A study of India's balance of payments

Abstract

The year was 1991. India was sitting on a huge debt which it was finding hard to service. Thegovernment finances were in shambles and the current account deficit had widened significantly.India's credit rating was downgraded and as a result, external funds dried up. By early 1991, India'sforeign exchange reserves had slumped to a mere 1 billion dollars, an amount sufficient to pay forjust a few weeks of imports. Even multilateral agencies like IMF refused to bail India out unless itembarked on a path of economic liberalization and structural reforms. Rupee had to be devaluedand government had to put tight control on its expenditure. India also embarked on a series ofreforms focusing upon economic liberalization.Though India is today in a much more comfortable situation vis-à-vis its BOP, its high trade andcurrent account deficit have often been a cause of concern. India's import basket is dominated bycrude oil, whose price has relentlessly increased over the last decade. Such is the dependence of ourbalance of payments on crude oil that an oil-shock resulting from disturbances in major oil producingnations, as has been witnessed recently, can throw India's BOP out of gear.After the 1991 crisis, there was a renewed push towards managing external sector and onmaintaining a healthy balance of payments. This has become all the more important now given ourhuge trade deficit which is being financed largely by a capital account surplus dominated by "hotmoney" pumped in by Foreign Institutional Investors (FIIs). In the rest of this report, we wouldanalyze trends in various components of India's BOP post liberalization and try to find out theproblems that still persist in out external sector. We would also study how an oil-shock can affectIndia's BoP. Finally based upon our observations, we would make recommendations to addressproblem areas in the BoP and maintain a healthy Balance of Payments.