CHAPTER VII IMPACT OF REFORMS ON BALANCE OF PAYMENTS

Transcription

1 CHAPTER VII IMPACT OF REFORMS ON BALANCE OF PAYMENTS 7.1 Introduction 7.2 Impact of Reforms on BOP Indicators 7.3 The Issue of Capital Account Convertibility 7.4 Impact of Reforms on Macroeconomic Indicators 7.5 Global Economic Crisis & India s Balance of Payments 7.6 Statistical Analysis 7. 7 Testing of Hypotheses 7.8 Summary 7.1 INTRODUCTION The Indian economy in general and the external sector in particular began to feel the real and full fledged impact of the stabilization, structural readjustment and policy reform measures introduced through New Economic Policy and the strategy of growth led exports introduced by the EXIM Policy , only by the year onwards. 7.2 IMPACT OF REFORMS ON BOP INDICATORS The impact of reforms has been analysed with reference to various balance of payments indicators like - (1) trade openness, (2) terms of trade, (3) exports & imports, (4) role of invisibles, (5) trends in current account, (6) trends in capital account, (7) external debt, (8) exchange rate management, and (9) reserve management Trade Openness Openness of a country with respect to foreign trade refers to its permissiveness towards exports and imports. Although the term openness of a country is also used 244

2 in the context of its attitude towards other types of inflows and outflows, most importantly capital, the focus is in terms of foreign trade. Ex ante, the openness of a country towards exports / imports is determined by the tariff and non-tariff restrictions it imposes on the flows of foreign trade. In the ex post sense, openness is generally measured by the trade GDP ratio of the country. Measured in terms of both ex ante and ex post definitions, the openness of the Indian economy has increased significantly since the introduction of economic reforms. A key aspect of the trade reforms of the 1990s was the reduction in import duties. India s customs tariff rates have been declining since Prior to 1990s, the maximum import duty rates on certain items were over 300 per cent. The peak rate of import duty on non agricultural imports was gradually reduced from as high as 150 per cent in to 25 per cent in Finally, the peak rate of import duty on non agricultural imports has been brought down to 10 per cent. The weighted average import duty rate declined from the very high level of 72.5 per cent in to 24.6 per cent in Thereafter it edged up again, inter alia, due to the imposition of various surcharges. The increase in the weighted average tariff rates since has been predominantly in agriculture and consumer goods sectors. In , the weighted average import duty rate was 29.0 per cent. Apart from this, the number of basic duty rates has come down drastically from 22 to 4 from to Table 7.1 gives the weighted average duty rates in India from to

3 Table 7.1: Weighted Average Import Duty Rates in India Year All Commodities Peak Customs Duty No. of Basic Duty Rates Source : Ahluwalia Montek (2002) Economic Reforms in India since 1991: Has Gradualism worked? Non tariff barriers are generally considered less desirable than tariffs. The most common non tariff barriers are the restrictions or prohibitions on imports maintained through the import licensing requirements. In the Indian context, for several decades QRs on imports of a wide range of products (mainly consumer goods) were justified for balance of payments reasons. Out of nearly 5000 Harmonized System Tariff lines at the 6 digit level, about 80 per cent were subject to some form of import licensing restrictions in mid With the external sector gathering strength, along with a reduction in tariffs, India has been following a consistent policy for gradual removal of restrictions on imports since In the initial phase of reforms in about 3000 tariff lines covering raw materials, intermediates and capital goods, were freed from licensing restrictions. India began removing BOP related Quantitative Restrictions (QRs) unilaterally since Tariff line wise import policy at 10 digit level of Harmonised System (HS), 246

4 International Trade Classification (ITC) was first announced in 1996, wherein 6161 tariff lines out of 10,096 lines were freed. In the subsequent years from 1997 to 2003 there was an increase in the number of tariff lines which were freed. Thus, the share of unrestricted products (tariff lines) under imports increased to more than 95 per cent in 2003 from about 61 per cent in Table 7.2 shows the details of different types of Non Tariff Barriers in the context of India s imports from 1996 to Reflecting the relaxation of quantitative restrictions, the proportion of items under canalization has declined from 27 per cent in to 19 per cent in It is also important to note that over a period of time there has been a shift in the number of items from Restricted List of Imports to the Open General List in phases. With effect from 31 st March 1999, the convention of publishing a negative list of exports and imports was discontinued. By 2003 action was completed on removal of restriction on tariff lines notified under WTO cover. QRs are however, still being maintained in about 5 per cent of tariff lines as permissible under Articles XX and XXI of GATT on grounds of health, safety, moral conduct and essential security. Year/ Type of NTB Table 7.2: Different Types of Non Tariff Barriers on India s Imports (Number of Tariff lines, 10 digit levels) Prohibited Restricted Canalised Special Import Licence (SIL) Free Total , , , , , , ,032 11, ,103 11,671 Source: Reserve Bank of India Report on Currency & Finance

5 It may be noted that trade liberalization in India has mainly been the result of its own unilateral initiative rather than brought about by multilateral trade commitments or regional trade agreements. In fact, in most items, India s customs tariff rates are at present significantly lower than the corresponding bound rates stemmings from obligations undertaken in the WTO. Table 7.3 shows the data about openness of the Indian economy with reference to exports to GDP, imports to GDP, and export import ratio. Table 7.3 shows that 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. RBI s Report on Currency & Finance has also pointed out that the ratio of exports to GDP increased from an average of 4.6 per cent during the 1980s to 8.0 per cent during the 1990s (excluding the year ) which represents an increase in export orientation of economy by 3.4 percentage points of GDP over one decade. Similarly, imports as a proportion of GDP increased from 7.2 per cent during the 1980s to 9.5 per cent during the 1990s. 1 The noticeable increase in the export GDP and import GDP ratios shows the increasing openness of India s foreign trade regime to global trade. Table 7.3: Openness of the Indian Economy (In Per cent) Period Exports / GDP Imports / GDP Trade / GDP Export / Import ratio to to to Source: Reserve Bank of India Handbook of Statistics on Indian Economy, &

6 It is evident from table 7.3, that India s trade to GDP ratio during the period from to was 11.8 per cent, which went up to 17 per cent during the period from to As per RBI s Report, India s total merchandise trade, an indicator of degree of openness of an economy, increased from about 11.8 per cent of GDP in 1980s to 17.4 per cent during the 1990s. 2 Further analysis of the data from to shows that it went up to nearly 27 per cent. Furthermore, table 7.3 also shows the average export import ratio, which is an indicator of the import financing capacity of exports. The export import ratio increased from about 64 per cent in the decade of 1980s to 84 per cent in 1990s. The RBI s Report too, confirms this view, as per the Report, the average export import ratio improved sharply from 64.0 per cent to 84.1 per cent between the 1980s and 1990s, and further increased to 85.2 per cent in The increase in export import ratio has thus reflected increase in alignment between India s export and import performance during the nineties as compared to eighties. 3 Further analysis of export import ratio from to shows that it decreased to 74 per cent. To conclude, the given data confirms the view that there has been an increase in India s trade openness after the reforms. Fig. 7.1 shows India s foreign trade ratios from to As is clear from fig.7.1 that all the ratios i.e. exports to GDP ( X/GDP), imports to GDP (M/GDP) and trade to GDP (TR/GDP) are reflecting an increasing trend, which is a reflection of India s growing trade openness. 249

7 Fig. 7.1 India s Foreign Trade Ratios 1991 to 2007 As Per cent of GDP ' 91-92' 92-93' 93-94' 94-95' 95-96' 96-97' 97-98' 98-99' Year 99-00' 00-01' 01-02' 02-03' 03-04' 04-05' 05-06' 06-07' X/GDP M/GDP TR/GDP Impact on Terms of Trade The success of reform measures also depends upon whether the terms of trade have moved in India s favour or not? There are three concepts of terms of trade which are commonly used in international economics. They are - (a) Gross barter terms of trade, (b) Net barter terms of trade, and (c) Income terms of trade. (a) Gross barter terms of trade imply volume index of exports expressed as a percentage of volume index of imports. (b) Net barter terms of trade imply unit value index of exports expressed as a percentage of unit value index of imports. (c) Income terms of trade imply the product of net barter terms of trade and volume index of exports expressed as a percentage. In general, a rise in unit value of exports in relation to the unit value of imports improves the country s terms of trade and has stimulating effect on export earnings. 250

8 Hence, it is the concept of net terms of trade which is commonly used by economists in their analysis of terms of trade. Table 7.4: India s Terms of Trade ( = 100) Period Gross Net Income to to to Source: Reserve Bank of India Handbook of Statistics on Indian Economy, & Table 7.4 shows that India s average gross barter terms of trade have declined from 145 in 1980s to 135 in 1990s and has been stable thereafter. However, the yearly data indicates that there was an improvement in the gross barter terms of trade in the first few years after the reforms. Similarly, India s net terms of trade, which measures the relative change in export and import prices have been generally fluctuating during the 1990s. But, a comparison between 1980s and 1990s shows that the net terms of trade have improved from 110 to 135. However, from to it has come down to 125. Import purchasing power of exports as measured by the income terms of trade have consistently improved during the 1990s on account of strong export growth in volume terms. The income terms of trade, increased from on an average from in 1980s to in the 1990s and further to from to In the Indian context, a number of studies have been undertaken to analyse the movement of terms of trade. An exercise for the period to

9 shows that there has been a secular upward movement in terms of trade ( in all the three measures : gross, net and income) during this period. The terms of trade pessimism has, therefore, not been validated in the Indian context. There has also been some apprehension regarding higher volatility of terms of trade following the opening up of the Indian economy. An analysis of India s terms of trade during the 1990s reveals that its volatility has come down significantly since as compared to the period between to , a period when the economy was relatively inward looking. (Table 7.5) Thus, we can conclude that the reforms have resulted into favourable terms of trade and large gains from trade for India. Table 7.5: India s Terms of Trade ( = 100) Period Gross Net Income to Mean CV to Mean CV Note : CV = Co-efficient of Variation Source: Government of India (2003) Economic Survey With the introduction of economic reforms since , there has been a substantial rise in both unit value and volume of exports. Though the increase in the volume of exports indicates the growth of exports in real terms, the unit value is the basic determinant of a country s balance of trade. The phenomenal rise in the unit value of exports since has led to an impressive improvement in India s terms of trade leading to a significant rise in exports and reduction in the balance of trade. 252

10 Table 7.6 gives the indices of India s exports in terms of unit value and volume. It is observed from table 7.6, that from to , the unit value index of exports rose from 108 to 292, and the volume index rose from 108 to 194. Hence, from to , the percentage change in unit value index was about 170 per cent and that of volume index was about 80 per cent. From to , the unit value index increased from 292 to 604, and the volume index rose from 194 to 461. Hence, from to , the percentage change in unit value index was 107, and that of volume index was 138. Thus, the volume index of exports has shown greater percentage increase in the 1990s after the reforms. In the year , the unit value index stood at 863 and the volume index stood at Thus, the percentage change in unit value index from to is 43 per cent and that of volume index is 153 per cent. Table 7.6 Indices of India s Exports ( = 100) Year Unit Value index Volume Index Percentage change (Unit value) Percentage change (Volume) Source: Reserve Bank of India Handbook of Statistics on Indian Economy, & It is observed from table 7.7, that from to , the unit value index of imports rose from 134 to 267, and the volume index rose from 137 to 237. Hence, from to , the percentage change in unit value index was about 99 per cent and that of volume index was about 72 per cent. From

11 to , the unit value index increased from 267 to 450, and the volume index rose from 237 to 705. Hence, from to , the percentage change in unit value index was 68, and that of volume index was 196. Thus, the volume index of imports has shown greater percentage increase in the 1990s after the reforms. In the year , the unit value index stood at 608 and the volume index stood at Thus, the percentage change in unit value index from to is 35 per cent and that of volume index is 190 per cent. Table 7.7 Indices of India s Imports ( = 100) Year Unit Value index Volume Index Percentage change (Unit value) Percentage change (Volume) Source: Reserve Bank of India Handbook of Statistics on Indian Economy, & An analysis of indices of exports and imports (unit value & volume) supports the observation in table 7.4 that India s net terms of trade became favourable and increased from 110 to 135 in the post reform period. It also supports the observation in table 7.4 that there was a decrease in net terms of trade from 135 to 125 from to

12 7.2.3 Impact on Exports & Imports It can be argued that the trade policy reforms initiated in 1991 have drastically changed the scenario and have resulted in a shift from inward oriented policy of the past to an outward oriented policy. Hence, the impact of reforms on exports & imports have been analysed in relation to - changes in export and import growth rates, changes in composition of exports and imports, direction of exports & imports etc. (a) Export Import Growth Rates As can be observed from table 7.8 that, both export and import growth rates registered an increase in the post reform period vis a vis 1980s. For instance, the average annual export growth rate rose from 16.8 per cent in 1980s to in 1990s. From 2001 to 2007, it was 18.0 per cent showing a marginal improvement. On the other hand, average annual import growth rate rose from14.55 in 1980s to in 1990s. From 2001 to 2007, it was 21.4 per cent, showing some improvement. Table 7.8: Growth Rates of Exports & Imports (In `. terms) (In Per cent) Particulars Exports Imports Source : Reserve Bank of India Handbook of Statistics on Indian Economy & However, a detailed calculation on the rates of growth in 1990s shows that the performance in the second half of the 1990s deteriorated considerably as compared with the first half of 1990s. (Table 7.9) For instance, on an average annual basis export growth rate during the first half of 1990s ( ) was per cent, 255

13 which fell considerably to 9.85 per cent in the second half of 1990s ( ). Similarly, on an average annual basis import growth rate fell from per cent in the first half of 1990s to per cent during the second half of 1990s. Table 7.9: Growth Rates of Exports & Imports (In `. terms) (In Per cent) Particulars Exports Imports Source: Reserve Bank of India Handbook of Statistics on Indian Economy & Some of the reasons for slowdown in export and import growth rate in the second half of 1990s can be attributed partly to slowdown in economic activity, fall in demand due to East Asian crisis, imposition of Non- tariff barriers by developed countries, weakening of overall demand and world trade volume. (b) Structure & Composition of Exports The impact of reforms can also be observed with respect to changes in the structure and composition of India s exports. The composition of exports is given in table Table 7.10 reflects some of the important observations regarding changes in the composition of exports in the post reform period. The observations are as follows: 1) The share of primary products (including agriculture & allied products and ores and minerals) in total exports was per cent in , and 24.0 per cent in It decreased to per cent in Further, by it fell to 15.5 per cent. 256

14 2) Manufactured products account for a major share of the increase in aggregate exports over the period to The share of manufactured products in total exports was 55.8 per cent in , which increased to 72.9 per cent, in By , its share went up to 80.7 per cent. This increase in share of exports of manufactured products clearly indicates that India has gradually transformed from a predominantly primary products exporting country into an exporter of manufactured goods. Aided by various export promotion measures, the share of manufactured goods in India s total exports increased from 70.7 per cent during to 75.3 during and further to 77.4 per cent during the However, in , the share of manufactured products in total exports fell to 67.2 per cent. 3) One interesting development regarding composition of exports can be cited with reference to exports of petroleum products. The share of petroleum products increased from 0.4 per cent in , to 2.9 per cent in , and further to 14.8 per cent in ) The commodity composition within the major groups has also undergone a considerable transformation. For instance, within the primary group, the share of ores and minerals, & traditional items like tea, coffee, cereals, handicrafts and carpets has declined while that of engineering goods and processed agricultural products has shown marked improvement in the post reform years. Similarly, the share of chemicals and allied products has improved while that of leather and manufactures has declined in the post reform period. 257

15 5) Export basket when classified on the basis of technology intensity reveals certain interesting facts. According to this, exports can be classified into five groups. The export basket can be categorized into primary commodities (Group I), manufactures based on labour and natural resources (Group II), manufactures characterized by low technology intensity (Group III), medium technology intensity (Group IV) and high technology intensity (Group V). Disaggregating India s exports according to this classification shows that although the share of other low and high intensive technology intensive exports has improved since the 1980s, the bulk of the structural shift has been concentrated in labour and natural resource based manufactures. (Group II). As a result, the products wherein India has the maximum presence in international market in terms of export share continued to be Group I and II commodities (such as, spices, marine products, precious and semi-precious stones, textiles, etc) during most of the 1990s. Data for recent years, however, indicate that the commodity structure of India s exports has slowly begun to shift towards higher technology intensive manufactures. 5 (Table 7.11). 6) It is expected that the future export drivers for India will be textiles, engineering goods, including automobiles and capital goods and processed food items. Textiles have long been a traditional export item for India accounting for nearly one fifth of the total exports during the 1990s. With the phasing out of Multi Fibre Arrangement (MFA) and dismantling of quotas from January 1, 2005, the potential for India s textile exports is likely to increase significantly. India s advantage in textile production, which is 258

16 labour intensive, lies in its competitive advantage in labour, raw materials including cotton and low import intensity. 7) Finally, India s export share in the world trade has increased perceptibly during the recent period. On an average, it was 0.48 per cent in 1980s, which increased to 0.53 per cent in By 2000 it was 0.72 per cent and by 2004 it was 0.84 per cent. To conclude, it can be pointed out that there was a perceptible improvement in India s export performance in the initial phase of the reform period both at the overall level and across commodities. The commodity composition of India s export basket has changed in favour of technology intensive and industrial products such as engineering goods, besides high value agricultural products. At the same time, reservations for the small scale industries, high transaction costs and low levels of factor productivity have adversely affected the performance of exports of our country. Table 7.10: Composition of India s Exports (In Per cent) Commodity Group I Primary Products II Manufactured Products III Petroleum Products IV Others ( Unclassified) Total Source: Reserve Bank of India Handbook of Statistics on Indian Economy &

17 Table 7.11: Technology Intensity of India s Exports (Percentage of total non oil exports) Commodity Group Group I Primary Commodities Group II - Manufactures (Based on labour & natural resources Group III Manufactures (Characterised by low technology intensity) Group IV Medium technology intensity Group V High Technology intensity Others Total Source: Reserve Bank of India : Report on Currency & Finance (c) Competitiveness of Exports - Exports of a country are said to be competitive if the country is able to sell its products at a lower or same price and earn the same return as its competitors. Competitiveness could arise from favourable endowment base in the economy, lower cost consideration or from better quality of the commodity produced. Export competitiveness depends on variables such as - remuneration of factors of production, exchange rate, productivity through the use of better technical skills and human resource development, and economies of scale. Besides this, institutional and policy mechanisms also play a pivotal role in enhancing the competitiveness. Finally, other non price factors such as quality and branding are also important which can contribute to exports competitiveness. An analysis of competitiveness of manufactured exports, as measured by a number of indicators reveals that India has competitive advantage with respect to some key indicators, viz., real exchange rate, labour productivity and unit labour cost. In fact, 260

18 the unit labour cost of manufacturing exports in India is one of the lowest among the developing countries. Revealed Comparative Advantage (RCA) is one of the indicators of a country s export competitiveness. RCA evaluates an economy s export share in a given sector relative to its overall export share. Information based on export data for India s four major exporting items viz. iron and steel, chemicals, textiles and clothing, for the year 1990 and 2000 reveals that India has been able to successfully consolidate its position in international markets in all these export sectors. Moreover, in sectors, such as, iron and steel, and chemicals, India appears to have a relatively more dominant presence in the world market vis a vis comparable countries such as China and Korea. Table 7.12 depicts the RCA of select manufacturing sectors of India, China & Korea. Table 7.12: Revealed Comparative Advantage of Select Manufacturing Sectors: Comparison of India, China & Korea Country Year Iron & Steel India Chemicals Textiles Clothing China Korea Source: Reserve Bank of India: Report on Currency & Finance (d) Structure & Composition of Imports Prior to , imports were classified into four groups namely, food and live animals chiefly for food, (Group I), raw materials and intermediate manufactures (Group II), capital goods (Group III), 261

19 and others (Group IV). However, from , onwards there has been a change in the classification of importables. They are classified into mainly two groups which are - Bulk imports (Group I), and Non bulk imports (Group II). The analysis of the changes in the structure and composition of imports in the post reform period is based on the classification from Hence, strict comparison between and is excluded. The composition of India s imports and structural changes therein during the post reform period are reflected in table The main observations are as follows 1) Petroleum and petroleum products have been the most significant item among bulk imports. The share of this item was 42 per cent in , which fell to 25.0 in In its share marginally went up to per cent. In , its share went up to per cent. It is pertinent to note that, while the share and absolute value of these imports showed sharp fluctuations over the years mainly on account of the large movements in international crude prices, the volume of such imports has grown significantly on account of increase in domestic consumption and the stagnation in domestic crude oil production. 2) Imports of capital goods occupy a dominant place in non bulk imports. The percentage share of imports of capital goods have remained almost stable during the post reform period. For instance, its share was 15.2 per cent in , which increased to 24.2 per cent in In its share decreased to per cent, however, by , its share again went up to per cent. 3) Commodity wise analysis reveals that while petroleum still continues to have a dominant presence in India s imports, capital goods and other 262

20 intermediary products for export purposes have emerged as key items of imports in the 1990s. 4) To meet the requirements of the gems and jewellery industry pearls and precious & semi precious stones are imported in large quantities. Pearls and precious stones imports were 3.3 per cent of total imports in , they more than doubled to 8.7 per cent by Its share was per cent in Its share then fell to 4.0 per cent in The declining share indicates high import intensity. 5) As a result of liberalization of trade policy in the post reform period and changing consumer tastes and preferences, imports of electronic goods and consumer goods have increased substantially during the post reform period. For instance, in , imports of electronic goods and consumer goods were just 4 per cent of total import expenditure. By , its share went up to 8.7 per cent of total import expenditure. 6) Another significant development during the 1990s has been the channelising of imports of gold through official routes. Imports of gold and silver have increased in the post - reform period due to a switchover from unofficial channel to official channel, initially through NRI baggage route, and subsequently through OGL route. 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. 263

21 Table 7.13: Composition of India s Imports (In Per cent) Items I Bulk Imports Of which (a)petroleum, Crude & Products (b) Bulk Consumption Goods (c) Other Bulk items II Non Bulk Imports Of which (a) Capital goods (b) Mainly Export Related Items (c) Others Total Imports Source: Reserve Bank of India Handbook of Statistics on Indian Economy & (e) Import Intensity of Exports in India Import intensity of exports can simply be defined as the degree of value addition of an imported item that subsequently gets exported. In the Indian context, gems and jewellery is a typical example of such export product having high import intensity. Another way of defining import intensity of exports is to identify those exports which are heavily dependent on imported inputs. It is observed that import intensity of exports for gems and jewellery and chemicals and allied products is very high. The extent of such import intensity however appears to be declining for both the items in recent years. Table 7.14 depicts the import intensity of select exports such as gems & jewellery and chemicals & allied products. It can be observed from table 7.14 that import intensity of gems & jewellery which was 72.5 in declined to in and that of chemicals and allied products declined from 61.1 to during the same period. One possible explanation for this decline in import intensity of exports can be increase in the domestic production of inputs which are required for this products. 264

22 Table 7.14: Import Intensity of Select Export Commodities (In Per cent) Products Gems & Jewellery Chemicals & Allied Products Source: Reserve Bank of India Report on Currency & Finance & Handbook of Statistics on Indian Economy (f) Direction of Exports & Imports For analyzing direction of exports and imports the countries have been divided into five groups like OECD (Group I), OPEC (Group II), Eastern Europe (Group III), Developing countries (Group IV), and Others (Group V). Some of the important observations regarding direction of exports as shown in table 7.15 are as follows 1) Destination - wise analysis of the Indian exports indicates an unchanged position in respect of Organisation for Economic Cooperation and Development (OECD) group being the largest market, increasing prominence of the Organisation of Petroleum Exporting Countries (OPEC) and the developing countries (Asia, Africa, and Latin America), and a steep erosion in the relative position of Eastern Europe. 2) As is clear from table 7.15, the share of OECD countries in India s export earnings was 46.6 per cent in , it further increased to 53.5 per cent in It was per cent in However, it came down to 41.2 per cent in ) The share of OPEC group in India s export earnings was 11.1 per cent in , which nearly halved to 5.6 per cent in By

23 2000, it doubled to per cent in In , it was increased to 16.4 per cent. 4) The share of Eastern Europe in India s exports was 22.1 per cent in , and 17.9 per cent in But, due to the disintegration of communist regimes, the share of Eastern Europe in India s export earnings drastically fell to 3.5 per cent in In , the share of Eastern Europe was a mere 2.0 per cent. 5) India s exports to developing countries were 19.2 per cent of total exports in It then marginally decreased to 17.1 per cent in But, within a span of ten years it increased to 28.4 per cent by Further, within a span of another six years it has shown a marked improvement and the share went up to 40.2 per cent in ) At the disaggregate level we find that almost half of the exports to OECD countries, are accounted by European Union Countries. 7) It is observed that among developing countries, India s exports to Asia occupies a larger share and has been increasing over a period of time. For instance, exports to Asia were 13.4 per cent in , which marginally increased to 14.4 per cent in In , its share was per cent and it further went up to 29.8 per cent in

24 Table 7.15: Direction of Exports (In Per cent) Group I OECD of which (a)european Union (EU) (b) Others II OPEC III Eastern Europe IV Developing Countries Of which (a) Asia (b) Others V Others Total Source: Reserve Bank of India Handbook of Statistics on Indian Economy & With respect to direction of imports as depicted in table 7.16 the important observations are as follows: 1) As is clear from the table 7.16 the share of imports from OECD countries was 45.7 per cent in , which further increased to 54.0 per cent in It fell to 43 per cent in and further to 34.5 per cent in The main reason for this was a fall in the share of European 267

25 Union from 29.4 per cent in to per cent in and to 15.3 per cent in ) The share of imports from OPEC group was 27.8 per cent in , which fell to 16.3 per cent in It increased to per cent in By it went up to 30.2 per cent. 3) The share of Eastern Europe in imports was 10.8 per cent in and 7.8 per cent in It drastically fell to 2 per cent in , mainly because of disintegration of USSR. By , its share marginally went up to 2.7 per cent. 4) The share of imports from developing countries increased from 15.7 per cent in , to 18.6 per cent in But within a span of ten years it increased to 29 per cent in In the year , imports from developing countries were 32.2 per cent of India s total imports. 5) It is important to note that among developing countries, imports from Asian countries occupy a larger share. For instance, imports from Asian countries were 14.0 per cent in , which went up to 20.0 per cent in and further to 25.5 per cent in ) It is important to note that subsequent to the opening up, India s imports have been sourced from a wider range of countries. The traditional import partners like Germany, Japan, UK & Australia have lost their relative market share, while new import partners from Africa and East Asia (including China) are gaining importance. 7) In recent years, Belgium from where India imports its major export oriented item of gems and jewellery, has emerged as one of the principal sources of imports. 268

26 Table 7.16: Direction of Imports (In Per cent) Group I OECD of which (a)european Union (EU) (b) Others II OPEC III Eastern Europe IV Developing Countries Of which (a) Asia (b) Others V Others Total Source: Reserve Bank of India Handbook of Statistics on Indian Economy & Financing of Trade Deficit Role of Invisibles in the Post Reform Period Invisibles have been considered as the most dependable source of financing country s trade deficits. The importance of invisibles increased tremendously after the initiation of trade reform measures in The fundamental changes in exchange and payment regime and opening up of the economy has resulted in buoyancy and substantial improvement in the invisible receipts. This has been 269

27 further boosted by technology related exports in general and software exports in particular and also by increase in investment income caused by high and increased foreign exchange reserves of the RBI. Invisible receipts mainly include all the income received in the form of travel, banking, consultancy, transportation, insurance, investment income, private transfers and official transfers. While invisible payments include all the payments made in the form of travel, transportation, insurance, investment income, private transfers and official transfers. As depicted in table 7.17, over a period of time invisible receipts as a percentage of GDP doubled from 2.4 per cent in to 4.8 per cent in It further increased to 6.7 per cent in Further within a span of seven years it doubled to 12.5 per cent of GDP in Net invisibles include the difference between the invisible receipts & invisible payments. A positive net invisibles means invisible receipts are more than invisible payments. While a negative net invisibles means invisible receipts are less than invisible payments. Thus, it is the positive net invisibles which finance the trade deficit. As shown in table 7.17, in , net invisibles as a percentage of GDP were negative i.e. 0.1 per cent. However, within a few years after reforms, it reached to a positive figure of 1.8 per cent in By , net invisibles 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 As pointed out by RBI s Report on Currency & Finance One of the most significant developments in current account of balance of payments in the 1990s was the remarkable growth in service transactions with the rest of the world, which was made possible by the revolution in information and communication 270

28 technology Reflecting the strong growth emanating from software exports, the traditional sources of service exports, viz., travel and transportation have declined in relative importance. Following the heavy inflow of invisible receipts, India s current account deficit (CAD) narrowed down considerably during the decade of 1990s. 6 Table 7.17: Invisible Receipts & Net Invisibles in the Post - Reform Period (In Per cent) Particulars Invisibles Receipts / GDP Net Invisibles / GDP Source: Reserve Bank of India Handbook of Statistics on Indian Economy & Although year to year fluctuations were there in net invisibles, on an average, 63 per cent of trade deficit was financed by net invisibles from to Earnings from invisibles exceeded the deficit on trade account in , and , with the result that there was a surplus in current account in these years. A detailed analysis of trends in invisibles as depicted in table 7.18 reveals the following (a) From 1991 to 2000, the average invisible receipts to GDP ratio was 4.75 per cent. In the first half of 1990s ( ), it was 3.70 per cent which increased to 5.8 per cent in the second half of 1990s.( ). Further, within a span of seven years ( ) it increased to 9.35 per cent. (b) From 1991 to 2000, the average net invisibles to GDP ratio was 1.55 per cent. In the first half of 1990s ( ) it was a mere 0.8 per cent. However, in the 271

29 second half of 1990s ( ) the percentage increased to 2.3 per cent. Further, from , it went up to 4.08 per cent. (c) The increase in the invisibles receipts to GDP ratio & net invisibles to GDP ratio, particularly from 1996 to 2007 can be attributed to the increase in service exports. (d) Table 7.19 depicts plan - wise financing of trade deficit by net invisibles. As is clear from table 7.19, in the Seventh Plan ( ), invisibles were able to finance only 25 per cent of trade deficit. But, from Eighth Plan onwards, the net invisibles have been able to finance more than 50 per cent of trade deficit. For instance, in the Eighth Plan ( ), 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 ( ). Further, in the Tenth Plan ( ), almost 99 per cent of trade deficit was financed by invisibles. This is because in the first two years of the Tenth Plan ( & ), the net invisibles were more than the trade deficit, resulting into current account surplus, in these two years. As is clear from table 7.19, the period of the Seventh Plan was a pre reform period and the period from Eighth Plan onwards is a post reform period. Hence, it can be concluded that invisibles have played an important role in the financing of trade deficit in the post reform period. Table 7.18: Invisible Receipts / GDP & Net Invisibles / GDP (In Per cent) Particulars Invisibles Receipts / GDP Net Invisibles / GDP Source: Reserve Bank of India Handbook of Statistics on Indian Economy &

30 Table 7.19: Financing of Trade Deficit by Net Invisibles (Plan wise Annual average) Particulars Seventh Plan ( ) Eighth Plan ( ) Ninth Plan ( ) Tenth Plan ( ) Trade Balance (In `. Crore) Invisibles Net (In `.Crore) Financing of trade deficit by Net Invisibles ( In Per cent ) Source: Reserve Bank of India Handbook of Statistics on Indian Economy & Fig.7.2 Trends in Invisibles 1991 to As Per cent of GDP Invisibles Receipts / GDP Invisibles Net / GDP ' 92-93' 94-95' 96-97' 98-99' Year 00-01' 02-03' 04-05' 06-07' Fig.7.2 shows the trends in invisibles from to It is clear from fig.7.2 that invisible receipts to GDP ratio was 2.4 in which increased to 6.7 in Further, within a span of seven years it doubled to 12.5 per cent. Similarly, the invisibles net to GDP ratio was a negative (- 0.1) in In the 273

31 year , the figure turned to be positive and gradually increased to 2.9 per cent in Again within a span of seven years it doubled to 5.8 per cent Trends in Current Account One of the factors underlying the external payments crisis of 1991 was the high levels of current account deficits (CAD) maintained during the 1980s which at the time of crisis had reached 3.1 per cent of GDP, well above the sustainable level for India. However, a combination of prudent and unorthodox policies for stabilization and structural change ensured that the crisis did not translate into financial instability or crisis. The external sector policies implemented in 1991, emphasized competitiveness of exports of both goods & services, a realistic and market based exchange rate regime, consolidation of external debt and a policy preference for non debt creating capital flows. These policies ensured that the current account deficit remained around one per cent of GDP and was comfortably financed even as the degree of openness of the economy rose significantly relative to preceding decades and capital flows began to dominate the balance of payments. A detailed study of the data of current account deficit to GDP ratio, as given in table 7.20, indicates that the CAD / GDP ratio reduced from 3.1 per cent in to 0.3 per cent in the year The average CAD / GDP ratio works out to be 1.02 per cent from the period to Further, there was a current account surplus for three consecutive years from to In , it was 0.7 per cent, in , it was 1.2 per cent and in it was 2.3 per cent. Thus, it is the first time in post independence period that there was a current account surplus in three consecutive years. 274

32 After recording a surplus for three years in a row, the current account once again recorded a deficit of 0.4 per cent of GDP in the year This deficit increased to 1.2 per cent in and marginally reduced to 1.1 per cent in In the context of current account, the Economic Survey observed: The current account has followed an inverted U shape pattern during the period to , rising to a surplus of over 2 per cent of GDP in Thereafter, it has returned close to its post 1990s reform average with a CAD of 1.2 per cent in , and 1.1 per cent in Table 7.20: Current Account Deficit 1991 to 2007 (As Percent of GDP) Year Current Account Deficit Note: A minus sign (-) indicates a surplus. Source: Reserve Bank of India Handbook of Statistics on Indian Economy &

33 In general, the history of the current account in India has followed distinct phases such as: (1) late 1950s to early 1960s when the current account deficit simply mirrored the deficits in merchandise trade; (2) mid 1970s till early 1980s when the trade deficit was moderated to a significant extent by surpluses in the invisible account; (3) second half of the 1980s when a distinct decline in support from invisible surpluses turned out to be a key factor in precipitating the crisis of ; and (4) the post period, when resumption of growth in net invisible earnings underpinned the favourable movement in India s current account balance. 8 With reference to successful management of current account in the post reform period, Reddy (2005) has pointed out certain unique features. They are: (a) The lessons of the 1991 crisis brought forth policies which ensured a low current account deficit in the ensuing years. This approach stood us in good stead in warding off the contagion from the Asian crisis of (b) 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. (c)the low current account deficit was underpinned by shifts in international competitiveness favouring software, IT exports and worker s remittances over traditional exports. (d) Although the fiscal deficit remained somewhat inflexible, it was not allowed to spill over into the current account, and (e) The current account deficit being the mirror image of the absorptive capacity, is best assessed over the business cycle rather than at discrete points. 9 Besides analyzing trends in the current account it is also necessary to consider the relationship between (a) exchange rates and current account, (b) current account and 276

34 saving investment balance, (c) fiscal deficit and current account and (d) operational issues of current account sustainability. (a) Exchange Rates and the Current Account - The exchange rate is widely accepted as a key determinant of current account balance. A downward movement in exchange rate leads to fall in export prices and rise in import prices, thus making exports cheaper (in foreign currency terms) and imports costlier (in domestic currency terms). This leads to rise in foreign demand and fall in domestic demand. These effects, in turn, bring about changes in the current account balance. From a policy perspective, the desired effects of exchange rate changes on the current account depend upon the Marshall Lerner condition i.e. - the sum of the price elasticities of foreign demand for exports and the domestic demand for imports should exceed one. The salutary effects of a change in the exchange rate in the on the current account depends critically on the extent to which exchange rate adjustment is transmitted to foreign currency export prices and import prices in the domestic currency i.e. the degree of pass through. Pass through is said to be complete when export prices (in foreign currency terms) & import prices (expressed in local currency) rise or fall by the full amount of the exchange rate change. Conversely, if the export prices in foreign currency do not change but do, in terms of domestic currency and on the other hand, import prices in domestic currency remain stable with prices of overseas exports bearing the exchange rate change, pass through is said to be zero. In the Indian context, studies in the early 1990s, for instance by Ghosh (1990) 10 & Sarkar (1992) 11 expressed pessimism regarding the role of exchange rate in improving export performance. A number of subsequent studies showed empirical evidence confirming the role of exchange rates as a significant determinant of 277