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CHAPTER VIII

SUMMARY, CONCLUSIONS AND SUGGESTIONS

8.1 Summary

8.2 Conclusions

8.3 Policy Suggestions

8.1 SUMMARY

Balance of Payments is said to be a systematic record of all international economic

transactions during a given period of time, usually a year. The study of balance of

payments represents macroeconomic aspect of international economics. The main

objective of the present study (as given in Chapter I) is to consider a review of the

measures to correct disequilibrium in India’s balance of payments from 1970 to

2007. Besides this the study has also focused on analyzing the effects of various

measures on the components of balance of payments. The present chapter deals with

a brief summary or overview of the findings to prove the hypotheses, policy

measures and conclusions.

To consider the evolution of the concept of balance of payments, a broad survey of

the different theories of international trade was undertaken.(Refer to Chapter II).

The analysis in this chapter revealed that the concept of balance of payments or

balance of trade was evolved for the first time in the writings of mercantilists.

However, they failed to address the issues such as – gains from trade, structure of

trade and terms of trade. Further, it was observed that the Ricardian theory and

Heckscher – Ohlin theory were relevant and were able to explain the pattern of

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world trade till the first half of the twentieth century. Later on, several economists

modified the Heckscher – Ohlin theory by introducing the role of economies of

scale, imperfect competition, differences in technology etc. For example, Posner’s

technological gap and Vernon’s product cycle theory were the two prominent

theories which analysed the effect of technical changes on the pattern of

international trade. The intra – industry trade models developed in late1970s

emphasized the view that economies of scale and imperfect competition can give

rise to trade even in the absence of comparative advantage. Some of the important

intra- industry models were developed by Krugman (1979), Lancaster (1980),

Helpman & Krugman (1985), etc. In the second half of 1980s, strategic trade policy

models were developed which included oligopolistic competition. In this context,

notable contributions were made by Krugman (1984) and Brander & Spencer

(1985). To conclude, the new theories which were developed after 1970s and 1980s

are quite capable of explaining the pattern of world trade today.

After independence for almost fifty years or so, India’s trade policy was ‘inward –

oriented’ with an objective to achieve rapid industrialization through import

substitution. This strategy covers the period from First Five Year Plan (1951 – 56) to

the Seventh Five Year Plan.(1985 – 90). However, from 1990 onwards there was a

major shift in the policy stance, when the country adopted ‘outward – oriented’ trade

strategy.

An in depth analysis of India’s trade policy shows that there were certain shifts in

the policy stance from time to time and it could be divided into three different

phases such as - Phase I – Import Restriction and Import Substitution (From 1950’s

to 1970s), Phase II – Export Promotion & Import Liberalisation (From 1970s to

1990s), and Phase III – Outward Orientation – (From 1990 onwards).

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Due to the adoption of Economic Planning, trade and industrialization policy were

subject to plan priorities. Phase I of trade policy covers the period of three Five Year

Plans (1951 – 52 to 1965 – 66) and the Three Annual Plans (1966 – 1969). The

policy of import restriction and import substitution was formulated by keeping in

view the limited foreign exchange reserves of the country, shortage of essential

consumer goods, requirements of capital goods, etc. Besides this, the country had to

import food grains to overcome shortages of food grains. Given the acute shortage

of foreign exchange most of the time, policymakers opted for direct allocation of

foreign exchange among different users and uses through import licences. The

import substitution strategy was also supported by appropriate monetary and fiscal

policies and by using tariff and non – tariff barriers such as licences & quotas. Phase

I of trade policy was also characterized by important features like – (a) devaluation

of rupee in June 1966, (b) adoption of new agricultural strategy to achieve self –

sufficiency in the production of food grains, (c) three wars (1962 with China, 1965

& 1971 with Pakistan), and (d) two severe successive droughts in 1965 – 66 and

1966 – 67. The trade policy during phase I, affected adversely exports reflecting a

poor export growth. It was observed that there was a consistent fall in exports as a

proportion of GDP until the early 1970s. For instance, exports as a per cent of GDP

fell from 6.4 per cent in First Plan to 4.2 per cent by the end of three Annual plans.

The effect on trade deficit showed that the average trade deficit to GDP ratio which

was 1.1 per cent in the First Plan increased to 3.3 per cent in the Second Plan and

thereafter decreased to 2.2 per cent in the Third and the three Annual Plans.

Similarly, the average current account deficit to GDP ratio which was 0.1 per cent of

GDP during the First Plan increased to 2.4 per cent in the Second Plan. It then

remained around 2.0 per cent of GDP during the Third and the three Annual Plans.

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The period from 1950s to 1970s also reflected stagnation in Real GDP growth rate,

which ranged from 3.5 per cent to 4.0 per cent per annum. However, one of the

positive impact of trade policy was seen in the context of industrial growth. For

instance, the industrial growth rate which was 5.7 per cent per annum in the First

Plan, increased to 7.2 per cent per annum in the Second Plan and further to 9.0 per

cent per annum in the Third Plan.

Phase II of export promotion & import liberalization covers the period from Fourth

Plan (1969 – 70 to 1973 -74) to Seventh Plan (1985 – 86 to 1989 - 90). During

seventies, several export promotion measures were implemented to generate higher

exports on a sustained basis. This export promotion measures implied a gradual shift

in the policy stance from import substitution to export promotion. Further, 1980s

marked the beginning of import liberalization wherein a more liberal policy of

imports of capital goods and technology was adopted. Besides this, the changes in

trade policy were also influenced by the recommendations of the Alexander

Committee (1978), Tandon Committee (1980) and Abid Hussain Committee (1984).

In a nutshell, these Committees emphasized on-simplification of import licensing

procedures, adoption of export promotion measures, phased reduction of tariffs,

announcement of trade policies for longer period etc. The recommendations given

by the above three Official Committees were implemented by the Government in

due course of time.

With respect to components of balance of payments it was observed that in the

Fourth Plan period (1969 – 1974) the average current account deficit to GDP ratio

was 0.3 per cent which turned into a surplus of 0.1 per cent in the Fifth Plan period

(1974 –79). Hence, the Fifth Plan period was considered as ‘golden period’ from

India’s balance of payments point of view. It is pertinent to note that the balance of

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payments remained comfortable in the Fifth Plan in spite of the first oil shock of

1973. The economy was able to manage the first oil shock fairly quickly due to – (a)

an improvement in export performance in the first half of 1970s, (b) slow expansion

of imports, (c) increase in invisible receipts in the form of private transfers, (d)

increase in foreign aid especially from IMF, and (e) restrictive fiscal & tight

monetary policy.

The second oil shock which occurred in 1979 had a serious negative impact on

India’s balance of payments. The surplus in the current account in the Fifth Plan

turned to deficit in the Sixth Plan. For instance, the average CAD/GDP ratio was 1.5

per cent in the Sixth Plan, which further increased to 2.2 per cent in the Seventh

Plan. Some of the important reasons which led to deterioration in the balance of

payments in the Sixth & Seventh Plan were – (1) stagnation in exports after 1976 –

77, (2) increase in import prices of crude petroleum, fertilizers, etc.(3) increase in

imports of capital goods (3) severe droughts of 1979 – 80 (4) fall in invisible

receipts, (5) expansionary monetary & fiscal policy, and (6) non – concessional

borrowing. The second oil shock was managed through measures such as – import

substitution in oil, restraining domestic consumption, loan from IMF and other

multilateral agencies.

With reference to the performance of exports during Phase II it is observed that in

the first half of 1970s exports performed well due to – (a) intensified export

promotion efforts by the government; (b) The emergence of Bangladesh as a trading

partner in 1971; (c) depreciation of NEER & REER (d) expansion in world trade &

(e) emergence of new markets such as OPEC. Similarly, during the period from

second half of 1970s to first half of 1980s exports performed poorly because of - (a)

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drop in the rate of growth of agricultural production; (b) increase in domestic

demand for manufactured products; (c) inflation; and (d) infrastructural bottlenecks.

With reference imports it is observed that our import bill mainly increased because

of (a) the two oil shocks;(b) increase in imports of food grains and defence

equipments; (c) increase in the imports of raw materials, semi finished goods,

manufactured goods and capital goods; and (d) increase in import intensity of

exports.

The second half of 1970s was characterized by massive expansion of foreign

exchange reserves due to increase in net invisibles, foreign aid and private transfer

payments. One of the important features which affected the India’s balance of

payments in the decade of eighties, was the emergence of large fiscal deficits

accompanied by current account deficits. The average CAD/GDP ratio was 2 per

cent from 1981 – 82 to 1990 – 91, while GFD / GDP ratio was 7 per cent.

During the first half of 1980s, the average CAD / GDP ratio was 1.65 per cent while

the FD / GDP ratio was 6.30 per cent. However, the second half of 1980s showed a

remarkable increase in both the deficits. For instance, the average CAD /GDP ratio

was 2.35, while GFD / GDP ratio was 7.70 per cent. The trends in fiscal deficit

reflect that during 1980 – 81 to 1990 – 91, the fiscal policy was highly expansionary.

Thus, the movements in current account deficit and fiscal deficit depicted the

existence of twin deficit phenomenon. In general, it was observed that up to end of

Sixth Plan, invisibles played an important role in financing trade deficit. However,

the situation changed from the Seventh Plan onwards when there was a rapid decline

in net invisible receipts. For instance, in the Sixth Plan 56 per cent of the trade

deficit was financed by invisibles while in the Seventh Plan only 25 per cent of the

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trade deficit could be financed by invisibles. The decline in net invisible receipts led

to greater dependence on external capital.

It was observed that up to the end of Sixth Plan, external assistance available on

concessional terms was the main source of financing current account deficit. For

example, during the Sixth Plan period, all the three sources taken together i.e.

external assistance, commercial borrowings and NRI deposits financed 74 per cent

of current account deficit. However, the situation changed drastically in the Seventh

Plan when all the sources together financed 87 per cent of current account deficit.

Moreover, all these sources were costly sources of financing which further led to the

problem of external debt. It was observed that India’s external debt to GDP ratio

increased from 12 per cent in 1980 – 81 to 26 per cent in 1990 – 91. Similarly, the

debt service ratio increased from 9 .5 per cent in 1980 – 81 to 35 per cent in 1990 –

91.

During the trade policy regime of Phase II (1970s to 1990s), the overall industrial

development was characterized by industrial deceleration & structural retrogression

(1965 to 1980) and industrial recovery. (1981 to 1990). The rate of industrial growth

fell steeply from 9.0 per cent per annum during the Third Plan to a mere 4.1 per cent

per annum during the period 1965 to 1976. The average industrial growth rate was

6.1 per cent per annum during the Fifth Plan period. Besides this, there was also

structural retrogression in the industrial sector during the period 1965 to 1980. Some

of the common causes for industrial deceleration were – (a) wars in 1965 & 1971 (b)

two severe droughts of 1965 – 66 & 1966 – 67, (c) first oil shock of 1973 (d) decline

in public investment and (e) infrastructural constraints. However, the adoption of

liberal industrial and trade policies & increase in infrastructure investment during

the Sixth & Seventh Plan led to recovery of industrial growth. For example, the

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industrial growth rate was 6.4 per cent per annum in the Sixth Plan which further

increased to 8.5 per cent per annum during the Seventh Plan.

With reference to inflation it was observed that it was around 9.0 per cent per annum

in 1970s, which slightly reduced to 8.0 per cent per annum in the 1980s.

The Real GDP growth rate showed some improvement as it nearly doubled from 2.9

per cent per annum in 1970s to 5.6 per cent per annum in 1980s.

A detailed study of India’s balance of payments reveals that deterioration in India’s

balance of payments started from the Seventh Plan onwards and ultimately reached

to a critical position in the year 1990 – 91. Moreover, there was a consensus among

the economists that the prelude to the crisis was the decade of eighties. Thus, the

year 1990 – 91 can be considered as the most difficult year from the India’s balance

of payments point of view. All the major macroeconomic indicators reflected the

presence of a balance of payments crisis. For instance, the CAD/GDP ratio increased

from 2.3 in 1989 - 90 to 3.1 per cent in 1990 – 91, which was clearly unsustainable.

The GFD / GDP ratio was more than seven per cent during the two years 1989 – 90,

and 1990 – 91. The foreign exchange reserves were just sufficient to cover two and

half months of imports during the two years i.e. 1989 -90 and 1990 – 91. The

average rate of inflation was 7.5 per cent in 1989 – 90, which went up to 10 per cent

in the year 1990 – 91 and further increased to 13.0 per cent in 1991 – 92. The Real

GDP growth rate which was 6.5 per cent in 1989 – 90, went down to 5.5 per cent in

1990 – 91, and further fell to 2.2 per cent in 1991 – 92. The debt indicators like debt

stock to GDP ratio and debt service ratio were also quite high during the said period.

For instance, debt stock to GDP ratio was 28.5 in 1990 -91 and it further went up to

38.5 in 1991 – 92. The debt service ratio ranged between 30.0 and 35. 0 was in 1990

-91 and 1991 – 92. In a nutshell, the country’s macroeconomic position was critical

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in 1990 – 91 characterized by unsustainable CAD/GDP ratio, high GFD / GDP ratio,

low foreign exchange reserves, high inflation, low Real GDP growth rate and high

debt stock to GDP ratio.

It was observed that the balance of payments crisis of 1990 – 91 was the result of

external as well as internal factors. The break down of Soviet bloc and Iraq – Kuwait

war were considered to be the main external factors leading to the crisis. While –

fiscal indiscipline, political uncertainty and instability, loss of investor’s confidence,

fall in invisibles surplus and rising external debt were considered to be the main

internal factors. However, many economists have considered macroeconomic

imbalances as the major cause behind the crisis. To overcome the balance of

payments crisis several reforms were introduced in July 1991 which were a mixture

of macroeconomic stabilization and structural adjustment. Major reforms were

introduced in fiscal, financial, industrial and trade sectors. The aim of fiscal reforms

was to correct fiscal imbalances and restore fiscal discipline. The monetary policy

reforms included – reduction in SLR and CRR, rationalizing the structure of interest

rates, etc. Reforms in the banking sector were based on the recommendations of

Narasimham Committee. Reforms in the industrial sector included - deregulation of

industry, abolishing of industrial licensing for major industries, amendment of

MRTP Act and disinvestment of public sector enterprises.

As the roots of crisis were related to trade and balance of payments, several reforms

were introduced in the trade sector. Thus, as far as the foreign trade sector is

concerned, the year 1991 is a ‘watershed’ because massive trade liberalization

measures adopted since this year mark a major departure from the relatively

protectionist trade policies pursued in earlier years. In the broader sense, the trade

policy package was essentially an ‘outward – oriented’ one. Some of the trade policy

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reforms introduced were – (a) reduction in tariffs and phasing out quantitative

restrictions, (b) decanalisation, (c) policy for trading houses, and (d) concessions and

exemptions for exporters etc.

Devaluation of rupee by nearly 20 per cent in July 1991 was yet another important

step undertaken to improve the balance of payments situation. Further, from March

1993 onwards a system of market determined exchange rate was adopted. Current

account convertibility was finally achieved in August 1994 when the Reserve Bank

further liberalized payments and accepted obligations under Article VIII of the IMF.

The reforms also included promotion of foreign investment in India.

The Indian economy in general and external sector in particular started realizing the

beneficial effect of reforms from 1992 – 93 onwards. Some of the beneficial effects

are as follows:

The improvement in foreign trade ratios such as exports / GDP, imports /

GDP, and trade / GDP reflect that there has been an increase in India’s trade

openness after the reforms. India’s exports / GDP ratio increased from 4.6

per cent during the decade of 1980s to 7.8 per cent in 1990s. The imports /

GDP ratio increased from 7.2 per cent to 9.3 per cent during the same

period. India’s trade to GDP ratio during the period from 1980 - 81 to 1989

– 90 was 11.8 per cent, which went up to 17 per cent during the period from

1990 – 91 to 1999 – 2000. Further from 2000 – 01 to 2006 – 07, there has

been increase in all the three ratios. For instance, the exports / GDP ratio

was 11.4, imports / GDP ratio was 15.3 and trade / GDP ratio was 26.8.

A key aspect of the trade reforms of the 1990s was the reduction in import

duties. It is observed that over a period of time the peak rate of import

duties has been reduced from 150 per cent in 1991 – 92 to 25 per cent in

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2003 – 04. Besides this, the number of basic duty rates have come down

drastically from 22 to 4 from 1991 – 92 to 2002 – 03.

The economic reforms have also resulted into improvement in terms of trade

(both net & income) over a period of time.

With reference to exports it was observed that after the introduction of

reforms, in the first half of 1990s there was a significant improvement in

India’s export performance both at the overall level and across commodities.

However, there was a slowdown in exports performance in the second half

of 1990s because of factors such as – slowdown in economic activity, fall in

demand due to East Asian crisis, imposition of Non- tariff barriers by

developed countries, and weakening of overall demand and world trade

volume.

The structure and composition of exports reveals that the share of primary

exports in total exports has decreased from 24.0 per cent in 1990 – 91 to

17.7 per cent in 1999 – 2000, while the share of manufactured exports in

total exports has increased from 72.9 per cent in 1990 – 91 to 80.7 in 1999 –

2000. This indicates that the country has gradually transformed from an

exporter of primary products to an exporter of manufactured products.

The exports of petroleum products have shown interesting results. The share

of petroleum products increased from 0.4 per cent in 1980 – 81, to 2.9 per

cent in 1990 – 91, and further to 14.8 per cent in 2006 - 07.

In the case of imports, petroleum and petroleum products have been the

most item among bulk imports. The share of this item was 25.0 per cent in

1990 – 91. In 1999 – 2000 its share marginally went up to 25.40 per cent. In

2006 – 07, its share went up to 30.76 per cent. It is pertinent to note that, the

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volume of such imports has grown significantly on account of increase in

domestic consumption and the stagnation in domestic crude oil production.

In the case of non – bulk imports capital goods occupy a dominant place in

The percentage share of imports of capital goods have remained almost

stable during the post – reform period. For instance, its share was 24.2 per

cent in 1990 – 91. By 1999 – 2000 its share decreased to 18.05 per cent, and

again by 2006 – 07, its share again went up to 25.35 per cent.

Hence, with respect to imports it can concluded that, there has been

compositional shifts in the structure of India’s imports towards higher

technology intensive and export oriented products during the 1990s.

Direction wise analysis of the Indian exports indicates an unchanged

position in respect of OECD group, increasing prominence of OPEC and the

developing countries of Asia, Africa and Latin America.

Direction wise analysis of imports indicate that subsequent to the opening

up, India’s import have been sourced from a wide range of countries. The

imports from traditional partners like Germany, Japan, UK & Australia are

reduced , while new import partners from Africa and East Asia (including

China) are gaining importance.

Invisibles have been considered as the most dependable source of financing

country’s trade deficits. It is found that the importance of invisibles

increased tremendously after the initiation of trade reform measures in 1991.

In 1990 – 91, net invisibles as a percentage of GDP were negative i.e. – 0.1

per cent. However, within a few years after reforms, they reached to a

positive figure of 1.8 per cent in 1994 – 95. By 1999 – 2000, net invisibles

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almost doubled and reached to 2.9 per cent of GDP. Further, within a span

of seven years, net invisibles went up to 5.8 per cent of GDP in 2006 – 07.

On an average, 63 per cent of trade deficit was financed by net invisibles

from 1991 – 92 to 2000 – 01. Earnings from invisibles exceeded the deficit

on trade account in 2001 – 02, 2002 – 03 and 2003 – 04, as a result there

was a surplus in current account in these years.

Plan wise financing of trade deficit indicates that in the Seventh Plan (1985

– 90), invisibles were able to finance only 25 per cent of trade deficit. But,

in the Eighth Plan (1992 – 97), invisibles were able to finance on an

average, 58 per cent of trade deficit. This financing increased to 82 per cent

in the Ninth Plan (1997 - 02), and further to 99 per cent in the Tenth Plan

(2002 – 07). Hence, it can be concluded that invisibles have played an

important role in financing the trade deficit in the post reform period. Our

analysis shows that during the post – reform period from 1991 – 92 to 2006

– 07 the average Net Invisibles / GDP ratio was 2.75 per cent. During the

same period, our moving average analysis shows a rising trend. Hence, we

can conclude that invisibles have played an important role in narrowing

down the CAD.

The high levels of current account deficits maintained during the 1980s had

reached to 3.1 per cent of GDP, which was well above the sustainable level

for India. However, the external sector policies implemented in 1991

ensured that the current account deficit remained around one per cent of

GDP and was comfortably financed.

A detailed study of CAD / GDP ratio revealed that this ratio, reduced from

3.1 per cent in 1990 – 91 to 0.3 per cent in the year 1991 – 92. The average

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CAD / GDP ratio works out to be 1.02 per cent from the period 1991 – 92 to

2000 – 01. Further, there was a current account surplus for three

consecutive years from 2001 – 02 to 2003 – 04. Hence, it was the first time

after independence there was a current account surplus in three consecutive

years. In 2006 – 07, the CAD / GDP ratio was 1.1 per cent. Our analysis

shows that the average CAD/GDP ratio during the period 1991-92 to 2006 -

07 is 0.55 per cent. At the same time, all the moving averages show a

falling trend during the said period.

In an open economy framework, maintaining the current account deficit at a

sustainable level is crucial. The sustainability of current account depends

upon external as well as domestic macroeconomic factors. In the recent

years, a number of criteria are used to assess sustainability. Some of the

indicators which are used to assess current account sustainability are - (1)

Trade deficit / GDP ratio, (2) CAD / GDP ratio, (3) GFD / GDP ratio, (4)

Private sector : S – I gap, (5) External debt / GDP ratio, (6) Short term debt /

total debt ratio (7) Non – debt capital flows /total capital flows (8) Debt

service ratio, (9) Changes in Real Effective Exchange Rate (REER),and (10)

Import cover. All the operational indicators of current account sustainability

for India indicate a steady improvement since the 1990s, except for the ratio

of fiscal deficit to GDP. Thus, 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. To conclude, on the basis of

trends in the current account in the post – reform period we accept the

hypothesis “that in spite of trade liberalization the current account deficit

has been within manageable levels.”

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The trends in fiscal deficit and current account deficit in the pre – reform

period depicted the existence of twin deficit phenomenon. Further, most of

the empirical studies showed that fiscal deficit cause current account

deficits. Our analysis also shows a high degree of positive correlation

between CAD & FD in the pre – reform period from 1981- 82 to 1990 – 91

However, the post – reform period especially since mid – 1990s shows that

the relationship between these two deficits has narrowed down. It is

observed that even though fiscal deficit has remained high, the current

account deficit has been reduced implying that a major part of the fiscal

deficit has been absorbed by a surplus in domestic saving of the private

sector. For example, the average current account deficit from 1991 – 92 to

2000 – 01 works out to be 1.02, while the average fiscal deficit is 5.67

during the same period. Hence, it is clear that although fiscal deficits

remained inflexible downwards, they did not spill over into the external

sector during the 1990s. Our analysis shows a weak negative correlation

between CAD & FD in the post - reform period. The average FD/GDP ratio

is 5.30 per cent while the average CAD / GDP ratio is 0.55 per cent, during

the period 1991 – 92 to 2006 – 07.

During 1980s, the widening current account deficits were mainly financed

by costly sources such as external commercial borrowings, NRI deposits and

loans from IMF. However, in the post – reform period, the strategy has

been to encourage long – term capital inflows and discourage short – term

volatile flows. Thus, a cautious approach has been adopted towards capital

flows in the post – reform period. The trends in capital account from 1991 –

92 to 2006 – 07 revealed that barring 1992 – 93 and 1995 – 96, the surplus

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in capital account has been sufficient to wipe out the deficit in current

account and create an overall surplus in the country’s balance of payments.

The four main components of capital account are (a) foreign investment, (b)

external assistance (c) external commercial borrowings, and (d) NRI

deposits.

Foreign investment includes – foreign direct investment (FDI) and foreign

portfolio investment (FPI). The policy makers realized that foreign

investment can play an important role in financing the current account

deficit. Hence, a major policy thrust towards attracting foreign direct

investment (FDI) was outlined in the New Industrial Policy Statement of

1991. Since then continuous efforts have been to attract foreign investment

in India in the form of direct investment and portfolio investment.

Responding to the policy efforts, the foreign investment inflows into India

(direct and portfolio) picked up sharply in 1993 – 94 and have been

sustained at higher level barring 1998 – 99, due to East Asian crisis. For

example, Plan - wise analysis of foreign investment reveals that during the

Eight Plan (1992 – 97) the average foreign investment was `. 13714 crore,

which increased to `.24502 in the Ninth Plan (1997 – 02). InTenth Plan

(2002 – 07) it more than trebled to `.79652 crore.

With respect to external assistance it is found that the reliance on this

source has been continuously declining in the post – reform period. On the

contrary, the reliance on costly sources such as external commercial

borrowings and NRI deposits has been rising. Plan - wise data indicates that

average ECBs were `.3720 crore in the Eighth Plan, which increased to

`.9425 crore in the Ninth Plan and further to `.17622 crore in Tenth Plan.

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Similarly, average NRI deposits were `.5226 crore in Eighth Plan, which

increased to `.7756 crore in the Ninth Plan and further to `.11778 crore

during Tenth Plan. Even though there has been an increase in

It is pertinent to note that even though in absolute terms ECBs and NRI

deposits have increased in post – reform period,(from Eighth Plan to Tenth

Plan) the overall policy has been to keep their maturity periods long and

costs low.

To conclude, the evolution of capital flows over the 1990s reveals a shift in

emphasis from debt to non – debt flows with the declining importance of

external assistance, ECBs and NRI deposits and the increased share of

foreign investment. For instance, the share of foreign investment in capital

account increased from 50.0 per cent in the Eighth Plan to 73.0 per cent in

the Tenth plan. While the share of NRI deposits in capital account declined

from 19.0 per cent in the Eighth Plan to 11.0 per cent in the Tenth Plan. Our

analysis shows that the capital inflows in the form of foreign investment

during the period from 1991 – 92 to 2006 – 07 are 58.0 per cent, while

external assistance is 13.46 per cent, ECBs are 16.35 per cent and NRI

deposits are 18.32 per cent. Hence, we accept the hypothesis that “there has

been a compositional shift in the capital account of the balance of payments

in the post – reform period.”

Management of external debt and improvement in debt sustainability

indicators can be considered as one of the important achievement in the post

– reform period. For instance, external debt to GDP ratio has come down

from 38.70 in 1992 to 22.0 in 2000 and further to 17.80 in 2007 and the debt

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service ratio has come down from 30.20 in 1992 to 17.10 in 2000 and to

4.80 in 2007.

In India, the exchange rate system has gone a paradigm shift from a system

of fixed exchange rates (until March 1992) to a market determined regime

since March 1993. The overall experience with the market determined

exchange rate system has been satisfactory.

India’s approach to reserve management until the balance of payments crisis

of 1991, was based on the traditional approach i.e. to maintain reserves in

relation to imports. However, by adopting a multiple indicator approach

there has been a paradigm shift in India’s approach to reserve management

in the post – reform period.

The trends in select indicators of reserve adequacy like – import cover, short

– term debt to reserves and external debt to reserves show a progressive

improvement in the post – reform period. For instance, the traditional trade

based indicator of reserve adequacy i.e. the import cover of reserves (foreign

currency assets) which was just 2.5 in 1991, increased to 8.2 in 2000 and

further to 12.5 in 2007. Similarly, the ratio of short – term debt to reserves

has gone down from 146.5 in 1991, to 10.35 in 2000 and further to 5.8 in

2006. The external debt to reserves has gone down from 1436.5 in 1991 to

258.35 in 2000 and further to 85.20 in 2007.

In the post – reform period the country’s foreign exchange reserves

(excluding Gold & SDRs) have reflected a phenomenal growth. The

country’s foreign exchange reserves have increased from `.4388 crore in

1990 – 91 to `.152924 crore in 1999 – 2000 and further to `.836597 crore in

2006 – 07.

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With respect to the impact of reforms on inflation, it is observed that during

the first half of 1990s the average WPI inflation rate was 10.0 per cent per

annum, while the second half of 1990s reflected a declining trend and it was

5.0 per cent per annum.

After the introduction of reforms in July 1991 major changes were also

introduced in the industrial sector The industrial growth rate shows a mixed

picture in the post – reform period. For instance, the average industrial

growth rate which was 7.4 per cent per annum during the Eighth Plan

declined to 5.0 per cent per annum in the Ninth Plan. However, in Tenth

Plan it again recovered and was 8.0 per cent per annum.

The macroeconomic crisis of 1991 also affected the Real GDP growth

adversely. The Real GDP growth which was 5.6 per cent per annum in 1990

– 91 sharply went down to 1.3 per cent per annum in 1991 – 92. However,

over a period of time, the reforms introduced in July 1991 seems to have

contributed to economic growth of the country. The data on Real GDP

growth reveals that during the Eighth Plan period, the average Real GDP

growth rate was 6.5 per cent per annum, which reduced to 5.5 per cent per

annum in the Ninth Plan. The fall in the growth rate in the Ninth Plan could

be attributed to the factors like -East Asian financial crisis, slowdown in

agricultural growth, fluctuations in industrial growth rate, etc. In the Tenth

Plan, once again there was revival of economic growth and the average

growth rate was 7.5 per cent per annum.

Capital account convertibility refers to the freedom of currency conversion

in relation to capital transactions in terms of inflows and outflows. Full

convertibility means that restrictions on capital account will be withdrawn

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by a country. India has adopted a gradual approach towards capital account

liberalization, which is based on the Report of the two Committee’s on

Capital Account Convertibility which were chaired by Shri. S. S. Tarapore.

Finally, it is observed that the introduction of major reforms in – fiscal,

financial, industrial and trade sectors in 1991 have resulted in – (1) increase

in trade openness, (2) satisfactory performance of exports, (3) increase in net

invisibles (4) maintaining a sustainable level of current account deficit,(5)

increase in non – debt creating flows like - foreign investment and decrease

in debt creating capital flows like external commercial borrowings & NRI

deposits, (6) improvement in key indicators of external debt (7) satisfactory

management of exchange rate (8) phenomenal increase in foreign exchange

reserves & improvement in indicators of reserve adequacy (9) control of

inflation (10) a satisfactory level of industrial growth (11) maintaining Real

GDP growth of about 5.5 per cent per annum and (12) a cautious approach

towards capital account liberalization. Further, a detailed study of India’s

Balance of Payments from 1991 – 92 to 2006 – 07 indicates that the country

has been able to achieve overall surplus in balance of payments in all the

years except in 1992 – 93 and 1995 – 96. On the basis of above we accept

the hypothesis that “the various measures undertaken to correct

disequilibrium in balance of payments have proved successful.”

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8.2 CONCLUSIONS

Some of the broad conclusions which can be derived from the present study are as

follows:

(1) In a broader sense, after independence for almost forty years or so India

adopted ‘inward - oriented strategy’ with a view to achieve rapid

industrialization through import substitution. This strategy covers the period

from First Five Year Plan (1951 – 56) to the Seventh Five Year Plan.(1985 –

90).

(2) The growing fiscal imbalances in the Seventh Plan leading to high fiscal

deficits and the spillover of the same into high current account deficits led to

CAD / GDP ratio of as high as 3.1 per cent resulted into the balance of

payments crisis of 1991. Besides this, the country had the problems of -

high inflation, low foreign exchange reserves, political uncertainty &

instability, loss of investors confidence, high level of external debt etc.

(3) The balance of payments crisis of 1991 led the policy makers to review the

trade strategy and as a result ‘outward – oriented strategy’ was adopted. The

government undertook several reforms in the – fiscal, financial, industrial

and trade sectors.

(4) The results of the reforms are reflected in the post – reform period which

covers the period from Eighth Plan (1992 to 1997) to Tenth Plan (2002 –

07).

(5) Some of the major achievements of trade sector reforms are: (a) increase in

trade openness, (b) satisfactory export performance, (c) maintaining a

reasonable level of current account deficit, (d) increase in non – debt

creating capital flows like foreign investment, (e) improvement in indicators

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of reserve adequacy and external debt, (f) control of inflation, (g)

satisfactory industrial and overall Real GDP growth.

(6) Besides this, considering the benefits and costs of capital account

liberalization, the country has followed a cautious approach towards capital

account convertibility. Full capital account convertibility is expected to be

achieved in the years to come.

(7) One of the major objective of reforms was to achieve fiscal consolidation.

The progress of fiscal correction shows mixed result in 1990s. No doubt

there was some reduction in fiscal deficit in the first half of 1990s. But, in

the second half of 1990s the process once again reversed due to industrial

slowdown and the impact of Fifth Pay Commission’s award. Moreover, this

fiscal consolidation was achieved by cutting down capital expenditure

instead of current expenditure.

(8) One of the important developments which took place in the second half of

2007 which affected the entire world was the US sub – prime crisis, which

subsequently became a global financial and economic crisis. This global

economic crisis started affecting India from the beginning of 2008. The

crisis led to rise in CAD / GDP ratio, rise in fiscal deficit, rise in inflation,

rise in capital outflows, etc. At the same time it led to fall in foreign

investments, depreciation of rupee, and a reduction in industrial growth rate.

To overcome the crisis, both the Government of India and RBI undertook

several measures. For instance, the Government of India undertook a fiscal

stimulus package and RBI announced reduction in CRR, SLR and other key

policy rates. However, it can be concluded that three factors helped to

manage the crisis. They were – (a) a well regulated financial sector, (b)

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gradual and cautious opening up of capital account, and (c) the availability

of large stock of foreign exchange reserves.

8.3 POLICY SUGGESTIONS

In the context of present study the following policy measures are suggested -

1) There are many structural weaknesses in the export sector such as – low

efficiency and productivity in resource use, lack of modern technology, lack

of proper planning, marketing and decision making. Hence it is utmost

important to remove the structural weaknesses in the export sector.

2) On the export front it is expected that textiles, engineering goods and

processed food items will be the major export drivers. Hence efforts should

be mobilized to increase the production and exports of these commodities.

3) Besides this there still exists a vast scope for exporting horticultural products

such as fruits and flowers. This can be done by developing appropriate

infrastructure and technology which is required for horticultural products.

4) Indian exports can be made more competitive by faster delivery of export

consignments, post – sale services, strengthening infrastructure, etc.

5) People all over the world are becoming Quality conscious and governments

are laying down rigid Quality standards for all food items and fresh

agricultural products. Hence, it is imperative that the highest attention should

be given to ensure quality of our agricultural products meeting domestic and

international standards. For this purpose, it is necessary to educate the

farmers, food processors, etc. through training programs, workshops, etc.

6) There are various incentive schemes which are available to exporters. All

these schemes are very cumbersome and time consuming, and various

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agencies are involved. These procedures should be simplified with the use of

information technology and policies to promote self – certification by export

houses should be encouraged. Preferential treatment should be granted to

exporters with a good track record.

7) The incentive schemes to promote exports should be designed in such a way

that which could generate maximum growth of exports. Export incentives

should be given to those items which have achieved high growth rates for a

period of ten years or so.

8) There is a scope to diversify Indian exports geographically. This can be

done by increasing exports to non – traditional markets such as Africa, South

Asia and South East Asia.

9) Import liberalization should be based on careful planning and should lead to

growth and higher productivity of Indian industry. The import substitution

industries must be given sufficient opportunity to improve their productive

capacity and competitiveness.

10) Trade liberalization and tariff reforms have provided necessary access to

Indian companies to acquire best inputs available at competitive prices.

Hence, it is necessary to continue with the tariff reforms in future.

11) The level of capital flows in the post – reform period suggests that some

widening of CAD / GDP ratio could be financed without much difficulty.

However, a careful monitoring of this ratio is necessary so that it should not

once again reach to an unsustainable level of beyond 3.0 per cent of GDP.

12) The policy of encouraging non – debt creating flows such as foreign

investment and discouraging debt creating flows such as external commercial

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borrowings and NRI deposits should be continued in order to keep external

debt within manageable levels.

13) In the post – reform period, foreign investment is regarded as a source of

capital, technology and managerial skills. However, adequate steps are still

necessary to enhance foreign direct investment rather than portfolio

investment. This is because it is the foreign direct investment which is

expected to increase employment and output in the country.

14) The fiscal consolidation in the post – reform period has been achieved by

reducing public investment. However, public investment is still essential in

sectors producing public goods and services. Hence, the policy of reduction

in public investment should be reversed.

15) Finally, steps should be undertaken to eventually achieve full capital

account convertibility on the basis of recommendations of the Tarapore

Committee - II.

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