Winds of change

In the first part of the BOP article, we had looked at the trends in balance of payments in the first seven plans and the persisting deficit faced therein. This problem was set to worsen in the next few years. In this article, we will look at the trend in India’s BOP in the eighth to twelfth plans, and see what steps were taken to address the persisting deficits.

BOP in the eighth to twelfth plans

The eighth plan (1992-97) was a period of implementation of trade and economic reforms which were initiated in 1991, in particular the Trade Policy of 1991, whereby tariffs were slashed and foreign direct investment (FDI) and foreign portfolio investment (FPI) were liberalised. Earlier, in 1991, the net invisibles account had turned negative mainly due to outflow of investment income, and the BOP deficit on the current account had reached a high of Rs 17,367 crore. This was 3.2% of GDP and unsustainable. In the first year of the eighth plan, the trade deficit was Rs 17,239 crore and net invisibles Rs 4,475 crore, which meant a current account deficit of Rs 12,764 crore. However, by the end of the eighth plan, the trade deficit had reached the highest-ever level of Rs 52,561 crore, which was a three-fold increase since the beginning of the plan. The current account deficit was Rs 16,283 crore. For the plan as a whole, the trade deficit was Rs 1,49,004 crore and the current account deficit was Rs 62,914 crore. These changes in the BOP were a direct result of the 1991 reforms, which encouraged exports and liberalised imports, encouraging technological upgradation. The current account deficit had fallen from 3.2% of GDP in 1990-91 to 1.4% in the last year of the eighth plan. Clearly, this was anticipated by the planners, and they set up the Rangarajan Panel in 1993 to suggest steps to manage the BOP better. The panel recommended that there should be a realistic exchange rate in place, external debt should be used prudently, foreign investors should not be extended better terms of operations than domestic investors, and the current account deficit should not cross 1.6% of GDP.

In the ninth plan (1997-2002), the current account deficit declined progressively to 0.6% in 2000-01 and showed a surplus of 0.7% in 2001-02. This was mainly on account of a strong showing on the invisibles account, which touched Rs 57,028 crore in 1999-2000 and further to Rs 71,381 crore in 2001-02. All in all, the ninth plan took important lessons on BOP from the eighth plan. This led to a surplus on the current account of Rs 16,426 crore and the current account showed a surplus of 0.7% of GDP in the terminal year of the plan. On the whole, the ninth plan had a trade deficit of Rs 30,2334 crore and a strong invisibles account showing of Rs 2,49,159 crore, leaving a current account deficit of Rs 53,175 crore, which was about 0.8% of GDP, much lower than in the eighth plan. It may be noted that this was the period in which the East Asian crisis occurred in 1997, and India’s BOP management in the face of the crisis was remarkable, as the above numbers show. The ninth plan document also worked out the sustainable levels of CAD and suggested a fresh methodology to do so. It suggested External Debt to Exports (ED/E) ratio as a good indicator of the sustainability of the CAD. This ratio was modified in the ninth plan to account for foreign exchange reserves and real interest rate on external borrowings. For example, with a 10% export growth rate, the sustainable CAD would be 2% of GDP and 1.7% of GDP if foreign exchange reserves are removed from the equation. The ninth plan also noted that a sustainable BOP was a function of prudent macroeconomic, fiscal and monetary policies. The following passage from the ninth plan illustrates this:

Large fiscal deficits entail high government borrowing held by the Reserve Bank of India (RBI), leads to an acceleration of growth in money supply, and this, in turn, fuels inflation. Otherwise, they tend to raise the rate of interest, increasing the domestic cost of production. As a result of either effect, Indian exports become less competitive. Therefore, it is important for successful balance of payments management that the consolidated general Government fiscal deficit is steadily brought down to the levels recommended in the Plan.

The tenth plan (2002-07) suggested that the CAD should rise to provide resources for the 8% growth of GDP and the level of CAD was projected to be 2.85% of GDP in 2006-07 and 1.6% of GDP for the plan as a whole. As it turned out, the strong showing on the invisibles account continued into the first two years of the tenth plan, when the current account showed a surplus of Rs 30,660 crore in 2002-03 and Rs 63,983 crore in 2003-04. These years also witnessed a strong showing of export growth, which kept the trade deficit in check. However, in 2004-05, imports surged because of a sharp rise in oil prices in 2005, and even though exports showed a good showing, we ended up with a high trade deficit of Rs 1,51,765 crore. This import surge continued for the remaining part of the tenth plan and the current account deficit was Rs 44,383 crore or 1.1% of GDP in 2006-07, the terminal year of the tenth plan (as against the 2.85% projected). Taking the tenth plan as a whole, while the trade deficit worsened in the last two years, the invisibles earnings showed a sharp increase on account of an increase in exports of services and tourism revenues. The tenth plan had a trade deficit of Rs 7,76,474 crore and a positive invisibles account of Rs 7,70,823 crore, which meant a deficit of Rs 5,651 crore, which was less than 1% of GDP.

In the eleventh plan (2007-12), the trend of rising trade deficit that had started in the last two years of the tenth plan, continued unabated. In 2007-08, the trade deficit was Rs 3,67,664 crore, which rose to high levels of around Rs 5.5 lakh crore to Rs 6 lakh crore in the next three years, before ending at Rs 9,12,100 crore in 2011-12, the last year of the plan. In 2007-08, the net invisibles were Rs 3,04,185 crore, leaving a current account deficit of Rs 63,479 crore, which was 1.3% of GDP. Matters became worse after the global financial crisis of 2008. In the next four years of the plan, the current account deficit continued to widen: it was 2.5% of GDP in 2008-09, 3.1% in 2009-10, 2.7% in 2010-11 and 4.2% in 2011-12. It may be noted that net invisibles continued to rise during the eleventh plan, but could not offset the trade deficit, which rose at an even higher pace, on account of high POL import all through the plan and high gold imports in 2011-12. On top of this, rising foreign investment led to a negative net investment income, leading to a further rise in the current account deficit. For the eleventh plan as a whole, the trade deficit was Rs 29,82,716 crore, which was more than three times that of the tenth plan. The net invisibles were Rs 20,25,906 crore, which were more than double the number in the tenth plan. This also led to a much greater current account deficit of Rs 9,56,910 crore in the eleventh plan as compared to the tenth plan.

In the twelfth plan (2012-17), the trade deficit continued to widen in the first year, and was Rs 10,64,456 crore, but fell in 2013-14 to Rs 8,84,845 crore. With a small rise in net invisibles in 2012-13, the current account deficit was Rs 4,79,610 crore, which was 4.8% of GDP. During this period, the Foreign Trade Policy (2015-20) was launched, which simplified and merged existing schemes such as Merchandise Exports from India Scheme (MEIS) and Service Exports from India Scheme (SEIS). Duty credit scrips were allowed to be freely transferable and could be used for paying customs and excise duty, export obligation was reduced under the EPCG scheme, and trade facilitation and ease of doing business got a big boost. It was expected that these schemes would bring down the current account deficit to 2.5% in 2016-17 and 3.4% for the twelfth plan as a whole.

Recently, the Foreign Trade Policy was announced in April 2023, which included various innovative measures such as developing districts as export hubs, trade facilitation by enhancing ease of doing business, and reducing processing time, duty exemption and remission on imports to be used for export promotion along with focusing on emerging areas such as e-commerce.

Conclusion

India’s trade integration with the world has increased over the years, which has meant increasing exports and imports of goods and services. However, one thing that has been a constant in India’s trade is the large imports of POL which, in turn, has contributed to high current account deficits. The other constant has been the rising share of positive net invisibles, including trade in services and remittances, which has muted the rise in current account deficit. In the coming times, there will be new geopolitical equations which, along with challenges on the climate change and technological front, will require India to be agile and respond fast to ensure a sustainable balance of payments.

The writer is Additional Chief Secretary, Department of Mass Education Extension and Library Services and Department of Cooperation, Government of West Bengal.