Meaning of Balance of Payments
A balance of payments statement is essentially a double -entry system of record of all economic transactions between the ‘residents’ of a country and the rest of the world carried out in a specific period of time.
In the vast ocean of economic terms, the Balance of Payments (BoP) stands as a compass guiding us through the intricate currents of international trade and finance. It’s a term often tossed around in discussions about global economics, but what does it really mean?
At its core, the Balance of Payments is a comprehensive record of a country’s economic transactions with the rest of the world over a specific period. Think of it as a financial diary that tracks all the money flowing in and out of a nation.
Now, let’s break down the two main components of this economic diary: the Current Account and the Capital and Financial Account.
Table of Contents
Current Account: The Everyday Transactions
The Current Account is like the daily expenses and income section of our financial records. It includes the trade balance, net income from abroad, and net transfers. In simpler terms, it’s the snapshot of a country’s day-to-day economic interactions with the world.
Trade Balance:
This is the most talked-about aspect of the Current Account. It records the value of a country’s exports minus its imports. A surplus here means the country is exporting more than it’s importing, while a deficit indicates the opposite.
Net Income from Abroad:
Ever wondered where the profits from multinational companies operating in your country go? Well, they contribute to this part of the Current Account. It includes dividends, interest, and wages earned by a country’s residents abroad, minus what foreigners earn within the country.
Net Transfers:
This covers money flowing between countries in the form of foreign aid, remittances, or gifts. Essentially, it’s the financial goodwill exchanged globally.
Capital and Financial Account: Investments and Borrowings
Now, let’s dive into the Capital and Financial Account, which deals with the long-term financial movements between countries.
Foreign Direct Investment (FDI):
This reflects the investments made by individuals and businesses in one country into assets located in another. It’s like buying a house or starting a business in a foreign land.
Foreign Portfolio Investment (FPI):
Unlike FDI, FPI involves investments in financial assets like stocks and bonds. It’s like buying a share of a company listed in another country.
Financial Derivatives and Other Investments:
This category covers various financial instruments and transactions, including currency swaps, loans, and central bank reserves.
Achieving Balance: The Ideal Scenario
The key idea behind the Balance of Payments is to strike a balance between a nation’s income and its spending on the global stage. A healthy balance indicates that a country is not overly dependent on external borrowing or running unsustainable trade deficits.
While a temporary imbalance can be normal, prolonged deficits may lead to concerns about a country’s economic stability. It’s like maintaining a budget – spending within your means and ensuring your income covers your expenses.
In conclusion, the Balance of Payments is a crucial tool for understanding how a country interacts economically with the world. By keeping an eye on the currents of trade, investments, and financial flows, we can navigate the global economic seas more effectively, ensuring a smoother journey for nations in this interconnected world.
Unraveling India’s Economic Landscape: A Peek into the Pre-1991 Balance of Payments
The economic journey of a nation is often marked by pivotal moments that shape its destiny. India, too, underwent a significant transformation in its economic policies, particularly in the realm of balance of payments, before the watershed year of 1991. In this retrospective exploration, we delve into the dynamics of India’s balance of payments during the pre-1991 period, shedding light on the challenges and circumstances that set the stage for transformative reforms.
Jalan used the following two criteria as a rough measure of the balance of payments problem in a particular year: (1) the current account deficit was more than one per cent of GDP and (2) the foreign exchange reserves were less than necessary to cover three months’ imports
Current Account Deficit in Balance of Payments
Period 1: 1956-57 to 1975-76:
This period comprising the Second, Third and Fourth plans and first two years of the Fifth Plan saw heavy deficits in balance of Payments and an extremely tight payments position.
Period 2: 1976-77 to 1979-80:
This relatively short period was a golden period as far as the balance of Payments is concerned. India had a small current account surplus of 0.6 per cent of the GDP during this period and also possessed foreign exchange reserves equivalent to about seven months’ imports.
Period 3: 1980-81 to 1990-91:
This period covering roughly the Sixth Plan (1980-81 to 1984-85) and Seventh Plan (1985-86 to 1989-90) was marked by severe balance of payments difficulties. In 1990-91, the deficit touched the astronomical figure of RS 16,934 crore.
Historical Context:
The pre-1991 era in India was characterized by a mixed bag of economic policies, influenced by a blend of socialism and central planning. The country, having gained independence in 1947, initially adopted protectionist measures to nurture domestic industries and reduce dependence on foreign goods. However, this approach led to a series of consequences that significantly impacted India’s balance of payments.
Trade Imbalances:
One of the primary challenges India faced was a persistent trade deficit. The country’s import-oriented development strategy, coupled with stringent restrictions on exports, resulted in a lopsided trade equation. The appetite for foreign goods exceeded the earnings from exports, creating a substantial imbalance and contributing to a widening current account deficit.
External Debt Burden:
To fund its ambitious development projects, India turned to external borrowing. While foreign loans poured in to support infrastructure and industrialization, they also left the country grappling with a mounting external debt. The burden of servicing this debt became an increasingly challenging aspect of India’s economic landscape, putting a strain on the balance of payments.
Currency Depreciation:
The pressure on the balance of payments was further exacerbated by the depreciation of the Indian rupee. As the trade deficit and external debt rose, the value of the rupee experienced downward pressure in the foreign exchange market. This not only increased the cost of servicing external debt but also led to inflationary pressures, affecting the overall economic stability.
Gold Crisis:
During the 1970s, India faced a severe balance of payments crisis triggered by rising oil prices and geopolitical tensions. In an effort to stabilize the situation, the government resorted to pledging gold reserves to secure loans. The gold crisis underscored the vulnerability of India’s external position and prompted a reevaluation of economic policies.
Policy Shifts:
The critical turning point came in 1991 when India embarked on a path of economic liberalization and globalization. The then Finance Minister, Dr. Manmohan Singh, introduced a series of reforms aimed at dismantling the restrictive policies of the past. Trade barriers were lowered, industries were deregulated, and foreign direct investment (FDI) was encouraged. These measures sought to address the structural issues that had plagued India’s balance of payments.
Impact of Reforms:
The post-1991 era witnessed a remarkable transformation in India’s economic landscape. The liberalization measures led to an influx of foreign capital, improved export competitiveness, and a more sustainable balance of payments. The country shifted from a state-centric model to a market-driven economy, fostering economic growth and development.
Capital Account: Financing The Deficit
A study of capital account of the balance of payments reveals the methods of financing the deficit in the current account of the balance of payments. In periods 1 and 2, the entire deficit was financed through inflows of concessional assistance and this kept the debt servicing burden low. In contrast, a substantial part of the deficit (indeed almost the entire incremental deficit, in dollar terms) had to be financed through non-concessional loans obtained on market related terms during period 3.
After 1984-85, the large current account deficit had to be financed through substantial inflows of capital by way of commercial borrowings and deposits by non resident Indians (NRIs). This increased the cost of external debt considerably over time. As a result, the debt-service ratio rose to 35.3 per cent in 1990-91 and stood at 30.2 per cent in 1991-92. The debt to GDP ratio also rose significantly to 41.0 per cent in 1991-92. The country also had to seek a substantial assistance from IMF (International Monetary Fund).
Conclusion:
Reflecting on the situation of India’s balance of payments before 1991 provides valuable insights into the challenges and decisions that shaped the nation’s economic trajectory. The pre-reform period was marked by imbalances, debt burdens, and crises that necessitated a reevaluation of economic policies. The subsequent liberalization and globalization efforts ushered in a new era, propelling India into the global economic arena and setting the stage for its emergence as a vibrant and dynamic economy.