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India’s Balance of Payments and the Exchange Rate in
the 2000sAvadhoot Nadkarni
Department of EconomicsUniversity of Mumbai
)
Sr. No. Receipts Payments Balance 1. Merchandise BOTM2. Services BOTS2A Non-Factor S2B Income3. Transfers BOTR4. Invisibles 2+35. Current A/C CAB=1+46. Capital Flows KAB
6Ai Investment6Aii Loans6Aiii Banking6Aiv Other7. Overall Bal OB=5+68. Change in R - OB
Balance of Payments: Definition
Balance of Payments (BOP) is a statement of transactions entered into by the residents of a country with the rest of the world (ROW), set out over a period of time, usually a year. The transactions include transactions in goods and services, as also in assets. They also include transfer payments.
Components of BOP
Current AccountCapital AccountReserve Changes AccountThe difference between the receipts and
payments on each of these accounts defines the balance on the account
The sum of the balances on these three accounts is zero reflecting the statement that BOPs always balance in the accounting sense
Components of the Current Account
Current Account◦Merchandise Trade Account◦Invisibles Account
Non-Factor Services Account Income Account Transfer Payments
Components of the Capital Account 1
Foreign Investment◦Direct◦Portfolio
Loans◦External Assistance◦Commercial Borrowings
Banking Capital including changes in NRI deposits
Components of the Capital Account 2
Rupee Debt ServiceOther Capital including trade creditsErrors and Omissions
Components of Reserve Changes Account
IMF Transactions – Purchases, Repurchases & Net
Increase (-) or Decrease (+) in ReservesTotal reserve Movement
Trade Balance
Trade deficits are increasing in absolute terms mainly due to POL imports
X as percent of M increased initially to 83% in 2002-03 (from 66% in 1990-91), but is again decreasing now to 60% in 2008-09
Trade balance need not be necessarily positive
Balance on the Invisibles
Invisibles Balance has been positive due to ◦ITES exports◦Transfer receipts
However the balance on invisibles has not been able to outweigh the negative trade balance has been negative in most years except 2001-02 to 2003-04
Current A/C Balance 1
The CAB has been negative for most years, since the positive invisible balance has not been able to outweigh the negative trade balance, except 2001-02 to 2003-04.
For a developing country the CAB needs to be negative as this provides additional resources that can be used for investment: X-M=(S-I)+(T-G)
CAB 2
Yet the implied positive KAB means that the debt has to be serviced if capital inflows are of debt-creating kind – too much of deficit can easily become non-sustainable
The optimum CAD for India seems to be 2% of GDP
The CAD in India has been around 1.5% of GDP in recent years, except in 2008-09when it increased to 2.5%
Financing of Trade Deficits
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
-150.00
-100.00
-50.00
0.00
50.00
100.00
150.00
Trade BalInv Net
Financing of CAD by Capital A/C Surplus
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
-40.00
-20.00
0.00
20.00
40.00
60.00
80.00
100.00
120.00
Cur A/CCap A/C
KAB
KAB has been positive and at times more positive than the negative CAB leading to increase in reserves
This has happened with many Asian countries – reflects the huge CAD of the US
We are following the policy of non-debt creating K inflows: FDI & FPI
Composition of Net K Flows 1
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
-10.00 0.00 10.00 20.00 30.00 40.00 50.00
Bank KLoansFor I
Composition of Net K Flows 2
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
-20.00 0.00 20.00 40.00 60.00 80.00 100.00 120.00
For ILoansBank K
Composition of Net K Flows 3
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
For ILoansBank K
Exchange Rate Policy 1
India follows a managed floating exchange rate regime
The avowed exchange rate policy of the RBI is that the rate is basically determined by the market, but since the market-determined rate tends to be volatile, the RBI manages the rate to avoid excess volatility in the market
This implicitly means that the RBI does not influence the level of the rate
Exchange Rate Policy 2
Yet the Real Effective Exchange Rate of the rupee has been relatively stable over the entire period
It can be said that volatility is being avoided not only in the short run, but also in the long run!
Apparently, the nominal rate is being managed to maintain the real rate in the face of higher domestic inflation compared to the trading partners
NEER vs. REER (6 Countries)
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
0.00
20.00
40.00
60.00
80.00
100.00
120.00
NEER-6REER-6
NEER vs. REER (36 Countries)
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
0.00
20.00
40.00
60.00
80.00
100.00
120.00
NEER-36REER-36
NEER-6 vs. NEER-36
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
0.00
20.00
40.00
60.00
80.00
100.00
120.00
NEER-6NEER-36
REER-6 vs. REER-36
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
0.00
20.00
40.00
60.00
80.00
100.00
120.00
REER-6REER-36
