India’s Balance of Payment (1991-2019): Robust capital inflows crucial to India’s BoP

Summary

In this report, we provide an overview of how India’s balance of payment account has performed in the last few decades, starting from the post-reform period of 1991. 

The balance of payment crisis in 1991 was an eye-opener for the policymakers in India. Consequent policy measures of international integration of the Indian economy led to capital inflows in the form of foreign direct investments (FDIs) and foreign portfolio investments (FPIs), which thus transformed the funding mechanism of India’s Balance of payment. 

In our view, the significant events which shaped India’s balance of payments account are (i) 1991 economic reforms (ii) IT boom in 2001-2004 (iii) India economic boom between 2004-10  (iv) Slowdown in FPI inflows from 2015.

New era for India post 1991

Insufficient capital inflows alongside widening trade deficit in 1980s almost depleted India’s foreign exchange reserves culminating into the balance of payment crisis in 1991. With a conditional bailout by the IMF and the subsequent reforms by the government, India was able to handle its adverse current account balance.

At the onset of the balance of payment crisis, India’s current account deficit accounted for 3% of GDP in the fiscal year 1990-91. Rupee devaluation, as an immediate measure by the Indian government to contain trade and current account deficit boosted India’s exports. The capital inflows mainly in terms of conditional loans from the IMF and due to international integration of the Indian economy, along with the narrowing of trade deficit, helped India’s current account balance remain modest for most of the 1990s.

 Post 1991, capital inflows more than sufficient to fund deficit in the current account

Note: The  years in the graph represents fiscal year, for instance, the year 1990 represents the period Apr'90-Mar'91 

IT boom helped India achieve current account surplus: 2001-2004

The rising international oil prices in early 2000s put India’s current account balance under stress as the deficit widened to 2.4% of the GDP in April-June 2000. But the subsequent boom in India’s IT industry led to a rise in demand for its software exports which offset the impact of trade deficit. As a result, India’s current account balance experienced a surplus between 2001Q1 and 2004Q2. 

Upswing in current account balance due to demand for software exports 

2004-2010: Period of economic boom

During a period of economic boom between 2004 -2010, India’s nominal GDP grew at an average annual rate of 15%. To support the economic activities the pace of growth rate in imports exceeded the exports. During this period, Indian market also became attractive to the foreign investors. With the influx of capital inflows through FDIs and FPIs, the country’s capital account balance experienced a surplus of 8.9% of the GDP in FY 2007-08. The imports supported the economic activities, but caused damage to India’s current account balance as trade deficit widened to 10% of GDP in FY 2008-09. In the same fiscal year the Lehman shock caused the capital account to turn to an outflow of 1.2% of the GDP. Interestingly, FDIs were able to withstand the shock maintaining a steady inflow of 1.8% of the GDP in FY 2008-09 and it has consistently remained stable in the following years.

2004-2010, period of economic boom and widening trade deficit

The Indian economy was able to rebound after the Lehman shock, and India markets remained a popular destination for international investors until 2015. 

Slowdown in FPI inflows from 2015

In the last few years, the capital inflows into the economy have generally remained stable mainly due to constant FDI inflows. However, capital inflows through FPIs has slowed down due to rise in interest rate in the US market, which led to repatriation of capital from risky emerging market like India to safer American bond market. 

 Decline in robustness of portfolio investment inflows from 2015

In our view India’s trend in its balance of payment has become quite strong. Years of robust capital inflow led to accumulation of FX reserves which sufficiently funded country’s imports. In the last few years India’s current account deficit has narrowed to an average of 1.5% of the GDP since FY 2015-16, attributed to fall in international oil prices and not because competitiveness of Indian exports.  Also, as observed the FPI inflows have weakened in the last few years. But India’s trade balance being more vulnerable to international developments there is a need to strengthen the capital inflows to safeguard its international balance