The balance of payments or BoP is the outcome of total monetary transactions of an economy with the outside world in a financial year. The Balance of payments may be calculated quarterly or yearly, but the yearly calculation is preferred by economies of the world. It is simply a summary of all the monetary transactions done by individuals, firms, and government bodies of a nation with the other nations.

Every economy has two types of accounts which are generally maintained by their central banks (RBI in India). These two accounts are current account and capital account. These are elaborated as:

Current Account

You may think that a current account is an account which business firms or a businessman opens with a bank to carry out their day to day transactions. Yes, you are right. But in the case of Balance of payments, it is a different thing. Here, it refers to the account maintained by every government of the world in which every type of current transactions is shown. Rather than government, it is maintained by the central bank of the country on behalf of the government. Current transactions of an economy include exports, imports, interest payment on a loan, interest received on loans forwarded, private remittances and transfer in between the countries.

All the transactions of current account may be credit or debit for an economy. Like we import crude oil from Iran, so we pay them dollars so it is a debit for us because we are paying to the other nations. While when we export some service or goods to other countries, we receive payments in dollars, so it is a credit type of transaction for us. Simply, if we receive money from outside world it is credit for us, while when we pay it is debit for us.

At the end of the year, the current account might be positive or negative depending upon whether we are paying more to other countries or receiving more form them. The positive current account is named as surplus current account while a negative current account is called as a deficit current account.

India’s current account deficit is expected to be 2.8 per cent of GDP this fiscal year. This is mainly due to higher crude oil prices in the oil market and consistent depreciation of rupee against dollar.

Capital Account

Capital account shows the capital kind of transactions of an economy with the other economies of the world. Transactions like external lending and borrowing, foreign currency deposits of banks, external bonds issued by the Government, foreign direct investment in the country, investments in the security market, etc are recording in the capital account. There is no surplus and deficit in the capital account like the current account.

How the Balance of Payments crisis occurred in India?

India faced the BoP crisis in 1991 which had its roots back in 1985 when India started to have a balance of payments problem. At that time trade deficit, as well as fiscal deficit, was very large in India. During the period from 1985 to 1989, the fiscal deficit was around an average of 10 per cent per annum. By the end of 1990 due to Gulf-war, the situation became so serious that the Indian foreign exchange reserves could barely finance three weeks’ worth of imports while the government came close to defaulting on its financial obligations. By the end of July that year, the low Forex reserves had led to a sharp devaluation of the rupee, which in turn worsened the twin deficit (trade deficit and fiscal deficit) problem. This led the government to airlift national gold reserves as a pledge to the International Monetary Fund (IMF) in exchange for a loan to recover form Balance of Payment crisis.

A trade deficit is simply the difference between exports and imports of a country with the other countries. When the imports are more than exports, it is a trade deficit otherwise it is a trade surplus. While the Fiscal deficit is a difference between total money collected by the government from various resources and total money it spends. For the financial year 2018-19, the government has set the fiscal deficit target of 3.3 per cent of GDP which was 3.5 per cent in the previous year.

What is Extended Fund Facility?

It is a service provided by the International Monetary Fund (IMF) to its member countries, which authorise the member countries to raise any amount of foreign exchange for IMF to recover form BoP crisis. However, as nothing comes free of cost, IMF puts certain conditions of structural reforms on the country which avails this facility. India has signed an agreement with IMF under Extended Fund Facility in 1981-82 for the first time.

Conditions put by IMF on India during BoP crisis

When a country borrows from the IMF, its government agrees to adjust its economic policies to overcome the problems that led it to seek financial aid from the international community. These loan conditions also serve to ensure that the country will be able to repay the funds so that the resources can be made available to other members in need. The Balance of payments crisis of the early 1990s also coerced India to borrow from IMF, which came along with some such conditions. These following conditions were put by IMF on India for providing loan during the crisis:

  1. Devaluation of the Indian rupee against the dollar by 22 per cent, which was done in two consecutive fortnights.

  2. Customs duty was reduced from a level of 130 per cent to a peak level of 30 per cent.

  3. Excise duty to be increased by 20 per cent to neutralise the revenue loss due to cut in customs duty.

  4. Government expenditure to be cut down by 10 per cent per year i.e. 10 per cent reduction in expenses like salaries, pensions, subsidies etc.

This is how IMF regulates the direction of structural reforms in an economy. The structural reforms by IMF in a balance of payments crisis not only provides the required cushion to the economy but also strengthens the economy if properly implemented. The purpose has been served in the case of India. India has not only fulfilled the conditions but also moved ahead of that.

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