CHAPTER VI CURRENT AND CAPITAL ACCOUNT CHANGES OF BALANCE OF PAYMENTS IN INDIA In this chapter, an attempt has been made to portray the changes that have occurred in the various components of current and capital account of the BOPs in the liberalised era of Indian economy. The term BOPs of a country is used to denote the record of its monetary transactions between the members of the home country and those of another country or the rest of the world in an accounting year. Such a record is useful for a number of purposes. The major purpose of such records, which are becoming increasingly elaborate and detailed, is to provide information to government authorities of the international position of the country, to help them in reaching decisions on monetary and fiscal policy on the one hand, and trade and payments questions, on the other. The BOPs of a country is kept in standard, double entry book-keeping under which each international transaction undertaken by residents of a country will result in a credit and debit entry of equal size.
179 Economic transactions include all such transactions that involve the transfer of title or ownership. While some transactions involve physical transfer of goods, services assets and money along with the transfer of title, some transactions do not. For example, suppose that a subsidiary company of a foreign undertaking is operating in India and making profit. This company may pay all its profits as dividend to the shareholders abroad, or it may, alternatively, reinvest its profit in India instead of paying dividends to its parent company abroad. Both kinds of transactions are recorded in the balance of payments accounts. What is important is the transfer of title and not the physical transfer of what is transacted. The term residents refer to the nationals of the reporting country. Tourists, diplomats, military personnel, temporary and migratory workers and the branches of foreign companies operating in the reporting country do not fall in the category of residents. The time period for BOPs is not specifically defined: it may be any period. The general reference period is, however, one year financial or calendar.
180 Balance of Payments on Current Account BOPs on current account mainly consists of two sub groups: (a) merchandise or the trade account and (b) invisible account. In the trade account or merchandise group, only transaction relating to goods or merchandise are recorded. That is, exports and imports of all goods are recorded. The invisible account usually comprises the services rendered and received by the residents of the nation. It consists of such transactions as banking and insurance charges, interest on loans, tourist expenditure, transport charges etc. Similarly, gifts or charities received or given away free by residents of the nation. It may be in cash or kind. Balance of Payment on Capital Account Capital account of BOPs deals with payments of debts and claims. It consists of all such items as may be employed in financing both imports and exports, namely, private balance, assistance by international institutions and specie flow and balance held on government account. Thus, there will be in capital account private (Non-Banking) loans- (i) Long term and (ii) Shortterm banking (excluding Central bank), Official (including Central Bank).
181 a) Loans b) Amortization c) Miscellaneous d) Reserves (including changes in the foreign exchange assets of the Central Bank). Current Account Deficit (CAD) The general belief is that high CADs are dangerous. In general, this is correct. But the converse that low CADs are good is not. CAD is nothing but a measurement of a country s saving gap, that is, the excess of investment over savings. It represents the net transfer of resources from the rest of the world to the country running the deficit. Therefore, in a developing country, with huge needs for funds for investment, a CAD makes sense. It allows it to finance investments that would have been well beyond what it could hope to finance with its ownerships. On the slip side, CADs are to be financed by foreign capital inflows. The capital flows are fickle, can be reversed and have to be serviced. The right CAD for any county, therefore, depends on its ability to absorb and service capital inflows. If these resources can be deployed, productivity and in ways that enhance its ability to repay, a high CAD to
182 GDP ratio is nothing to worry about. But, if they cannot, then it is initiating trouble. Too high a ratio can prove unsustainable in the long run as it did in East Asian economies in 1998 and in Mexico earlier. To that extent, low ratio has its advantages. But, too low a ratio carries with it an opportunity cost of not being able to benefit from resources that could be drawn from outside. Balance of Payments The evolution of India s BOPs during 1990-91 to 2007-08 reflects robust improvements on several fronts. A noteworthy aspect of the strength of the current account is that the rising degree of openness-merchandise and invisibles transactions taken together estimated at close to 37 per cent of GDP in 2003-04. The aguers well for the rising international competitiveness of the Indian economy and the sustainability of the external sector. The key indicators of India s BOPs are presented in Table 6.1.
183 TABLE 6.1 KEY INDICATORS OF INDIA S BALANCE OF PAYMENTS Item/Year 1990-1991 1999-2000 2001-2002 2004-2005 (US $ Million) 2007-2008 Trade Balance -9438-17841 -11574-33702 -91626 Invisibles, net -242 13143 14974 31232 74592 Current Account Balance -9680-4698 3400-2470 -17034 Capital Account net 7056 10444 8551 28022 107993 Overall Balance -2492 6402 11757 26159 92164 Foreign Exchange 5834 38694 54716 141514 309723 Reserves Source: Handbook of Statistics on Indian Economy 2008-2009. Table 6.1 presents key indicators of India s BOPs. It is important to note that after a long gap of 24 years. India has achieved current account balance in the year 2001-02 to the tune of 3400 US $ million. But India could not sustain it continuously. But the overall balance shows a surplus of 6402 US $ million in 1999-2000 to 92164 US $ million in 2007-08.
184 Figure 6.1 Key Indicators of India s Balance of Payments 350000 300000 250000 200000 US $ Million 150000 100000 50000 0-50000 -100000 1990-91 1999-2000 2001-02 2004-05 2007-08 Year Trade Balance Current Account Balance Overall Balance Invisibles, net Capital Account net Foreign Exchange Reserves
TABLE 6.2 INDIA'S OVERALL BALANCE OF PAYMENTS - BEFORE LIBERALIZATION (US $ Million) Items 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 Merchandise (Exports+Imports) -7869-7273 -6979-6715 -5654-7834 -7316-7168 -9361-7456 -9437 Invisible net 5065 4094 3572 3499 3238 2967 2756 2316 1364 615-243 Current Account -2804-3179 -3407-3216 -2417-4867 -4560-4852 -7997-6841 -9860 Capital Account 1665 657 2087 2655 3147 4506 4512 5047 8064 6977 7056 Source: Handbook of Statistics on Indian Economy, 2008-2009. Reserve Bank of India Annual Report 2008-2009
TABLE 6.3 INDIA'S OVERALL BALANCE OF PAYMENTS - AFTER LIBERALIZATION (US $ Million) Items 1991-92 1992-93 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 Merchandise (Exports + Imports) -2798-5447 -4056-9049 -11359-14815 -15507-13246 -17841-12460 -11574-10690 -13718-33702 -51904-61782 -91626 Invisible net 1620 1921 2897 5680 5447 10196 10008 9208 13143 9794 14974 17035 27801 31232 42002 52217 74592 Current Account -1178-3526 -1159-3369 -5912-4619 -5999-4038 -4698 2666 3400 6345 14083-2470 9902 9565-17034 Capital Account 3915 3876 8894 8502 4089 12007 9844 8437 10444 8840 8551 10840 16736 28022 25470 45203 107993 Source: Handbook of statistics on Indian Economy, 2008-2009. Reserve Bank of India Annual Report 2008-2009
TABLE 6.4 INDIA S BALANCE OF PAYMENTS ON CURRENT ACCOUNT (US $ Million) Item / Year 1990-91 1991-92 1992-93 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 Merchandise (Exports + Imports) -9438-2798 -5447-4056 -9049-11359 -14815-15507 -13246-17841 -12460-11574 -10690-13718 -33702-51904 -61782-91626 Invisibles -242 1620 1921 2897 5680 5447 10196 10008 9208 13143 9794 14974 17035 27801 31232 42002 52217 74592 Non-factor Services 980 1207 1129 534 602-200 726 1319 2165 4064 1692 3324 3643 10144 15426 23170 29469 37565 Transfers 2530 4242 4215 5633 8509 8852 12777 12209 10587 12638 13106 15856 16838 22162 20785 24687 30079 41944 Incomes -3752-3829 -3423-3270 -3431-3205 -3307-3520 -3544-3559 -5004-4206 -3446-4505 -4979-5855 -7331-4917 Current Account Balance (Net) -9680-1178 -3526-1159 -3369-5912 -4619-5999 -4038-4698 2666 3400 6345 14083 2470 9902 9565 17034 Source: Handbook of statistics on Indian Economy, 2008-2009.
TABLE 6.5 INDIA S BALANCE OF PAYMENTS ON CAPITAL ACCOUNT (US $ Million) Item / Year 1990-91 1991-92 1992-93 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 I Foreign Investment (net) (a+b) 103 133 557 4233 4807 4615 5964 5353 2312 5117 5862 6686 4161 13744 13000 15528 14753 44957 a) i) Foreign Direct Investment 97 129 315 586 1343 2143 2842 3562 2480 2167 3272 4734 3217 2388 3713 3034 7693 15401 ii) Portfolio Investment 6 4 242 3647 3579 2660 3312 1828-68 3024 2590 1952 944 11356 9287 12494 7060 29556 b) Abroad - - - - -115-188 -190-37 -100-74 -170-69 -35 0-24 0 56 162 II Loans (a+b+c) 5533 3982 411 1812 3035 2200 4795 4799 4418 1601 5264-1261 -3850-4365 10909 7909 24490 41930 a) External Assistance (Net) 2204 3034 1856 1895 1518 868 1101 885 799 891 410 1117-3128 -2858 1923 1702 1775 2114 b) Commercial borrowings 2254 1462-366 686 1124 1284 2856 4010 4367 333 4303-1585 -1692-2925 5194 2508 16103 22633 c) Short term to India 1075-514 -1079-769 393 48 838-96 -748 377 551-793 970 1419 3792 3699 6612 17183 III Banking Capital (net) (a+b) 682 567 3826 2264-334 763 2229-893 699 2127-1961 2864 10425 6033 3874 1373 1913 11757 a) Commercial banks 904 138 2930 1658-626 938 2225-1260 -447 2304-1882 2660 10135-2925 5194 2508 1581 12110 b) others -222 429 896 606 292-175 4 367 1146-177 -79 204 209-468 -105 931 332-353 iv) Rupee Debt Service -1193-1240 -878-1054 -983-952 -727-767 -802-711 -617-519 -474-376 -417-572 -162-121 v) Other capital flows (net) 1931 473-40 1639 1977-2537 -254 1352 1810 2310 292 781 578 1699 656 1232 4209 9470 Total capital account 7056 3915 3876 8894 8502 4089 12007 9844 8437 10444 8840 8551 10840 16736 28022 25470 45203 107993 Source: Handbook of statistics on Indian Economy, 2008-2009.
185
186 Table 6.2 clearly shows that, before the liberalization process in India (1980-81 to 1990-91) India continuously experienced current account deficit. It has increased from 2804 US $ million in 1980-81 to 9860 US $ million in 1990-91.
187
188 India s overall balance of payments situation after liberalization process shows that, due to surplus in capital account only. India is able to sustain its overall balance and balance of payments situation effectively.
189
190 It is noted from Table 6.4 that the most important item in the BOPs on current account is balance of trade, which refers to imports and exports of goods. In Table 6.4, the balance of trade does not balance and shows a deficit in all the 18 years. Due to surplus in invisible account, there was a surplus on current account during 2004-2005 and 2005-2006. It may be noted that, after several years, in 2001-02 BOPs on current account on India was found to be in surplus. India s BOPs on current account has been in surplus for eight successive years during 2001-2008. However, in 2004-05, 2005-2006, 2006-2007, there has been a deficit in the BOPs on current account but in 2007-2008 there has been a surplus in the BOPs on current account. Contrary to popular perception, deficit on current account is not always bad, provided it is within reasonable limits. In fact, deficit on current account represents the extent of capital inflows (i.e. foreign investment) in India during a year. Table 6.5 gives the position of India s overall BOPs on capital account for eighteen years from 1990-91 to 2007-08.
191
192 It is obvious from Table 6.5, if all items of BOPs on capital account are taken into account, we have surplus of 7056 and 8840 and 107993 million US$ in 1990-91, 2000-01 and 2007-08 respectively. It is important to note that this surplus on capital account is mainly due to foreign investment in India and NRI deposits which do not belong to us. These foreign investment funds, especially FII funds and non-resident deposits, can flow out of India, if situation in India is not favourable. H 0 : There is no structural change in the capital account during the 1980-81 to 2007-08. H 1 : There is structural change in the capital account during the 1980-81 to 2007-08. Chow Test result for structural changes in capital account for the year 1990-91 to 2007-08 is depicted in Table 6.6. TABLE 6.6 CHOW TEST RESULT FOR STRUCTURAL CHANGES CAPITAL ACCOUNT FOR THE YEAR (1990-91 TO 2007-08) Residual Sum of Squares Values S 1 = 0.9492486 S 2 = 3.6586285 S 3 = 6.356667 S 4 = 4.6078771 S 5 = 1.7487899 Degrees of freedom = (2, 24) Calculated F value Table F value 5% level of Significance F = 4.55 F = 3.40
193 In Table 6.6, the calculated F value is greater than the table F value for the degree of freedom (2, 24) at 5% level of significance. So the null hypothesis, that is, there is no structural change in the capital account is rejected and the alternative hypothesis, that is there is a structural change in capital account is accepted. Ratio Analysis of Current Account In order to have a clear understanding of the importance of each of the individual items to the total items, the ratio analysis has been made use of. In this study, ratio of current account to the overall BOPs account and ratio of the capital account to the overall BOPs account has been analysed. Ratio of current account to the overall BOPs account in India for the year 1990-91 to 2007-08 is presented in Table 6.7.
194 TABLE 6.7 RATIO OF CURRENT ACCOUNT TO THE OVERALL BALANCE OF PAYMENTS ACCOUNT IN INDIA FOR THE YEAR (1990-91 TO 2007-08) Year Current Account (US $ Million) Overall balances (US $ Million) Ratio 1990-91 -9680-2492 3.88 1991-92 -1178 2599-0.45 1992-93 -3526-590 5.98 1993-94 -1159 8535-0.14 1994-95 -3369 5787-0.58 1995-96 -5912-1222 4.84 1996-97 -4619 6793-0.68 1997-98 -5999 4511-1.33 1998-99 -4038 4222-0.96 1999-00 -4698 6402-0.73 2000-01 2666 5868 0.45 2001-02 3400 11757 0.29 2002-03 6345 16985 0.37 2003-04 14083 31421 0.45 2004-05 -2470 26159 0.09 2005-06 9902 15052 0.66 2006-07 9565 36606 0.26 2007-08 -17034 92164 0.18 Source: Computed by the researcher from the RBI Annual Reports. Ratio of capital account to the overall BOPs account in India for the year 1990-91 to 2007-08 is presented in Table 6.8.
195 TABLE 6.8 RATIO OF CAPITAL ACCOUNT TO THE OVERALL BALANCE OF PAYMENTS ACCOUNT IN INDIA FOR THE YEAR (1990-91 TO 2007-08) Year Capital Account (US $ Million) Overall balances (US $ Million) Ratio 1990-91 7056-2492 -2.83 1991-92 3915 2599 1.51 1992-93 3876-590 -6.57 1993-94 8894 8535 1.04 1994-95 8502 5787 1.47 1995-96 4089-1222 -3.35 1996-97 12007 6793 1.77 1997-98 9844 4511 2.18 1998-99 8437 4222 1.99 1999-00 10444 6402 1.63 2000-01 8840 5868 1.51 2001-02 8551 11757 0.73 2002-03 10840 16985 0.64 2003-04 16736 31421 0.53 2004-05 28022 26159 1.07 2005-06 25470 15052 1.69 2006-07 45203 36606 1.23 2007-08 107993 92164 1.17 Source: Computed by the researcher from the RBI Annual Reports, Various Issues.
196 Current account during the post-reform period from 1990-91 to 2007-08 is presented in Table 6.9. TABLE 6.9 CURRENT ACCOUNT DURING THE POST REFORM PERIOD FROM 1990-91 TO 2007-08 Year Current Account (US $ Million) Index Number 1990-91 -9680 100.00 1991-92 -1178 12.17 1992-93 -3526 36.43 1993-94 -1159 11.97 1994-95 -3369 34.79 1995-96 -5912 61.05 1996-97 -4619 47.70 1997-98 -5999 61.95 1998-99 -4038 41.70 1999-00 -4698 48.52 2000-01 2666 27.53 2001-02 3400 35.11 2002-03 6345 65.52 2003-04 14083 145.42 2004-05 -2470 25.51 2005-06 9902 102.27 2006-07 9565 98.79 2007-08 -17034 175.93 Source: Computed by the researcher from the RBI Annual Reports. The balance on current account can always show a deficit or a surplus. The deficit on the current account and on the account of capital
197 transactions can be financed by EA (loans and grants), drawings from the IMF and allocation of the SDRs. In the year 2007-08, the value of the current account was US $ million 17034 and it has increased. Further, from the index number that has been calculated, it could be seen that there is seventeen fold increase in the balances of the current account during the period from 1990-91 to 2007-08. Capital account during the post-reform period from 1990-91 to 2007-08 is presented in Table 6.10. TABLE 6.10 CAPITAL ACCOUNT DURING THE POST REFORM PERIOD FROM 1990-91 TO 2007-08 Year Capital Account Index Number (US $ Million) 1990-91 7056 100.00 1991-92 3915 55.48 1992-93 3876 54.93 1993-94 8894 126.05 1994-95 8502 120.49 1995-96 4089 57.95 1996-97 12007 170.17 1997-98 9844 139.51 1998-99 8437 119.57 1999-00 10444 148.01 2000-01 8840 125.28 2001-02 8551 121.18 2002-03 10840 153.62 2003-04 16736 237.17 2004-05 28022 397.12 2005-06 25470 360.95 2006-07 45203 640.60 2007-08 107993 1530.44 Source: Computed by the researcher from the RBI Annual Reports.
198 Table 6.10 shows that capital account during the post-reform period from 1990-91 to 2007-08. The balance in the capital account in the total BOPs account has been increasing up to the 1990-91. In 1990-91, the balance in the capital account was US $ million 7056. It however, decreased to the level of US $ million 3915 in the year 2007-08. The balance in the capital account was US $ million 107993. From the index number that has been calculated, it could be seen that there has been a seventeen-fold increase in the balance of the capital account during the period from 1990-91 to 2007-08. Merchandise Trade A key objective of structural reforms instituted in the aftermath of the crisis of 1991 was to correct the implicit anti-export bias built up during the first three and a half decades of planning and to reap the competitiveness and efficiency gains for the economy from a more open trade regime. The major elements of the era are; First, arrangements were put in place for the move towards a marketdetermined exchange rate. Second, since 1992 the trade policy imbibed a medium-term perspective. Third, a key aspect of the trade reforms has been a substantial reduction in import tariff rates and a drastic rationalization of
199 the tariff structure, including their dispersion. Fourth, concerted efforts have been made to dismantle the non-tariff barriers that were predicted upon the BOPs reasons under the GATT. Fifth, the RBI has undertaken several measures to ensure adequate and timely availability of bank credit for trade finance at competitive interest rates. Sixth, there has been a policy thrust for creating appropriate institutional arrangements for supporting a vigorous export drive. These include export processing zones, special economic zones, overseas banking units and technology parks. India has engaged herself constructively in multilateral trade negotiations under the WTO. Within its multilateral commitments, India has forcefully articulated its position, which reflects the concerns of the developing countries. In tune with the worldwide spread of regional trading liberalization, India has entered into several preferential trade agreements. These reforms in the trade policy regime have unlocked entrepreneurial energies. India s merchandise exports have been rising at a rate of over 20 per cent per annum, in US dollar terms, in recent years. As a result, the secular decline in India s share in world exports from two per cent in 1950 to 0.5 per cent in the 1980s has been halted. This share began rising in the 1990s and is currently at 0.8 per cent. The export strategy
200 envisages a doubling of India s share in the world merchandise trade by 2008-09. Trade and Current Account A distinguishing feature of India s external sector developments during the year 2004-05 was the expansion of the merchandise trade deficit to more than five per cent of GDP from an average of a little below three per cent of GDP during 1990-2008. Underlying this expansion in the trade, deficit was a surge in oil imports on the back of the soaring international crude oil prices and the pickup in investment demands as well as the growing strength of domestic industrial activity. This trend in imports may continue in view of the possible strengthening of upturn of activity in the economy. However, an intrinsic link between merchandise imports and exports has emerged and become entrenched so that the large expansion in imports is also spurring vigorous export growth. Given the recent experience, this order of the trade deficit appears to be manageable at this stage and is consistent with our growth aspirations. Despite the large trade deficit, the current account recorded only a modest deficit of less than one per cent of GDP in 2004-05 after a continuous run of surpluses over the three-year period, 2001-2004. The high
201 trade deficit during 2004-05 was to a large extent accommodated by the net invisible surplus at five per cent of GDP, supported by buoyant services exports and sustained remittances from migrant workers overseas. In fact, invisible surpluses have traditionally provided valuable support to India s BOPs and in recent years, they have taken on the character of a permanent component in the current account. It is in this context it seems to be that we believe that the current account deficit is sustainable with enough headroom available for accommodating even higher levels of investment activity. From a cross-country perspective, the Indian experience with managing the current account reveals some unique features. First, the lessons of the 1991 crisis brought forth policies, which ensured a low current account deficit in the ensuring years. This approach stood us in good stead in warding off the contagion from the Asian crisis of 1997-98. Second, the sustainability of the current account was ensured by a policy choice for non-debt flows and emphasis on the consolidation and reduction of external debt. Third, the low current account deficit was underpinned by shifts in international competitiveness favouring software, IT exports and workers remittances over traditional exports. Fourth, although the fiscal deficit remained somewhat inflexible, it was not allowed to spill over into the current account. Finally, the CAD being the mirror image of the absorptive
202 capacity, it is best assessed over the business cycle rather than at discrete points. International comparison of balance on current account for the year 2001-2008 is presented in Table 6.11. TABLE 6.11 INTERNATIONAL COMPARISON OF BALANCE ON CURRENT ACCOUNT FOR THE YEAR 2001 TO 2008 (As per cent of GDP) Country / Country Group 2001 2005 2006 2007 2008 Country Russia 11.1 11 9.5 5.9 6.1 China 1.3 7.2 9.5 11.0 10.0 India 0.3-1.3-1.1-1.0-2.8 Korea 1.6 1.8 0.6 0.6-0.7 Brazil -4.2 1.6 1.3 0.1-1.8 Mexico -2.6-0.5-0.5-0.8-1.4 South Africa 0.3-4.0-6.3-7.3-7.4 Country group Advance Economies -0.8-1.1-1.3-1.0-1.1 Central and Eastern Europe Developing -1.9-4.8-6.5-7.7-7.5 Asia 1.5 4.0 6.0 6.9 5.8 Middle East 6.4 19.7 21.0 18.2 18.8 Source: World Economic Outlook Database, April 2009. Table 6.11 shows that international comparison of balance of current account for the year 2001-2008. A comparison of current account position
203 across country groups during 2001-08 reveals that advanced economies and Central and Eastern Europe recorded current account deficits, while developing Asia and Middle East showed current account surpluses. The current account surplus of China improved steadily from 1.3 per cent of GDP in 2001 to 11.0 per cent in 2007 and was 10.0 per cent in the year 2008, characterized by an adverse eternal environment. India s current account deficit moved in a narrow range of 1.0-1.3 per cent and was -2.8 percent in 2008. Magnitude and Trends in Invisibles India s current account developments, particularly since the mid- 1970s are characterisied by two elements: persistence of trade deficits and buoyant invisible surpluses, which have set the trajectory for the current account balances. Resurgence of invisible surpluses in the 1990s, after a hiatus in the late 1980s, have in fact, restrained the CAD within a narrow corridor in the 1990s and guided the surpluses in the recent years. Thus, a sustained rise in invisibles surplus has significantly minimised the risk to the external payments position. Furthermore, the persistence of current account surpluses (for three years) together with significant capital inflows enabled further easing of payment restrictions on current and capital account transactions both for individuals and the corporates. The invisible balances
204 have provided a modicum of stability to the current receipts as the invisible balances as ratio to GDP have witnessed relative stability. The stagnation in invisibles receipts during the 1980s gave way to level shift during the 1990s, as reflected in the share of invisibles in the current receipts rising to 47 per cent in 2005-06 from 29 per cent in 1990-91. The invisible surplus continued to rise to reach a level of US $ 40.9 billion in 2005-06, emanating from buoyant services exports and sustained remittances from migrant workers overseas. In tandem with the growth momentum in the services sector and its rising contribution to GDP, the comparative advantage of India in services exports is reflected in India s services exports growing at above 20 per cent, on an average, since the mid- 1990s. Within the services exports, rising prominence of business services reflects high skill intensity of the Indian work force. There has also been a strong revival in the international tourist interest in India in recent years. An important feature of services exports is that India has emerged as a major software exporting country with a level of US $ 23.6 billion in 2005-06, expanding at a steady rate of over 30 per cent in the recent past. With workers remittances at US $ 24.6 billion in 2005-06, India continued to
205 retain its position among the leading remittance receiving countries in the world market by relative stability in such inflows. The sustained expansion in remittances since the 1990s was underpinned by structural reforms, including a market-based exchange rate, current account convertibility as well as shifts in labour migration pattern to increasingly high skilled categories. A significant rise in the invisible receipts since the mid-1990s is attributable to an improved competitive advantage in business and technological services exports. The rising prominence of business services reflects high skill intensity of the Indian work force. A marked feature of services exports, besides the shift in the trend level of exports, has been the reduced volatility, which provided a modicum of stability to the current receipts. The selected indicators on invisibles (1990-91 to 2007-08) are presented in Table 6.12.
206 TABLE 6.12 SELECTED INDICATORS ON INVISIBLES (1990-91 TO 2007-08) (in per cent) Items / Year Net invisibles (US & million) Net Invisible / Trade Balance Invisible receipts / Invisible payments Invisible receipts / GDP Invisible Payments / GDP 1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 -0.2 5.4 9.8 15.0 17.0 28.0 31.0 42.0 52.0 74.0-2.6 48.0 78.6 129.4 159.4 202.7 92.7 79.4 84.2 88.0 96.9 144.6 143.6 168.8 168.4 208.1 181.5 181.0 185.0 186.0 2.3 5.0 7.0 7.7 8.3 8.9 9.9 11.1 12.5 12.6 2.4 3.4 4.9 4.6 5.0 4.3 5.5 5.9 6.8 6.3 Source: Reserve Bank of India, Monthly Bulletin, March 2009. The major components of invisibles account in terms of GDP for the year 1990-91 to 2007-08 are presented in Table 6.13.
207 TABLE 6.13 MAJOR COMPONENTS OF INVISIBLES ACCOUNT IN TERMS OF GDP FOR THE YEAR 1990-91 TO 2007-08 Year Receipts Payments Net Services Transfers Income Total Services Transfers Income Total Services Transfer Income Total 1990-91 1.4 0.8 0.1 2.3 1.1 0.0 1.3 2.4 0.3 0.8-1.2-0.1 1995-96 2.1 2.5 0.4 5.0 2.1 0.0 1.3 3.4 0.0 2.5-0.9 1.5 1999-00 3.5 2.8 0.4 6.7 2.6 0.0 1.2 3.8 0.9 2.8-0.8 2.9 2000-01 3.5 2.9 0.6 7.0 3.2 0.0 1.7 4.9 0.3 2.9-1.1 2.1 2001-02 3.6 3.4 0.7 7.7 2.9 0.1 1.6 4.6 0.7 3.3-0.9 3.1 2002-03 4.1 3.5 0.7 8.3 3.4 0.2 1.4 5.0 0.7 3.3-0.7 3.4 2003-04 4.5 3.8 0.6 8.9 2.8 0.1 1.4 4.3 1.7 3.7-0.8 4.6 2004-05 6.2 3.1 0.7 9.9 4.0 0.1 1.4 5.5 2.2 3.0-0.7 4.4 2005-06 7.1 3.2 0.8 11.1 4.3 0.1 1.5 5.9 2.9 3.1-0.7 5.2 2006-07 8.1 3.4 1.0 12.5 4.8 0.2 1.8 6.8 3.2 3.3-0.8 5.7 2007-08 7.7 3.8 1.2 12.6 4.5 0.2 1.6 6.3 3.2 3.6-0.4 6.3 Source: RBI, Monthly Bulletin, March 2009. Table 6.13 shows that the major contributor to invisibles receipts in India have been services exports followed by transfers and income. Services exports accounted for about 60 per cent of the total invisible receipts in 2007-09. The importance of services exports in India has grown significantly, with the services GDP ratio rising from 1.4 per cent in 1990-91 to 7.7 per cent in 2007-08 driven by software services, which have grown in terms of both size and destination. Reflecting this, India has
208 emerged as a major software exporting country with a level of US $ 40.3 billion in 2007-08, expanding at an average rate of around 34 per cent in the past few years despite a global IT slow down. Within invisibles, transfer receipts have hovered around 3 per cent of GDP reflecting a steady increase in inward remittances for family maintenance and higher local withdrawals on the back of better investment opportunities. With private transfers at US $ 43.5 billion in 2007-08, India continued to retain its position among the leading remittance receiving countries in the world with relative stability in such inflows. The sustained expansion in remittances since the 1990s was underpinned by structural reforms, including a market-based exchange rate, current account convertibility as well as shifts in the labour migration pattern to increasingly high skilled categories. Receipts under the income account have also increased substantially since 2003-04, reflecting mainly higher earnings on deployment of FCA. The reinvested earnings by FDI companies invested abroad have also contributed partly to the higher investment income. In line with increase in invisible receipts, invisible payments have also increased in recent years mainly due to services related payments, which increased from 3.2 per cent of GDP in 2000-01 to 4.5 per cent of GDP in 2007-08. The services payments have been driven by payments
209 under business, transportation and travel reflecting increased business activities and strong growth in imports. On the other hand, payments under the income account have been broadly stable, moving in a narrow range of 1.4 1.8 per cent of GDP over the same period. Thus, higher receipts coupled with lower payments have resulted in a significant improvement in net invisibles, which has increased from 2.1 per cent of GDP in 2000-01 to 6.3 per cent of GDP by 2007-08. Capital Account and India s Balance of Payments Since the initiation of gradual liberalization of the capital account in 1991, the capital flows have been in excess of Current Account Deficit (CAD) except, in 1992-93 and 1995-96, adding to the reserves. It is interesting to note that the stock of external debt came down steeply from 28.7 per cent of GDP at the end of March 1991 to 17.4 per cent by March 2005. The decline in debt reflected the policy-induced shift in the composition of the capital account in favour of non-debt flows. The level of the short-term debt shift continues to be low at US $ 7.5 billion as at the end of March 2005. As regards the composition of capital flows, there is of late, almost a total shift in favour of private flows. The FDI increased from less than one per cent of net capital flows in the 1980s to 20 per cent of net
210 capital flows in 2004-05. Total portfolio investment flows on account of FIIs, GDRs and others were US $ 8.9 billion in 2004-05 on top of net inflows of US $ 11.4 billion in the preceding year. In brief, given the adverse international experience with unfettered capital account liberalization, India has been risk averse and has adopted a policy of active management of the capital account. The compositional shifts in the capital account have been consistent with the policy framework, imparting stability to the BOPs. The sustainability of the current account is increasingly viewed as consistent with the volume of normal capital flows. The substitution of debt by non-debt flows also gives us room for manoeuvre since debt levels, particularly, ECBs, have been moderate and can be raised in the event of a sustained pick up in the demand for external resources. There is also the cushion available from the FERs. Since non-debt creating flows are dominating, the emphasis is on encouraging inflows through FDI, and enhancing the quality of portfolio flows by strict adherence to what may be described as Know Your Investor principle. Further, in view of entrepreneurial skills in India and evolving synergies in a global economy, overseas investment by Indian corporate has been receiving a positive response. Further, prudential
211 regulations over financial intermediaries, especially over banks, in respect of their foreign exchange exposures and transactions are a dynamic component of management of capital account as well as financial supervision. Workers Remittances Workers remittances are a large and rapidly growing source in foreign exchange for many countries, but surprisingly little is known about this economic effects, what determines this size and growth rate and what policy makers can do maximize their benefits. Remittance inflows have become an important source of financing of current account deficit not only in India but also in several countries. According to the world Bank estimates, remittance flows to developing countries defined as the transfers trade by migrant workers to family and friends in their home country have surged from US $ 58 billion in 1995 to US $305 billion in 2008. 1 In 2003, remittance inflows for 90 developing countries analyzed in the WEO study amounted to about $ 100 billion the equivalent of 50 per cent to total capital inflows of 1.4 per cent of aggregate 1 Narayana. M.S. and Lalitha. K. (2010), Impact of Global Recession on Migrant Remittances and Foreign Investment, Southern Economist, Vol. 49, No. 3, June, P. 45.
212 GDP. In many developing countries, remittances constitute the single largest source of foreign exchange, exceeding export revenues, Official Aid, FDI and other private capital inflows. Remittances are equivalent to about 6.7 per cent of developing countries imports and 7.5 per cent of their domestic investment, indicating the significance of their inflows for the host economies, especially smaller economies. Inward Remittances Remittances were even larger than total capital inflows in many developing countries in 2004 and exceeded merchandise exports in a number of countries. In part, the surge in officially recorded remittances to developing countries in recent years reflects better data collection owing to greater awareness of the development potential of remittances as well as concerns about money laundering. In a number of countries, Government policies to improve banking access and the technology of money transfers through formal channels, workers remittances are found to be countercyclical and as such they have provided some element of stability to the recipient countries.
213 Remittance Inflows to India The surge in workers remittances to India, responding to the oil boom in the Middle East during the 1970s and 1980s, and the information technology revolution in the 1990s, has put India as the highest remittance receiving country in the world. Remittances include repatriation of funds for family maintenance and local withdrawals from the NRI deposits. Table 6.14. The workers remittances to various countries are presented in TABLE 6.14 WORKERS REMITTANCES TO VARIOUS COUNTRIES (US $ Million) Country 1991 1996 2003 2004 Brazil 1,057 1,866 2,018 2,459 China - 1,672 3,343 4,627 Colombia - - 3,060 3,170 Egypt 4,054 3,107 2,961 3,341 India 3,275 8,453 21,885 19,612 Mexico 2,414 4,224 13,396 16,613 Morocco 1,990 2,165 3,614 4,221 Pakistan 1,541-3,963 3,943 Portugal 4,517 3,575 2,752 3,032 Spain 1,792 2,749 4,718 5,189 Source: Balance of Payments Statistics Yearbook, 2005, IMF and Reserve Bank of India.
214 Table 6.15 presents a summary of private transfers to India from 1990-91 to 2007-08. TABLE 6.15 PRIVATE TRANSFERS TO INDIA Year Total Remittances (US $ Billion) Share in Current Receipts (per cent) Total Remittances (per cent of GDP) 1990-91 2.1 8.0 0.7 1995-96 8.5 14.0 3.22 1999-00 12.07 15.0 2.72 2000-01 12.05 16.9 2.84 2001-02 15.4 16.9 3.29 2002-03 16.39 18.8 3.39 2003-04 21.61 19.9 3.69 2004-05 20.25 21.9 3.03 2005-06 24.55 24.0 3.08 2006-07 27.51 26.4 3.28 2007-08 45.00 25.8 3.84 Source: RBI Annual Report 2008-09 Inward remittances have offset India s merchandise trade deficit to a large extent, thus keeping CADs modest through the 1990s. The sustained expansion in remittances since 1990s has been underpinned by structural reforms, including market-based exchange rate, current account convertibility as well as a shift in the labour outflow pattern from semiskilled to increasingly high-skilled categories. Policy initiatives to
215 facilitate remittance flows through speedier and cost effective money transfer arrangements like banking channels, money transfer agencies and post offices have also contributed to stability in remittances. While banking channels account for bulk of the inward remittances to India, Money Transfer Service Scheme (MTSS) and Rupee Drawing Arrangements (RDA) are also assuming significance. These schemes provide benefits of easier and speedier operations and play an important role in expanding the outreach of remittance services to remote locations in the country. Yet India s dominant position in remittance receipts is a relatively recent one. In 1990-91, for instance, RBI reported that remittances from overseas Indians were a modest $2.1 billion. They have risen steadily in the last 15 years, and rather dramatically in the last 10. The figures rose to $12.3 billion in 1996-97, and then jumped to almost $22 billion in 2003-04. Between 2004-05 and 2007-08, remittances almost doubled. With a small dip in 2004-05, the 2007-08 figures RBI report suggests that the trend is here to stay. The relative importance of these remittances in India s economy, then explain the reasons for this exponential gain, focusing on the effects of
216 Government and commercial bank policies, the profile of recent emigrants and the strength of the Indian economy. Relative Importance of Remittances It is generally assumed that in a large economy like India s, the impact of remittances is negligible. But, compared with some important economic and fiscal indicators, their relative importance is significant. Today, remittances represent 3.08 per cent of the country s GDP a sharp rise from 0.7 per cent in 1990-91. In 2005-06, remittances were higher than the US $ 23.6 billion in revenues from India s Software exports, which is particularly impressive since software exports increased 33 per cent that year. Table 6.16. The workers remittances; top recipient countries are presented in
217 TABLE 6.16 WORKERS REMITTANCES: TOP RECIPIENT COUNTRIES (US $ Billion) Country / Year 2004 2006 2007 2008 2009 India 21.7 26.9 27 45 55.06 China 21.3 22.52 25.7 40.5 n.a. Philippines 10.7 12.7 14.4 16.4 17.3 Mexico 21.7 25.6 26.1 25.1 21.2 Poland 12.0 n.a. 12.5 13.75 n.a. Bangladesh 4.2 5.5 6.6 9 10.7 Pakistan 4.2 5.1 6 7 8.7 Morocco n.a. n.a. 5.7 6.7 n.a. Source: Reserve Bank of India Bulletin 2008-2009 Inward remittances from Indians working abroad, reached US $ 21.7 billion in 2004 and US $ 45 billion in 2008, maintaining India s position as the leading recipient of remittances in the World. Economic Openness In the present World economic scenario, the policy of economic openness is imperative for any form of country for its own development. Openness refer to transactions relating to trade in goods and services, movement of capital and labour and movement of financial assets Asian Development Outlook (ADO), (1999) describes a number of ways to
218 measure economic openness, but there is no such single index which measures overall economic openness. Based on fair important aspects of trade policy (a study by Asian Development Bank) calculates trade openness index ( 0 value for closed economy and for full open economy) for different groups of Asian countries. The study reveals that east Asia scores 0.97, South East Asia scores 0.73, while South Asia scores only 0.06, East and South Asian countries have much benefited from globalization, enjoying faster growth and generally more equitable distribution of income and also achieved impressive social development than South Asian countries which have less openness.
219 TABLE 6.17 OPENNESS OF INDIAN ECONOMY (1990-91 TO 2007-08) (Rs. in Crore) Year Export Import Export + Import GDP Openness (X+M) /GDP (X+M) /GDP x 100 1990-91 33153 50086 83239 1083572 0.0768 7.68 1991-92 44923 51417 96340 1099072 0.0877 8.77 1992-93 54761 72000 126761 1158025 0.1095 0.95 1993-94 71146 83869 155015 1223816 0.1267 2.67 1994-95 84329 112749 197078 1302076 0.1514 1.51 1995-96 108481 146542 255023 1396974 0.1826 8.26 1996-97 121193 173754 294947 1508378 0.1956 9.50 1997-98 132703 190508 323211 1573263 0.2054 0.54 1998-99 144436 198914 344350 1678410 0.2052 0.52 1999-00 162753 240112 402865 1786525 0.2256 2.56 2000-01 207852 264589 472441 1864300 0.2534 5.34 2001-02 213345 268300 481645 1972606 0.2442 4.45 2002-03 260079 311776 571855 2048287 0.2791 7.91 2003-04 303915 367301 671216 222758 0.3020 0.20 2004-05 381785 533550 915335 2388768 0.3832 8.32 2005-06 465748 695412 1161160 2616101 0.4439 4.39 2006-07 579128 865404 1444532 2871118 0.5031 0.31 2007-08 637190 999286 1636476 3129717 0.5229 2.29 Source: Computed by the researcher from RBI Bulletin, Various Issues.
220 Table 6.17 shows that the openness of Indian economy varies between 0.52 to 7.68. The openness of Indian economy after liberalization is good, but not impressive. From 7.68 in 1990-91, it has increased to 8.32 in 2004-05, but decreased to 2.29 in 2007-08. The conclusion from the evidence is that India has to move many more steps forward to the reach international integration in terms of trade.
221 The following chart summarises the impact on external sector reforms on Indian economy in a nutshell. -------------------------------------------------------------------------------------------- Sl.No. Capital Flows 1990-91 2007-08 -------------------------------------------------------------------------------------------- 1. Debt creating flows 83.3 per cent 49.6 per cent 2. Non-debt creating flows 1.5 per cent 41.5 per cent Thus, the growth on non-debt creating flows is positive and impressed during the reform era. -------------------------------------------------------------------------------------------- Sl.No. Foreign Capital 1990-91 2007-08 -------------------------------------------------------------------------------------------- 1. FII 97 US$ Million 32,345 2. FPI 6 US$ Million 29,395 Thus, both FDI and FPI have grown by leaps and bounds since 1991. Thus, the external sector reform is highly successful in attracting foreign capital towards India. -------------------------------------------------------------------------------------------- Sl.No. Foreign Reserves 1990-91 2007-08 -------------------------------------------------------------------------------------------- 1. FERs 5 US $ billion 309 US $ billion 2. Foreign Exchange to Imports 3 months 15 months 3. Ratio of reserves to Shortterm Debt 0.68% 6.9% The FERs is 7 times higher than short-term debt. exchange to cover import has increased from 3 months to 15 months. The foreign --------------------------------------------------------------------------------------------
222 -------------------------------------------------------------------------------------------- Sl.No. External Debt 1990-91 2007-08 -------------------------------------------------------------------------------------------- 1. Growth of External Debt 83.8 US$ Million 221.2 US$ Million 2. External Debt to GDP Ratio 28.7 19 3. Debt Service Ratio 35.3 4.8 4. World Debt Status Third largest Fifth largest Debtor Debtor 5. Short term debt to Percentage to total debt 10.2 20.9 The performance of Indian economy in the liberalisation era is quite successful by the above variables except the ratio of short-term debt to total debt. -------------------------------------------------------------------------------------------- Sl.No. Balance of Payment 1990-91 2007-08 -------------------------------------------------------------------------------------------- 1. Current Account -1178 US $ million 17034 US $ million 2. Capital Account 3915 US $ million 107993 US $ million India s BOPs on current account has been in surplus from 2001 to 2008. The surplus in capital account also increased from 3915 US $ million in 1990-91 to 107993 US $ million in 2000.01. 3. Workers Remittances 2.1 US$ billion 45 US$ billion 4. Economic Openness 7.68 2.29 --------------------------------------------------------------------------------------------