India’s Balance of Payments (BoP)

Source: The post India’s Balance of Payments has been created, based on the article “How to read India’s Balance of Payments” published in “Indian express” on 6th July 2024

UPSC Syllabus Topic: GS Paper3-Economy

Context: The article discusses India’s Balance of Payments, which records financial transactions with other countries. It notes a recent surplus in the current account for the first time in 11 quarters but explains that a current account deficit isn’t necessarily bad for a developing economy like India.

For detailed information on Balance of payment read this article here

What is the Balance of Payments?

1. The Balance of Payments (BoP) is a comprehensive record of a country’s financial transactions with the outside world. It details the money that flows into and out of the country, categorized as either positive (inflows) or negative (outflows).
2. The BoP includes two main accounts: the Current Account and the Capital Account.
3. Current Account: It includes the trade of goods (which was in deficit due to higher imports than exports) and the trade of services and other invisibles (which recorded a surplus). These invisibles include services like IT, banking, insurance, and remittances from Indians abroad, which helped offset the deficit from the goods trade.
4. Capital Account: This account captures investment-related transactions such as Foreign Direct Investment (FDI) and Foreign Institutional Investments (FII), reflecting a strong inflow of foreign investments.

How Do Foreign Exchange Reserves Fit In?

1. Foreign exchange reserves play a crucial role in India’s Balance of Payments (BoP).
2. When there is a surplus in the BoP, indicating more dollars coming into the country than going out, the Reserve Bank of India (RBI) intervenes.
3. The RBI absorbs these excess dollars to increase its foreign exchange reserves.
4. This action helps stabilize the rupee’s value. If the RBI did not boost the reserves, the rupee would appreciate, making Indian exports more expensive and less competitive internationally.
5. Maintaining these reserves is essential for managing the exchange rate and supporting overall economic stability.

Why Shouldn’t We Always Aim for a Surplus?

1. Aiming for a current account surplus is not always beneficial for an economy, especially for developing ones like India.
2. A surplus might indicate underutilized economic capacity, as seen during the COVID-19 lockdowns in FY 2020-21, which halted much economic activity, leading to an undesirable surplus.
3. Typically, a current account deficit of 1.5%-2% of GDP is considered healthy for India. It suggests robust domestic demand and necessary imports of capital goods to expand production capabilities.
4. Such a deficit supports long-term economic growth by facilitating investments in productive assets, which are crucial for boosting export capabilities in the future.

Question for practice:

Discuss the role of foreign exchange reserves in India’s Balance of Payments and how they impact the value of the rupee.