Pariksha SaathiLesson 9 of 10 · Indian Economy
Balance of Payments, Exchange Rates, FDI, FEMA and the WTO
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Balance of payments
The balance of payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world over a period, usually a year; in India the RBI compiles it. It is kept by double entry, so in accounting terms it always balances; a surplus or deficit means the balance before the change in foreign exchange reserves. The current account records exports and imports of goods (visible trade, whose difference is the trade balance), services such as software, tourism and transport, primary income such as interest, dividends and wages, and secondary income, mainly remittances and gifts. India usually has a deficit in goods trade that is partly offset by a surplus in services and large remittance inflows.
Capital account and reserves
The capital account records changes in foreign assets and liabilities: foreign direct investment, portfolio investment, external commercial borrowings, external assistance, non-resident Indian deposits and other banking capital. A current account deficit must be financed by a capital account surplus or by drawing down reserves. India's foreign exchange reserves, held and managed by the RBI, have four parts: foreign currency assets, gold, Special Drawing Rights (SDRs) and the reserve tranche position with the IMF. Errors and omissions is the balancing item for statistical gaps.
Exchange-rate regimes
Under a fixed or pegged regime the government sets the value of the currency; under a floating regime demand and supply in the foreign exchange market decide it; a managed float lets the market decide while the central bank steps in to curb sharp swings. Devaluation is an official cut in the value of a pegged currency and depreciation a fall caused by the market; their opposites are revaluation and appreciation. India devalued the rupee in 1949, 1966 and 1991. It moved from a basket peg to the Liberalised Exchange Rate Management System (LERMS) in March 1992, which had a dual rate, and to a unified market-determined rate, a managed float, in March 1993.
Convertibility
Convertibility is the freedom to change domestic currency into foreign currency and back at the market rate. India made the rupee fully convertible on the current account in August 1994 by accepting Article VIII of the IMF's Articles of Agreement, so that payments for trade, travel, education and remittances can be made freely within rules. Capital account convertibility, the freedom to move capital in and out for investment, is only partial; the Tarapore Committees of 1997 and 2006 laid out a gradual path towards it.
FDI, FPI and FEMA
Foreign direct investment (FDI) carries a lasting interest and some management control, often with technology; foreign portfolio investment (FPI) buys shares and bonds for financial returns and can leave quickly, which is why it is called hot money. In India an investment of 10 per cent or more of a listed company's equity is treated as FDI, and less than that as FPI, which SEBI regulates. FDI comes through the automatic route, needing no prior approval, or the government route, needing approval from the ministry concerned since the Foreign Investment Promotion Board was abolished in 2017; a few sectors such as lottery, gambling and chit funds are closed to it. The Foreign Exchange Management Act (FEMA) 1999, in force from 1 June 2000, replaced FERA 1973: FERA was a strict control law under which violations were criminal offences, while under FEMA most violations are civil, and its aim is to facilitate external trade and payments and develop the foreign exchange market. The Enforcement Directorate enforces it.
GATT and the WTO
The General Agreement on Tariffs and Trade (GATT), signed at Geneva in 1947 with India among its founding members, reduced tariffs through rounds of negotiation. Its last, the Uruguay Round (1986-94), ended with the Marrakesh Agreement of 1994, which created the World Trade Organization (WTO) on 1 January 1995, with headquarters in Geneva and India as a founder member. The WTO covers goods, services (GATS), intellectual property (TRIPS), investment measures (TRIMS) and agriculture, where subsidies are sorted into amber, blue and green boxes. Its top body, the Ministerial Conference, meets at least once every two years, its dispute settlement system rules on trade disputes, and its core principles are most-favoured-nation treatment and national treatment.
The IMF and the World Bank group
Both were planned at the Bretton Woods Conference in New Hampshire, USA, in July 1944, both are based in Washington, D.C., and India is a founding member of both. The International Monetary Fund lends to countries with balance of payments problems, monitors members' economies and created Special Drawing Rights in 1969; each member's quota decides its contribution, voting power and access to loans. The World Bank group has five institutions: the International Bank for Reconstruction and Development (IBRD), the International Development Association (IDA, 1960) for soft loans to the poorest countries, the International Finance Corporation (IFC, 1956) for the private sector, the Multilateral Investment Guarantee Agency (MIGA, 1988) and the International Centre for Settlement of Investment Disputes (ICSID, 1966). The IBRD and IDA together are called the World Bank; India is not a member of ICSID.
Key facts
- Current account: goods (trade balance), services, primary income, secondary income (remittances); capital account: FDI, FPI, ECBs, external assistance, NRI deposits.
- Forex reserves (managed by the RBI): foreign currency assets, gold, SDRs and the reserve tranche position with the IMF.
- Devaluation (official, fixed regime) vs depreciation (market, floating regime); the rupee was devalued in 1949, 1966 and 1991.
- LERMS March 1992 (dual rate); unified market-determined rate March 1993; current account convertibility August 1994 (IMF Article VIII).
- Tarapore Committees 1997 and 2006: road map for capital account convertibility, which remains partial.
- FDI: 10 per cent or more of a listed company's equity; FPI: below 10 per cent, regulated by SEBI; FIPB abolished in 2017.
- FERA 1973 (control, criminal) replaced by FEMA 1999, in force 1 June 2000 (management, civil); enforced by the Enforcement Directorate.
- GATT 1947, Geneva; Uruguay Round 1986-94; Marrakesh Agreement 1994; WTO 1 January 1995, Geneva; Ministerial Conference at least every two years.
- Bretton Woods, July 1944: IMF and IBRD, both in Washington, D.C.; SDR created 1969; World Bank = IBRD + IDA.
- World Bank group: IBRD, IDA (1960), IFC (1956), MIGA (1988), ICSID (1966); India is not a member of ICSID.
Quick revision
BoP: current account (goods, services, income, remittances) + capital account (FDI, FPI, ECB, NRI deposits); reserves = FCA, gold, SDR, IMF reserve tranche; rupee devalued 1949, 1966, 1991; LERMS 1992, unified rate 1993; current account convertible Aug 1994; Tarapore 1997, 2006; FDI = 10% or more; FEMA 1999 (from 1 June 2000) replaced FERA 1973; GATT 1947, WTO 1 Jan 1995 Geneva; IMF and World Bank from Bretton Woods 1944; WB group: IBRD, IDA, IFC, MIGA, ICSID.