CHAPTER VII IMPACT OF REFORMS ON BALANCE OF PAYMENTS

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 1992 97, only by the year 1992 93 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. 7.2.1 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

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 1991. 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 1991 92 to 25 per cent in 2003 04. 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 1991 92 to 24.6 per cent in 1996-97. Thereafter it edged up again, inter alia, due to the imposition of various surcharges. The increase in the weighted average tariff rates since 1998 99 has been predominantly in agriculture and consumer goods sectors. In 2002 03, 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 1991 92 to 2002 03. Table 7.1 gives the weighted average duty rates in India from 1991 92 to 2002 03. 245

Table 7.1: Weighted Average Import Duty Rates in India Year All Commodities Peak Customs Duty No. of Basic Duty Rates 1991 92 72.5 150 22 1992 93 60.6 110 20 1993 94 46.8 85 16 1994 95 38.2 65 16 1995-96 25.9 50 12 1996 97 24.6 52 9 1997 98 25.4 45 8 1998 99 29.2 45 7 1999 00 31.4 40 7 2000 01 35.7 38.5 5 2001 02 35.1 35.8 4 2002-03 29.0 30.8 4 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 1991. 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 1991. In the initial phase of reforms in 1991 92 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 1996. Tariff line wise import policy at 10 digit level of Harmonised System (HS), 246

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 1996. Table 7.2 shows the details of different types of Non Tariff Barriers in the context of India s imports from 1996 to 2003. Reflecting the relaxation of quantitative restrictions, the proportion of items under canalization has declined from 27 per cent in 1988-89 to 19 per cent in 1997 98. 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 1996 59 2984 127 765 6161 10,096 1997 59 2322 129 1043 10,202 6649 1998 59 2314 129 919 6781 10,202 1999 59 1183 37 886 8055 10,220 2000 59 968 34 226 8854 10,141 2001 59 479 29 -- 9582 10,149 2002 52 554 33 -- 11,032 11,671 2003 52 484 32 -- 11,103 11,671 Source: Reserve Bank of India Report on Currency & Finance 2002-03 247

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 2001 02 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 1991 92 ) 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 1980-81 to 1989-4.6 7.2 11.8 63.8 90 1990-91 to 1999 7.8 9.3 17.1 84.0-2000 2000-01 to 2006-07 11.4 15.3 26.8 74.2 Source: Reserve Bank of India Handbook of Statistics on Indian Economy, 2005 06 & 2007 08. 248

It is evident from table 7.3, that 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. 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 2000 01 to 2006-07 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 2001 02. 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 2000 01 to 2006 07 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 1990-91 to 2006 07. 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

Fig. 7.1 India s Foreign Trade Ratios 1991 to 2007 As Per cent of GDP 40 35 30 25 20 15 10 5 0 90-91' 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 7.2.2 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

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 (1978 79 = 100) Period Gross Net Income 1980 81 to 1989-90 145.29 110.00 141.50 1990-91 to 1999-2000 134.38 134.75 439.50 2000 01 to 2006-07 135.35 125.35 1034.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy, 2005 06 & 2007 08. 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 2000 01 to 2006 07 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 141.5 in 1980s to 439.5 in the 1990s and further to 1034.0 from 2000 01 to 2006 07. In the Indian context, a number of studies have been undertaken to analyse the movement of terms of trade. An exercise for the period 1970 71 to 2001 02 251

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 1992 93 as compared to the period between 1970 71 to 1989-90, 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 (1978 79 = 100) Period Gross Net Income 1970-71 to 1989-90 Mean 126.9 111.1 114.6 CV 19.6 17.3 34.9 1990 91 to 2001-02 Mean 134.6 134.7 510.9 CV 10.1 9.6 33.3 Note : CV = Co-efficient of Variation Source: Government of India (2003) Economic Survey 2002 03. With the introduction of economic reforms since 1991 92, 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 1990 91 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

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 1980 81 to 1990 91, the unit value index of exports rose from 108 to 292, and the volume index rose from 108 to 194. Hence, from 1980 81 to 1990 91, the percentage change in unit value index was about 170 per cent and that of volume index was about 80 per cent. From 1990 91 to 1999 2000, the unit value index increased from 292 to 604, and the volume index rose from 194 to 461. Hence, from 1990 91 to 1999 2000, 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 2006 07, the unit value index stood at 863 and the volume index stood at 1164. Thus, the percentage change in unit value index from 1999 2000 to 2006 07 is 43 per cent and that of volume index is 153 per cent. Table 7.6 Indices of India s Exports (1978 79 = 100) Year Unit Value index Volume Index Percentage change (Unit value) Percentage change (Volume) 1980-81 108.5 108.1 --- --- 1990 91 292.5 194.1 170.35 79.60 1999 00 604.0 461.0 106.85 137.60 2006-07 863.0 1164.0 42.90 152.50 Source: Reserve Bank of India Handbook of Statistics on Indian Economy, 2005 06 & 2007 08. It is observed from table 7.7, that from 1980 81 to 1990 91, the unit value index of imports rose from 134 to 267, and the volume index rose from 137 to 237. Hence, from 1980 81 to 1990 91, the percentage change in unit value index was about 99 per cent and that of volume index was about 72 per cent. From 1990 91 253

to 1999 2000, the unit value index increased from 267 to 450, and the volume index rose from 237 to 705. Hence, from 1990 91 to 1999 2000, 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 2006 07, the unit value index stood at 608 and the volume index stood at 2047. Thus, the percentage change in unit value index from 1999 2000 to 2006 07 is 35 per cent and that of volume index is 190 per cent. Table 7.7 Indices of India s Imports (1978 79 = 100) Year Unit Value index Volume Index Percentage change (Unit value) Percentage change (Volume) 1980 81 134.2 137.9 --- --- 1990 91 267.7 237.7 99.00 72.45 1999 00 450.0 705.0 68.00 196.00 2006-07 608.0 2047 35.12 190.35 Source: Reserve Bank of India Handbook of Statistics on Indian Economy, 2005 06 & 2007 08. 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 2000 01 to 2006-07. 254

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 17.45 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 18.75 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 1981-1990 1991-2000 2001-2007 Exports 16.80 17.45 18.00 Imports 14.55 18.75 21.40 Source : Reserve Bank of India Handbook of Statistics on Indian Economy 2005 06 & 2007-08 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 (1991 95) was 23.25 per cent, 255

which fell considerably to 9.85 per cent in the second half of 1990s (1996 2000). Similarly, on an average annual basis import growth rate fell from 21.15 per cent in the first half of 1990s to 11.25 per cent during the second half of 1990s. Table 7.9: Growth Rates of Exports & Imports (In `. terms) (In Per cent) Particulars 1991-1995 1996-2000 Exports 23.25 9.85 Imports 21.15 11.25 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 06 & 2007-08 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 7.10. 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 36.80 per cent in 1980 81, and 24.0 per cent in 1990 91. It decreased to 17.70 per cent in 1999 2000.Further, by 2006 07 it fell to 15.5 per cent. 256

2) Manufactured products account for a major share of the increase in aggregate exports over the period 1990 91 to 2006-07. The share of manufactured products in total exports was 55.8 per cent in 1980 81, which increased to 72.9 per cent, in 1990 91. By 1999 2000, 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 1987 90 to 75.3 during 1992 97 and further to 77.4 per cent during the 1997 2002. 4 However, in 2006 07, 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 1980 81, to 2.9 per cent in 1990 91, and further to 14.8 per cent in 2006-07. 4) 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

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

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 1990. 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 1980 81 1990 91 1999 2000 2006-07 I Primary Products 36.80 24.00 17.70 15.50 II Manufactured Products 55.80 72.90 80.70 67.20 III Petroleum Products 0.40 2.90 0.10 14.80 IV Others ( Unclassified) 7.00 0.80 1.50 2.50 Total 100.00 100.00 100.00 100.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 06 & 2007-08 259

Table 7.11: Technology Intensity of India s Exports 1980 2000 (Percentage of total non oil exports) Commodity Group 1980 1990 2000 Group I Primary Commodities 40.9 26.6 18.9 Group II - Manufactures 38.5 51.1 52.6 (Based on labour & natural resources Group III Manufactures 5.7 4.8 6.6 (Characterised by low technology intensity) Group IV Medium technology intensity 7.0 6.6 6.6 Group V High Technology intensity 5.1 9.3 11.7 Others 2.8 1.6 3.6 Total 100.00 100.00 100.00 Source: Reserve Bank of India : Report on Currency & Finance 2002 03 (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

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 1990 0.4 Chemicals Textiles Clothing 0.8 4.0 4.4 2000 China 1990 1.4 0.6 1.0 0.7 5.3 3.7 4.3 4.8 2000 Korea 1990 0.5 1.3 0.5 0.3 2.4 2.3 4.0 2.9 2000 1.4 0.6 2.2 2.7 Source: Reserve Bank of India: Report on Currency & Finance 2002 03 (d) Structure & Composition of Imports Prior to 1987 88, 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

and others (Group IV). However, from 1987 88, 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 1987 88. Hence, strict comparison between 1980 81 and 1990 91 is excluded. The composition of India s imports and structural changes therein during the post reform period are reflected in table 7.13. 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 1980 81, which fell to 25.0 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, 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 1980 81, which increased to 24.2 per cent in 1990 91. In 1999 2000 its share decreased to 18.05 per cent, however, by 2006 07, its share again went up to 25.35 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

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 1980 81, they more than doubled to 8.7 per cent by 1990 91. Its share was 10.95 per cent in 1999 2000. Its share then fell to 4.0 per cent in 2006 07. 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 1993 94, imports of electronic goods and consumer goods were just 4 per cent of total import expenditure. By 2006 07, 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

Table 7.13: Composition of India s Imports (In Per cent) Items 1990 91 1999 2000 2006-07 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 45.10 25.00 2.30 17.80 54.90 24.20 15.30 15.40 39.55 25.40 4.85 9.30 60.45 18.05 18.35 24.05 45.45 30.76 2.30 12.39 54.55 25.35 9.62 19.58 Total Imports 100.0 100.00 100.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 06 & 2007-08 (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 1999 2000 declined to 46.85 in 2006 07 and that of chemicals and allied products declined from 61.1 to 45.15 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

Table 7.14: Import Intensity of Select Export Commodities (In Per cent) Products 1990 91 1999 2000 2006-07 Gems & Jewellery 71.20 72.50 46.85 Chemicals & Allied Products 74.40 61.10 45.15 Source: Reserve Bank of India Report on Currency & Finance 2002 03 & Handbook of Statistics on Indian Economy 2008-09 (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 1980 81, it further increased to 53.5 per cent in 1990 91. It was 57.30 per cent in 1999 2000. However, it came down to 41.2 per cent in 2006 07. 3) The share of OPEC group in India s export earnings was 11.1 per cent in 1980 81, which nearly halved to 5.6 per cent in 1990 91. By 1999 265

2000, it doubled to 10.58 per cent in 1999 2000. In 2006 07, it was increased to 16.4 per cent. 4) The share of Eastern Europe in India s exports was 22.1 per cent in 1980 81, and 17.9 per cent in 1990 91. 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 1999-2000. In 2006 07, 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 1980 81. It then marginally decreased to 17.1 per cent in 1990 91. But, within a span of ten years it increased to 28.4 per cent by 1999 2000. 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 2006 07. 6) 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 1980 81, which marginally increased to 14.4 per cent in 1990 91. In 1999 2000, its share was 22.28 per cent and it further went up to 29.8 per cent in 2006 07. 266

Table 7.15: Direction of Exports (In Per cent) Group 1980 81 1990 91 1999 2000 2006-07 I OECD of which 46.60 53.50 57.30 41.20 (a)european Union (EU) (b) Others 27.50 19.10 21.80 31.70 25.48 31.82 20.40 20.80 II OPEC 11.10 5.60 10.58 16.40 III Eastern Europe 22.10 17.90 3.50 2.00 IV Developing Countries Of which (a) Asia 19.20 13.40 17.10 14.40 28.40 22.28 40.20 29.80 (b) Others 5.80 2.70 6.12 10.40 V Others 1.00 5.90 0.22 0.20 Total 100.00 100.00 100.00 100.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 2006 & 2007 08 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 1980 81, which further increased to 54.0 per cent in 1990 91. It fell to 43 per cent in 1999 2000 and further to 34.5 per cent in 2006 07. The main reason for this was a fall in the share of European 267

Union from 29.4 per cent in 1990 91 to 25.48 per cent in 1999 2000 and to 15.3 per cent in 2006 07. 2) The share of imports from OPEC group was 27.8 per cent in 1980 81, which fell to 16.3 per cent in 1990 91. It increased to 25.88 per cent in 1999 00. By 2006 07 it went up to 30.2 per cent. 3) The share of Eastern Europe in imports was 10.8 per cent in 1980 81 and 7.8 per cent in 1990 91. It drastically fell to 2 per cent in 1999 2000, mainly because of disintegration of USSR. By 2006 07, 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 1980 81, to 18.6 per cent in 1990 91. But within a span of ten years it increased to 29 per cent in 1999 2000. In the year 2006 07, 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 1990 91, which went up to 20.0 per cent in 1999 2000 and further to 25.5 per cent in 2006 07. 6) 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

Table 7.16: Direction of Imports (In Per cent) Group 1980 81 1990 91 1999 2000 2006-07 I OECD of which 45.70 54.00 43.00 34.50 (a)european Union (EU) (b) Others 21.00 24.70 29.40 24.60 22.10 20.90 15.30 19.20 II OPEC 27.80 16.30 25.88 30.20 III Eastern Europe 10.30 7.80 2.00 2.70 IV Developing Countries Of which (a) Asia 15.70 11.40 18.60 14.00 29.00 20.00 32.20 25.50 (b) Others 4.30 4.60 9.00 6.70 V Others 0.50 3.30 0.12 0.40 Total 100.00 100.00 100.00 100.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 2006 & 2007 08 7.2.4 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 1991. 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

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 1990 91 to 4.8 per cent in 1994 95. It further increased to 6.7 per cent in 1999 2000. Further within a span of seven years it doubled to 12.5 per cent of GDP in 2006 07. 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 1990 91, 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 1994 95. By 1999 2000, 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 2006 07. As pointed out by RBI s Report on Currency & Finance 2001 02 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

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 1990-91 1994 95 1999 00 2006-07 Invisibles Receipts / GDP 2.4 4.8 6.7 12.5 Net Invisibles / GDP - 0.1 1.8 2.9 5.8 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 2006 & 2007 08 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 1991 92 to 2000 01. Earnings from invisibles exceeded the deficit on trade account in 2001 02, 2002 03 and 2003 04, 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 (1991 1995), it was 3.70 per cent which increased to 5.8 per cent in the second half of 1990s.(1996 2000). Further, within a span of seven years (2001 2007) 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 (1991 1995) it was a mere 0.8 per cent. However, in the 271

second half of 1990s (1996 2000) the percentage increased to 2.3 per cent. Further, from 2001 2007, 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 (1985 90), 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 (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). Further, in the Tenth Plan (2002 07), almost 99 per cent of trade deficit was financed by invisibles. This is because in the first two years of the Tenth Plan (2002 03 & 2003 04), 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 1991 2000 1991 95 1996 2000 2001-2007 Invisibles Receipts / GDP 4.75 3.70 5.80 9.35 Net Invisibles / GDP 1.55 0.80 2.30 4.08 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 2006 & 2007 08 272

Table 7.19: Financing of Trade Deficit by Net Invisibles (Plan wise Annual average) Particulars Seventh Plan (1985 90) Eighth Plan (1992 97) Ninth Plan (1997 02) Tenth Plan (2002 07) Trade Balance (In `. Crore) - 54205-29801 - 60467-155295 Invisibles Net (In `.Crore) 13162 17219 49832 154165 Financing of trade deficit by Net Invisibles ( In Per cent ) 25.00 58.00 82.00 99.00 Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 2006 & 2007 08 Fig.7.2 Trends in Invisibles 1991 to 2007 14 12 As Per cent of GDP 10 8 6 4 2 0 Invisibles Receipts / GDP Invisibles Net / GDP -2 90-91' 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 1990 91 to 2006 07. It is clear from fig.7.2 that invisible receipts to GDP ratio was 2.4 in 1990 91 which increased to 6.7 in 1999 2000. 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 1990 91. In the 273

year 1991 92, the figure turned to be positive and gradually increased to 2.9 per cent in 1999 2000. Again within a span of seven years it doubled to 5.8 per cent. 7.2.5 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 1990 91 to 0.3 per cent in the year 1991 92. The average 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. In 2001 02, it was 0.7 per cent, in 2002 03, it was 1.2 per cent and in 2003 04 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

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 2004 05. This deficit increased to 1.2 per cent in 2005 06 and marginally reduced to 1.1 per cent in 2006 07. In the context of current account, the Economic Survey 2007 08 observed: The current account has followed an inverted U shape pattern during the period 2001 02 to 2006 07, rising to a surplus of over 2 per cent of GDP in 2003 04. Thereafter, it has returned close to its post 1990s reform average with a CAD of 1.2 per cent in 2005 06, and 1.1 per cent in 2006 07. 7 Table 7.20: Current Account Deficit 1991 to 2007 (As Percent of GDP) Year Current Account Deficit 1990 91 3.1 1991 92 0.3 1992 93 1.7 1993-94 0.4 1994 95 1.0 1995 96 1.7 1996 97 1.2 1997 98 1.4 1998 99 1.0 1999 00 1.0 2000 01 0.6 2001 02-0.7 2002 03-1.3 2003-04 -2.3 2004 05 0.4 2005 06 1.2 2006 07 1.1 Note: A minus sign (-) indicates a surplus. Source: Reserve Bank of India Handbook of Statistics on Indian Economy 2005 06 & 2007 08 275

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 1990 91; and (4) the post 1990-91 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 1997 98. (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

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