Economic Development and Policy in India 2 Notes

Introduction

 

In India normally records its International transactions in order to know its international economic position. These transactions are recorded in Balance of Payments.  

Balance of Payments (BoP)

BOP is statistics systematically summaries the economic transactions of an economy with the rest of the World (i.e.transactions between resident & non resident entities) during a given period. It is an account of what the residents of a country receive from the rest of the world in a particular year on account of sale of goods, services and other invisible items as well as an account of capital trans- fer from the other countries, and also what these residents have paid out to the other countries on account of purchase of all these items and the transfer of capital fro this country to the rest of the world. 

It can be better appreciated in terms of the national income accounting identity: GDP  = C+G+I+X-M. In other words, domestic output (GDP) is equal to private consumption(C), plus government consumption (G), plus domestic investment (I), plus net exports (X-M). If net exports of goods and services (X-M) are negative (i.e. Balance of Trade is negative or there is a trade(including services) deficit,), the domestic economy is absorbing more than it can produce. In other words, absorption (C+G+I) by the domestic economy is greater than domestic output (GDP). This adverse trade balance (or trade deficit) is also reflected in Current Account of BOP, which besides covering goods and services, also covers income (investment income & compensation of employees) and current transfers (remittances, grants etc). In case the combined net effect of trade balance, income and current transfers is also negative, the same results in Current Account Deficit . The deficit needs to be financed by external borrowings and/or investments which are constituents of Financial Accounts.

Balance of Trade (BOT)

BOT is a merchandise balance. It refers to the difference in the value of imports and exports of goods. If the value of exports of goods is more than the value of import of goods, then it called Favourable BoT and vice versa. It is a narrower concept as compared to BOP. In the world of growing capital transactions ad payments of services across nations, the concept of BoT has little relevance. 

Now we have seen that summarises the difference between balance of trade and balance of payments. 

Difference between Balance of Trade and Balance of Payments. 

Balance of Trade

1. It records transactions relating to trade of goods only.

2. Balance of trade account does not record transaction of capital nature.

3. It is a part of current account of the balance of payments.

Balance of Payments

1. Its records transactions relating to both goods and services. 

2. Balance of Payments account records transactions of capital nature.

3. It is more comprehensive and has three accounts of which BoT is a part.

COMPONENTS OF BALANCE OF PAYMENTS  

Balance of Payments is divided into two main accounts. These are:

• Current Account
• Capital Account 

Current Account : As per Balance of Payment Manual(IMF), current account covers all transactions (other than those in financial items) that involve economic values and occur between resident and non resident entities. Also covered are offsets to current economic values provided or acquired without a quid pro quo. Specifically, the major classifications are goods and services, income, and current transfers. Thus, current account is a broader measure than trade balance as it also includes income( investment income & compensation of employees ) & current transfers. 

Current account of the BoP, transactions can be classified into merchandise (exports and imports) and invisibles. Invisible transactions are further classified into three categories, namely  

(a) Services- travel, transportation, insurance, Government not included elsewhere (GNIE) and miscellaneous (such as, communication, construction, financial, software, news agency, royalties, management and business services etc);

(b) Income ( investment income & compensation of employees ); and

(c) Current Transfers (grants, gifts, remittances, etc.) which do not have any quid pro quo. Investment income covers receipts and payments of income associated, respectively, with residents’ holdings of external financial assets and with residents’ liabilities to non-residents. Investment income consists of direct investment income, portfolio investment income, and other investment income. The current account of the BoP provides information not only on international trade in goods, but also on international transactions in services. 

The former balance of payments capital account has been redesignated as the capital and financial account as per the fifth edition of Balance of Payments Manual(IMF) and the revised account has two major components:

The Capital Account - The Financial Account These are in accordance with the same accounts in the System of National Accounts (SNA). Assets represent claims on residents and liabilities represent indebtedness to non residents.   

Financial Account: All components are classified according to type of investment or by functional subdivision (

(a) direct investment, 

(b) portfolio investment, 

(c) other investment, 

(d) reserve assets (external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes)). 

For the category of direct investment, there are directional distinctions (abroad or in the reporting economy) and, for the equity capital and other capital components within this category, asset or liability distinctions. For the categories of portfolio investment and other investment, there are the customary asset or liability distinctions. Particularly significant for portfolio investment and other investment is the distinction by type of instrument (equity or debt securities, trade credits, loans, cur- rency and deposits, other assets or liabilities). The traditional distinction, which is based on original contractual maturity of more than one year or one year or less, between long- and short-term assets and liabilities, applies only to other investment. 

India’s Balance of Payment – Historical Perspective  

India’s BoP evolved reflecting both the changes in our development paradigm and exogenous shocks from time to time. In the 60 year span, 1951-52 to 2011-12, six events had a lasting impact on our BoP: (i) the devaluation in 1966; (ii) first and second oil shocks of 1973 and 1980; (iii) external payments crisis of 1991; (iv) the East Asian crisis of 1997; (v) the Y2K event of 2000; and (vi) the global financial crisis of 2008 and subsequent Euro zone crisis .

The first phase can be considered from the 1950s through mid-1960s. In the early 1950s, India was reasonably open. For example, in 1951-52, merchandise trade, exports plus imports, accounted for 16 per cent of GDP. Overall current receipts plus payments were nearly 19 per cent of GDP. Subsequently, the share of external sector in India’s GDP gradually declined with the inward looking policy of import substitution. 

Moreover, Indian export basket comprised mainly traditional items like tea, cotton textile and jute manufactures. Not only the scope of world trade expansion in these commodities was less but additionally India had to face competition from new emerging suppliers, such as Pakistan in jute manufactures and Sri Lanka and East Africa in tea. The financial account records an economy’s transaction in external financial assets and liabilities. Sector of the domestic transactor (general government, monetary authorities, banks and other sectors) is also used .

TRENDS IN INDIA’S BALANCE OF PAYMENTS 

Overall balance of payments includes balance of payments on current account and capital account. Through economic reforms of 1991, efforts were made to attract foreign investment. This resulted in more capital receipts and favourable balance of payments.