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PRESENTATION ON INDIA’S BALANCE OF PAYMENTS 2013 AND EXCHANGE RATES
Submitted ByGroup II, Defence Executives Batch 2013Narsee Monjee Business School,Mumbai
(Shipra Sharma, Ashwini Kumar Y, Raghuram N, Dhirendra Kumar, Mahesh R, Achuthan JK)
14 October 2013
INDIA’S BALANCE OF PAYMENTS POSITION 2013
Balance of Payments : DefinitionThe Balance of Payments of a Country can be defined as the Statistical Record of a Country’s International Trade over a certain period of time, presented in the form of double entry Book-keeping.
Balance of Payments (BoP) accounts, are an accounting record of all monetary transactions between a Country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest abroad, are recorded as negative or deficit items.
INDIA’S BALANCE OF PAYMENTS POSITION 2013
Balance of Payments : Definition ……….
When all components of the BOP accounts are
included they must sum up to zero with no overall
surplus or deficit. For example, if a country is importing
more than it exports, its trade balance will be in deficit,
but the shortfall will have to be counterbalanced in other
ways – such as by funds earned from its foreign
investments inflows, by running down existing central
bank reserves or by accepting loans (with stringent
conditionalities) from outside.
INDIA’S BALANCE OF PAYMENTS POSITION 2013
Balance of Payments : Explanation of Disequilbrium
The Balance of Payments of a Country is said to be in equilibrium when
the demand for foreign exchange is exactly equivalent to the supply of
it. The BoP is in disequilibrium when there is a deficit. When there is a
deficit in the Balance of Payments, the demand for foreign exchange
exceeds the ACTUAL AVAILABILITY. A number of factors may cause
disequilibrium in the Balance of Payments. These various causes may be
broadly categorized into :
(a) Economic Factors
(b) Political Factors
(c) Sociological Factors
INDIA’S BALANCE OF PAYMENTS POSITION 2013Balance of Payments : Explanation of Disequilbrium ……..
1. Economic Factors : A number of economic factors may cause disequilibrium in the BOP. These are :
(a) ‘Developmental’ Disequilibrium : Large-scale developmental expenditures usually increase the purchasing power, aggregate demand and prices, resulting in substantially large imports. The development disequilibrium is common in developing countries, because large-scale capital goods imports give rise to a deficit in the Balance of Payments. (b) ‘Capital’ Disequilibrium : Cyclical fluctuations in general business activity are one of the prominent reasons for the balance of payments disequilibrium. Depression always brings about a drastic shrinkage in world trade, while prosperity stimulates it. A Country enjoying an economic boom experiences more rapid growth in its imports than its exports. (c) ‘Secular’ Disequilibrium : Sometimes, the BoP disequilibrium persists for a long time because of certain secular trends in the economy. The factors of high aggregate demand and high domestic prices (eg of petroleum and gold) may result in imports being higher than exports. This could be one of the reasons for the persistent Balance of Payments deficit of India.(d) ‘Structural’ Disequilibrium : Structural changes in the economy may also cause Balance of Payments disequilibrium. Such structural changes include the requirement of alternative sources of supply, enhanced consumer demand, the exhaustion of productive resources, inefficient domestic manufacturing capabilities, excessive regulative mechanisms and cost-overun.
2. Political Factors : Certain internal or external political factors may also produce a BoP disequilibrium. A country plagued with political instability may experience large capital outflows, inadequacy of domestic investment, etc.
3. Social Factors : Sometimes social factors also influence the BoP. For instance a laidback attitude of the people, excessive taxation regime, lack of incentives etc. will affect Volumes of Imports and Exports.
BALANCE OF PAYMENTS
Current Account (CA)
This is record of a country’s trade in goods and services in the current period.
CA = Exports (X) – Imports (M)
It is divided into 4 sub-categories: Goods Trade Services Trade Income Current Transfers
The sum of the four sub-categories = CA Balance
Capital Account (KA)
This includes all short-term and long-term transactions pertaining to financial assets.
KA = Capital Inflow (cr) – Capital Outflow (dr)
The two main components: Capital Account. Financial Account (direct, portfolio, other).
KA Balance = Sum of Capital Account and Financial Account.
OFFICIAL RESERVES
Records the purchase or sale of official reserve assets by the Central Bank. These assets include
Commercial Paper, Treasury Bills and Bonds Foreign Currency Money deposited with the IMF
This account shows the change in foreign exchange reserves held by the Central Bank.
Since the BOP must balanceCA + KA + RFX = 0
CA + KA = – RFX
The Balance of Payments Identity
For floating rate regime countries, such as the U.S., Canada etc official reserves are relatively unimportant.
Statistical Discrepancy (E&O)
The identity CA + KA = – RFX assumes that all transactions are measured accurately.
Inaccurate recording of transactions (errors & omissions), results in the above equality not holding. For BOP to balance,
CA + KA + E&O = – RFX
Assuming changes in official reserves, errors are approximately zero:
Current Account = (–) Capital Account
This will hold approximately for floating rate countries
A surplus in the BOP generally implies that the demand for the country’s currency exceeded the supply and that the government should allow the currency value to increase – or intervene and accumulate additional foreign currency reserves in the Official Reserves Account. (NA for India!)
A deficit in the BOP implies an excess supply of the country’s currency on world markets, and the government should then either devalue the currency or expend its official reserves to support its value.
BOP in Total
Accounting Principles
1. Any transaction resulting in a payment to foreigners is entered in the BOP accounts as a debit and is given a negative sign.
2. Any transaction resulting in a receipt from foreigners is entered as a credit and given a positive sign.
3. Current Account records transactions involving exports and imports of goods and services
4. Capital Account records transactions involving the purchase and sale of assets.
5. Double-Entry book keeping: Every international transaction automatically enters twice, once as a credit and once as a debit.
Examples of Transactions
Credit Transactions (+ve): Provision of goods and services to non-residents Income receivable from non-residents A decrease in foreign financial assets An increase in foreign financial liabilities
Debit Transactions (-ve): Purchase of goods & services from non-residents Income payable to non-residents An increase in foreign financial assets A decrease in foreign financial liabilities
INDIA'S OVERALL BALANCE OF PAYMENTS(US $ million)
Item/Year 2010-11 2011-12 2012-13
Credit Debit Net Credit Debit Net Credit Debit Net
1 2 3 4 5 6 7 8 9 10A. Current Account
1. Merchandise 256159 383481 -127322 309774 499533 -189759 306581 502237 -195656
2. Invisibles (a+b+c) 190488 111218 79269 219229 107625 111604 224044 116551 107493
a) Services 124636 80555 44081 142325 78227 64098 145678 80763 64915
i) Travel 15793 11026 4768 18462 13762 4699 17999 11823 6176
ii)Transportation 14246 13880 366 18241 16382 1859 17334 14806 2528
iii) Insurance 1945 1400 545 2632 1497 1134 2227 1409 818
iv) G.n.i.e. 535 820 -285 478 780 -302 574 813 -239
v) Miscellaneous 92117 53430 38687 102513 45806 56707 107544 51912 55632
of which : Software services 53100 2194 50905 62212 1256 60957 65867 2363 63504
Business services 24050 27694 -3644 25910 26788 -878 28447 30349 -1902
Financial services 6508 7483 -975 5967 7984 -2018 4949 4633 316
Communication services 1562 1152 410 1600 1557 43 1686 741 945
b) Transfers 56265 3125 53140 66761 3267 63494 68090 4057 64034
i) Official 647 631 16 632 607 25 463 772 -309
ii) Private 55618 2494 53125 66129 2660 63469 67627 3285 64342
c) Income 9587 27538 -17952 10144 26131 -15988 10276 31731 -21455
i) Investment income 8471 25546 -17075 7676 24141 -16465 7202 29572 -22370
ii) Compensation of employees 1116 1992 -876 2468 1991 477 3074 2159 914
Total Current account (1+2) 446647 494700 -48053 529003 607158 -78155 530625 618788 -8816
INDIA’S BALANCE OF PAYMENTS POSITION 2013
BoP Position as on 31 March 2013 Current Account (in Billion $) Earnings SpendingsA1. Merchandise Exports 306.58
2. Merchandise Imports 502.34
3. BALANCE OF TRADE - 195.664. Invisibles (which include :-) 107.49
(a) Software Exports less Imports : 64.92
(b) Private Transfers less Income Outflow : 42.89
Total Current Account Deficit = - 88.16
INDIA’S BALANCE OF PAYMENTS POSITION 2013
INDIA’S CURRENT ACCOUNT DEFICIT
Points to Note
1. Current Account Deficit is 4.2 % of GDP.
2. Average BOT Deficit was running @ - 16.31 Billion $ / Month !
3. Share of Manufactured Goods & Engineering Goods in Exports was only 41 %. This needs to expand @ 15-20 % every year over the next 5 Years by a CCEA monitored strategy, if we have to quickly get into the Safety Zone.
4. Petroleum Imports was $ 169.4 Billion $. Urgent need to give priority to Oil & Gas Exploration & Production to cut down imports from the present 80 % to < 50 % over the next 7 Years.
INDIA’S BALANCE OF PAYMENTS POSITION 2013BoP Position as on 31 March 2013
Capital Account (in Billion $) Earnings Spendings
This primarily includes :-
Points to Note :1. Urgent Need to expedite creating 8 ‘Shenzhen’ Model and Size EPZ, one in each Maritime State.2. FDI needs to be given ‘Tax free’ status for 5 Years PERIOD.3. Sufficient Quantity of Long Term Foreign Currency ‘India Bonds’ needs to be issued in International
Currency Markets, at attractive Rate of Interest to bring in Foreign Capital.
B
1. FDI 19.82
2. Portfolio Investment (FII) 26.89
3. External Assistance 0.98
4. Commercial Borrowings 8.49
5. Suppliers Credits 21.66
6. Banking Capital (mainly NRI Deposits) 16.57
7. Other Capital Outflow - 5.05
8. Foreign Exchange Reserves Interventions - 3.83
9. Errors and Omissions 2.69
NET CAPITAL ACCOUNT = 88.16
INDIA’S BALANCE OF PAYMENTS POSITION 2013
General Comments
1. India’s CAD Problem has been saved by the ‘Factors’ of Remittances by Indians Working Abroad + Invisible Exports (Software, BPO etc). But these Factors are reliable, only under favourable circumstances.
2. Tourism and Transit facilities Industry needs to be given a tremendous ‘Boost’ by quickly improving the Quality. Each State of ours must becomean International Tourist Destination with good connectivity.
3. We must not rely on FII inflows, as these are ‘volatile’ and not available when there is ‘Stress’.
How to correct the Balance of Payment ?
• Earning more foreign exchange through additional exports or reducing imports
• Quantitative changes in exports and imports require FURTHER policy changes
• Such policy measures are in the form of monetary, fiscal and non-monetary measures.
FOREIGN TRADE POLICY
• TECHNOLOGICAL UPGRADATION• INCENTIVES FOR PROMOTING INVESTMENT IN
LABOUR INTENSIVE SECTORS• ENCOURAGEMENT FOR MANUFACTURING
SECTOR IN DOMESTIC MARKET• SIMPLIFICATION OF PROCEDURES• MARKET & PRODUCT DIVERSIFICATION
Measures to Boost Visible Trade
• Cabinet Secretary appointed an Inter-Ministerial Committee to suggest short and medium term measures to enhance Exports from MSME (Micro, Small and Medium Enterprises) sectors in India
• The Committee submitted its report in July 2013
Report of the Inter-Ministerial Committee
• the major problems for the MSMEs relate to the availability and cost of credit, marketing support, improving productivity, technology / skill upgradation, infrastructure and the institutional framework for the MSMEs.
• Issues are also related to specific products like Chemicals, Plastic, Leather, Handicrafts, Textiles and Agricultural Products and specific Markets
MAJOR RECOMMENDATIONS OF THE COMMITTEE
• Availability and Cost of Credit– An additional interest subvention of 2% for those
exporters who repay on a timely basis– automatic increase in foreign currency limits due
to rupee depreciation– banks to aim for at least 40% export credit to
MSMEs and targets for banks to increase MSME borrowers by 10% annually until 2017
MAJOR RECOMMENDATIONS OF THE COMMITTEE
• Marketing Support:– Enhancement of budget and scope under
MDA/MAI schemes– greater focus on brand building and trade fairs– double income tax deduction for marketing
expenses– support for E-Commerce and a focus on Asian
Markets
MAJOR RECOMMENDATIONS OF THE COMMITTEE
• Productivity/Technology/Skills Upgradation– Modification in labour laws to enable more
overtime hours and employment of women in night shifts with necessary safety
– enhancement of technology upgradation schemes with both capital subsidy and interest subvention
– setting up of research/resource/product development centres
MAJOR RECOMMENDATIONS OF THE COMMITTEE
• Infrastructure for MSMEs– 24*7 facilities for export consignments at major
air cargo/sea port complexes– enhancement of ASIDE scheme and development
of MSME clusters near Highways/Rail Corridors.• Incentives/Taxes related issues:
– A differential corporate/income tax regime for MSME exporters
– reduce costs & removal of service tax
MAJOR RECOMMENDATIONS OF THE COMMITTEE
• Institutional Framework– resolve policy and implementation related issues– greater coordination at the ground level between
Customs and DGFT offices.
• Sector Specific Issues– a cess of 0.1% on the production of chemical and
Plastics for creating a fund for technology upgradation for the two sectors
– Support for handicrafts, horticulture, agricultural exports.
INDIA’S BALANCE OF PAYMENTS POSITION 2013
CONCLUSION1. The ‘Quantitative Easing’ Tapering Policy announced in Aug 2013 by the US Federal Reserve Bank by which Additional Supply of 80 Billion $ per Month will cease, caused the flight of FII. Therefore hereafter FII should be taken as only ‘birds of passage’ and treated as ‘opportunistic’ investors. The Rupee lost 19 % of its value. We must plan for CAD to come under 1% of GDP over the next 4 years.2. Even a small nation like S. Korea exports manufactured goods 10 times that of India! A nation’s competitiveness is judged by its manufacturing and marketing efficiency. Thus there is the urgent need for political direction, bureaucratic coordination, a supporting financial system (sub 10 % interest rates), all out emphasis on infrastructure improvements, and a separate Ministry of International Trade & Exports.3. We must convert this CAD Problem and Rupee Downslide situation into an Opportunity, by taking strong Policy Measures over the next 3 Months – speeding up Investments internally, bringing in Monthly Performance Accountability Audit in all Govt Depts, taking all Measures to double India’s Manufactured Goods Exports over the next 4 Years, and creating ‘Brand India’ value abroad. The Nation should ‘live’ the CREDO of doing International Commerce, for generating Growth.
Exchange Rate determination is a complex activity.The following exhibit provides an overview of the
many determinants of Exchange Rates.This road map is first organized by the three major
schools of thought (parity conditions, balance of payments approach, asset market approach), and secondly by the individual drivers within those approaches.
These are not competing theories but rather complementary theories.
DETERMINATION OF EXCHANGE RATES
DETERMINATION OF EXCHANGE RATES
The theory of purchasing power parity is the most widely accepted theory of all Exchange Rate determination theories :– PPP is the oldest and most widely followed of the
Exchange Rate theories.– Most Exchange Rate determination theories have PPP
elements embedded within their frameworks.– PPP calculations and forecasts are however plagued
with structural differences across countries and significant data challenges in estimation.
Parity Conditions Approach
The balance of payments approach is the second most utilized theoretical approach in exchange rate determination:– The basic approach argues that the equilibrium exchange
rate is found when currency flows match up Current and Financial Account activities.
– This framework has wide appeal as BOP transaction data is readily available and widely reported.
– Critics may argue that this theory does not take into account stocks of money or financial assets.
Balance of Payments Approach
The asset market approach argues that Exchange Rates are determined by the supply and demand for a wide variety of financial assets:
– Shifts in the supply and demand for financial assets alter Exchange Rates.
– Changes in monetary and fiscal policy alter expected returns and perceived relative risks of financial assets, which in turn alter Exchange Rates.
Asset Market Approach
The asset market approach assumes that whether foreigners are willing to hold claims in monetary form depends on an extensive set of investment considerations or drivers (among others) :– Relative real interest rates– Prospects for Economic Growth– Capital Market liquidity– A Country’s economic and social infrastructure– Political safety– Corporate governance practices– Contagion (spread of a crisis within a region)– Speculation
Asset Market Approach
Equilibrium Exchange Rate
Qty
$1.50
S$
DEquilibrium
What Changes the Equilibrium Rate? Inflation Rates:
Higher domestic inflation means less demand for local goods (and decreased supply of foreign currency), plus more demand for foreign goods (increased demand for foreign currency).
Interest Rates: Higher domestic (real) interest rates may attract investment
funds causing a decrease in demand for foreign currency and an increase in supply of foreign currency. BOP Position becomes vulnerable if there is flight of FII Capital. Own manufacturing capability and exports of value added items suffers greatly due to high cost of investment capital.
Economic Growth: Stronger economic growth attracts foreign investment funds
automatically causing a decrease in demand for foreign currency and an increase in supply of foreign currency.
What Changes the Equilibrium Rate?
Political & Economic Risks: Higher political or economic risk in the domestic country
results in increased demand and reduced supply of foreign currency.
Changes in Future Expectations: Any improvement in future expectations regarding the
domestic currency or economy will decrease the demand for foreign currency and increase the supply of foreign currency.
Government Intervention: Maintain weak currency to improve export competitiveness.
Numerous foreign exchange forecasting services exist, many of which are provided by banks and independent consultants.
Some multinational firms have their own in-house forecasting capabilities.
Predictions can be based on elaborate econometric models, technical analysis of charts and trends, intuition, and a certain measure of gall.
Forecasting in Practice
Technical analysts, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.
The single most important element of technical analysis is that future exchange rates are based on the current exchange rate.
Exchange rate movements can be subdivided into three periods:– Day-to-day– Short-term (several days to several months)– Long-term
Forecasting in Practice
The longer the time horizon of the forecast, the more inaccurate the forecast is likely to be.
Whereas forecasting for the long run must depend on the economic fundamentals of exchange rate determination, many of the forecast needs of the firm are short to medium term in their time horizon and can be addressed with less theoretical approaches.
Forecasting in Practice
Forecasting in Practice
Currency Forecasting Projections
For each currency you can do the following: RPPP and IFE (long-term influences) Technical analysis (past trends) Asset market approach (ongoing relationships and changes?) Balance of payments approach Unbiased forward rate
Then you conclude with your overall prediction based on all of these methods and allocate funds to your trading strategy.
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Trade Balances & Exchange Rates
