Group 3

Bhuvaneshwari R Chaitra J Chandramohan Nayak M Neelu K Pragya P Madhusudanaan NM PGP 14/206 PGP 14/207 14/207 PGP 14/209 14/209 PGP 14/216 14/216 PGP 14/221 14/221 PGP 14/225 14/225

Agenda
Overview of the crisis Balance of Payments ² the machinery India before the crisis Events leading to the crisis The Crisis and recovery Post Crisis India Conclusion

1990 ² What happened?
Exchange rate was subjected to severe adjustment Foreign exchange reserves were barely adequate for 3 weeks of imports Was on a brink of default

BALANCE OF PAYMENT CRISIS!!!

BoP- An Introduction
An accounting record of all monetary transactions between a country and the rest of the world Sources of funds : positive or surplus item
Exports, receipts of loans and investments

Usage of funds : negative or deficit items
Imports or investment in foreign countries

All the components of a BoP sheet must balance: no overall surplus/deficits.

Composition of BoP Sheet
Two primary compositions of a BoP sheet:
Current account
Balance of trade + Factor payments + Cash transfers

Capital account
Reserves account along with the loans and investment between the country and the RoW

BoP = Current account ² Capital account ± balancing items

Types of Deficits A visible trade deficit A nation is importing more physical goods than it exports An overall current account deficit A basic deficit Current account plus foreign direct investment .

Balancing Mechanisms Rebalancing by changing the exchange rate Rebalancing by adjusting internal prices and demand CA = NS ² NI Rules based rebalancing mechanisms .

Balance of Payments Crisis??? .

What is BoP Crisis? Currency crisis / balance-of-payments crisis is a speculative attack in the foreign exchange market Speculative attack in the foreign exchange market The massive selling of a country's currency assets by both domestic and foreign investors Countries that utilize a fixed exchange rate are more susceptible to a speculative attack than countries utilizing a floating exchange rate because they have large amount of reserves necessary to hold the fixed exchange rate in place at that fixed level .

if a government chooses to maintain a fixed exchange rate during a speculative attack. as illustrated by the Argentine and East Asian financial crisis . they risk the chance of severe economic depression or financial collapse.What is BoP Crisis? But.

First Generation Model An adaptation of Stephen Salant and Dale Henderson·s model of speculative attacks in gold market Sudden speculative attack on fixed exchange rate can be a result from rational behavior by investors Occurs when investors foresee that a government is running an excessive deficit .

Second Generation Model The reason investors attack the currency is that they expect other investors to attack is true .

force liquidation of long run assets Argues that a currency crisis may cause a banking crisis if local banks have debts denominated in foreign currency .Third Generation Model Deal with how problems in the banking and financial system interact with currency crisis Suggests that "over borrowing" by banks to fund ¶moral hazard lending· is a form of hidden government debts Suggests that self-fulfilling panics that hit the financial intermediaries.

Decade of Comfort ² 70·s Comfortable during the 70·s 1973-74 oil shocks ² aftermath saw increase in foreign aid. private transfers and booming exports Global trade flourished ² exports increased Price levels lower in India compared to other countries ² depreciation of Rupee Private transfers increased seven-fold .

2 % of GDP Aid was higher than financial requirements for the decade ² built up reserves Close of decade: Foreign exchange reserves covering 7 months of imports! .Decade of Comfort ² 70·s Private transfers helped support 80% of trade deficit Result : 1978-79 : Current account deficit was just 0.

BOP upto 1981-82 The second oil shock of 1979 was severe Increase in POL imports Exports were decreased due to international recession These factors led to a Current Account deficit .

6% in dollar terms whereas exports increased at rate of 3. there was a ease on pressure on BOP due to  Decline in volume growth of imports from an average rate of 11% to 2%  Net Oil imports declined substantially as domestic production spurted to 29 million tones after the discovery of crude oil in Bombay High Non-POL imports rose at an average rate of 3.2% in volume terms .BOP upto 1981-82 During 1982-83 to 1984-85.

BOP upto 1981-82 Invisibles Account deteriorated as interest payments to service external borrowing acquired a rising trend Commercial borrowings and non-resident deposits emerged as the important sources of finance External assistance remained the major source of foreign capital inflow .

Build up to the crisis Second half of the eighties witnessed the building up of strains on the BOP Current Account Deficit remained high throughout Trade deficit occurred despite a increase in exports Manufactured exports increased during this period .

Build up to the crisis Heavy interest payments on foreign debts Fiscal deficit ² 8.2% of GDP Heavy borrowing from IMF ² debt-service ratio increased -13.9% in 89-90 .6% in 1984-85 to 30.

Build up to the crisis The genesis of the economic crisis in India. The root cause of the crisis was the large and growing fiscal imbalance Large fiscal deficits emerged as a result of mounting government expenditures . lies in the large and persistent macroeconomic imbalances that developed over the 1980s. which surfaced in 1991.

Build up to the crisis Fiscal deficits led to high levels of borrowing by the government from RBI.7 % in 1990-91. .4% in 1985-86 and to 12. with an expansionary impact on money supply leading directly to high rate of inflation The gross fiscal deficit of the government rose from 9.0% of GDP in 1980-81 to 10.

the internal debt of the government accumulated rapidly.Build up to the crisis These deficits had to be met by borrowings. rising from 35% of GDP at the end of 198081 to 53% of GDP at the end of 1990-91 interest payments increased from 2% of GDP in 198081 to 4% in 1990-91 .

Build up to the crisis The dynamic interrelationship between the fiscal and trade deficits. resulted in large current account deficits in the balance-of-payments In order to meet these large and persistent current account deficits. large scale commercial borrowings were undertaken along with contraction of substantial short-term debt. .

.Build up to the crisis The capital account of the balance-of-payments began experiencing strains after 1986 with the bunching of repayment obligations to the IMF and some of the private creditors.

Build up to the crisis BOP Deficit leads to Reduced Foreign Investments Forex reserves Depletion External Borrowings Debt Trap .

The Crisis 1990 ² 1992 ´Uglyµ Series of unfortunate events Gulf crisis of 1990 ² increase in oil import bill Burden of repatriating and rehabilitating of NRIs from West Asia Deterioration of invisible account Increase in price of oil => overall current account deficit in 1990-91 : US $ 9.7 billion .

Russia World growth declined from 4.5% in 1988 to 2. Rajiv Gandhi assassination ² reduced credibility of India .Important trading partners grew weak ² US.5% in 1991 Result : Export volume growth reduced to 4% Political turmoil ² VP Singh government overthrown.

2 billion Overshot IMF SDR reserves Only option ² commercial borrowing Loss of investor confidence .Credit agencies downgraded India Simultaneous outflow of NRI deposits Serious difficulties in rolling over of short term loans Current account deficit of $9.Capital Account problems Foreign reserves very low at $1.7 billion almost impossible to finance .

industrial and foreign investment policies Loss of reserves stemmed by less imports Result : 1991-92 ended with current account deficit of less than 1% of GDP! .Revival Government ² 2 tasks Compress imports Find ´exceptional financingµ Unorthodox steps taken ² Pledging of gold Adjustment in exchange rate Structural reforms in trade.

Government deficit ² Percentage of GDP .

Current Account trends .

Real exchange rate trends .

External debts ² As a percentage of GDP .

Foreign exchange reserves .

unified exchange rate. basket-pegged system.Corrective Policies conscious policy of industrial de-regulation exchange rate was devalued system transformation from discretionary. following a short intermediate period of dual rates Anti-export bias in the trade and payments regime was also reduced substantially A phased reduction in the exceptionally high customs tariffs A phased elimination of quantitative restrictions on imports . to a market-determined.

Corrective Policies Policies were initiated to encourage both direct and portfolio foreign investment Short-term debt was reduced and strict controls put in place to prevent future expansion Medium-term borrowing from private commercial sources was made subject to annual caps and minimum maturity requirements Growth of NRI deposits was moderated through reduction of incentives Foreign exchange reserves were consciously accumulated to provide greater insurance against external sector stresses and uncertainties .

e.2 billion $ per year. . an average of 2. i..Effects of Liberalization Trade and Investment Flows Surge in exports Significant rise in foreign direct investment and other capital flows Substantial increase in ¶private transfers· under the category of ¶invisibles· in balance of payments account In ten years.2001. Over 37 billion dollars of foreign investment flowed 18 billion $ was direct investment. 1991.

5 per cent of GDP between 1991 and 2001 . Export growth momentum and the exchange rate reforms .Effects of Liberalization Trade and Investment Flows Private transfers grew to a level of 10-12 billion dollars in the latter half of 1990s.the two major factors which helped contain the current account deficit in BOP to 1 to 1.

Effects of Liberalization Balance of Payment Surplus NRI deposits with the banking system in India on the rise from 13 billion dollars in 1991-92 to 23.8 billion dollars by March 2001 Balance of payments recorded an overall surplus consecutively for five years from 1996-97 India·s foreign exchange reserves.the average annual addition being 4.5 billion dollars . barely one billion in the pre-crisis year reached $ 40 billion (other than gold and SDR) .

.growth rates moving up to 11 and 20% in the two years ended March 2001 India successfully withstood the fall-out effects of the Asian financial turmoil in 1997 the economic sanctions imposed by USA and other countries following the nuclear tests in May 1998t the sharp rise in international oil prices since the closing months of 1999.Effects of Liberalization Balance of Payment Surplus External sector .

Recovery of the 1990s Transition from an onerous trade regime to a market-friendly system encompassing both trade and current payments Acceleration of GDP growth to 6.7 per cent in the period 1992-97 was the highest India had ever achieved over a five year period Sum of external current payments and receipts as a ratio to gross domestic product (GDP) doubled from about 19% in 1990²91 to around 40% by March 2001 .

Recovery of the 1990s Stabilization measures of 1991-93 restored macroeconomic stability and fuelled one of the swiftest recoveries of economic dynamism and business environment seen anywhere in the world in recent decades GDP growth recovered to nearly 6 per cent in 199394 and exceeded 7 per cent in each of the next three years Manufacturing recorded average real growth of 11.3 per cent in the four years 1993-94 to 1996-97 .

Recovery of the 1990s Export growth in dollar terms averaged 20 per cent in the three years 1994 ² 1996 and the rates of aggregate savings and investment in the economy peaked in 1995-96 Real fixed investment rose by nearly 40 %. led by a more than 50 % increase in industrial investment Private investment showed an astounding average growth of 16.3% per annum during 1992-96 Restoration of confidence and liberalization of foreign investment policies triggered a temporary surge in foreign capital inflow .

8 36.1 30.1 25.6 21 13.9 0 10 20 30 40 50 -8.2 10.4 1992-93 1991-92 1990-91 1989-90 1988-89 1987-88 1986-87 1985-86 1980-81 -10 1980-81 1991-92 1985-86 1992-93 1986-87 1993-94 1987-88 1994-95 1988-89 1995-96 1989-90 1996-97 1990-91 .1 48.6 26.External commercial borrowings ECB/TC (%) 1996-97 1995-96 1994-95 1993-94 10.7 20.8 31.6 9.

. oil exploration and telecommunications. 1994-95: Some private sector power and petroleum companies finalizing their financing packages 1995-96: Large demand for borrowing with projects in petroleum.External commercial borrowings 1993-94: Result of a concious government policy to maintain a strict control over external indebtness and resulted favourably in improving the credit rating of India by international agencies.

External Assistance EXTERNAL ASSISTANCE/TC (%) 70 60.7 34.3 18.9 46.2 36.8 26.5 19 11.7 1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1980-81 1991-92 1985-86 1992-93 1986-87 1993-94 1987-88 1994-95 1988-89 1995-96 1989-90 1996-97 1990-91 .2 43.9 36.9 60 50 40 30 20 10 0 63.6 29.7 33.

. In 1994-95 decided not to approach IMF for medium term funds.supervise and strengthen various projects.Measures for utilization Advance release of funds to state governments Disintermediation of loans to central public sector units Setting up of a Project Management Unit (PMU) as part of the department of Economic Affairs to monitor .

2 20 20.6 Axis Title 10 9 5 5.3 20.5 0 1990-91 -5 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 -3.Export Growth EXPORT GROWTH (%) 25 20.4 15 11.9 -10 .6 4.

Why such unimpressive export trend ? Decline in world trade since the second half of 1997 Decline in export prices of some major items of manufactured goods Growing infrastructure bottlenecks Appreciation of the rupee in real effective exchange rate terms. .

5 15 14.Growth of Imports GROWTH OF IMPORTS (%) 25 21.6 20 16.4 12.1 -10 .6 0 1990-91 -5 1993-94 1995-96 1996-97 1997-98 1998-99 1999-00 -7.1 10 Axis Title 10 5 4.

Conclusions Can liberalized trade policies land us again in the problems that we faced few years back? Market determined exchange rate-lead us to nearly equilibrium status Market can provide advanced warning signals POL imports needs special attention to protect from external shocks Experts· opinion: Maintain 15% annual exports growth! .