Lecture 2 - BOP Deficits, Foreign Trade Measures and Policies | International Economics- In Depth Basics and Analysis PDF Download

 Page 1


 
 
 
 
 
 
 
 
 
 
Lesson: BOP Deficits, Foreign Trade Measures and 
Policies 
Lesson Developers: Vaishali kapoor and Rakhi 
Arora 
College/Department: Delhi University 
 
 
Page 2


 
 
 
 
 
 
 
 
 
 
Lesson: BOP Deficits, Foreign Trade Measures and 
Policies 
Lesson Developers: Vaishali kapoor and Rakhi 
Arora 
College/Department: Delhi University 
 
 
 
Table of Contents: 
1. Introduction to Balance of Payments 
2. BOP disequilibrium 
2.1 it’s Causes 
2.2 BOP crisis in India 
2.3 Rationale for reforms in 1991 
3. Correcting BOP disequilibrium 
3.1 Steps to correct BOP 
3.2Measures adopted in India 
4. Export Promotion 
4.1 Export Promotion in India 
4.2 Organization for promoting export 
4.3 Export Promotion Measures in India 
5. Trade Policy 
6. Multi National Corporations 
6.1 pros and cons of MNCs 
6.2 Role of MNCs in India 
7. Summary 
8. Exercises 
9. Glossary 
10. References 
Learning Outcomes: 
After studying this chapter, a student should be able to:- 
1. Define Balance of Payments 
2. Justify rationale for reforms in India. 
3. Mention steps to correct BOP deficit. 
4. List Export promoting organizations in India. 
5. State export promotion measures in India. 
6. Explain trade policies undertaken by GoI. 
7. Understand role of MNCs in India. 
  
Page 3


 
 
 
 
 
 
 
 
 
 
Lesson: BOP Deficits, Foreign Trade Measures and 
Policies 
Lesson Developers: Vaishali kapoor and Rakhi 
Arora 
College/Department: Delhi University 
 
 
 
Table of Contents: 
1. Introduction to Balance of Payments 
2. BOP disequilibrium 
2.1 it’s Causes 
2.2 BOP crisis in India 
2.3 Rationale for reforms in 1991 
3. Correcting BOP disequilibrium 
3.1 Steps to correct BOP 
3.2Measures adopted in India 
4. Export Promotion 
4.1 Export Promotion in India 
4.2 Organization for promoting export 
4.3 Export Promotion Measures in India 
5. Trade Policy 
6. Multi National Corporations 
6.1 pros and cons of MNCs 
6.2 Role of MNCs in India 
7. Summary 
8. Exercises 
9. Glossary 
10. References 
Learning Outcomes: 
After studying this chapter, a student should be able to:- 
1. Define Balance of Payments 
2. Justify rationale for reforms in India. 
3. Mention steps to correct BOP deficit. 
4. List Export promoting organizations in India. 
5. State export promotion measures in India. 
6. Explain trade policies undertaken by GoI. 
7. Understand role of MNCs in India. 
  
 
1.Introduction to Balance of Payments 
Balance of Payment of a country is a systematic record of all economic transactions between 
a country & rest of the world, for a given financial year.  BOP is the difference between 
receipts from and payments to foreign countries. BOP is favorable if receipts exceed 
payments. 
Balance of Payments has two accounts: 
i) Current Account 
Current account records value of export & import of goods and services and 
interest, profit & dividends and remittances. All the receipts are credit items and 
payments are on debit side of current account. If receipts exceed payments then 
it is called current account surplus and if payments exceed receipts it is said to 
have deficit in current account. 
 
ii) Capital Account 
Capital account is summary of investment and borrowings. Foreign investment 
and a country’s borrowings are credit (receipts) and investment abroad and 
lending are debit items (payments). Similar to current account, capital account is 
in surplus if receipts exceed payments& vice-a versa. 
 
It is expected that if there is current account deficit then it will be nullified by capital 
account surplus or vice-a-versa or else, both accounts are in balance.  BOP remains always 
are balance i.e. total receipts equal total payments.  If imports exceed exports then to 
manage CAD, a country either needs to borrow or sell assets abroad. During 1980s, India 
maintained a current account deficit. Simultaneously, India’s ability to manage its economy 
eroded which shook international financial community’s confidence and international credit 
ratings downgraded and access to external credit was denied.  This all created deficit in 
capital account as well during the same time when India had CAD (1980s). The deficit in 
two accounts was paid by fall in reserves and reserves fell to just above $1 billion (Dec’91). 
Reserves fell so low that India’s only a week’s requirement of imports could be fulfilled. 
This chapter has five sections. First section covers causes of BOP disequilibrium and causes 
specific to India’s BOP crisis. Section two discusses measures adopted by government of 
India. Third section covers export promotion policy and organizations involved. Fourth 
section described import & export polices of India. In the last section, role of MNCs in India 
is analyzed. 
 
2. BOP Disequilibrium 
Current amount deficit (CAD) refers to excess of value of imports of goods & services over 
value of exports of goods and services and investment income.  There are various causes 
that trigger CAD. It could be when either exports fall or imports rise or both. 
Page 4


 
 
 
 
 
 
 
 
 
 
Lesson: BOP Deficits, Foreign Trade Measures and 
Policies 
Lesson Developers: Vaishali kapoor and Rakhi 
Arora 
College/Department: Delhi University 
 
 
 
Table of Contents: 
1. Introduction to Balance of Payments 
2. BOP disequilibrium 
2.1 it’s Causes 
2.2 BOP crisis in India 
2.3 Rationale for reforms in 1991 
3. Correcting BOP disequilibrium 
3.1 Steps to correct BOP 
3.2Measures adopted in India 
4. Export Promotion 
4.1 Export Promotion in India 
4.2 Organization for promoting export 
4.3 Export Promotion Measures in India 
5. Trade Policy 
6. Multi National Corporations 
6.1 pros and cons of MNCs 
6.2 Role of MNCs in India 
7. Summary 
8. Exercises 
9. Glossary 
10. References 
Learning Outcomes: 
After studying this chapter, a student should be able to:- 
1. Define Balance of Payments 
2. Justify rationale for reforms in India. 
3. Mention steps to correct BOP deficit. 
4. List Export promoting organizations in India. 
5. State export promotion measures in India. 
6. Explain trade policies undertaken by GoI. 
7. Understand role of MNCs in India. 
  
 
1.Introduction to Balance of Payments 
Balance of Payment of a country is a systematic record of all economic transactions between 
a country & rest of the world, for a given financial year.  BOP is the difference between 
receipts from and payments to foreign countries. BOP is favorable if receipts exceed 
payments. 
Balance of Payments has two accounts: 
i) Current Account 
Current account records value of export & import of goods and services and 
interest, profit & dividends and remittances. All the receipts are credit items and 
payments are on debit side of current account. If receipts exceed payments then 
it is called current account surplus and if payments exceed receipts it is said to 
have deficit in current account. 
 
ii) Capital Account 
Capital account is summary of investment and borrowings. Foreign investment 
and a country’s borrowings are credit (receipts) and investment abroad and 
lending are debit items (payments). Similar to current account, capital account is 
in surplus if receipts exceed payments& vice-a versa. 
 
It is expected that if there is current account deficit then it will be nullified by capital 
account surplus or vice-a-versa or else, both accounts are in balance.  BOP remains always 
are balance i.e. total receipts equal total payments.  If imports exceed exports then to 
manage CAD, a country either needs to borrow or sell assets abroad. During 1980s, India 
maintained a current account deficit. Simultaneously, India’s ability to manage its economy 
eroded which shook international financial community’s confidence and international credit 
ratings downgraded and access to external credit was denied.  This all created deficit in 
capital account as well during the same time when India had CAD (1980s). The deficit in 
two accounts was paid by fall in reserves and reserves fell to just above $1 billion (Dec’91). 
Reserves fell so low that India’s only a week’s requirement of imports could be fulfilled. 
This chapter has five sections. First section covers causes of BOP disequilibrium and causes 
specific to India’s BOP crisis. Section two discusses measures adopted by government of 
India. Third section covers export promotion policy and organizations involved. Fourth 
section described import & export polices of India. In the last section, role of MNCs in India 
is analyzed. 
 
2. BOP Disequilibrium 
Current amount deficit (CAD) refers to excess of value of imports of goods & services over 
value of exports of goods and services and investment income.  There are various causes 
that trigger CAD. It could be when either exports fall or imports rise or both. 
 
2.1 Causes of BOP Disequilibrium 
a) Fixed Exchange rate 
Fixed exchange rate, if has led to overvaluation of a currency, then economy faces CAD.  
This will occur on two accounts. Firstly, imports become cheaper and higher quantities 
are imported.  Secondly, exports become uncompetitive and quantity of exports fell. 
 
b) Economic growth 
Economic growth fuels the demand for all goods and services which includes imports and 
hence, worsen current account of BOP. 
 
c) Decline in Competitiveness 
If economy’s exports are not competitive in the international markets then fall in exports 
is witnessed.  Competitiveness of a country can deteriorate due to increase in economy’s 
inflation. 
d) Recession in other countries 
If other countries especially which are main trading partners experiences recession/ 
contraction in economy causes exports to decline. 
e) Borrowing Money 
If countries (especially so developing countries) borrow money then it worsens the current 
amount deficit. 
f) Demonstration effect 
When people in developing part of the world imitate the consumption pattern of developed 
bloc, their imports will rise.  
g) Development Programmes 
Developing countries’ government/private sector need to either build up infrastructure, core 
industries or even consumption goods production system, would have to depend on imports 
of capital goods & technology for prolonged period which causes disequilibrium in BOP. 
h) Natural factors 
Natural factors could include natural calamities, shortage of rainfall which induces a country 
to import in such emergent situations, which could hamper current account balance. 
 
i)Poor Marketing strategies 
 
Developed bloc has maintained a good current account surplus due to improved marketing 
strategies and on the other hand, poor marketing strategies lead to current account deficit 
in developing nations. 
Page 5


 
 
 
 
 
 
 
 
 
 
Lesson: BOP Deficits, Foreign Trade Measures and 
Policies 
Lesson Developers: Vaishali kapoor and Rakhi 
Arora 
College/Department: Delhi University 
 
 
 
Table of Contents: 
1. Introduction to Balance of Payments 
2. BOP disequilibrium 
2.1 it’s Causes 
2.2 BOP crisis in India 
2.3 Rationale for reforms in 1991 
3. Correcting BOP disequilibrium 
3.1 Steps to correct BOP 
3.2Measures adopted in India 
4. Export Promotion 
4.1 Export Promotion in India 
4.2 Organization for promoting export 
4.3 Export Promotion Measures in India 
5. Trade Policy 
6. Multi National Corporations 
6.1 pros and cons of MNCs 
6.2 Role of MNCs in India 
7. Summary 
8. Exercises 
9. Glossary 
10. References 
Learning Outcomes: 
After studying this chapter, a student should be able to:- 
1. Define Balance of Payments 
2. Justify rationale for reforms in India. 
3. Mention steps to correct BOP deficit. 
4. List Export promoting organizations in India. 
5. State export promotion measures in India. 
6. Explain trade policies undertaken by GoI. 
7. Understand role of MNCs in India. 
  
 
1.Introduction to Balance of Payments 
Balance of Payment of a country is a systematic record of all economic transactions between 
a country & rest of the world, for a given financial year.  BOP is the difference between 
receipts from and payments to foreign countries. BOP is favorable if receipts exceed 
payments. 
Balance of Payments has two accounts: 
i) Current Account 
Current account records value of export & import of goods and services and 
interest, profit & dividends and remittances. All the receipts are credit items and 
payments are on debit side of current account. If receipts exceed payments then 
it is called current account surplus and if payments exceed receipts it is said to 
have deficit in current account. 
 
ii) Capital Account 
Capital account is summary of investment and borrowings. Foreign investment 
and a country’s borrowings are credit (receipts) and investment abroad and 
lending are debit items (payments). Similar to current account, capital account is 
in surplus if receipts exceed payments& vice-a versa. 
 
It is expected that if there is current account deficit then it will be nullified by capital 
account surplus or vice-a-versa or else, both accounts are in balance.  BOP remains always 
are balance i.e. total receipts equal total payments.  If imports exceed exports then to 
manage CAD, a country either needs to borrow or sell assets abroad. During 1980s, India 
maintained a current account deficit. Simultaneously, India’s ability to manage its economy 
eroded which shook international financial community’s confidence and international credit 
ratings downgraded and access to external credit was denied.  This all created deficit in 
capital account as well during the same time when India had CAD (1980s). The deficit in 
two accounts was paid by fall in reserves and reserves fell to just above $1 billion (Dec’91). 
Reserves fell so low that India’s only a week’s requirement of imports could be fulfilled. 
This chapter has five sections. First section covers causes of BOP disequilibrium and causes 
specific to India’s BOP crisis. Section two discusses measures adopted by government of 
India. Third section covers export promotion policy and organizations involved. Fourth 
section described import & export polices of India. In the last section, role of MNCs in India 
is analyzed. 
 
2. BOP Disequilibrium 
Current amount deficit (CAD) refers to excess of value of imports of goods & services over 
value of exports of goods and services and investment income.  There are various causes 
that trigger CAD. It could be when either exports fall or imports rise or both. 
 
2.1 Causes of BOP Disequilibrium 
a) Fixed Exchange rate 
Fixed exchange rate, if has led to overvaluation of a currency, then economy faces CAD.  
This will occur on two accounts. Firstly, imports become cheaper and higher quantities 
are imported.  Secondly, exports become uncompetitive and quantity of exports fell. 
 
b) Economic growth 
Economic growth fuels the demand for all goods and services which includes imports and 
hence, worsen current account of BOP. 
 
c) Decline in Competitiveness 
If economy’s exports are not competitive in the international markets then fall in exports 
is witnessed.  Competitiveness of a country can deteriorate due to increase in economy’s 
inflation. 
d) Recession in other countries 
If other countries especially which are main trading partners experiences recession/ 
contraction in economy causes exports to decline. 
e) Borrowing Money 
If countries (especially so developing countries) borrow money then it worsens the current 
amount deficit. 
f) Demonstration effect 
When people in developing part of the world imitate the consumption pattern of developed 
bloc, their imports will rise.  
g) Development Programmes 
Developing countries’ government/private sector need to either build up infrastructure, core 
industries or even consumption goods production system, would have to depend on imports 
of capital goods & technology for prolonged period which causes disequilibrium in BOP. 
h) Natural factors 
Natural factors could include natural calamities, shortage of rainfall which induces a country 
to import in such emergent situations, which could hamper current account balance. 
 
i)Poor Marketing strategies 
 
Developed bloc has maintained a good current account surplus due to improved marketing 
strategies and on the other hand, poor marketing strategies lead to current account deficit 
in developing nations. 
 
2.2 BOP Crisis in India 
Current Account Deficit (CAD) is regular feature of Indian economy since the embarkment of 
planning period except a few years of first five-year plan and it has shown an increasing 
trend.  CAD was of the tune Rs.62.93 billion in 1987—88 which almost tripled in three years 
time period to Rs.173.67 billion is 1990-91.These deficits led to massive fall in reserves of 
India. 
The factors that caused BOP crisis in India were:- 
1.Trade deficit 
The pattern of increasing imports accompanied with rise in exports which is less than 
increase in imports lead to trade deficit. Import bill for India during 1980s increased at an 
alarming rate. 
a) Import liberalization 
In 1980s, though no reforms were initiated, but change in outlook & liberalizing 
imports led to quick rise in imports of capital goods& technology which caused huge 
current account deficit since mid 80s till 1990-91. 
b) Increase in prosperity to import 
Due to developmental programmes and ISI policies and building up core industries 
led to greater imports of capital goods & increase is national income, at the same 
time caused increase in imports of consumer durables. 
c) Oil Crisis 
Oil is the single most important component of India’s import bill.  OPEC cartel raised 
the prices of Oil (in 1973 & 1979) which led to further burden on current account. 
 
d) Negative attitude towards Indian goods and India’s negotiation and marketing skills 
had led to poor performance of Indian exports. 
 
2.Inflation 
India was experiencing inflation at the rate of 17% in Aug’91. Inflation was high owing to 
the inefficiencies in industrial production, oil price hikes and higher money supply growth 
rate. 
3.Huge fiscal deficit 
Large fiscal deficits have multi dimensional impact on macroeconomic variable which erode 
competitiveness 
a) Huge fiscal deficits contributed to the large current account deficits 
b) It led to the expansion of money supply leading to the high rates of inflation.  
c) Large fiscal deficits pre-empted significant proportion of economy’s savings. This led to 
scarcity of funds for investment which swelled interest rates in the economy, which in 
turn discouraged new investment and reduced our international competitiveness.