As a UPSC aspirant, delving into the intricacies of India’s economy is paramount, and understanding concepts like Balance of Payments (BoP) and Foreign Trade becomes indispensable. The UPSC NCERT Notes on the Indian Economy meticulously dissect these critical components, offering a comprehensive understanding essential for aspirants. BoP elucidates the economic transactions between a nation and the rest of the world, encompassing trade in goods, services, capital, and financial assets. Meanwhile, Foreign Trade embodies the exchange of goods and services across international borders, elucidating India’s integration into the global economic landscape. These notes serve as a beacon, illuminating the complexities of India’s economic interactions on the world stage, equipping UPSC aspirants with the knowledge requisite for success in the competitive examination.
Balance of Payment (BoP):
- BoP encompasses the difference in the value of imports and exports across visible, invisible, and capital transfer items.
- It serves as a comprehensive record of all economic transactions between a country and the rest of the world during a specific period.
- BoP aids in understanding the economic status and planning for expansion, providing vital signals for future policy formulation.
- The accounts within BoP include the Current Account and the Capital Account.
Economic Transactions in BoP:
Various economic transactions are documented in BoP, such as:
- Visible Items: Encompassing all physical goods imported and exported.
- Invisible Items: Encompassing services like insurance, banking, shipping, investment income (profit, dividend, etc.), and unilateral transfers (gifts, etc.).
Components of BoP
The main components of the Balance of Payments (BoP) include:
Current Account of BoP:
- The Current Account records the exports and imports of goods and services, along with transfer payments. In other words, transactions under the current account of the BoP are classified into merchandise (exports and imports) and invisibles.
Invisible transactions are further categorized into three main groups:
- Services: Comprising travel, transportation, insurance, government services not included elsewhere (GNIE), and miscellaneous services. Miscellaneous services include communication, royalties, management, and business services.
- Income: Encompassing non-resource services, also known as invisible items, exchanged between a country and the rest of the world. Services of banking, insurance, etc., fall into this category.
- Transfers: Involving grants, gifts, remittances, etc., that do not have any quid pro quo. This category includes receipts and payments abroad.
Structure of Current Account of BoP
| Structure of Current Account of BoP | Visible Items | Invisible Items |
| Export of Goods | Eport of Goods | |
| Import of Goods | ||
| Export of Services | Export of Services | |
| Import of Services | Import of Services | |
| Unilateral Transfer | Unilateral Transfer |
Capital Account of BoP
- The Capital Account of the Balance of Payments (BoP) categorizes capital inflows based on the instrument (debt or equity) and maturity (short or long-term). Key components of the Capital Account include foreign investment, loans, and banking capital.
- The Capital Account documents all international transactions involving the purchase and sale of assets such as money, stocks, and bonds. In India, Foreign Direct Investment (FDI) is prioritized over portfolio flows due to its greater stability. Preference is given to rupee-denominated debt over foreign currency debt, and medium to long-term debt is favored over short-term debt.
- Capital flows are influenced by both push and pull factors. Push factors, external to an economy, encompass elements like low-interest rates, abundant liquidity, and limited investment opportunities in advanced economies. Pull factors, on the other hand, are internal to an economy and include robust economic performance and an improved investment climate resulting from economic reforms in emerging economies.
Components of Capital Accounts and their Liabilities
| Components of Capital Account | Parts of Capital Account Components |
| Foreign Investment | (i) FDI |
| (ii) Portfolio Investment (FII, ADRs/GDRs) | |
| Loans | External Assistance |
| External Commercial Borrowings (ECBs) | |
| Trade Credit | |
| Types of Liabilities | Non-debt Liabilities |
| Debt Liabilities | |
| Banking Capital | |
| NRI Deposits | |
| Debt Liabilities |
Major Efforts in BOP
- Foreign exchange reserves were built to very comfortable positions and the difficulties of BoP came under control.
- The reasons for the same are as follows:
- Trade balance has always been in deficit since, imports have always exceeded exports.
- When current account deficits are larger than capital account surpluses, foreign exchange reserves are also used to cover these deficits.
- The existing state of affairs can be summarized as follows:
- Irreversible Trade Deficit: Our unavoidable imports of oil, coal, and India’s affinity for gold have contributed significantly to the persistent trade deficit.
- Rise in Imports: Several factors contribute to the rapid increase in imports, including the establishment of an industrial base (especially in the early stages), a surge in export-related imports (such as gems, jewelry, and capital goods), an increase in imports of industrial raw materials, rising prices, and imports of Petroleum, Oil, and Lubricants (POL) products.
- Devaluation and Depreciation of the Rupee: The devaluation and depreciation of the rupee have resulted in higher import prices, making exports more affordable. However, due to the low price and income elasticities of demand for exports, the growth in exports has been slow and insufficient to match the rising imports.
- Slow Rise in Export Earnings: While export earnings have increased, they have not kept pace with the escalating imports. The growth in exports has been neither substantial nor continuous, leading to a deficit in financing the rising imports.
- Debt Service: The Balance of Payments (BoP) problem has intensified due to the increasing obligation of amortizing payments. In 2011-12, the debt service ratio was 6%, highlighting the challenge of financing the rising imports with slow-paced exports. The most effective solution to India’s BoP problem is seen in cost reduction and enhancing competitiveness in the global market.
- Appreciation: The recent appreciation of the rupee has made exports more expensive and imports cheaper, potentially exacerbating the Balance of Payments (BoP) problem.
Balance of Payment Crisis
- Balance of Payment Crisis: Also known as a currency crisis, the BoP crisis occurs when a nation struggles to pay for essential imports or service its external debt payments. The causes of the Balance of Payment crisis in India in 1991 included high government expenditure, a significant increase in internal debt, a high Current Account Deficit triggered by rising crude oil prices during the Gulf War, and a depletion of Forex reserves.
Management of BoP:
- The government has implemented various measures for the management of BoP, including policies for managing foreign exchange reserves, foreign exchange rate management, and handling foreign debt. These actions aim to address the challenges posed by the trade deficit and ensure the stability of India’s external financial position.
Policies for Management of Foreign Exchange Reserves
- Foreign exchange reserves are assets held in reserve by a Central Bank in foreign currencies, such as bonds, treasury bills and other government securities.
- It needs to be noted that the majority of foreign exchange reserves are held in US dollars.
- Foreign currency assets, gold reserves, Special Drawing Rights (SDR), and Reserve Position with the International Monetary Fund (IMF) constitute the essential components of India’s foreign exchange reserves.
Management of Foreign Exchange Rates:
- The management of exchange rates is intricately linked to trade policy.
- Consequently, addressing the current account deficit in the Balance of Payments (BoP) involves potential adjustments to exchange rates.
- Acknowledging this, the Indian government implemented a market-determined exchange rate system in 1993, allowing market forces to determine the value of the rupee.
- The Reserve Bank of India (RBI) intervenes when necessary to prevent excessive fluctuations in the market.
- The primary goal of foreign exchange rate management in India is to maintain the foreign value of the rupee at a genuine and reliable level.
Foreign Exchange Reserves:
- Foreign exchange reserves play a crucial role in the Balance of Payments (BoP) and are integral to assessing an economy’s external position. India’s reserves encompass Foreign Currency Assets (FCAs), gold, Special Drawing Rights (SDRs), and the Reserve Tranche Position (RTP) in the IMF.
Foreign Exchange Rate:
- The foreign exchange rate represents the price of the domestic currency concerning another currency.
- It is a means of comparing the relative values of different currencies.
- Exchange rates can be either fixed or floating, with the former determined by the Central Bank and the latter influenced by market dynamics of demand and supply.
Exchange Rate System in India:
- In India, the exchange rate signifies the rate at which the Indian rupee is exchanged with other international currencies, such as the US Dollar, in the foreign exchange market.
- Historically linked to the British pound sterling, India transitioned to fixing and maintaining the external value of the rupee in terms of gold or the US dollar after independence.
- Full convertibility of the rupee on the current account was announced in the 1994-95 budget.
Reserve Tranche with IMF:
- The reserve tranche is a segment of a member country’s quota with the IMF, comprising gold or foreign currency.
- Twenty-five percent of the total quota must be paid in foreign currency or gold (reserve tranche or gold tranche), while the remaining 75% can be in domestic currencies (credit tranche).
- Contributions to the IMF consist of national currency and Special Drawing Rights (SDR), which denominates quotas in terms of a basket of major international currencies.
Types of Exchange Rates:
- Key types of foreign exchange rates include Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER), serving as indicators of a country’s external competitiveness over time.
- Nominal Effective Exchange Rate (NEER) represents the weighted average of bilateral nominal exchange rates of the home currency against foreign currencies. In contrast, Real Effective Exchange Rate (REER) is calculated as a weighted average of nominal exchange rates, adjusted for relative price differentials between the home and foreign countries.
- Nominal rupee depreciation, while having some downsides such as increased imported inflation, proves beneficial over time by offsetting higher domestic inflation and maintaining the competitiveness of Indian exports.
- REER captures movements in cross-currency exchange rates and inflation differentials between India and its major trading partner, reflecting the external competitiveness of Indian products. The RBI has constructed indices for both NEER and REER, covering six currencies (US Dollar, Euro, Pound Sterling, Japanese Yen, Chinese Renminbi, and Hong Kong Dollar) and 36 currencies.
Comparison between NEER and REER:
- NEER is the weighted bilateral exchange rates of the domestic currency against foreign currencies.
- REER is the average of the NEER, adjusted for inflation effects, offering a more nuanced view of competitiveness.
- While NEER is an indicator of a country’s international competitiveness in the foreign exchange market, REER holds more significance for economists due to its adjustment for price changes in the NEER.
India’s Present Exchange Rate Policy:
- India has shifted from a fixed exchange rate policy to a market-determined exchange rate, operating as a floating rate regime with occasional central intervention. The present exchange rate policy focuses on careful monitoring and management, allowing underlying demand and supply conditions to determine exchange rate movements in an orderly manner.
- Policy Options for RBI in Managing Exchange Rates:
- Using Policy Rates: RBI can adjust policy rates (Repo Rate, CRR, SLR, etc.) to influence exchange rates. Lowering interest rates increases the rupee’s supply, leading to depreciation, while raising interest rates tightens rupee supply, resulting in appreciation.
- Using Forex Reserves: RBI can sell forex reserves to buy Indian rupees, supporting the demand for the rupee selectively.
- Easing Capital Controls: Relaxing capital controls allows more capital inflows, addressing currency depreciation by expanding market participation.
Foreign Exchange Rate Systems:
- Fixed Exchange Rate System: The weaker currency is pegged or tied to the stronger currency, with the rate determined by the government or central bank, independent of market forces.
- To ensure stability in currency rates, the Central Bank or government engages in purchasing foreign exchange when the foreign currency rate rises and selling it when the rates decline. This practice is referred to as pegging, making the fixed exchange rate system synonymous with the pegged exchange rate system.
FERA and FEMA:
- The Foreign Exchange Regulation Act (FERA), established in 1974, proved ineffective in restraining activities like the expansion of Trans National Corporations (TNCs).
- Following the 1993 amendment, FERA transitioned into the Foreign Exchange Management Act (FEMA) during the winter session of Parliament in 1999.
- While FERA imposed strict regulations on certain payments related to foreign exchange and securities, FEMA focused on managing foreign exchange rather than regulating it, signifying a shift in the government’s approach toward foreign capital.
Methods of Fixed Exchange Rate:
- Gold Standard System: Each country defines the value of its currency in terms of gold, establishing a common unit of parity between different countries’ currencies.
- Bretton Woods System: This replaced the gold standard and allowed some adjustments, known as the adjusted peg system.
- Managed Floating Exchange Rate: A hybrid system combining fixed and flexible elements, where market forces determine the exchange rate, with the Central Bank intervening to stabilize it during currency appreciation or depreciation.
- Flexible Exchange Rate System: Exchange rates are determined by the forces of demand and supply in the foreign exchange market, also known as the Floating Rate of Exchange or Free Exchange Rate.
Liberalized Exchange Rate Regime/System:
- India has transitioned from a fixed currency system to a liberalized currency system, with two prevalent exchange rate types.
- The Reserve Bank of India determines one, while the other is based on the demand and supply of currency in the market, mostly guided by a market-determined exchange rate.
Devaluation of Money:
- Devaluation refers to a deliberate downward adjustment in a country’s currency value relative to another currency, a group of currencies, or a standard in a fixed exchange rate system.
- It is distinct from depreciation, which occurs in a floating exchange rate system and signifies a fall in the currency’s value.
- Devaluation is a monetary policy tool used by countries with fixed or semi-fixed exchange rates and should not be confused with depreciation or revaluation.
Effects of Devaluation:
- Export Competitiveness: Devaluation makes exports more competitive and affordable for foreigners, leading to increased demand for exports.
- Expensive Imports: Devaluation raises the cost of imports, reducing the demand for imported goods.
- Increased Aggregate Demand (AD): Devaluation can contribute to higher economic growth by boosting exports and limiting imports, leading to increased AD. This, in turn, may result in higher Real GDP and inflation.
Devaluation in India (1991):
- In July 1991, the Indian Government devalued the rupee by approximately 18-19%.
- Simultaneously, the trade policy shifted from highly restrictive measures to a system of freely tradable EXIM scrips, allowing exporters to import 30% of the value of their exports.
Currency Appreciation:
- Exchange Rate Changes: A change in exchange rates causes one currency’s value to rise and the other’s to fall.
- Appreciation: When a currency’s value increases, it appreciates; conversely, a decrease in value is depreciation.
- Reasons for Appreciation: Currencies appreciate due to factors like government policy, interest rates, trade balances, and business cycles.
Currency Convertibility:
- Fully Convertible Currency: A monetary unit allowing holders to freely convert it into any other currency at prevailing exchange rates.
- Historical Background: Before World War I, the gold standard prevailed, allowing currency conversion based on gold or other currencies.
- Post the Bretton Woods system’s failure in 1971, a shift occurred, and full convertibility implies unrestricted conversion of a country’s currency in foreign exchange and vice versa.
Convertibility of Rupee in India:
- Partial Convertibility: The Indian rupee achieved partial convertibility in 1992, aiming to integrate the Indian economy globally.
- Operational Framework: Under this system, 60% of exchange earnings were convertible at market rates, while the remaining 40% followed officially determined rates.
Capital Account Convertibility in India
- Capital Account Convertibility (CAC) for Indian Economy refers to the abolition of all limitations concerning the movement of capital from India to different countries across the globe.
- According to the Tarapore Committee, Capital Account Convertibility refers to the freedom to convert local financial assets into foreign financial assets and vice-versa at market determined rates of exchange.
- It is associated with changes of ownership in foreign or domestic financial assets and liabilities and embodies the creation and liquidation of claims on or by the rest of the world.
- There is partial capital account convertibility in India. Though tremendous capital account liberalisation measures were taken place since launch of economic reforms
- The Second Tarapore Committee, appointed by the RBI to outline the framework for Fuller Capital Account Convertibility, presented several key recommendations.
- The three-phase approach suggested for the full convertibility of the rupee in the capital account included Phase-1 (2006-07), Phase-II (2007-09), and Phase-III (2011).
Some noteworthy recommendations are as follows:
- Increase the ceiling for External Commercial Borrowings (ECB) with automatic approval.
- Permit NRIs to invest in capital markets and provide tax benefits for NRI deposits.
- Strengthen banking regulations for improvement.
- Prohibit Foreign Institutional Investors (FIIs) from investing fresh money through participatory notes.
- Emphasize the need for transparent fiscal consolidation to mitigate the risk of a currency crisis.
- Acknowledge the swift and adverse reactions of short-term debt flows during currency crises, necessitating proactive measures.
- Stress the importance of strong and resilient domestic financial institutions, especially banks, for financial market efficiency during currency crises.
- Recommend a review of tax benefits for special deposit schemes for NRIs (NRERA and FCNR(B)).
- Allow non-residents, excluding NRIs, to open FCNR(B) and NRERA accounts without tax benefits, subject to KYC and FATF norms.
- Propose the prohibition of FIIs from investing fresh money through participatory notes, with existing P-notes holders given an exit route.
Current Account Convertibility:
- Current account convertibility entails the freedom to convert domestic currency into foreign currency and vice versa for trade in goods and invisibles (services, transfers, or income from investment).
- This allows individuals and entities to exchange currencies in the foreign exchange market.
- In India, full current account convertibility has been in place since August 20, 1993, following measures to liberalize exchange controls and shift to market-determined exchange rates since March 1993.
Foreign Capital:
- Foreign capital inflow can be concessional or non-concessional, with non-concessional flows including External Commercial Borrowings (ECBs), loans on market terms, NRI deposits, and foreign investment. Foreign investment is further categorized into Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII), representing direct investment in the productive capacities of a country by external entities.
Foreign Direct Investment (FDI)
- It refers to direct investment in the productive capacities of a country by someone from outside the country.
- Investment may take the form of establishing a new plant or acquiring shares of a company, granting the foreign entity control over the company’s operations.
- A foreign company can establish its presence in India through two methods: creating a company under the Companies Act or establishing an unincorporated entity like a Liaison office, project office, or branch office.
- In 2021, the Government of India amended FDI regulations, raising the foreign investment limit in the insurance sector from 49% to 74%.
- The Make in India initiative, launched in September 2014, further liberalized FDI policies for 25 sectors.
- India achieved its highest annual FDI of $83.57 billion in 2021-22, surpassing the previous year’s $83.57 billion, despite the military operation in Ukraine and the Covid-19 pandemic.
- India’s FDI inflows have increased twentyfold since the inflows were only $4.3 billion.
- Leading FDI equity inflows came from Singapore (27%), followed by the USA (18%) and Mauritius (16%). The computer software and hardware sector emerged as the top recipient, constituting around 25%, followed by the service sector (12%) and the automobile industry (12%).
- Karnataka led the states with a 38% share of the total FDI equity inflows in 2021-22, followed by Maharashtra (26%) and Delhi (14%).
Sectors Open to FDI:
- Most sectors are partially open to FDI, with a cap and specific conditions. FDI in India has two entry routes.
- In sectors where FDI is allowed up to 100%, it enters under the automatic route, subject to sectoral regulations and conditions. No approval from the Reserve Bank of India (RBI) or the government is required, but the investment must be notified to the RBI’s regional office within 30 days.
- In sectors where FDI is allowed under the government route, prior approval from the Foreign Investment Promotion Board (FIPB) was required.
Sectors Prohibited for FDI:
- Atomic energy generation, Investments in Chit Funds, Cigars, Cigarettes, or any related tobacco industry, Gambling or Betting businesses, Housing and Real Estate (except townships, commercial projects, etc.), Lotteries (online, private, government, etc.), Trading in Transferable Development Rights (TDRS), Railway Operations (other than permitted activities).
Key Changes in FDI Limits
| Sector | Key Changes in FDI Limits | % of FDI/Equity | Entry Route |
| Defense Sector | 100% | 100% | Automatic route |
| Telecom Services | 100% | 100% | Automatic route |
| Tea Plantation | (Automatic route increased from 49% to 74%) | Automatic upto 49%, government route beyond 49% | Automatic route |
| Asset Reconstruction Company | 100% | 100% | Automatic route |
| Petroleum and Natural Gas (Exploration) | 100% | Automatic route | Automatic route |
| Petroleum and Natural Gas (PSUs) | 49% | Automatic | Automatic route |
| Commodity Exchange | 49% | Automatic route | Automatic route |
| Power Exchanges | 100% | Automatic route | Automatic route |
| Pension Sector | 74% | Automatic route | Automatic route |
| Stock Exchanges/ Clearing Corporations | 49% | Automatic route | Automatic route |
| Credit Information Companies | 100% | Automatic route | Automatic route |
| Courier Services | 100% | Automatic route | Automatic route |
| Single Brand Product Retail Trading | 100% | Automatic upto 49%, government route beyond 49% | Automatic route |
| Insurance Sector | 74% | Automatic route | Automatic route |
| Pharmaceuticals | 100% | Automatic route | Automatic route |
| Animal Husbandry | 100% | Automatic route | Automatic route |
| Food Item | 100% | Automatic route | Automatic route |
| e-Commerce | 100% | Automatic route | Automatic route |
Abolition of the Foreign Investment Promotion Board (FIPB):
- The Union Cabinet has approved the elimination of the 25-year-old Foreign Investment Promotion Board (FIPB). Going forward, individual ministries will take on the responsibility of directly approving foreign investment proposals.
- This decision aligns with Finance Minister Arun Jaitley’s proposal to discontinue the FIPB, as outlined in the 2016-2017 Union Budget. The FIPB was established in the mid-nineties under the Prime Minister’s office during the era of economic liberalization.
- The rationale behind this move is rooted in the fact that over 90% of Foreign Direct Investment (FDI) inflows, in terms of value, already occur through the automatic route. The government anticipates that the removal of the FIPB will contribute to an improved ease of doing business.
Foreign Institutional Investment (FII):
- A Foreign Institutional Investor (FII) refers to an entity registered in a country outside the one in which it is making investments. In the Indian context, this term is used for companies investing in the country’s financial markets.
- In 2013, India adopted the internationally recognized definition of FII to eliminate ambiguity between Foreign Institutional Investment (FII) and Foreign Direct Investment (FDI). Now, an investor with a stake of less than 10% in a company is treated as FII, while an investor with a stake exceeding 10% is categorized as FDI.
- FIIs are allowed to invest in securities in both the primary and secondary markets, covering shares, debentures, and warrants of listed or unlisted companies. Entities eligible to be treated as FIIs in India include Pension Funds, Mutual Funds, Banks, Investment Trusts, Sovereign Wealth Funds, and Foreign Central Banks.
- FIIs can invest in various instruments such as government securities, commercial paper, derivatives, units of schemes floated by domestic mutual funds, Indian depository receipts, and security receipts.
- They typically invest through registered brokers on recognized Indian Stock Exchanges or via sub-accounts. Participatory Notes (P-Notes) and Qualified Foreign Investors (QFIs) are additional mechanisms used in the context of FII investments.
Participatory Notes (P-Notes):
- P-Notes are financial instruments employed by investors or hedge funds not registered with the Securities and Exchange Board of India (SEBI) to invest in Indian securities. Brokerages in India purchase domestic securities and issue P-Notes to foreign investors, allowing them to benefit from dividends or capital gains from these securities without being directly registered.
Qualified Foreign Investor (QFI):
- A QFI is an individual who meets specific criteria, including being a resident in a country or group that is a member of the Financial Action Task Force (FATF) and residing in a country that is a signatory to the International Organization of Securities Commission (IOSCO) MoU or has a bilateral MoU with SEBI.
- Such person should not be resident in India or registered with SEBI as an FII or a sub-account of FII.
- Global Depository Receipts (GDRs): These are equity instruments issued in international markets like London, Luxembourg, etc. Indian companies utilize GDRs to raise capital from abroad, denominated in currencies such as dollars or euros.
- American Depository Receipts (ADRs): These are equity instruments issued to American retail and institutional investors, listed in New York on exchanges like Nasdaq or the New York Stock Exchange.
- Indian Depository Receipts (IDRs): Similar to ADRs or GDRs, IDRs are employed by non-Indian companies in the Indian stock markets to issue equity to Indian investors. QFIs, distinct from FIIs and Non-Resident Indians, can invest directly in mutual funds and stocks of Indian companies.
- The introduction of the QFI scheme aimed to address concerns regarding money laundering and due diligence, facilitating increased foreign capital inflows, reducing market volatility, and deepening the markets.
Foreign Debt Overview:
- Foreign debt refers to funds borrowed by a government, corporation, or private household from another country’s government or private lenders. The rising trend of foreign debt in recent decades has had notable implications, especially for developing economies.
External Debt Types:
Long-term and Short-term Debt:
- Long-term debt: Original maturity exceeding one year.
- Short-term debt: Original maturity of one year or less, with the possibility of on-demand payments.
Multilateral and Bilateral Debt:
- Multilateral creditors: Institutions like the International Development Association (IDA), International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), etc.
- Bilateral creditors: Nations involved in one-to-one loan arrangements, with examples including Japan, Germany, the United States, France, etc.
Sovereign and Non-Sovereign Debt:
- Sovereign debt: Encompasses external debt resulting from loans received by the Government of India through external assistance programs, including borrowings from the IMF, defense debt, Rupee debt, and foreign currency defense debt. Non-Sovereign debt comprises other components of external debt.
Trade/Export Credits:
- Loans and credits extended for imports by overseas suppliers, banks, and financial institutions to both sovereign and non-sovereign entities.
External Commercial Borrowings (ECB):
- Includes borrowings from commercial banks, financial institutions, and funds raised by issuing securitized instruments such as bonds, Floating Rate Notes (FRN), and securities by commercial banks.
India’s external debt
- India’s external debt comprises the portion of the country’s financial obligations acquired from commercial institutions, banks, and international financial entities such as the World Bank, IMF, and sovereign governments. Over time, India has witnessed a rise in its external debt, ranking among the most indebted nations globally in terms of total outstanding debt.
- As of the end of March 2022, India’s external debt stood at $620.7 billion, marking an 8.2% increase from $573.7 billion in March 2021. In rupees, this amounted to an estimated 47.1 lakh crore, reflecting a growth of 12.4% from 41.9 lakh crore a year earlier.
- Commercial lenders constituted the largest share of outstanding debt at the end of March 2022, accounting for approximately 36.7%, followed by NRI depositors (24%) and trade creditors (19.5%). The US dollar held the dominant position, representing 53.2% of the total external debt.
- Long-term debt, forming 80.4% of the total debt, grew by 5.6% to reach US $499.1 billion as of the end of March 2022. Meanwhile, short-term debt, constituting the remaining portion, increased by 20.4% to US $111.7 billion.
- Concessional debt, making up 8.3% of the total debt, decreased by 0.7% to US $51.4 billion as of the same date. However, in relation to Gross Domestic Production (GDP), the external debt as a percentage slightly declined to 19.9% from 21.2% in the previous fiscal year (2020-21).
Sovereign (Government) and Non-Sovereign (Non-Government) Debt
- Sovereign Debt includes:
- External debt outstanding on account of loans received by Government of India, under the external assistance programme and civilian component of rupee debt.
- Other government debt comprising borrowings from IMF, defence debt component of rupee debt as well as foreign currency defence debt.
- FII in Government Securities. Non-Sovereign includes the remaining components of external debt.
External Commercial Borrowings (ECBs)
- External Commercial Borrowings (ECBs) cover a broad spectrum, including loans from commercial banks, financial institutions, securitized instruments like bonds (such as India Development Bonds and Resurgent India Bonds), Floating Rate Notes (FRN), and borrowings through buyers’ credit and supplier credit mechanisms.
- In times of economic prosperity and sound fiscal conditions, domestic borrowers may benefit from lower interest rates, extended maturity periods, and capital gains resulting from domestic currency appreciation.
- Conversely, during economic crises and capital flow reversals, a depreciating domestic currency could lead to increased debt service liabilities, requiring more domestic currency for foreign exchange payments.
- An additional concern would be the debt overhang problem, as the local currency’s debt volume is likely to increase. This could potentially lead to corporate distress, particularly given the tendency for the rupee to depreciate precisely during periods of economic stress, when Indian businesses face pressure on revenues and margins.
Non-Resident Indian (NRI) Deposits
NRI deposits come in three forms:
- Non-Resident (External) Rupee Account (NRE Account) Deposits, introduced in 1970, allow any NRI to open an account with funds remitted to India through a foreign bank. The deposited amount, along with accrued interest, can be repatriated.
- Foreign Currency Non-Resident (Banks) [Deposits (FCNR-B)] were introduced on May 15, 1993. These term deposits are maintained in Pound Sterling, Dollar, Japanese Yen, Euro, Canadian Dollar, and Australian Dollar.
- The maximum period for these deposits was increased from 6 months to 1 year in October 1999. Since July 26, 2005, banks have been authorized to accept FCNR (B) deposits with a maturity period of up to 5 years, compared to the previous limit of 3 years.
- Non-Resident Ordinary Rupee (NRO) Accounts allow any person residing outside India to open and maintain an account with an authorized bank for bona fide transactions denominated in Indian rupees.
- NRO accounts can be in the form of current, savings, recurring, or fixed deposits. NRIs or Persons of Indian Origin (PIO) can remit up to USD 1 million per financial year from the balances held in NRO accounts.
Prelims Facts
- What term refers to the systematic recording of all import and export transactions of a country within a specified period, typically a year? Balance of Payment (BoP) [IAS (Pre) 2010
- If the exchange rate shifts from 60 to 65 rupees per US Dollar due to market forces within a given timeframe, it indicates -Depreciation of Rupee [JPSC (Pre) 2021
- The largest foreign exchange earnings for India come from the export of -Iron (BPSC (Pre) 2015]
- What constitutes the majority share of India’s export trade? -Diamonds, jewels, and jewelry [UPPSC (Mains) 2004)
- In which year is the Department of Commerce aiming to position India as a major player in global trade? –2020 (UP RO/ARO (Mains) 2014, UPPSC (Mains) 2014, 2017]
- Which authority approves foreign exchange for importing goods? -Reserve Bank of India [UPPSC (Pre) 2011)
- Participatory Notes (PNs) are linked with -Foreign Institutional Investors [IAS (Pre) 2007
- Which country holds the largest share in cumulative FDI inflows into India? -Mauritius [UPPSC (Mains) 2010
- In India, the Foreign Investment Promotion Board (FIPB) now operates under -Ministry of Finance [UPPSC (Mains) 2007)
- Foreign currency with a tendency for rapid movement is termed -Hot currency [BPSC (Pre) 2015
- The greatest portion of Foreign Direct Investment (FDI) from 1997 to 2000 was directed towards -Service sector [IAS (Pre) 2001)
- Allowing the unrestricted conversion of rupee to other currencies and vice versa is referred to as -Convertibility of rupee [IAS (Pre) 2015
- Export-import trade refers to -Goods imported for export [UPPSC (Mains) 2002]
UPSC NCERT Practice Questions
1. BoP (Balance of Payment) refers to
(a) transactions in the flow of capital.
(b) transactions relating to receipts and payment of Invisible.
(c) transactions relating only to exports and imports.
(d) systematic record of all its economic transaction with the rest of the world.
2. Which of the following does not form part of current account of Balance of Payments?
(a) Export and import of goods.
(b) Export and import of services.
(c) Income receipts and payments.
(d) Capital receipts and payments.
3. Which one of the following factors is taken account to calculate the Balance of Payment (BOP) of a country?
(a) Current Account
(b) Changes in the Foreign Exchange Reserves
(c) Error and Omissions
(d) All of the above
4. In which of the following years was the trade balance favourable to India? BPSC (Pre) 2015
(a) 1970-71 and 1974-75
(b) 1972-73 and 1976-77
(c) 1972-73 and 1975-76
(d) 1971-72 and 1976-77
5. Which one of the following countries is the largest source of the Foreign Direct Investment in the Indian Economy?
(a) United States
(b) Switzerland
(c) Singapore
(d) Mauritius
6 . Which of the following is/are not FDI policy changes after 2010?
1. Permission of 100% FDI in automotive sector.
2. Permitting foreign airlines to make FDI upto 49%.
3. Permission of upto 51% FDI under the government approval route in multi-brand retailing, subject to specified conditions.
4. Amendment of policy on FDI in single-brand product retail trading for aligning with global practices.
Select the correct answer using the codes given below.
(b) 2 and 4
(a) Only 1
(c) 1 and 2
(d) 1, 2 and 3
7. Which one of the following is the investment in securities that is intended for financial gain only and does not create a lasting interest in or effective management control over an enterprise?
(a) Foreign Direct Investment
(b) Portfolio Investment
(c) Equity Direct Investment
(d) Both ‘a’ and ‘c
8. Both Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) are related to investment in a country. Which one of the following statements best represents an important difference between the two? IAS (Pre) 2011
(a) FII helps bring better management skills and technology, while FDI only brings in capital. availability in
(b) FII helps in increasing capital general, while FDI only targets specific sectors.
(c) FDI flows only into the secondary market, while FII targets primary market.
(d) FII is considered to be more stable than FDI.
9. Participatory Notes (PNs) are associated with which one of the following? IAS (Pre) 2007
(a) Consolidated Fund of India
(b) Foreign Institutional Investors
(c) United Nations Development Programme
(d) Kyoto Protocol
10. Which among the following has the largest share in the foreign exchange reserves of India?
(a) Securities of international institutions
(b) Gold reserves
(c) FCA
(d) NRI deposits
11. Tarapore Committee was associated with which one of the following? IAS (Pre) 2007
(a) Special Economic Zones
(b) Fuller capital account convertibility
(c) Foreign exchange reserves
(d) Effect of oil-prices on the Indian economy
12. Consider the following. IAS (Pre) 2021
1. Foreign Currency Convertible Bonds.
2. Foreign institutional investment with certain conditions.
3. Global depository receipts.
4. Non-resident external deposits
Which of the above can be included in Foreign Dire Investments (FDI)?
(a) 1, 2 and 3
(b) Only 3
(c) 2 and 4
(d) 1 and 4
13. Consider the following statements. The Indian rupee is fully convertible IAS (Pre) 2009
1. in respect of Current Account of Balance of Payments.
2. in respect of Capital Account of Balance of Payments.
3. into gold.
Which of the statements given above is/are correct?
(a) Only 1
(b) Only 3
(c) 1 and 2
(d) 1, 2 and 3
14. Consider the following statements. Full convertibility of the rupee may mean
1. Its free float with other international currencies.
2. Its direct exchange with any other international currency at any prescribed place inside and outside the country
3. It acts just like any other international currency
Which of these statements are correct?
(a) 1 and 2
(b) 1 and 3
(c) 2 and 3
(d) 1, 2 and 3
15. The Capital Account Convertibility of the Indian rupee implies IAS (Pre) 1998
(a) that the Indian rupee can be exchanged by the authorised dealers for travel.
(b) that the Indian rupee can be exchanged for any major currency for the purpose of trade in goods and services.
(c) that the Indian rupee can be exchanged for any major currency for the purpose of trading financial assets.
(d) None of the above
Know Right Answer
1. (d)
2. (b)
3. (d)
4. (b)
5. (c)
6. (a)
7. (b)
8. (b)
9. (b)
10. (c)
11. (b)
12. (a)
13. (a)
14. (a)
15. (c)
Frequently Asked Questions (FAQs)
Q1: What is the significance of the Balance of Payments in the context of the Indian economy?
A1: The Balance of Payments (BoP) is a crucial economic indicator that reflects a country’s economic transactions with the rest of the world. In the context of the Indian economy, it is significant because it helps assess the country’s overall economic health, the sustainability of its external trade, and its ability to meet international payment obligations. A favorable BoP, with a surplus in the current account, indicates that the country is exporting more goods and services than it is importing, contributing positively to its economic growth.
Q2: How does the Foreign Trade Policy influence India’s trade relations and economic development?
A2: The Foreign Trade Policy (FTP) plays a pivotal role in shaping India’s trade relations and fostering economic development. By outlining strategies and measures, the FTP aims to boost exports, reduce trade deficits, and attract foreign investment. It provides a framework for tariff regulations, export promotion initiatives, and trade facilitation measures. Effective implementation of the FTP can enhance India’s competitiveness in the global market, promote diversification of exports, and contribute to sustainable economic growth.
Q3: How do exchange rates impact India’s foreign trade and Balance of Payments?
A3: Exchange rates play a critical role in influencing India’s foreign trade and Balance of Payments. Fluctuations in exchange rates can affect the competitiveness of Indian goods and services in the international market. A depreciation of the Indian rupee can make exports more competitive but may also increase the cost of imports, leading to potential challenges in maintaining a favorable trade balance. Additionally, exchange rate movements impact the valuation of foreign currency reserves, influencing the overall health of the Balance of Payments. A stable and well-managed exchange rate is essential for fostering a conducive environment for foreign trade and economic stability.
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