India’s Current Account: An Analysis of Growth

 

Akash Kumra

Associate Professor, Department of Economics, Faculty of Arts, M. S. University of Baroda, Vadodara, Gujarat

 

ABSTRACT:

Faced with a severe balance of payments crisis, India entered into an IMF influenced structural adjustment program. In addition to the conventional expenditure switching and reducing policies, as part of the IMF agreement, a range of far-reaching economic policy reforms was launched in July 1991 in the external, industrial, financial and public sectors. These policies also influenced the structure of current account over period of time. A deficit in the current account leads to depletion of foreign currency assets as these assets are used as a source to fund deficit which forms part of capital account. Current account plays a vital role in the overall balance of payment a diversified current account regime is argued by many policymakers over a longer period. More focus was on import controls and export promotions. In context to this the paper tries to examine the changes that took place in current account and its components during the reform period (i.e. 1991-92 to 2015-16) as well as more precisely during the second generation reform period (i.e. 2001-02 to 2015-16). Here, an attempt is also made to examine the growth and stability during the two time period. Imports not only have witnessed higher growth but has also registered the higher instability during the second generation reform period.

 

 

 

I.1 INTRODUCTION:

Current account covers all transactions (other than those in financial items) that involve economic values and occur between resident and non- resident entities. Also covered are offsets to current economic values provided or acquired without a quid pro quo. Specifically, the major classifications are goods and services, income, and current transfers. Thus, current account is a broader measure than trade balance as it also includes income (investment income and compensation of employees) and current transfers. The current account, provides information not only on international trade in goods, but also on international transactions in services¹.

 

 

 

These transactions can be classified into merchandise (exports and imports) and invisibles. Invisible transactions are further classified into three categories, namely (a) Services-travel, transportation, insurance, Government not included elsewhere (GNIE) and miscellaneous (such as, communication, construction, financial, software, news agency, royalties, management and business services etc); (b) Income (investment income and compensation of employees); and (c) Current Transfers (grants, gifts, remittances, etc.) which do not have any quid pro quo. Investment income covers receipts and payments of income associated, respectively, with residents’ holdings of external financial assets and with residents’ liabilities to non-residents.

 

Investment income consists of direct investment income, portfolio investment income, and other investment income. A deficit in the current account leads to depletion of foreign currency assets as these assets are used as a source to fund deficit which forms part of capital account. Depletion of foreign currency assets reduces money supply which in turn results to liquidity issues. High imports results in higher demand for dollar causing rupee to weaken (rupee depreciation) which in turn impacts liquidity.

 

In the long run, a current account deficit can sap economic vitality. Foreign investors may begin to question whether economic growth can provide an adequate return on their investment. Demand could weaken for the country's assets, including the country's government bonds. As a result, the national currency will gradually lose value relative to other currencies. This automatically lowers the value of the assets in the foreign investors' currency. This further depresses the demand for the country's assets. Hence, could lead investors to dump the assets at any price. The only saving grace is that the country's holdings of foreign assets are denominated in foreign currency. As the value of its currency declines, the value of the foreign assets rise, thus further reducing the current account deficit. On the other hand, a lower currency value should increase exports, as the goods and services become more competitively priced. Similarly, demand for imports should lessen, as inflation on foreign goods and services sets in. These trends should stabilize any current account deficit.

 

The consequences of a current account deficit would be -- a lower standard of living for the country's residents. According to the inter-temporal approach, the current account deficit is the outcome of forward-looking dynamic saving and investment decisions driven by expectations of productivity growth, government spending, interest rates, and several other factors. Within this framework, the current account balance behaves as a buffer against transitory shocks in productivity or demand². The impact of economic changes on the current account balance may vary according to their origin, persistence and timing of such changes. With respect to their origin, shocks may be country-specific or global. Global productivity shocks have a smaller impact on current account deficits than country-specific shocks³. Similarly, the persistence of the shocks, whether transitory or permanent, may produce a different response of the current account balance. A permanent productivity shock may widen the current account deficit as it may generate a surge in investment and a decline in savings [given that it causes consumption to rise by more than gross output]. On the other hand, transitory productivity shocks may move the current account into surplus, as there may be no investment response to a purely temporary shock.

 

It is the external factors as well as domestic factors that were responsible for the deterioration of the current account of non-oil developing countries. India is also facing a deficit in her current account, therefore, in this paper a detail examination of trends in current account and its key components have been attempted. 

 

I.2 OBJECTIVE AND HYPOTHESIS OF THE PAPER:

India has completed more than a period of two decades of economic reforms. Since, the reforms were initiated as a result of external sector shocks, it is desirable to evaluate the performance of India’s current account during this period. With this as a back drop, this paper has the following main objectives:

1.     The first objective is to analyse the behaviour of India’s Current Accounts in two trade regimes i.e. (a) period of administrative control and regulation of trade, and (b) period of liberalisation and global orientation.

2.     The second objective is to analyse the behaviour of India’s exports and imports in two trade regimes. In particular the unhealthy trends in imports.

 

Based on these objectives the central hypothesis of the present study is that economic reforms have brought growth and stability in India’s current account and balance of payments. It is expected that reforms brings about a change in the structure of current account to make the country less vulnerable to the external shocks. Not only, will this but it also improve the secular trend of the deterioration in the current account. The hypothesis has been tested on the basis of the methods described below. To make a study comprehensive enough a time period corresponding to pre and post reform has been considered.

 

Although this study pertains to a post-reform period, for sake of comparison the decade prior to reform was also considered. Accordingly, the whole time period has been divided into:

 

Pre-Reform Period [P1]	1980-81 to 1990-91
Post-Reform Period [P2]	1991-92 to 2015-16
Overall period	1980-81 to 2015-16.

 

Further, to know the real impact of reforms on the current account, and on its main components. The post-reform period is further divided into two: First generation reform period and second generation reform period⁴.

 

First Generation Reform Period-I [R1]	1990-91 to 2000-01.
Second Generation Reform Period-II [R2]	2001-02 to 2015-16.
Reform-Period [P2]	1991-92 to 2015-16

 

I.3   Methodology and Source of Data:

(A) Methodology:

For the purpose of examining the trend the most used method of ordinary least square (OLS) is used. With this method a straight line trend is obtained. This line is called the line of the best fit. The equation of a straight line is Y = a + bt. Where, Y is the dependent variable, ‘a’ is the constant, ‘b’ is the slope of coefficient of the dependent variable and ‘t’ is the time. Such a model is called linear trend model. Here the time variable ‘t’ is known as the trend variable. If the slope coefficient is positive, there is an upward trend in Y whereas if it is negative, there is a downward trend in Y.

 

As mentioned earlier this paper considers a period corresponding to pre and post- reform regime. Accordingly, two separate regressions can be considered-one for the pre-reform period and the other for the post-reform period, respectively:

i)  Y_t = a + b.t

ii)  Y_t = a^, + b^, .t.

 

Since the above two regression equations can be combined into a multiple regression by adding intercept and slope dummies to equation (i), we get the equation:⁵

 

Y_t =a + b.t + (a^, - a) Dt+ (b^, - b) Dt+ u_t

                                        or

Y_t = b₀ + b₁t + b₂D + b₃D.t + u_t

 

Where Y_t is the time series under study or determinant, t is the time variable and D is the intercept dummy which assumes the value one for the post-reform period and zero for the pre-reform period⁶.

 

D.t is the slope dummy which is nothing but the time variable during the post-reform period and zero otherwise. If the coefficient of, say, slope dummy, (b₃), is statistically significant and positive, it can be concluded that the regression equation for the post-reform period is different from that of the pre- reform period and that the change in the series is higher during the post-reform period (as b₃ > b₁).  Similarly, if the coefficient of, say, slope dummy, (b₃), is statistically significant and positive, it can be concluded that the regression equation for the second generation reform  period is different from that of the first generation reform period and that the change  in the series is higher during the  second generation reform period (as b₃ > b₁).

 

Further the Coefficient of Variation is estimated to study the variability in the variables understudy. The normalized measure of dispersion of a probability distribution is called as coefficient of variation as often abbreviated as CV. Coefficient of Variation Cv = Standard Deviation / Mean. It represents the ratio of the standard deviation to the mean, and it is a useful statistic for comparing the degree of variation from one data series to another, even if the means are drastically different from each other. This paper mainly uses the above mentioned methods for the analysis of growth and stability. However, it also makes use of other statistical tools such as line graph, averages and median. Simple growth rate have been calculated for the purpose of comparative study as well to examining the trend during the two sub-periods under the study.

 

(B) Source of Data:

The study is essentially of an empirical nature and its basic materials have been drawn from secondary sources of date such as ‘Handbook of Statistics on Indian Economy’ published by RBI, Annual Reports on Currency and Finance of the RBI, Economic Surveys of the Government of India and Reports of the Indian Institute of Foreign Trade. For the purpose of analysis the paper has been divided in to three sections, section one includes the introduction, objective and methodology. Analysis of the results has been examined in section two. Section three deals with policy recommendations.

 

II.1. Analysis of Study Period (Growth Rate):

During 1981-82 exports grew at 16.50% but the growth became negative -3.19% in 1985-86 in dollar terms, this on account of a deceleration in indigenous oil production, protectionist tendencies in international trade. Exports registered the highest growth of approx. 37% in 1989-90 (See, Graph-1).

 

 

Graph -1: Annual Exports Growth [1980-81 to 2015-16]

Between 1990-91-2009-10 export growth was in the range of 29.92% (in 1993-94) to 14.62% (in 2007-08). The years of low growth were 2001-02 (2.64%) and 2009-10 (0.62%), this was mainly due to deceleration of global economy⁷. Similarly, the financial turmoil had a dampened the global demand and slowed down capital inflows which affected India’s export sector⁸. Further, exports growth declined continuously after 2010-11 onwards and it registered a lowest and negative growth of -9.91% during 2015-16. This was the result of subdued global growth and trade.

 

However, imports growth as depicted by log linear trend line has shown a rising trend (See, Graph-2).

Imports grew from 10.74% in 1980-81 to 33.12% in 1988-89⁹. Growth in India’s merchandise imports in 2004-05 at 45.26% dollar terms was the highest since 1980-81.

 

This surge in growth in 2004-05 was mainly due to the steep rise in price of crude petroleum and other commodities with value of POL imports increasing by 45.1 per cent. Lower tariffs, a cheaper US dollar, a buoyant manufacturing sector and high export growth boosted non-oil imports by 39 per cent, particularly capital goods, intermediates, raw materials and imports needed for exports¹⁰.

 

 

Graph-.2: Annual Imports Growth [1980-81 to 2015-16]

 

 

Graph-2 [a]: Annual Growth in India’s Merchandise.

 

In the year 2015-16 imports registered a negative growth of -8.06%, mainly on account of decline in crude oil prices resulting in lower levels of Petroleum, Oil and Lubricants (POL) imports.

 

 

 

A comparative picture of export growth and import over a period of time i.e study period reveals that exports growth accelerated, but imports increased faster and resulted in a widening of the trade deficit in particular during the 1992-93 and 2004-05, when imports have registered the highest growth in dollar terms (See, Graph-2 [a]).

A lasting solution to the payment problem would need more vigorous attempts at a micro level to sustain and also strengthen the momentum of exports growth.

 

 

 

Further, during 1985-86 invisibles declined because the bunching of repayment obligations on past borrowings from the IMF and other sources, the unfavorable climate for the concessional assistance and uncertainties about the inflow of remittances from Indian working abroad (See, Graph-3).

 

 

Graph-3: Annual Growth in India’s Current Account, Trade Balance and, Invisibles. [1980-81 to 2015-16]

 

Table-1: Annual Growth in Key Components of Current Account [1980-81 to 2015-16]

Source: Calculated from “Handbook of Statistics on Indian economy” RBI Publication -2016.

 

Wide fluctuation have been witnessed in the growth of invisibles in dollar terms during the study period. Growth became negative in the year 1991-92 due to the impact of gulf crisis, whereas was highest in the year 2015-16.  Further, an important component of the invisibles, according to the RBI Bulletin, is private transfers, which was ranged around $12 billion in 1997-98, 1998-99 and 1999-2000.

 

Overall, private transfers have been providing a cushion to balance of payments over the years. They are primarily accounted for by remittances by non-residents for family maintenance. In particular, they include repatriation of savings by Indian residents abroad. During the study period [i.e. 1980-81 to 2015-16] exports grew by 17.76 percent in dollar terms which is marginally higher than the growth of imports (17.04 percent) and trade balance has registered a growth of 22.21%, during the period. Invisibles have also shown the positive growth of 5.94% in dollar terms. Current account grew by 33.04 percent, (See, Table-1).

 

Imports have indicated more volatility when compared to exports. This is a matter of concern because this puts pressure on the demand for foreign exchange¹¹.

 

Table-2, shows that exports as well as imports both have registered a negative trend during study period (i.e. 1980-81 to 2015-16), it is only invisibles that registered a growth of 7.3 percent. Although the trend was not statistically significant in any of the case.

 

Table-2: Trend in Key Components of Current Account of Balance of Payments [1980-81 to 2015-16]  Growth Rate

Note: Figures in parentheses are t-values. (*): Significant at the 1 percent level, (**): Significant at the 5 percent level

Table-3: Key Components of Current Account of Balance of Payments [P1 and P2]

Source: Calculated from “Handbook of Statistics on Indian economy” RBI Publication -2016

 

Table-4: Key Components of Current Account of Balance of Payments [P1 and P2] [1980-81 to 1990-91 and 1991-92 to 2015-16]

Y	b0	bt	bD	bD.t	R Square	F
Xgr	9.480	1.515	21.32**	-2.08**	0.148	1.796
	(1.305)	(1.294)	(2.098)	(-1.726)
Mgr	4.846	1.809	23.08**	-2.244	0.105	1.215
	(0.560)	(1.296)	(1.905	(-1.559)
TBgr	-0.487	2.298	52.852	-3.435	0.050	0.548
	(-0.015)	(0.450)	(1.193)	(-0.653)
INVgr	33.415	-10.635	-397.4**	27.262	0.190	2.425
	(0.213)	(-0.421)	(-1.81)	(1.048)
CURacgr	12.378	2.831	91.858	-5.838	0.028	0.301
	(0.152)	90.216)	(0.808)	(-0.43)
OVERBgr	353.869	-117.9**	-1289.2**	151.6**	0.195	2.511
	(0.855)	(-1.768)	(-2.227)	(2.206)

Note: Figures in parentheses are t-values. (*): Significant at the 1 percent level, (**): Significant at the 5 percent level

 

Current account also has indicated a negative trend, therefor an analysis of trend during the reform period becomes imperative.

 

II. 2. Analysis of Pre and Post-Reform Period:

A comparative examination of behavior of exports and imports during the pre and post- reform period reveals that imports grew from 14.80% in pre-reform period to 17.93% during post- reform period. Whereas, exports witnessed a marginal decline from 17.81 % in pre-reform period to 17.74% in post-reform period. As a result of this trade balance grew from 12.15% in pre-reform period to 26.23% in post reform period. However, a positive growth have been indicated by the invisible from -25.08% in pre-reform period to 18.35% in post reform period, (See, Table-3)¹².

 

During the post- reform period not only the current account deficit has increased but instability has also increased. All the components such as exports, imports, invisibles have shown the higher coefficient of variation during the post- reform period as compared to the pre-reform period.

 

During post reform period both growth of exports as well as imports were declined as compared to pre-reform period. The slope coefficient is negative for both (See, Table-4).

 

 

Graph-4: Exports Growth (During Reform Period 1990-91 to 2015-16.

 

 

Graph-5:Imports Growth (During Reform Period 1990-91 to 2015-16):

 

It is only invisibles that have registered a positive trend during post reform period.

 

II.3. Analysis of First and Second Generation Reforms Period:

An examination of exports growth within the reform period depicts not only a continuous decline but also a negative growth in dollar terms from 1991-92 (35.50%) to 2015-16 (-9.91%). Similar, trend is also indicated by the log-linear trend line, during the respective time period, (See, Graph-4).

 

Almost, similar trend is shown by the imports growth in dollar terms, from a high of 40% in 1992-93 it fell to -7.94 in 201-16, (See, Graph-5).

 

A close examination reveals that Indian imports have always shown higher growth as compared to the exports, both while increasing as well as decreasing in dollar terms. In the year 2015-16 both exports (-9.91%) as well as imports (-7.94%) have shown a declining trend. Exports have shown a declining trend because the global economic activities remained subdued in 2015, as growth in emerging market and developing economies (EMDE) declined for the fifth consecutive year and recovery in advanced economies was modest. In addition, a dual monetary policy--a gradual tightening in monetary policy in the US in the backdrop of its resilient recovery and easy monetary policy in several other major advanced economieshas led to uncertainties and posed challenges¹³.

 

Imports growth declined due to fall in the imports of the petroleum, oil and lubricants (POL)¹⁴.

 

Growth of invisibles have indicated a wide fluctuation from -1083.60% in 1991-92 to 876.73% in 2015-16 (See, Graph-6).

 

 

Graph-6: Trade Balance, Invisibles and Current Account Growth Trend

 

 

 

Table-5: Key Components of Current Account of Balance of Payments

Years Growth [%]	Current A/C	A. Exports	B. Imports	C. Trade Balance	D.  Invisibles	Overall Balance
R1
AAGR	55.59	20.22	19.12	29.83	-80.73	-581.64
Median	21.10	18.57	18.57	33.93	4.79	-112.11
C.V	2.85	0.45	0.63	2.21	-4.21	-1.80
R2
AAGR	21.19	15.90	17.42	24.27	80.30	25.29
Median	27.55	17.81	17.81	16.71	26.71	-7.62
C.V	5.31	0.79	0.90	1.60	2.75	6.51

Source: Calculated from “Handbook of Statistics on Indian economy” RBI Publication -2016

 

Table-6: Key Components of Current Account of Balance of Payments [R1 and R2] [1990-91 to 2000-01 and 2001-02 to 2015-16]

Note: Figures in parentheses are t-values. (*): Significant at the 1 percent level, (**): Significant at the 5 percent level.

 

A comparative picture of first generation and second generation reform [R1 and R2] is provided by Table-5. It becomes evident from the table that during second generation reform period the growth of both exports as well as imports were declined as compared to first generation reform period. But, here exports declined more than the imports¹⁵. Further, exports as well as imports both have shown higher instability during second generation reform period.

 

Higher instability of exports as compared to imports is a really a matter of concern because it indicates inconsistence in foreign demand for our exports this ultimately effects the flow of foreign exchange. It is to be noted that current account has registered a declining trend during this period (Second generation reform period, (21.19%) as compared to first generation reform period (55.59%), but has shown more instability. This because both exports and imports became more volatile during second generation reform period. However, growth in invisible has shown a higher growth from during second generation reform period (80.30%).

 

The overall balance has also indicated a higher growth from -581% during first generation reform period to 25.29% during second generation reform period. Here, also instability has increased during the second generation reform period.

 

The overall analysis shows that instability in exports, imports and invisibles has increased during second generation reform period when compared to first generation reform period this is a matter of concern. Regression results also reveals a positive changes in the growth of exports and imports during second generation reform period when compared with first generation reform period, (See, Table-6).

 

Although the results are not statistically significant. The only exception was growth of invisibles. The growth of net invisible to the current account was negative during [1990-91].

 

However, during the second generation reform period a rapid growth is witnessed in this category, contributing a large surplus to India’s balance of payment account. Although this surplus was not enough to eliminate the merchandise deficit, which could contribute significantly to neutralize the magnitude of the impact of the huge deficit¹⁶. A notable development found in the performance of the growing contribution of the invisibles. Among the three components such as services, transfers and income, the largest surplus was generated by the services followed by transfers. Further, the relationship between current account with exports and Imports clearly shows that current account is more influenced by imports rather than exports and invisibles.

Table-7:  Regression Result (1980-2016)

Note: Figures in parentheses are t-values. (*): Significant at the 1 percent level, (**): Significant at the 5 percent level

 

Table-8: Key Components of Balance of Payments Current Account. [Growth Rate]

Source: Author’s calculation from RBI data.

 

A one percent increase in imports growth results into around six percent increase in growth of current account deficit (See, Table-7).

 

CONCLUSION:

The above analysis of current account reveals that during the second generation reform period it has registered a lowest growth (i.e. 21.19 percent) this shows that the government objective to control the current account deficit through the proper policy frame work is successful. It became possible by controlling the imports, it fell by 1.7 percent during the same period (See, Table -8). However, the high volatility in the growth of current account is a matter of concern because it generates the doubts on the success of current policies adopted by the government to control the current account deficit (CAD) in the future. India should adopt the motion strategies and the policy measures which catalyze the growth of exports in several different sectors as well as in newer markets. Free Trade Agreements (FTAs) with the trading countries can also prove to be fruitful if followed in true spirit.

 

REFERENCE:

1.      Balance of payment manual (IMF). The fifth edition of the Balance of Payments Manual (the Manual) continues the series of international standards that have been issued by the International Monetary Fund (IMF) for providing guidance to member countries in the compilation of balance of payments and related data on the international investment position.

2.      See, Sachs, 1981; Obstfeld and Rogoff, 1995, 1996; Ghosh, 1995; Razin, 1995.

3.      See, Glick and Rogoff, 1995; Razin, 1995.

4.      The term `second generation reform' was coined by the IMF in the context of the perception by some that the globalization of the world economy, while benefiting developing countries to a degree with an increase in trade and investment, would also create certain problems of a magnitude sufficient to result in their near or complete marginalization. The IMF intended that second generation reform would supplement basic reform structured on the achievement of balance of payments viability, reduction of government deficits, trade liberalization and a reduction of the role of the state. [See, Michel Camdessus, 1999].

5.      The dummy variable approach allows testing of variety of hypotheses about any structural break. It allows to, determine if it is the intercept or slope that is different. If Chow test is used then it will reduces the degrees of freedom.

6.      Similarly, ‘D’ the intercept dummy assumes the value one for the post-adjustment period and zero for the adjustment period.

7.      The situation exacerbated in the aftermath of the September 11 terrorist attacks in US. Consequently, export growth has suffered and industrial profitability has also been affected by the prevailing low commodity and product prices globally

8.      Export growth has fallen due deepening of the global financial crises mid-way through 2008-09.

9.      This was the result of the sharp rise in the international prices of metals, chemicals and edible oils.

10.   See, Economic Survey 2005-06.

11.   Volatility is measured by coefficient of variation (See. Table-1).

12.   Current account registered a higher growth from 27.95% in pre-reform period to 35.07% in post-reform period this due to higher growth of imports during the post –reform period.

13.   The decline owed to sluggish global demand and low global commodity prices, particularly of petroleum.

14.   POL, imports declined by 41.4 per cent to US$ 73.1 billion in 2015- 16 (April-January) as against US$ 124.8 billion in 2014-15 (April-January), as a result of the steep fall in international crude oil prices. (See, Economic Survey 2015-16).

15.   Exports growth fell from 20.22% in R1 to 15.90% in R2 (i.e. by -4.32%), similarly, imports growth also fell from 19.12% in R1 to 17.42% (i.e. by -1.7%).

16.   See, Dr. Jomon Mathew (2013).

 

 

 

 

Received on 13.11.2018         Modified on 21.11.2018

Accepted on 28.12.2018      ©AandV Publications All right reserved