In 1990, India had a severe balance of payments crisis, which fuelled a series of reforms that opened the country to foreign investment. Today, India has a balance of payments surplus.
Here's all you need to know about balance of payments and its importance:
In a globalized world, no country is self-sufficient. Every country purchases and sells goods and services to another. This includes both public and private transactions. The balance of payments calculates the value of these transactions. Usually, the value of the outflows should be equal to the total inflow of money into the country. However, this is not so because payments are sometimes delayed or paid over a longer term. For this reason, countries can have a deficit or surplus of BoP in the short-term. A deficit is when you owe money to the world, while a surplus is when your cash inflows exceed your outflows.
Balance of payments comprises of three kinds of accounts - current, capital and financial account. The current account calculates the total value of imports and exports of goods and services. The latter is called 'invisibles'. India's current account has run a deficit for many years. This deficit (CAD) hit a peak of $87.8 billion in 2012-13 on account of a high import bill - especially due to oil and gold imports. Since gold is a non-essential commodity, the government imposed measures to curb imports. As a result, trade deficit - when imports exceed exports - fell to $147.6 billion in 2013-14 from $195.7 billion the previous year. However, in terms of net trade of services, India reported a surplus of $73 billion, up from $64.9 billion in FY13. This helped the CAD fall by more than half to $32.4 billion.
Money is also exchanged between countries through investments or other kinds of financial transactions. This is calculated in the capital and financial accounts. After the 1990 crisis when India did not have enough money left to fund its deficit, it opened markets partially to foreign investors. Today, India runs a net surplus of $33.3 billion in its capital and financial accounts. This money is used to fund the current account deficit. An increase in borrowings from outside the country has a negative impact on the capital account, while an increase in foreign investment inflows has a positive impact.
India's capital and current accounts have a strong bearing on the rupee value. This is because, when you owe the world money, you have to sell rupee and buy dollars or other foreign currencies. Similarly, when a foreigner invests in India, rupee is bought while dollars are sold. An increase in demand for the rupee leads to an appreciation in its value and vice-versa. This was the reason why the rupee fell 20% to Rs 69-to-a-dollar levels between May and August 2013. Foreign investors exited the Indian capital market in droves, while the country's current account deficit stood at a lifetime high.
Every country's sovereign bond - issued by the government - is analyzed by credit ratings agencies. Depending on the risks involved, a credit rating is given from time to time. Greater the risks, poorer is the credit rating. For this reason, an increase in deficit is detrimental to credit rating. This is because a high deficit is a liability. When a country owes more to the world, the risks of a default of interest payments to bond holders increase. This is the reason credit ratings agencies like Moody's and S&P issued warnings to India about its high current account and fiscal deficits.
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