Evaluation of India's current BOP standing: The possibility of a crisis

Abstract

A nine year low of 5.3% GDP growth in the first quarter of fiscal 2013, an unprecedentedcurrent account deficit (CAD) of 3.7% of GDP, loss of investor confidence in the Indianmarkets, high interest rates, stubborn inflation, a falling rupee, depleting reserves, stalledforeign investments projects of the likes of POSCO, policy paralysis on FDI in retail,insurance and aviation, a fiscal deficit of 5.9% that has overshot estimates and agovernment that is losing credibility within the country over corruption and is incapable oftaming its smaller allies. These are all ingredients of a crisis. Interestingly many of thefeatures of this impending crisis (or are we in it already?) remind one of the debilitatingbalance of payment crisis of 1991 when the nation, pushed to the brink of financialdisaster, was rescued in dramatic fashion by Dr. Manmohan Singh – the hero of the 1991episode but perhaps as Times magazine puts it an “underachiever” 20 years later.Balance of Payment is an account of the country’s ability to balance the inflow and outflowof foreign funds. Thus, a country may have a surplus or deficit through international tradeand positive net foreign income flows from abroad it also transacts internationally throughownership investments (FDI), portfolio investments. The balance is settled throughexternal borrowings. The country needs to ensure that it has sufficient funds to meet theseexternal payment obligations. If the country manages this well and has a net inflow of fundsthen its foreign exchange reserves receive a boost else there is a drawdown on the reservesshould the reverse happens. This explains why countries with large current account deficitbut uncertain capital flows prefer to have large forex reserves. The problem arises, like itdid for India in 1991, when the forex reserves are already as low as 3.15% of imports [14]that the country was unable to honor its international obligations. In the current economicscenario, India’s oil bills is huge (140 bn USD [0.6] for fiscal 2012) and since we producelittle oil ourselves the demand is price inelastic. Thus, unless the country is able to increaseits exports so that it outpaces the growth in imports, the CAD is for here to stay. Hence,there is a need to allow foreign funds, particularly FDI and portfolio investments, in thecountry to ward off a BOP event. It appears the India in recent times, through uncheckedrise of its trade deficit and through policy inaction that has prevented the flow of foreignfunds into the country through FDI and FII, pushed itself into a situation which resembles a1991 revisit [15][16]. Let us take a look at the numbers to see if indeed such is the case.