BoP Crisis in India
From 1947 till 1956-57, the India had a current account surplus. By the end of the first plan, the Trade deficit was Rs. 542 Crore and Net Invisibles was Rs. 500 Crore, thus giving a BoP deficit in Current Account worth Rs. 42 Crore. From this time onwards, the trade deficit increased from 3.8% of the GDP at market prices to 4.5% of GDP. Due to this, the government imposed the exchange controls. This was the first BoP crisis, ever India faced, after independence.
Second BOP crisis
In 1965, when India was at war with Pakistan, the US responded by suspension of aid and refusal to renew its PL-480 agreement on a long term basis. The idea of US as well as World Bank was to induce India to adopt a new agricultural policy and devalue the rupee. Thus, the Rupee was devalued by 36.5% in June 1966. This was followed by a substantial rationalization of the tariffs and export subsidies in an expectation of inflow of the foreign aid. The BoP improved, but not because of inflow of foreign aid but because of the decline in imports.
After the 1966-67, the BoP of India remained comfortable till 1970s. The first oil shock of 1973-74 was absorbed by the Indian Economy due to buoyant exports. After that there was an expansion of the international trade.
Crisis of 1990-91
When we usually discuss about the BoP crisis in India, we refer to that one of 1990-91. This crisis had its origin from the fiscal year 1979-80 onwards. By the end of the 6th plan, India’s BoP deficit (Current account) rose to Rs. 11384 crore. It was the mid of 1980s when the BoP issue occupied the centre position in India’s macroeconomic management policy. The second Oil shock of 1979 was more severe and the value of the imports of India became almost double between 1978-78 and 1981-82. From 1980 to 1983, there was global recession and India’s exports suffered during this time.
The trade deficit was not been offset by the flow of the funds under net invisibles. Apart from the external assistance, India had to meet its colossal deficit in the current account through the withdrawal of SDR and borrowing from IMF under the extended facility arrangement. A large part of the accumulated foreign exchange fund was used to offset the BoP.
During the 7th plan, between 1985-86 and 1989-90, India’s trade deficit amounted to Rs. 54, 204 Crore. The net invisible was Rs. 13157 Crore and India’s BoP was Rs. 41047 Crore. India was under a sever BoP crisis. In 1991, India found itself in her worst payment crisis since 1947. The things became worse by the 1990-91 Gulf war, which was accompanied by double digit inflation.
India’s credit rating got downgraded. The country was on the verge of defaulting on its international commitments and was denied access to the external commercial credit markets. In October 1990, a Net Outflow of NRI deposits started and continued till 1991.
The only option left to fulfil its international commitments was to borrow against the security of India’s Gold Reserves as collateral. The prime Minister of the country’s caretaker government was Chandrashekhar and Finance Minister was Yashwant Sinha. The immediate response of this Caretaker government was to secure an emergency loan of $2.2 billion from the International Monetary Fund by pledging 67 tons of India’s gold reserves as collateral. This triggered the wave of the national sentiments against the rulers of the country. India was called a “Caged Tiger”. On 21 May 1991, Rajiv Gandhi was assassinated in an election rally and this triggered a nationwide sympathy wave securing victory of the Congress. The new Prime Minister was P V Narsimha Rao. P V Narsimha Rao was Minister of Planning in the Rajiv Gandhi Government and had been Deputy Chairman of the Planning Commission. He along with Finance Minister Manmohan Singh started several reforms which are collectively called “Liberalization”. This process brought the country back on the track and after that India’s Foreign Currency reserves have never touched such a “brutal” low.
In 1991, the following measures were taken:
- In 1991, Rupee was once again devaluated.
- Due to the currency devaluation the Indian Rupee fell from 17.50 per dollar in 1991 to 45 per dollar in 1992.
- The Value of Rupee was devaluated 23%.
- Industries were Delicensed.
- Import tariffs were lowered and import restrictions were dismantled.
- Indian Economy was opened for foreign investments.
- Market Determined exchange rate system was introduced. This was initiated with LERMS
Correction of BoP crisis
Liberalized Exchange Rate Management System
In the Union Budget 1992-93, a new system named LERMS was started. The LERMS was introduced from March 1, 1992 and under this, a system of double exchange rates was adopted. Under LERMS, the exporters could sell 60% of their foreign exchange earning to the authorized Foreign Exchange dealers in the open market at the open market exchange rate while the remaining 40% was to be sold compulsorily to RBI at the exchange rates decided by RBI.
Another important feature of LERMS was that the Government was providing the foreign exchange only for most essential imports. For less important imports, the importers had to arrange themselves from the open market.
Thus, we see that LERMS was introduced with twin objectives of building up the Foreign Exchange Reserves and discourage imports. At that time, the government was successful in achieving both of these objectives.
Rangarajan Panel for correcting BoP
The Report of the High Level Committee on Balance of Payments, of which Dr. Rangarajan was the Chairman, was submitted in June 1993. The important recommendations of this panel were as follows:
- A realistic exchange rate and a gradual relaxation of the restrictions on the current account should go hand in hand.
- Current account deficit of 1.6% of GDP should be treated as a ceiling.
- Government should be cautious of extending concessions or facilities to the Foreign Investors. The concessions were more to the foreign investors than to the domestic players.
- All external debts should be pursued on a prioritized on the basis of the Use on which the debt is to be put.
- No approval should be accorded for a commercial loan which has a maturity of less than 5 years.
- There should be efforts so that Debt flows can be replaced by the equity flows.
- RBI should target a level of reserves that took into account liabilities that may arise for debt servicing, in addition to imports of three months.
Topics: Economic Survey 2010-11