym to foreign trade policy, may be a set of guidelines and instructions established by the govt. Within the sphere of foreign trade i.e., import and export of India. Exim policy may be a five-year plan. It's updated every year on 31st march and therefore the modifications, improvements and new scheme become effective from 1st April every year. Exim policy of the Indian government is regulated by foreign trade development and regulation act, 1992.
EXIM POLICY (2015-2020)
The new Exim policy has been formulated focusing increases in export scenario, boosting production and supporting the concepts like MAKE in India and Digital India.
Q4) What are the features of EXIM policy?
A4) Two new schemes namely “MERCHANDISE EXPORTS FROM INDIA SCHEME(MEIS)” and service EXPORTS FROM INDIA SCHEME (SEIS) has been introduced replacing multiple schemes existing earlier.
• MEIS to promote export of notified goods to notified markets and SEIS for advantage of all exporters in India.
• Reduce export obligations by 25% and give boost to domestic manufacturing supporting the “Make in India” concept
• Both MEIS and SEIS firm will get subsidized office spaces in SEZs, along with other benefits
• As a step to digital India concept, online procedure to upload digitally signed document by CA/CS/Cost Accountant Aare developed and further mobile app for filing tax, stamp duty has been developed.
• Benefits of MEIS would be eligible for e commerce of handicraft, handlooms; books etc. exports up to 25000 per consignment will get SEIS benefit.
• Duty credit scraps to be freely transferable and usable for payments of custom duty, excise duty and service tax.
• Recognition of status holder has been changed from rupees to us dollars earing. The position status holder will recognize and reward those entrepreneurs who helped in India to become a major export player.
• Manufactures who also are status holders are going to be enabling to self-certify their manufactured goods as originating from India.
• Repeatedly submission of physical copies of documents available on Exporter Importer Profile isn't required
• Agricultural and village industry products to be supported across the globe at rates of 3 and 5% under MEIS.
• Export obligation period for export items related to defence, military store, aerospace and atomic energy to be 24 months. Certificate of independent Chartered Engineer for redemption of EPGG authorization is not any longer required.
Q5) What is the impact of EXIM policy on the economy?
A5) The EXIM Policy 2015-2020 has expected to double the share of India in world trade from present level of three by the year of 2020.
Simplifying the present, the multiple schemes, the new policy has come up with two schemes MEIS & SEIS that reduce the complexity and encourage the entrepreneur. Similarly, use of technology to perform the compliance reduces the transaction cost and manual errors.
This policy has also focused moving far from reliance on subsidies. By extending benefits under EPCG on domestic procurement and offering them more products under MEIS, the policy further seeks to incentive the exports.
Generation of new employment and providing quality products at reasonable price to consumers are expected to be delivered by the policy.
In short, EXIM policy boosts productivity and earn exportable surplus at competitive rates in export.
The EXIM policy 2015-2020 is very praiseworthy as it purely focuses on developing export potential, improving export performance, encouraging foreign trade and creating favourable balance of balance of payments resolving quality complaints and trade disputes. Good governance and export are facilitated by this policy and hope the expectations the policy has brought, will be met.
Q6) What is Balance of payment?
A6) Balance of Payment (BOP) may be a statement which records all the monetary transactions made between residents of a country and therefore the rest of the world during any given period. This statement includes all the transactions made by/to individuals, corporate and therefore the government and helps in monitoring the flow of funds to develop the economy. When all the weather is correctly included within the BOP, it should sum up to zero during a perfect scenario. This means the inflows and outflows of funds should balance out. However, this doesn't ideally happen in most cases.
BOP statement of a country indicates whether the country has a surplus or a deficit of funds i.e., when a country’s export is more than its import, its BOP is said to be in surplus. On the opposite hand, BOP deficit indicates that a country’s imports are quite its exports. Tracking the transactions under BOP is something similar to the double entry system of accounting. This means, all the transaction will have a debit entry and a corresponding credit entry.
Q7) What are the elements of balance of payment?
A7) There are three components of balance of payment viz current account, capital account, and financial account. The total of the current account must balance with the total of capital and financial accounts in ideal situations.
1. Current Account
The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
2. Capital Account
All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
3. Financial Account
The flow of funds from and to foreign countries through various investments in real estates, business ventures, foreign direct investments etc. is monitored through the financial account. This account measures the changes within the foreign ownership of domestic assets and domestic ownership of foreign assets. On analysing these changes, it can be understood if the country is selling or acquiring more assets (like gold, stocks, equity etc.).
Q8) Why balance of payment is significant for a country?
A8) A country’s BOP is important for the following reasons:
• BOP of a country reveals its financial and economic status.
• BOP statement can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating.
• BOP statement helps the government to make a decision on fiscal and trade policies.
• It provides important information to analyse and understand the economic dealings of a country with other countries.
• By studying its BOP statement and its components closely, one would be able to identify trends that may be beneficial or harmful to the economy of the county and thus, then take appropriate measures.
Q9) Explain India’s Balance of payments since 2001.
A9) India’s balance of payments (BOP) in 2000-01 remained comfortable and the external sector experienced a distinct improvement. There were, however, some pressures on the BOP during the first half of the year on account of the significant hardening of international oil prices, the sharp downturn in international equity prices and successive increases in interest rates in the United States and Europe; but the situation eased with the mobilization of funds under the India Millennium Deposits, which helped to revert the declining trend in reserves and enhanced confidence in the strength of India’s external sector. As a result, the BOP situation experienced a turnaround in the second half of the year, 2000-01. Overall, the current account deficit in 2000-01 narrowed further to about 0.5 per cent of GDP from 1.1 per cent of GDP in the previous year. This improvement in current account deficit was made possible largely because of the dynamism in export performance, a sustained buoyancy in invisible receipts, reflecting sharp increases in software service exports and private transfers, and partly due to the subdued non-oil import demand.
Exports, on BOP basis, registered strong growth of 19.6 per cent in US dollar terms in 2000-01, on the heels of a strong recovery of 9.5 per cent in the previous year. Total imports, on payment basis, recorded only a moderate growth of 7.0 per cent during2000-01, much lower than the sharp increase of 16.5 per cent in 1999-2000. The moderate growth in total imports in 2000-01 was, in fact, largely because of a 24.1 per cent increase in the oil import bill, while non-oil import growth, on BOP basis, remaining subdued at only 2.0 per cent. Non-oil, non-gold imports, on customs basis, grew at a very high rate of about 20 per cent per annum, on an average, during 1992-93 to 1995- 96. The growth rate decelerated sharply to just about 3.5 per cent per annum during the next four years ended 1999-00. As expected, the growth of non-oil, non-gold imports tended to be moderate when the initial impact of trade liberalisation got absorbed, and the exchange rate providing reasonable incentives for cost-effective import substitution. This allays the fears that trade liberalisation would swamp the domestic market with cheaper imports. In 2000-01, nonoil, non-gold imports recorded a negative growth of 6.7 per cent, mainly because of the continuous industrial slowdown in recent years and the resulting lack of demand for imports. Reflecting the trends in exports and imports, the deficit on the trade account of BOP narrowed to US $14.37 billion or 3.1 per cent of GDP in 2000-01 from US $17.84 billion (4.0 per cent of GDP) in 1999-2000 (Table 6.2). The net inflow of invisibles, at US $11.79 billion, covered about 82 per cent of the deficit on the trade account in 2000-01, leaving a financing gap of only US $2.68 billion on the current account. This deficit on the current account represented 0.5 per cent of GDP, compared with the deficit of 1.1 per cent of GDP (US $4.70 billion) in 1999-2000. 6.8 The recovery in capital flows witnessed in 1999-2000, after some set back in 1998-99, which had been a consequence of the East-Asian crisis and partly due to the economic sanctions on India, was broadly maintained. Net inflows of capital (excluding IMF) on the capital account of BOP in 2000-01 were about US $9.02 billion, which were lower than such inflows of US $10.44 billion in the previous year. This reduction is mainly accounted for some bunching of repayments of commercial borrowings and significant net outflows under banking capital. On the other hand, capital inflows in 2000-01 were bolstered by the mobilisation of funds of US $5.51 billion under India Millennium Deposits (IMD) in October/November 2000. Fresh inflows of funds for portfolio investments in India by FIIs in 2000-01 amounted to about US $1.85 billion, which was only slightly lower than the US $2.14 billion in 1999-2000. Net accretions to non-resident deposits during 2000-01 rose by over 50 per cent to US $2.32 billion. Gross disbursement of external assistance at US $2.94 billion was comparable with the normal trends in recent years. Gross borrowing on commercial terms, excluding IMD, at US $3.81 billion in 2000-01 was higher than such normal borrowings of US $3.19 billion in the previous year. 6.9 The sharp reduction in current account deficit and the funds raised under IMD making up for the dip in overall net capital inflows through normal sources during 2000-01, as indicated above, resulted in a large accumulation of official foreign exchange reserves for the fifth year in succession. On BOP basis, reserves rose by a substantial US $5.83 billion. This was on top of an increase of US $6.14 billion in 1999- 2000 and an increase of US $4.51 billion per year, on an average, during the previous three years, 1996-97 to 1998-99. Official BOP statistics, as compiled by the RBI, for the year 2001-02 are available so far only for the first half of the year. However, a tentative assessment of BOP outlook for the current year indicates that the current account deficit in 2001-02 might widen somewhat, but it is expected to remain within 1 per cent of GDP. The widening of current account deficit will be mainly due to the poor export performance. Export performance faltered in the current year, as is evident from the growth rate of about 0.6 per cent, in US dollar terms, recorded by the DGCI&S data for the first nine months of 2001- 02. On the other hand, the resulting pressure on trade account will be eased to a large extent on account of moderation in oil import bill, following softening of international oil prices after September 2001. The net inflow of invisibles, despite larger outflows on account of interest and dividend payments, is expected to remain broadly at last year’s level, supported by a continued buoyancy in software service exports and private transfers. The widening of the current account deficit will, however, be more than matched by the expected net capital inflows from normal sources, resulting in large accretions to reserves. During the first ten months of current financial year (2001-02), the foreign currency assets of the RBI have increased by about US $7.01 billion from US $39.55 billion at end-March 2001 to US $46.56 billion at end-January, 2002.
Q10) What are the causes of unfavorable balance of payment?
A10) Import of Machinery- Since independence, import of machinery has been trending up, because-a) during World War ii, industrial machines were exclusively used, causing their large-scale depreciation and therefore needing replacement and, b) planned programs of industrialization fostered capital intensive technology that depended on imports. Accordingly, balance of payments turned unfavorable.
2. Import of War equipment- large amount of war equipment was imported owing to vulnerable borders, adding to import bills.
3. Setting up Embassies in rest of the world- Independent India had to establish its political relations with other countries. To that end, it had to set up its embassies in foreign countries. It was an expensive affair. It also turned balance of payments unfavorable.
4. Export of traditional items took a hit- Owing to International competition, our traditional exports (jute and tea, in particular) suffered a setback.
5. Increase in the price of petroleum products- Value of imports has gone up on account of constant hike in the price of petrol and petroleum products. In 1973, price of petrol was 2 dollar per barrel. It has now gone up to 36 dollars. In 1970-71, petrol worth Rs, 136 crore was imported. In 1980-81, value of imported petrol rose to Rs. 5,264 crore and in 2011-12, the import bill of petrol further rose to Rs. 7, 43,075 crores.
6. Payments of interest on foreign debt- Foreign loans contracted by the Government amounted to approximately Rs. 17,65,333 crores till 2011-12. Interest on these loans in 2011-12 was approximately Rs. 1, 04,155 crore. It caused a major disequilibrium in the balance of payment.
7. Widening gap between Imports and Exports- Over time, Imports have risen faster than Exports. Consequently, gap between imports and exports has tended to widen, contributing to negative balance of payments.
8. Gulf War- In 1991, Gulf War (war between Iraq and several western countries) also had its adverse effect on its balance of payments. On the one hand, price of crude oil shot up and on the other, remittances by Indians in the Gulf countries (Kuwait, Iraq, etc.) drastically declined.
Besides, several miscellaneous factors also accounted for adverse balance of payments. These include poor quality of our export goods, malpractices of Indian exporters, low competitiveness of Indian goods owing to high cost of production, etc.
Q11) What is Convertibility of Indian rupee?
A11) For the first time, the Union allows 1992-93 has made the Indian rupee partially convertible. This was an inevitable move for the expeditious integration of Indian economy with that of the planet so as to face the serious current account deficit within the balance of payments, the govt. Of India introduced the partial convertibility of rupee from March 1. 1992.
Under this system, which remained in operation for a period of 1 year, 60 per cent of the exchange earnings were convertible in rupees at market determined exchange rate and therefore the remaining 40 per cent earnings were convertible in rupees at the officially determined rate of exchange.
The entire foreign exchange requirement for meeting import obligations was required to be purchased at market determined rate of exchange, excepting a few specified imports and imports on the government account.
The term convertibility of a currency indicates that it is often freely converted into the other currency. Convertibility also can be identified as the removal of quantitative restrictions on trade and payments on current account. Convertibility establishes a system where the market place determines the rate of exchange through the free interplay of demand and supply forces.
In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q12) Explain Current account convertibility of Indian rupee.
A12) Current account convertibility is that the next phase for attaining full convertibility of rupee. Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes, while capital account convertibility refers to an identical liberalization of a country’s capital transactions like loans and investment, both short term and future.
The International monetary fund (IMF) which works towards the establishment of multilateral system of payments, requires member countries to move towards restoration of current account convertibility, but permits them to restrict convertibility for capital transactions.
Current account convertibility has been defined as the freedom to buy or sell foreign exchange for the subsequent international transactions:
(a) All payments due in connection with foreign trade, other current business, including services and normal short-term banking and credit facilities;
(b) Payments due as interest on loans and as net income from other investments;
(c) Payments of moderate amount of amortization of loans or for depreciation of direct investment; and
(d) Moderate remittances for family living expenses.
Q13) Explain Capital Account Convertibility of Indian rupee.
A13) The next and final step in this line is that the convertibility of rupee on capital account. But we must draw a pointy distinction between currency convertibility within the current and capital accounts. Capital account convertibility refers to a liberalization of a country’s capital transactions like loans and investment, both short term and future also as speculative capital flows.
When it involves capital account convertibility, one has got to be more prudent and be very much sure about its capacity to launch such a system. If the country can build a large stock of international reserves, then only this system could provide a bonus. Confidence within the financial system and a steady macro-economic environment are very much essential to the introduction of capital account convertibility of rupee in near future.
Capital account convertibility in India is often introduced in stages by gradually widening access to resident Indians to external financial markets. Within the light of historical experience, the overall view is that opening from the capital account should occur late within the sequencing of stabilization and structural reforms.
Capital account convertibility is likely to be sustainable as long as it's supported by credible macro- economic policies, listing reduction in fiscal deficit, moderation in inflation and a flexible financial system which may adapt to changing situations as some of the essential pre-conditions for capital account convertibility. Thus, capital account convertibility implies the right to transact in financial assets with foreign countries without restrictions. Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
But within the context of the necessity for attracting higher capital inflows into the country, it's also important for the government to introduce convertibility on capital account, as foreign investors may enter confidently only there's an assurance that the exit doors will always remain open.
The Budget 2002-03 has adopted a cautious step towards Capital Account Convertibility by allowing NRI to repatriate their Indian income. Considering this condition alongside the comfortable foreign exchange reserve of the country at present, the government is now favouring a make towards fuller capital account convertibility within the context of changes within the last 20 years. For the mean solar time on 18th March, 2006 Prime Minister Dr. Manmohan Singh asked the Finance Ministry and RBI to figure out a roadmap for fuller capital account convertibility supported current realities. Dr.Singh is of the view that such roadmap for fuller capital account convertibility would attract greater foreign investments into the country.
Thus, it's expected that the govt. Of India and therefore the RBI are going to announce a roadmap soon for the attainment of fuller capital account convertibility of the country. However, while taking decision for full convertibility of rupee, the government should take adequate care of its possible consequences.
In the meantime, on 29th March, 2006, 160 renowned Indian economists asked the govt. To desist from moving towards full convertibility of rupee because it was brought with dangerous consequences. They argued, “We urge the UPA government from such an unnecessary and dangerous measure. This (full float of rupee) would expose Indian economy to extreme volatility”.
The statement made by about 160 leading economists from various institutions across the country and signed by Prof. Prabhat Patnaik of JNU, Delhi also expressed apprehension that to expose the country to unpredictable movements in capital flows would create a potential for fragility and crisis and particularly when the stock market is witnessing a speculative boom.
Q14) What is Tara-pore Committee’s Second Report on Capital Account Convertibility?
A14) With the growing strength of balance of payments within the post-1991 period and with external sector remaining robust and gaining strength every year and therefore the relative macro-economic stability with high growth providing a conducive environment relaxation of capital controls, RBI, in pursuance of the announcement the Prime Minister constituted a committee on March 20, 2006 with Mr. S.S. Tara pore as its chairman for setting out a roadways towards fuller capital account convertibility. The committee submitted its report to the RBI on July 31, 2006.
Keeping itself conscious of the risks involved within the movement towards fuller convertibility of the Rupee as emanating from race experiences during this regard the committee calibrated the liberalization road map to the specific contexts of preparedness—namely, a strong macroeconomic framework, sound financial systems and markets and prudential regulatory and supervisory architectures.
After making review of the existing capital controls, it detailed a broad five-year time-frame for movement towards fuller convertibility in three phases: Phase-I (2006-07); phase ii (2007-08 to, 2008-09) and phase iii (2009-10 to 2010-11).
The report recommended the meeting of certain indicators/targets as a concomitant to the movement in: meeting FRBM targets; shifting from this measures of fiscal deficit to a measure of the public Sector Borrowing Requirement (PSBR); segregating government debt management and monetary policy operations through the fixing of the office of public debt independent of the RBI; imparting greater autonomy and transparency within the conduct of monetary policy; and slew of reforms in banking sector including one banking legislation and reduction within the share of Government/RBI within the capital of public sector bank.
Keeping the current account deficit to GDP ratio under 3 per cent; and evolving appropriate indicators of adequacy of reserves to hide not only import requirements, but also liquidity risks associated with present kinds of capital flows, short-term debt obligations and broader measures including solvency.
Thus, the committee recommended a three-phase strategy for moving towards capital account convertibility. Although, RBI has not been taken any final decision on acceptance of the recommendations in totality but it's initiated measures on an on-going basis beginning with the announcement in Us Mid-term Review of the Annual Policy Statement for 2007-08.
Q15) In which type of constituent elements, capital account convertibility?
A15) Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
Q16) What was India’s exports during the last 25 years?
A16) During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q17) What are the three major elements of capital account?
A17) There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
Q18) What is Hawala trade?
A18) In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q19) What is Current Account?
A19) The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
Q20) What is Capital Account?
A20) All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
Unit 3
India’s Foreign Trade and Balance of Payment
Q1) What is the role of foreign trade in economic development of countries?
A1) Importance/Role of foreign trade in economic development of countries
Following points explain the need and importance of foreign trade to a nation:
1. Division of labour and specialization – Foreign trade results in division of labour and specialization at the world level. Some countries have abundant natural resources thus they should export raw materials and import finished goods from countries which are advanced in skilled manpower. Thus, foreign trade gives benefits to all or any the countries and thereby leading to division of labour and specialization.
2. Optimum allocation and utilization of resources – due to specialization, unproductive lines can be eliminated and wastage of resources are often minimized or avoided. In other words, resources are channelized for the production of only those goods which would give highest returns. Thus, there's rational allocation and utilization of resources at the international level thanks to foreign trade.
3. Equality of prices – Prices is often stabilized by foreign trade. It helps to keep the demand and supply position stable, which successively stabilizes the prices.
4. Availability of multiple choices – Foreign trade helps in providing a better option to the consumers. It helps in making available new varieties to consumers all over the world, thus giving the consumers a wide variety of options to settle on from.
5. Ensures quality and standard goods – Foreign trade is highly competitive so as to take care of and increase the demand for goods, the exporting countries have to continue the quality of goods. Thus, foreign trade ensures that the quality and standardized goods are produced
6. Raises Standard of Living of the people – Imports can facilitate standard of living of the people. This is because people can have a choice of new and better kinds of goods and services. By consuming new and better sorts of goods, people can improve their standard of living.
7. Generate employment opportunities – Foreign trade helps in generating employment opportunities, by increasing the mobility of labour and resources. It generates direct employment in import sector and indirect employment in other sector of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication), etc.
8. Facilitate economic development – Imports facilitate economic development of a nation. This is often because with the import of capital goods and technology, a country can generate growth in all sectors of the economy, i.e., agriculture, industry and service sector.
9. Assistance during natural calamities – During natural calamities such as earthquakes, floods, famines, etc., the affected countries face the problem of shortage of essential goods. Foreign trade enables a rustic to import food grains and medicines from other countries to help the affected people.
10. Maintains balance of payment position – Every country has to maintain its balance of payment position. Since every country has got to import which ends up in outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.
11. Brings reputation and helps earn goodwill – a country which is involved in exports earns goodwill within the international market. For e.g., Japan has earned a lot of goodwill in foreign markets because of its exports of quality electronic goods.
12. Promotes World Peace – Foreign trade brings countries closer. It facilitates transfer of technology and other assistance from developed countries to developing countries. It brings different countries closer because of economic relations arising out of trade agreements. Thus, foreign trade creates a friendly atmosphere for avoiding wars and conflicts. It promotes world peace as such countries try to maintain friendly relations among themselves.
Q2) Explain India’s foreign trade since 2001.
A2) Over the last 25 years since India’s liberalisation, its foreign trade has expanded multi fold and seen significant structural shifts in product as well as geographic composition. The easing of quantitative restrictions as well as significant reduction in tariff levels across product lines has aided the growth of foreign trade in the first two decades post liberalisation. In-fact, the share of foreign trade (both exports and imports) in India’s GDP stood at over 43 percent during 2011-13 as against 13 -15 percent during early nineties. However, over the last few years there has been a marked deceleration in India’s foreign trade, both exports as well as imports, primarily on account of subdued global demand and dip in global commodity prices. This article presents a detailed analysis of India’s foreign trade trends, assessing the performance of key export commodities in current challenging global environment.
During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q3) What do you mean by EXIM policy?
A3) EXIM Policy, a synonym to foreign trade policy, may be a set of guidelines and instructions established by the govt. Within the sphere of foreign trade i.e., import and export of India. Exim policy may be a five-year plan. It's updated every year on 31st march and therefore the modifications, improvements and new scheme become effective from 1st April every year. Exim policy of the Indian government is regulated by foreign trade development and regulation act, 1992.
EXIM POLICY (2015-2020)
The new Exim policy has been formulated focusing increases in export scenario, boosting production and supporting the concepts like MAKE in India and Digital India.
Q4) What are the features of EXIM policy?
A4) Two new schemes namely “MERCHANDISE EXPORTS FROM INDIA SCHEME(MEIS)” and service EXPORTS FROM INDIA SCHEME (SEIS) has been introduced replacing multiple schemes existing earlier.
• MEIS to promote export of notified goods to notified markets and SEIS for advantage of all exporters in India.
• Reduce export obligations by 25% and give boost to domestic manufacturing supporting the “Make in India” concept
• Both MEIS and SEIS firm will get subsidized office spaces in SEZs, along with other benefits
• As a step to digital India concept, online procedure to upload digitally signed document by CA/CS/Cost Accountant Aare developed and further mobile app for filing tax, stamp duty has been developed.
• Benefits of MEIS would be eligible for e commerce of handicraft, handlooms; books etc. exports up to 25000 per consignment will get SEIS benefit.
• Duty credit scraps to be freely transferable and usable for payments of custom duty, excise duty and service tax.
• Recognition of status holder has been changed from rupees to us dollars earing. The position status holder will recognize and reward those entrepreneurs who helped in India to become a major export player.
• Manufactures who also are status holders are going to be enabling to self-certify their manufactured goods as originating from India.
• Repeatedly submission of physical copies of documents available on Exporter Importer Profile isn't required
• Agricultural and village industry products to be supported across the globe at rates of 3 and 5% under MEIS.
• Export obligation period for export items related to defence, military store, aerospace and atomic energy to be 24 months. Certificate of independent Chartered Engineer for redemption of EPGG authorization is not any longer required.
Q5) What is the impact of EXIM policy on the economy?
A5) The EXIM Policy 2015-2020 has expected to double the share of India in world trade from present level of three by the year of 2020.
Simplifying the present, the multiple schemes, the new policy has come up with two schemes MEIS & SEIS that reduce the complexity and encourage the entrepreneur. Similarly, use of technology to perform the compliance reduces the transaction cost and manual errors.
This policy has also focused moving far from reliance on subsidies. By extending benefits under EPCG on domestic procurement and offering them more products under MEIS, the policy further seeks to incentive the exports.
Generation of new employment and providing quality products at reasonable price to consumers are expected to be delivered by the policy.
In short, EXIM policy boosts productivity and earn exportable surplus at competitive rates in export.
The EXIM policy 2015-2020 is very praiseworthy as it purely focuses on developing export potential, improving export performance, encouraging foreign trade and creating favourable balance of balance of payments resolving quality complaints and trade disputes. Good governance and export are facilitated by this policy and hope the expectations the policy has brought, will be met.
Q6) What is Balance of payment?
A6) Balance of Payment (BOP) may be a statement which records all the monetary transactions made between residents of a country and therefore the rest of the world during any given period. This statement includes all the transactions made by/to individuals, corporate and therefore the government and helps in monitoring the flow of funds to develop the economy. When all the weather is correctly included within the BOP, it should sum up to zero during a perfect scenario. This means the inflows and outflows of funds should balance out. However, this doesn't ideally happen in most cases.
BOP statement of a country indicates whether the country has a surplus or a deficit of funds i.e., when a country’s export is more than its import, its BOP is said to be in surplus. On the opposite hand, BOP deficit indicates that a country’s imports are quite its exports. Tracking the transactions under BOP is something similar to the double entry system of accounting. This means, all the transaction will have a debit entry and a corresponding credit entry.
Q7) What are the elements of balance of payment?
A7) There are three components of balance of payment viz current account, capital account, and financial account. The total of the current account must balance with the total of capital and financial accounts in ideal situations.
1. Current Account
The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
2. Capital Account
All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
3. Financial Account
The flow of funds from and to foreign countries through various investments in real estates, business ventures, foreign direct investments etc. is monitored through the financial account. This account measures the changes within the foreign ownership of domestic assets and domestic ownership of foreign assets. On analysing these changes, it can be understood if the country is selling or acquiring more assets (like gold, stocks, equity etc.).
Q8) Why balance of payment is significant for a country?
A8) A country’s BOP is important for the following reasons:
• BOP of a country reveals its financial and economic status.
• BOP statement can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating.
• BOP statement helps the government to make a decision on fiscal and trade policies.
• It provides important information to analyse and understand the economic dealings of a country with other countries.
• By studying its BOP statement and its components closely, one would be able to identify trends that may be beneficial or harmful to the economy of the county and thus, then take appropriate measures.
Q9) Explain India’s Balance of payments since 2001.
A9) India’s balance of payments (BOP) in 2000-01 remained comfortable and the external sector experienced a distinct improvement. There were, however, some pressures on the BOP during the first half of the year on account of the significant hardening of international oil prices, the sharp downturn in international equity prices and successive increases in interest rates in the United States and Europe; but the situation eased with the mobilization of funds under the India Millennium Deposits, which helped to revert the declining trend in reserves and enhanced confidence in the strength of India’s external sector. As a result, the BOP situation experienced a turnaround in the second half of the year, 2000-01. Overall, the current account deficit in 2000-01 narrowed further to about 0.5 per cent of GDP from 1.1 per cent of GDP in the previous year. This improvement in current account deficit was made possible largely because of the dynamism in export performance, a sustained buoyancy in invisible receipts, reflecting sharp increases in software service exports and private transfers, and partly due to the subdued non-oil import demand.
Exports, on BOP basis, registered strong growth of 19.6 per cent in US dollar terms in 2000-01, on the heels of a strong recovery of 9.5 per cent in the previous year. Total imports, on payment basis, recorded only a moderate growth of 7.0 per cent during2000-01, much lower than the sharp increase of 16.5 per cent in 1999-2000. The moderate growth in total imports in 2000-01 was, in fact, largely because of a 24.1 per cent increase in the oil import bill, while non-oil import growth, on BOP basis, remaining subdued at only 2.0 per cent. Non-oil, non-gold imports, on customs basis, grew at a very high rate of about 20 per cent per annum, on an average, during 1992-93 to 1995- 96. The growth rate decelerated sharply to just about 3.5 per cent per annum during the next four years ended 1999-00. As expected, the growth of non-oil, non-gold imports tended to be moderate when the initial impact of trade liberalisation got absorbed, and the exchange rate providing reasonable incentives for cost-effective import substitution. This allays the fears that trade liberalisation would swamp the domestic market with cheaper imports. In 2000-01, nonoil, non-gold imports recorded a negative growth of 6.7 per cent, mainly because of the continuous industrial slowdown in recent years and the resulting lack of demand for imports. Reflecting the trends in exports and imports, the deficit on the trade account of BOP narrowed to US $14.37 billion or 3.1 per cent of GDP in 2000-01 from US $17.84 billion (4.0 per cent of GDP) in 1999-2000 (Table 6.2). The net inflow of invisibles, at US $11.79 billion, covered about 82 per cent of the deficit on the trade account in 2000-01, leaving a financing gap of only US $2.68 billion on the current account. This deficit on the current account represented 0.5 per cent of GDP, compared with the deficit of 1.1 per cent of GDP (US $4.70 billion) in 1999-2000. 6.8 The recovery in capital flows witnessed in 1999-2000, after some set back in 1998-99, which had been a consequence of the East-Asian crisis and partly due to the economic sanctions on India, was broadly maintained. Net inflows of capital (excluding IMF) on the capital account of BOP in 2000-01 were about US $9.02 billion, which were lower than such inflows of US $10.44 billion in the previous year. This reduction is mainly accounted for some bunching of repayments of commercial borrowings and significant net outflows under banking capital. On the other hand, capital inflows in 2000-01 were bolstered by the mobilisation of funds of US $5.51 billion under India Millennium Deposits (IMD) in October/November 2000. Fresh inflows of funds for portfolio investments in India by FIIs in 2000-01 amounted to about US $1.85 billion, which was only slightly lower than the US $2.14 billion in 1999-2000. Net accretions to non-resident deposits during 2000-01 rose by over 50 per cent to US $2.32 billion. Gross disbursement of external assistance at US $2.94 billion was comparable with the normal trends in recent years. Gross borrowing on commercial terms, excluding IMD, at US $3.81 billion in 2000-01 was higher than such normal borrowings of US $3.19 billion in the previous year. 6.9 The sharp reduction in current account deficit and the funds raised under IMD making up for the dip in overall net capital inflows through normal sources during 2000-01, as indicated above, resulted in a large accumulation of official foreign exchange reserves for the fifth year in succession. On BOP basis, reserves rose by a substantial US $5.83 billion. This was on top of an increase of US $6.14 billion in 1999- 2000 and an increase of US $4.51 billion per year, on an average, during the previous three years, 1996-97 to 1998-99. Official BOP statistics, as compiled by the RBI, for the year 2001-02 are available so far only for the first half of the year. However, a tentative assessment of BOP outlook for the current year indicates that the current account deficit in 2001-02 might widen somewhat, but it is expected to remain within 1 per cent of GDP. The widening of current account deficit will be mainly due to the poor export performance. Export performance faltered in the current year, as is evident from the growth rate of about 0.6 per cent, in US dollar terms, recorded by the DGCI&S data for the first nine months of 2001- 02. On the other hand, the resulting pressure on trade account will be eased to a large extent on account of moderation in oil import bill, following softening of international oil prices after September 2001. The net inflow of invisibles, despite larger outflows on account of interest and dividend payments, is expected to remain broadly at last year’s level, supported by a continued buoyancy in software service exports and private transfers. The widening of the current account deficit will, however, be more than matched by the expected net capital inflows from normal sources, resulting in large accretions to reserves. During the first ten months of current financial year (2001-02), the foreign currency assets of the RBI have increased by about US $7.01 billion from US $39.55 billion at end-March 2001 to US $46.56 billion at end-January, 2002.
Q10) What are the causes of unfavorable balance of payment?
A10) Import of Machinery- Since independence, import of machinery has been trending up, because-a) during World War ii, industrial machines were exclusively used, causing their large-scale depreciation and therefore needing replacement and, b) planned programs of industrialization fostered capital intensive technology that depended on imports. Accordingly, balance of payments turned unfavorable.
2. Import of War equipment- large amount of war equipment was imported owing to vulnerable borders, adding to import bills.
3. Setting up Embassies in rest of the world- Independent India had to establish its political relations with other countries. To that end, it had to set up its embassies in foreign countries. It was an expensive affair. It also turned balance of payments unfavorable.
4. Export of traditional items took a hit- Owing to International competition, our traditional exports (jute and tea, in particular) suffered a setback.
5. Increase in the price of petroleum products- Value of imports has gone up on account of constant hike in the price of petrol and petroleum products. In 1973, price of petrol was 2 dollar per barrel. It has now gone up to 36 dollars. In 1970-71, petrol worth Rs, 136 crore was imported. In 1980-81, value of imported petrol rose to Rs. 5,264 crore and in 2011-12, the import bill of petrol further rose to Rs. 7, 43,075 crores.
6. Payments of interest on foreign debt- Foreign loans contracted by the Government amounted to approximately Rs. 17,65,333 crores till 2011-12. Interest on these loans in 2011-12 was approximately Rs. 1, 04,155 crore. It caused a major disequilibrium in the balance of payment.
7. Widening gap between Imports and Exports- Over time, Imports have risen faster than Exports. Consequently, gap between imports and exports has tended to widen, contributing to negative balance of payments.
8. Gulf War- In 1991, Gulf War (war between Iraq and several western countries) also had its adverse effect on its balance of payments. On the one hand, price of crude oil shot up and on the other, remittances by Indians in the Gulf countries (Kuwait, Iraq, etc.) drastically declined.
Besides, several miscellaneous factors also accounted for adverse balance of payments. These include poor quality of our export goods, malpractices of Indian exporters, low competitiveness of Indian goods owing to high cost of production, etc.
Q11) What is Convertibility of Indian rupee?
A11) For the first time, the Union allows 1992-93 has made the Indian rupee partially convertible. This was an inevitable move for the expeditious integration of Indian economy with that of the planet so as to face the serious current account deficit within the balance of payments, the govt. Of India introduced the partial convertibility of rupee from March 1. 1992.
Under this system, which remained in operation for a period of 1 year, 60 per cent of the exchange earnings were convertible in rupees at market determined exchange rate and therefore the remaining 40 per cent earnings were convertible in rupees at the officially determined rate of exchange.
The entire foreign exchange requirement for meeting import obligations was required to be purchased at market determined rate of exchange, excepting a few specified imports and imports on the government account.
The term convertibility of a currency indicates that it is often freely converted into the other currency. Convertibility also can be identified as the removal of quantitative restrictions on trade and payments on current account. Convertibility establishes a system where the market place determines the rate of exchange through the free interplay of demand and supply forces.
In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q12) Explain Current account convertibility of Indian rupee.
A12) Current account convertibility is that the next phase for attaining full convertibility of rupee. Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes, while capital account convertibility refers to an identical liberalization of a country’s capital transactions like loans and investment, both short term and future.
The International monetary fund (IMF) which works towards the establishment of multilateral system of payments, requires member countries to move towards restoration of current account convertibility, but permits them to restrict convertibility for capital transactions.
Current account convertibility has been defined as the freedom to buy or sell foreign exchange for the subsequent international transactions:
(a) All payments due in connection with foreign trade, other current business, including services and normal short-term banking and credit facilities;
(b) Payments due as interest on loans and as net income from other investments;
(c) Payments of moderate amount of amortization of loans or for depreciation of direct investment; and
(d) Moderate remittances for family living expenses.
Q13) Explain Capital Account Convertibility of Indian rupee.
A13) The next and final step in this line is that the convertibility of rupee on capital account. But we must draw a pointy distinction between currency convertibility within the current and capital accounts. Capital account convertibility refers to a liberalization of a country’s capital transactions like loans and investment, both short term and future also as speculative capital flows.
When it involves capital account convertibility, one has got to be more prudent and be very much sure about its capacity to launch such a system. If the country can build a large stock of international reserves, then only this system could provide a bonus. Confidence within the financial system and a steady macro-economic environment are very much essential to the introduction of capital account convertibility of rupee in near future.
Capital account convertibility in India is often introduced in stages by gradually widening access to resident Indians to external financial markets. Within the light of historical experience, the overall view is that opening from the capital account should occur late within the sequencing of stabilization and structural reforms.
Capital account convertibility is likely to be sustainable as long as it's supported by credible macro- economic policies, listing reduction in fiscal deficit, moderation in inflation and a flexible financial system which may adapt to changing situations as some of the essential pre-conditions for capital account convertibility. Thus, capital account convertibility implies the right to transact in financial assets with foreign countries without restrictions. Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
But within the context of the necessity for attracting higher capital inflows into the country, it's also important for the government to introduce convertibility on capital account, as foreign investors may enter confidently only there's an assurance that the exit doors will always remain open.
The Budget 2002-03 has adopted a cautious step towards Capital Account Convertibility by allowing NRI to repatriate their Indian income. Considering this condition alongside the comfortable foreign exchange reserve of the country at present, the government is now favouring a make towards fuller capital account convertibility within the context of changes within the last 20 years. For the mean solar time on 18th March, 2006 Prime Minister Dr. Manmohan Singh asked the Finance Ministry and RBI to figure out a roadmap for fuller capital account convertibility supported current realities. Dr.Singh is of the view that such roadmap for fuller capital account convertibility would attract greater foreign investments into the country.
Thus, it's expected that the govt. Of India and therefore the RBI are going to announce a roadmap soon for the attainment of fuller capital account convertibility of the country. However, while taking decision for full convertibility of rupee, the government should take adequate care of its possible consequences.
In the meantime, on 29th March, 2006, 160 renowned Indian economists asked the govt. To desist from moving towards full convertibility of rupee because it was brought with dangerous consequences. They argued, “We urge the UPA government from such an unnecessary and dangerous measure. This (full float of rupee) would expose Indian economy to extreme volatility”.
The statement made by about 160 leading economists from various institutions across the country and signed by Prof. Prabhat Patnaik of JNU, Delhi also expressed apprehension that to expose the country to unpredictable movements in capital flows would create a potential for fragility and crisis and particularly when the stock market is witnessing a speculative boom.
Q14) What is Tara-pore Committee’s Second Report on Capital Account Convertibility?
A14) With the growing strength of balance of payments within the post-1991 period and with external sector remaining robust and gaining strength every year and therefore the relative macro-economic stability with high growth providing a conducive environment relaxation of capital controls, RBI, in pursuance of the announcement the Prime Minister constituted a committee on March 20, 2006 with Mr. S.S. Tara pore as its chairman for setting out a roadways towards fuller capital account convertibility. The committee submitted its report to the RBI on July 31, 2006.
Keeping itself conscious of the risks involved within the movement towards fuller convertibility of the Rupee as emanating from race experiences during this regard the committee calibrated the liberalization road map to the specific contexts of preparedness—namely, a strong macroeconomic framework, sound financial systems and markets and prudential regulatory and supervisory architectures.
After making review of the existing capital controls, it detailed a broad five-year time-frame for movement towards fuller convertibility in three phases: Phase-I (2006-07); phase ii (2007-08 to, 2008-09) and phase iii (2009-10 to 2010-11).
The report recommended the meeting of certain indicators/targets as a concomitant to the movement in: meeting FRBM targets; shifting from this measures of fiscal deficit to a measure of the public Sector Borrowing Requirement (PSBR); segregating government debt management and monetary policy operations through the fixing of the office of public debt independent of the RBI; imparting greater autonomy and transparency within the conduct of monetary policy; and slew of reforms in banking sector including one banking legislation and reduction within the share of Government/RBI within the capital of public sector bank.
Keeping the current account deficit to GDP ratio under 3 per cent; and evolving appropriate indicators of adequacy of reserves to hide not only import requirements, but also liquidity risks associated with present kinds of capital flows, short-term debt obligations and broader measures including solvency.
Thus, the committee recommended a three-phase strategy for moving towards capital account convertibility. Although, RBI has not been taken any final decision on acceptance of the recommendations in totality but it's initiated measures on an on-going basis beginning with the announcement in Us Mid-term Review of the Annual Policy Statement for 2007-08.
Q15) In which type of constituent elements, capital account convertibility?
A15) Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
Q16) What was India’s exports during the last 25 years?
A16) During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q17) What are the three major elements of capital account?
A17) There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
Q18) What is Hawala trade?
A18) In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q19) What is Current Account?
A19) The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
Q20) What is Capital Account?
A20) All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
Unit 3
India’s Foreign Trade and Balance of Payment
Q1) What is the role of foreign trade in economic development of countries?
A1) Importance/Role of foreign trade in economic development of countries
Following points explain the need and importance of foreign trade to a nation:
1. Division of labour and specialization – Foreign trade results in division of labour and specialization at the world level. Some countries have abundant natural resources thus they should export raw materials and import finished goods from countries which are advanced in skilled manpower. Thus, foreign trade gives benefits to all or any the countries and thereby leading to division of labour and specialization.
2. Optimum allocation and utilization of resources – due to specialization, unproductive lines can be eliminated and wastage of resources are often minimized or avoided. In other words, resources are channelized for the production of only those goods which would give highest returns. Thus, there's rational allocation and utilization of resources at the international level thanks to foreign trade.
3. Equality of prices – Prices is often stabilized by foreign trade. It helps to keep the demand and supply position stable, which successively stabilizes the prices.
4. Availability of multiple choices – Foreign trade helps in providing a better option to the consumers. It helps in making available new varieties to consumers all over the world, thus giving the consumers a wide variety of options to settle on from.
5. Ensures quality and standard goods – Foreign trade is highly competitive so as to take care of and increase the demand for goods, the exporting countries have to continue the quality of goods. Thus, foreign trade ensures that the quality and standardized goods are produced
6. Raises Standard of Living of the people – Imports can facilitate standard of living of the people. This is because people can have a choice of new and better kinds of goods and services. By consuming new and better sorts of goods, people can improve their standard of living.
7. Generate employment opportunities – Foreign trade helps in generating employment opportunities, by increasing the mobility of labour and resources. It generates direct employment in import sector and indirect employment in other sector of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication), etc.
8. Facilitate economic development – Imports facilitate economic development of a nation. This is often because with the import of capital goods and technology, a country can generate growth in all sectors of the economy, i.e., agriculture, industry and service sector.
9. Assistance during natural calamities – During natural calamities such as earthquakes, floods, famines, etc., the affected countries face the problem of shortage of essential goods. Foreign trade enables a rustic to import food grains and medicines from other countries to help the affected people.
10. Maintains balance of payment position – Every country has to maintain its balance of payment position. Since every country has got to import which ends up in outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.
11. Brings reputation and helps earn goodwill – a country which is involved in exports earns goodwill within the international market. For e.g., Japan has earned a lot of goodwill in foreign markets because of its exports of quality electronic goods.
12. Promotes World Peace – Foreign trade brings countries closer. It facilitates transfer of technology and other assistance from developed countries to developing countries. It brings different countries closer because of economic relations arising out of trade agreements. Thus, foreign trade creates a friendly atmosphere for avoiding wars and conflicts. It promotes world peace as such countries try to maintain friendly relations among themselves.
Q2) Explain India’s foreign trade since 2001.
A2) Over the last 25 years since India’s liberalisation, its foreign trade has expanded multi fold and seen significant structural shifts in product as well as geographic composition. The easing of quantitative restrictions as well as significant reduction in tariff levels across product lines has aided the growth of foreign trade in the first two decades post liberalisation. In-fact, the share of foreign trade (both exports and imports) in India’s GDP stood at over 43 percent during 2011-13 as against 13 -15 percent during early nineties. However, over the last few years there has been a marked deceleration in India’s foreign trade, both exports as well as imports, primarily on account of subdued global demand and dip in global commodity prices. This article presents a detailed analysis of India’s foreign trade trends, assessing the performance of key export commodities in current challenging global environment.
During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q3) What do you mean by EXIM policy?
A3) EXIM Policy, a synonym to foreign trade policy, may be a set of guidelines and instructions established by the govt. Within the sphere of foreign trade i.e., import and export of India. Exim policy may be a five-year plan. It's updated every year on 31st march and therefore the modifications, improvements and new scheme become effective from 1st April every year. Exim policy of the Indian government is regulated by foreign trade development and regulation act, 1992.
EXIM POLICY (2015-2020)
The new Exim policy has been formulated focusing increases in export scenario, boosting production and supporting the concepts like MAKE in India and Digital India.
Q4) What are the features of EXIM policy?
A4) Two new schemes namely “MERCHANDISE EXPORTS FROM INDIA SCHEME(MEIS)” and service EXPORTS FROM INDIA SCHEME (SEIS) has been introduced replacing multiple schemes existing earlier.
• MEIS to promote export of notified goods to notified markets and SEIS for advantage of all exporters in India.
• Reduce export obligations by 25% and give boost to domestic manufacturing supporting the “Make in India” concept
• Both MEIS and SEIS firm will get subsidized office spaces in SEZs, along with other benefits
• As a step to digital India concept, online procedure to upload digitally signed document by CA/CS/Cost Accountant Aare developed and further mobile app for filing tax, stamp duty has been developed.
• Benefits of MEIS would be eligible for e commerce of handicraft, handlooms; books etc. exports up to 25000 per consignment will get SEIS benefit.
• Duty credit scraps to be freely transferable and usable for payments of custom duty, excise duty and service tax.
• Recognition of status holder has been changed from rupees to us dollars earing. The position status holder will recognize and reward those entrepreneurs who helped in India to become a major export player.
• Manufactures who also are status holders are going to be enabling to self-certify their manufactured goods as originating from India.
• Repeatedly submission of physical copies of documents available on Exporter Importer Profile isn't required
• Agricultural and village industry products to be supported across the globe at rates of 3 and 5% under MEIS.
• Export obligation period for export items related to defence, military store, aerospace and atomic energy to be 24 months. Certificate of independent Chartered Engineer for redemption of EPGG authorization is not any longer required.
Q5) What is the impact of EXIM policy on the economy?
A5) The EXIM Policy 2015-2020 has expected to double the share of India in world trade from present level of three by the year of 2020.
Simplifying the present, the multiple schemes, the new policy has come up with two schemes MEIS & SEIS that reduce the complexity and encourage the entrepreneur. Similarly, use of technology to perform the compliance reduces the transaction cost and manual errors.
This policy has also focused moving far from reliance on subsidies. By extending benefits under EPCG on domestic procurement and offering them more products under MEIS, the policy further seeks to incentive the exports.
Generation of new employment and providing quality products at reasonable price to consumers are expected to be delivered by the policy.
In short, EXIM policy boosts productivity and earn exportable surplus at competitive rates in export.
The EXIM policy 2015-2020 is very praiseworthy as it purely focuses on developing export potential, improving export performance, encouraging foreign trade and creating favourable balance of balance of payments resolving quality complaints and trade disputes. Good governance and export are facilitated by this policy and hope the expectations the policy has brought, will be met.
Q6) What is Balance of payment?
A6) Balance of Payment (BOP) may be a statement which records all the monetary transactions made between residents of a country and therefore the rest of the world during any given period. This statement includes all the transactions made by/to individuals, corporate and therefore the government and helps in monitoring the flow of funds to develop the economy. When all the weather is correctly included within the BOP, it should sum up to zero during a perfect scenario. This means the inflows and outflows of funds should balance out. However, this doesn't ideally happen in most cases.
BOP statement of a country indicates whether the country has a surplus or a deficit of funds i.e., when a country’s export is more than its import, its BOP is said to be in surplus. On the opposite hand, BOP deficit indicates that a country’s imports are quite its exports. Tracking the transactions under BOP is something similar to the double entry system of accounting. This means, all the transaction will have a debit entry and a corresponding credit entry.
Q7) What are the elements of balance of payment?
A7) There are three components of balance of payment viz current account, capital account, and financial account. The total of the current account must balance with the total of capital and financial accounts in ideal situations.
1. Current Account
The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
2. Capital Account
All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
3. Financial Account
The flow of funds from and to foreign countries through various investments in real estates, business ventures, foreign direct investments etc. is monitored through the financial account. This account measures the changes within the foreign ownership of domestic assets and domestic ownership of foreign assets. On analysing these changes, it can be understood if the country is selling or acquiring more assets (like gold, stocks, equity etc.).
Q8) Why balance of payment is significant for a country?
A8) A country’s BOP is important for the following reasons:
• BOP of a country reveals its financial and economic status.
• BOP statement can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating.
• BOP statement helps the government to make a decision on fiscal and trade policies.
• It provides important information to analyse and understand the economic dealings of a country with other countries.
• By studying its BOP statement and its components closely, one would be able to identify trends that may be beneficial or harmful to the economy of the county and thus, then take appropriate measures.
Q9) Explain India’s Balance of payments since 2001.
A9) India’s balance of payments (BOP) in 2000-01 remained comfortable and the external sector experienced a distinct improvement. There were, however, some pressures on the BOP during the first half of the year on account of the significant hardening of international oil prices, the sharp downturn in international equity prices and successive increases in interest rates in the United States and Europe; but the situation eased with the mobilization of funds under the India Millennium Deposits, which helped to revert the declining trend in reserves and enhanced confidence in the strength of India’s external sector. As a result, the BOP situation experienced a turnaround in the second half of the year, 2000-01. Overall, the current account deficit in 2000-01 narrowed further to about 0.5 per cent of GDP from 1.1 per cent of GDP in the previous year. This improvement in current account deficit was made possible largely because of the dynamism in export performance, a sustained buoyancy in invisible receipts, reflecting sharp increases in software service exports and private transfers, and partly due to the subdued non-oil import demand.
Exports, on BOP basis, registered strong growth of 19.6 per cent in US dollar terms in 2000-01, on the heels of a strong recovery of 9.5 per cent in the previous year. Total imports, on payment basis, recorded only a moderate growth of 7.0 per cent during2000-01, much lower than the sharp increase of 16.5 per cent in 1999-2000. The moderate growth in total imports in 2000-01 was, in fact, largely because of a 24.1 per cent increase in the oil import bill, while non-oil import growth, on BOP basis, remaining subdued at only 2.0 per cent. Non-oil, non-gold imports, on customs basis, grew at a very high rate of about 20 per cent per annum, on an average, during 1992-93 to 1995- 96. The growth rate decelerated sharply to just about 3.5 per cent per annum during the next four years ended 1999-00. As expected, the growth of non-oil, non-gold imports tended to be moderate when the initial impact of trade liberalisation got absorbed, and the exchange rate providing reasonable incentives for cost-effective import substitution. This allays the fears that trade liberalisation would swamp the domestic market with cheaper imports. In 2000-01, nonoil, non-gold imports recorded a negative growth of 6.7 per cent, mainly because of the continuous industrial slowdown in recent years and the resulting lack of demand for imports. Reflecting the trends in exports and imports, the deficit on the trade account of BOP narrowed to US $14.37 billion or 3.1 per cent of GDP in 2000-01 from US $17.84 billion (4.0 per cent of GDP) in 1999-2000 (Table 6.2). The net inflow of invisibles, at US $11.79 billion, covered about 82 per cent of the deficit on the trade account in 2000-01, leaving a financing gap of only US $2.68 billion on the current account. This deficit on the current account represented 0.5 per cent of GDP, compared with the deficit of 1.1 per cent of GDP (US $4.70 billion) in 1999-2000. 6.8 The recovery in capital flows witnessed in 1999-2000, after some set back in 1998-99, which had been a consequence of the East-Asian crisis and partly due to the economic sanctions on India, was broadly maintained. Net inflows of capital (excluding IMF) on the capital account of BOP in 2000-01 were about US $9.02 billion, which were lower than such inflows of US $10.44 billion in the previous year. This reduction is mainly accounted for some bunching of repayments of commercial borrowings and significant net outflows under banking capital. On the other hand, capital inflows in 2000-01 were bolstered by the mobilisation of funds of US $5.51 billion under India Millennium Deposits (IMD) in October/November 2000. Fresh inflows of funds for portfolio investments in India by FIIs in 2000-01 amounted to about US $1.85 billion, which was only slightly lower than the US $2.14 billion in 1999-2000. Net accretions to non-resident deposits during 2000-01 rose by over 50 per cent to US $2.32 billion. Gross disbursement of external assistance at US $2.94 billion was comparable with the normal trends in recent years. Gross borrowing on commercial terms, excluding IMD, at US $3.81 billion in 2000-01 was higher than such normal borrowings of US $3.19 billion in the previous year. 6.9 The sharp reduction in current account deficit and the funds raised under IMD making up for the dip in overall net capital inflows through normal sources during 2000-01, as indicated above, resulted in a large accumulation of official foreign exchange reserves for the fifth year in succession. On BOP basis, reserves rose by a substantial US $5.83 billion. This was on top of an increase of US $6.14 billion in 1999- 2000 and an increase of US $4.51 billion per year, on an average, during the previous three years, 1996-97 to 1998-99. Official BOP statistics, as compiled by the RBI, for the year 2001-02 are available so far only for the first half of the year. However, a tentative assessment of BOP outlook for the current year indicates that the current account deficit in 2001-02 might widen somewhat, but it is expected to remain within 1 per cent of GDP. The widening of current account deficit will be mainly due to the poor export performance. Export performance faltered in the current year, as is evident from the growth rate of about 0.6 per cent, in US dollar terms, recorded by the DGCI&S data for the first nine months of 2001- 02. On the other hand, the resulting pressure on trade account will be eased to a large extent on account of moderation in oil import bill, following softening of international oil prices after September 2001. The net inflow of invisibles, despite larger outflows on account of interest and dividend payments, is expected to remain broadly at last year’s level, supported by a continued buoyancy in software service exports and private transfers. The widening of the current account deficit will, however, be more than matched by the expected net capital inflows from normal sources, resulting in large accretions to reserves. During the first ten months of current financial year (2001-02), the foreign currency assets of the RBI have increased by about US $7.01 billion from US $39.55 billion at end-March 2001 to US $46.56 billion at end-January, 2002.
Q10) What are the causes of unfavorable balance of payment?
A10) Import of Machinery- Since independence, import of machinery has been trending up, because-a) during World War ii, industrial machines were exclusively used, causing their large-scale depreciation and therefore needing replacement and, b) planned programs of industrialization fostered capital intensive technology that depended on imports. Accordingly, balance of payments turned unfavorable.
2. Import of War equipment- large amount of war equipment was imported owing to vulnerable borders, adding to import bills.
3. Setting up Embassies in rest of the world- Independent India had to establish its political relations with other countries. To that end, it had to set up its embassies in foreign countries. It was an expensive affair. It also turned balance of payments unfavorable.
4. Export of traditional items took a hit- Owing to International competition, our traditional exports (jute and tea, in particular) suffered a setback.
5. Increase in the price of petroleum products- Value of imports has gone up on account of constant hike in the price of petrol and petroleum products. In 1973, price of petrol was 2 dollar per barrel. It has now gone up to 36 dollars. In 1970-71, petrol worth Rs, 136 crore was imported. In 1980-81, value of imported petrol rose to Rs. 5,264 crore and in 2011-12, the import bill of petrol further rose to Rs. 7, 43,075 crores.
6. Payments of interest on foreign debt- Foreign loans contracted by the Government amounted to approximately Rs. 17,65,333 crores till 2011-12. Interest on these loans in 2011-12 was approximately Rs. 1, 04,155 crore. It caused a major disequilibrium in the balance of payment.
7. Widening gap between Imports and Exports- Over time, Imports have risen faster than Exports. Consequently, gap between imports and exports has tended to widen, contributing to negative balance of payments.
8. Gulf War- In 1991, Gulf War (war between Iraq and several western countries) also had its adverse effect on its balance of payments. On the one hand, price of crude oil shot up and on the other, remittances by Indians in the Gulf countries (Kuwait, Iraq, etc.) drastically declined.
Besides, several miscellaneous factors also accounted for adverse balance of payments. These include poor quality of our export goods, malpractices of Indian exporters, low competitiveness of Indian goods owing to high cost of production, etc.
Q11) What is Convertibility of Indian rupee?
A11) For the first time, the Union allows 1992-93 has made the Indian rupee partially convertible. This was an inevitable move for the expeditious integration of Indian economy with that of the planet so as to face the serious current account deficit within the balance of payments, the govt. Of India introduced the partial convertibility of rupee from March 1. 1992.
Under this system, which remained in operation for a period of 1 year, 60 per cent of the exchange earnings were convertible in rupees at market determined exchange rate and therefore the remaining 40 per cent earnings were convertible in rupees at the officially determined rate of exchange.
The entire foreign exchange requirement for meeting import obligations was required to be purchased at market determined rate of exchange, excepting a few specified imports and imports on the government account.
The term convertibility of a currency indicates that it is often freely converted into the other currency. Convertibility also can be identified as the removal of quantitative restrictions on trade and payments on current account. Convertibility establishes a system where the market place determines the rate of exchange through the free interplay of demand and supply forces.
In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q12) Explain Current account convertibility of Indian rupee.
A12) Current account convertibility is that the next phase for attaining full convertibility of rupee. Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes, while capital account convertibility refers to an identical liberalization of a country’s capital transactions like loans and investment, both short term and future.
The International monetary fund (IMF) which works towards the establishment of multilateral system of payments, requires member countries to move towards restoration of current account convertibility, but permits them to restrict convertibility for capital transactions.
Current account convertibility has been defined as the freedom to buy or sell foreign exchange for the subsequent international transactions:
(a) All payments due in connection with foreign trade, other current business, including services and normal short-term banking and credit facilities;
(b) Payments due as interest on loans and as net income from other investments;
(c) Payments of moderate amount of amortization of loans or for depreciation of direct investment; and
(d) Moderate remittances for family living expenses.
Q13) Explain Capital Account Convertibility of Indian rupee.
A13) The next and final step in this line is that the convertibility of rupee on capital account. But we must draw a pointy distinction between currency convertibility within the current and capital accounts. Capital account convertibility refers to a liberalization of a country’s capital transactions like loans and investment, both short term and future also as speculative capital flows.
When it involves capital account convertibility, one has got to be more prudent and be very much sure about its capacity to launch such a system. If the country can build a large stock of international reserves, then only this system could provide a bonus. Confidence within the financial system and a steady macro-economic environment are very much essential to the introduction of capital account convertibility of rupee in near future.
Capital account convertibility in India is often introduced in stages by gradually widening access to resident Indians to external financial markets. Within the light of historical experience, the overall view is that opening from the capital account should occur late within the sequencing of stabilization and structural reforms.
Capital account convertibility is likely to be sustainable as long as it's supported by credible macro- economic policies, listing reduction in fiscal deficit, moderation in inflation and a flexible financial system which may adapt to changing situations as some of the essential pre-conditions for capital account convertibility. Thus, capital account convertibility implies the right to transact in financial assets with foreign countries without restrictions. Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
But within the context of the necessity for attracting higher capital inflows into the country, it's also important for the government to introduce convertibility on capital account, as foreign investors may enter confidently only there's an assurance that the exit doors will always remain open.
The Budget 2002-03 has adopted a cautious step towards Capital Account Convertibility by allowing NRI to repatriate their Indian income. Considering this condition alongside the comfortable foreign exchange reserve of the country at present, the government is now favouring a make towards fuller capital account convertibility within the context of changes within the last 20 years. For the mean solar time on 18th March, 2006 Prime Minister Dr. Manmohan Singh asked the Finance Ministry and RBI to figure out a roadmap for fuller capital account convertibility supported current realities. Dr.Singh is of the view that such roadmap for fuller capital account convertibility would attract greater foreign investments into the country.
Thus, it's expected that the govt. Of India and therefore the RBI are going to announce a roadmap soon for the attainment of fuller capital account convertibility of the country. However, while taking decision for full convertibility of rupee, the government should take adequate care of its possible consequences.
In the meantime, on 29th March, 2006, 160 renowned Indian economists asked the govt. To desist from moving towards full convertibility of rupee because it was brought with dangerous consequences. They argued, “We urge the UPA government from such an unnecessary and dangerous measure. This (full float of rupee) would expose Indian economy to extreme volatility”.
The statement made by about 160 leading economists from various institutions across the country and signed by Prof. Prabhat Patnaik of JNU, Delhi also expressed apprehension that to expose the country to unpredictable movements in capital flows would create a potential for fragility and crisis and particularly when the stock market is witnessing a speculative boom.
Q14) What is Tara-pore Committee’s Second Report on Capital Account Convertibility?
A14) With the growing strength of balance of payments within the post-1991 period and with external sector remaining robust and gaining strength every year and therefore the relative macro-economic stability with high growth providing a conducive environment relaxation of capital controls, RBI, in pursuance of the announcement the Prime Minister constituted a committee on March 20, 2006 with Mr. S.S. Tara pore as its chairman for setting out a roadways towards fuller capital account convertibility. The committee submitted its report to the RBI on July 31, 2006.
Keeping itself conscious of the risks involved within the movement towards fuller convertibility of the Rupee as emanating from race experiences during this regard the committee calibrated the liberalization road map to the specific contexts of preparedness—namely, a strong macroeconomic framework, sound financial systems and markets and prudential regulatory and supervisory architectures.
After making review of the existing capital controls, it detailed a broad five-year time-frame for movement towards fuller convertibility in three phases: Phase-I (2006-07); phase ii (2007-08 to, 2008-09) and phase iii (2009-10 to 2010-11).
The report recommended the meeting of certain indicators/targets as a concomitant to the movement in: meeting FRBM targets; shifting from this measures of fiscal deficit to a measure of the public Sector Borrowing Requirement (PSBR); segregating government debt management and monetary policy operations through the fixing of the office of public debt independent of the RBI; imparting greater autonomy and transparency within the conduct of monetary policy; and slew of reforms in banking sector including one banking legislation and reduction within the share of Government/RBI within the capital of public sector bank.
Keeping the current account deficit to GDP ratio under 3 per cent; and evolving appropriate indicators of adequacy of reserves to hide not only import requirements, but also liquidity risks associated with present kinds of capital flows, short-term debt obligations and broader measures including solvency.
Thus, the committee recommended a three-phase strategy for moving towards capital account convertibility. Although, RBI has not been taken any final decision on acceptance of the recommendations in totality but it's initiated measures on an on-going basis beginning with the announcement in Us Mid-term Review of the Annual Policy Statement for 2007-08.
Q15) In which type of constituent elements, capital account convertibility?
A15) Although the rupee isn't fully convertible on the capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications involving Indian direct foreign investment abroad beyond US $ 4 million or those not qualifying for fast-track clearance.
Q16) What was India’s exports during the last 25 years?
A16) During the last 25 years, India’s exports have increased more than 17 times, from US$ 18.1 billion in 1990- 91 to US$ 309 billion in 2014-15, and India’s imports have increased 19 times, from US$ 23.5 billion in 1990-91 to US$ 447 billion in 2014-15. India’s share in global exports has moved up from mere 0.6 percent in early nineties to 1.7 percent currently. Likewise, India’s share in global imports has increased from around 0.6 percent during early nineties to 2.4 percent currently. In the first decade of this period (1990-91 to 1999-2000), India’s exports grew at a CAGR of 8.1 percent and imports at 8.7 percent. The real surge was witnessed in the next decade (2000-01 to 2009-10), when exports grew at 16.8 percent and imports at 21.5 percent annually. This trend continued until 2011-12, after which there has been a steady decline in trade owing to global slowdown. In 2014-15, exports dipped by 1.8 percent while imports dipped by 0.4 percent. For the first 11 months in financial year 2015-16, exports as well as imports have seen a sharp decline. While exports are lower by 16.7 percent y-o-y, imports have declined by 14.8 percent y-o-y.
Q17) What are the three major elements of capital account?
A17) There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.
Q18) What is Hawala trade?
A18) In India, hawala trade normally handles about 4 billion dollars a year. Until recently, this was traceable to the increasing differential between official and hawala exchange rates. This convertibility of rupee has bridged this gap and in restraint the hawala trade effectively.
Q19) What is Current Account?
A19) The current account is used to monitor the inflow and outflow of goods and services between countries. This account covers all the receipts and payments made with reference to raw materials and manufactured goods. It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. When all the goods and services are combined, together they create up to a country’s Balance of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It might be visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between countries is stated as visible items and import/export of services (banking, information technology etc.) are referred to as invisible items. Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This will even be personal transfers like – money sent by relatives to their family located in another country.
Q20) What is Capital Account?
A20) All capital transactions between the countries are monitored through the capital account. Capital transactions include the purchase and sale of assets (non-financial) like land and properties. The capital account also includes the flow of taxes, purchase and sale of fixed assets etc. by migrants moving out/in to a different country. The deficit or surplus within the current account is managed through the finance from capital account and vice versa.
There are 3 major elements of capital account:
Loans & borrowings – It includes all kinds of loans from both the private and public sectors located in foreign countries.
Investments – These are funds invested within the corporate stocks by non-residents.
Foreign exchange reserves – foreign exchange reserves held by the central bank of a country to monitor and control the exchange rate does impact the capital account.