Consentia on Law - VOl - II

FOREIGN TRADE AND BALANCE OF PAYMENT

INTRODUCTION

Balance of Payment of a country is one of the important indicators for International trade, which significantly affect the economic policies of a government. As every country strives to a have a favourable balance of payments, the trends in, and the position of, the balance of payments will significantly influence the nature and types of regulation of export and import business in particular. Balance of Payments is a systematic and summary record of a country’s economic and financial transactions with the rest of the world over a period of time. The balance of payments is a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world.

International trade is an activity of strategic importance in the development process mainly of a developing economy. Scarce foreign exchange resources provide crucial inputs and capital goods that are needed in the early stages of economic development. In view of the several limitations to the inflow of foreign aid, foreign trade assumes greater significance in the earnings and conserves foreign exchange resources. The choice of suitable economic policies- import substitution, or export promotion and related trade and industrial policies constitute significant part in the overall framework of the economic policy.

Chapter-1

FOREIGN TRADE


 Foreign Trade is the exchange of capital, goods, and services across foreign borders or territories. In most countries, such trade represents a significant share of gross domestic product (GDP). While foreign trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries.

Industrialization, advancement in technology transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the foreign trade system. Increasing foreign trade is crucial to the continuance of globalization. Without foreign trade, nations would be limited to the goods and services produced within their own borders.

Foreign trade is, in principle, not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that foreign trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.

Another difference between domestic and foreign trade is that factors of production such as capital and labor are typically more mobile within a country than across countries. Thus foreign trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Trade in goods and services can serve as a substitute for trade in factors of production.

RECENT TREND

The World merchandise trade value surpassed the pre-crisis (2008) level of US $ 16 trillion, reaching US $ 18.26 trillion in 2011 after an interregnum of two years. However, world trade volume decelerated sharply to 2.8 per cent in 2012 from 5.9 per cent in 2011 and 12.6 per cent in 2010. World exports fell by 0.2 per cent in the first three quarters of 2012 over the corresponding periods of 2011 as per World Trade Organization (WTO) statistics. As per the January 2013 update of the IMF, world trade volume is projected to grow by 3.8 per cent in 2013 which is down 0.7 percentage points compared to its October 2012 update. Import and export volume growth rates of emerging market and developing economies are however projected to be higher than those of advanced economies. Global economic uncertainty including doubts about the ultimate resolution of the crisis in the euro area, doubts about the pace of fiscal withdrawal in the US, challenges to sustaining growth after the earthquake reconstruction rebound in Japan and trade disruptions with China, though of a passing nature, continue to cast their shadows on the trade growth of emerging and developing economies (EDEs) including India.

INDIA’S MERCHANDISE TRADE

India’s merchandise trade increased exponentially in the 2000s decade from US$ 95.1 billion in 2000-1 to US$ 620.9 billion in 2010-11 and further to US$ 793.8 billion in 2011-12. India’s share in global exports and imports also increased from 0.7 per cent and 0.8 per cent respectively in 2000 to 1.7 per cent and 2.5 per cent in 2011 as per the WTO. Its ranking in the leading exporters and importers improved from 31 and 26 in 2000 to 19 and 12 respectively in 2011. While India’s total merchandise trade as a percentage of the gross domestic product (GDP) increased from 28.2 percent in 2004-5 to 43.2 per cent in 2011-12 as per provisional estimates, India’s merchandise exports as a percentage of GDP increased from 11.8 per cent to 16.5 per cent during the same period.

Chapter-2

               BALANCE OF PAYMENT

       Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of goods, services, financial capital, and financial transfers. The BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.[1]

When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.

While the overall BOP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account, the capital account excluding the central bank’s reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term “balance of payments” often refers to this sum: a country’s balance of payments is said to be in surplus (equivalently, the balance of payments is positive) by a specific amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said to be negative) if the former are less than the latter.

The two principal parts of the BOP accounts are the current account and the capital account:-

1) The current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It is the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers. It is called the current account as it covers transactions in the “here and now” – those that don’t give rise to future claims.

2) The Capital Account records the net change in ownership of foreign assets. It includes the reserve account (the foreign exchange market operations of a nation’s central bank), along with loans and investments between the country and the rest of world (but not the future regular repayments/dividends that the loans and investments yield; those are earnings and will be recorded in the current account). The term “capital account” is also used in the narrower sense that excludes central bank foreign exchange market operations: Sometimes the reserve account is classified as “below the line” and so not reported as part of the capital account.

Expressed with the broader meaning for the capital account, the BOP identity assumes that any current account surplus will be balanced by a capital account deficit of equal size – or alternatively a current account deficit will be balanced by a corresponding capital account surplus:

 current account + broadly defined capital account + balancing item = 0

The balancing item, which may be positive or negative, is simply an amount that accounts for any statistical errors and assures that the current and capital accounts sum to zero. By the principles of double entry accounting, an entry in the current account gives rise to an entry in the capital account, and in aggregate the two accounts automatically balance. A balance isn’t always reflected in reported figures for the current and capital accounts, which might, for example, report a surplus for both accounts, but when this happens it always means something has been missed – most commonly, the operations of the country’s central bank – and what has been missed is recorded in the statistical discrepancy term (the balancing item).An actual balance sheet will typically have numerous sub headings under the principal divisions. For example, entries under Current account might include:

1)Trade – buying and selling of goods and services

  • Exports – a credit entry
  • Imports – a debit entry
  • Trade balance – the sum of Exports and Imports

2)Factor income – repayments and dividends from loans and investments

  • Factor earnings – a credit entry
  • Factor payments – a debit entry
  • Factor income balance – the sum of earnings and payments.

While the BOP has to balance overall, surpluses or deficits on its individual elements can lead to imbalances between countries. In general there is concern over deficits in the current account. Countries with deficits in their current accounts will build up increasing debt and/or see increased foreign ownership of their assets. The types of deficits that typically raise concern are:

  • A visible trade deficit where a nation is importing more physical goods than it exports (even if this is balanced by the other components of the current account.)
  • An overall current account deficit.
  • A basic deficit which is the current account plus foreign direct investment (but excluding other elements of the capital account like short terms loans and the reserve account.)

CAUSES OF BOP IMBALANCES

There are conflicting views as to the primary cause of BOP imbalances, with much attention on the US which currently has by far the biggest deficit. The conventional view is that current account factors are the primary cause– these include the exchange rate, the government’s fiscal deficit, business competitiveness, and private behaviour such as the willingness of consumers to go into debt to finance extra consumption.

 Chapter-3

 FOREIGN TRADE AND BALANCE OF PAYMENT

Balance of Payment of a country is one of the important indicators for International trade, which significantly affect the economic policies of a government. As every country strives to a have a favourable balance of payments, the trends in, and the position of, the balance of payments will significantly influence the nature and types of regulation of export and import business in particular. Balance of Payments is a systematic and summary record of a country’s economic and financial transactions with the rest of the world over a period of time. The balance of payments is a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. Transactions, for the most part between residents and nonresidents, consist of those involving goods, services, and income; those involving financial claims on, and liabilities to, the rest of the world; and those (such as gifts) classified as transfers, which involve offsetting entries to balance—in an accounting sense—one-sided transactions.

(a) Transactions in good and services and income between an economy and the rest of the world,
(b) Changes of ownership and other changes in that country’s monetary gold, SDRs, and claims on and liabilities to the rest of the world, and                                                                                (c) Unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting.

A country’s balance of payments can also commonly defined as the record of transactions between its residents and foreign residents over a specified period. Each transaction is recorded in accordance with the principles of double-entry bookkeeping, meaning that the amount involved is entered on each of the two sides of the balance-of-payments accounts. Consequently, the sums of the two sides of the complete balance-of-payments accounts should always be the same, and in this sense the balance of payments always balances. However, there is no bookkeeping requirement that the sums of the two sides of a selected number of balance-of-payments accounts should be the same, and it happens that the (im)balances shown by certain combinations of accounts are of considerable interest to analysts and government officials. It is these balances that are often referred to as “surpluses” or “deficits” in the balance of payments.
The Balance of Trade takes into account only the transactions arising out of the exports and imports of the visible terms; it does not consider the exchange of invisible terms such as the services rendered by shipping, insurance and banking; payment of interest, and dividend; expenditure by tourists, etc. The balance of payments takes into account the exchange of both the visible and invisible terms. Hence, the balance of payments presents a better picture of a country’s economic and financial transactions with the rest of the world than the balance of trade. Nature of Balance of Payments Accounting The transactions that fall under Balance of Payments are recorded in the standard double- entry book-keeping form, under which each international transaction undertaken by the
country results in a credit entry and a debit entry of equal size, As the international transactions are recored in the double-entry book-keeping form, the balance of payments must always balance, i.e., the total amount of debits must equal the total amount of credits. Somethimes, the balancing item, error and omissions, must be added to balance the balance of payments.

CONCEPTUAL FRAMEWORK OF THE BALANCE OF PAYMENTS

The Reserve Bank of India (RBI) is responsible for compiling the balance of payments for India. The RBI obtains data on the balance of payments primarily as a by-product of the administration of the exchange control. In accordance with the Foreign Exchange Management Act (FEMA) of 1999, all foreign exchange transactions must be channeled through the banking system, and the banks that undertake foreign exchange transactions must submit various periodical returns and supporting documents prescribed under the FEMA. In respect of the transactions that are not routed through banking channels, information is obtained directly from the relevant government agencies, other concerned agencies, and other departments within the RBI. The information is also supplemented by data collected through various surveys conducted by the RBI. Data are prepared on a quarterly basis and are published in the Reserve Bank of India Bullet[2]

        Chapter-4

 

INDIA’S RECENT FOREIGN TRADE AND BALANCE OF PAYMENT

The Indian economy has been experiencing a major transformation since 1990’s in the wake of unilateral economic reforms initiated since 1991 and the reorientation of the economy in accordance with the rules and regulations within the multilateral framework of GATT/WTO. Accordingly the globalization of production process, market for goods as well as financial markets has been initiated, though slowly. This has generated debate on the linkage between trade policy and economic growth along with poverty and income inequalities. The large quantities of capital inflows and trade liberalization have brought forefront the debate on the linkages between trade policy and the macro variables. The World Bank and IMF have endorsed liberalization policies in developing countries such as India and began to condition funds to the member countries on the basis of implementation of these policies.

TRADE POLICY OF INDIA

 India’s trade policy has been inward looking and based on several regulations and controls. Huge tariff rates and non- tariff barriers have been the hallmark till recently. India has been continuing with quantitative restrictions (QRs) on imports since 1957. These restrictions were imposed in the wake of severe foreign exchange crisis that threatened to disturb the stability of its balance of payments. This crisis has been the result of an emphasis given to industrial development during the II Five Year Plan in the name of import substituting industrialization. India continued with inward looking policies, though, there were efforts to open up the economy for competition during 1980’s. Till 1990’s, India’s domestic production was highly protected and roughly 93% of its tradable goods continued to be protected by some type of quantitative restrictions. India’s trade policy regime has been restrictive and complex till the trade reforms have been initiated in 1990s. There were various methods of licensing, categories of importers and methods of importing. The later policy documents have been simple in terms of content, rules and regulations. Though, the inward looking import substitution strategy pursued vigorously during the Second and third Five Year Plans combining both QRs and tariffs helped the economy to make significant capacity additions in manufacturing particularly in the areas like chemicals and pharmaceuticals, light engineering and transport equipment agriculture sector largely been ignored. The country along with the devaluation of the rupee in 1966 initiated policies in a systematic way to exploit the available [3]capacities through export promotion. However, larger portions of consumer goods imports remain still protected by QRs. The relaxations were extended to some restricted commodities through freely transferable import licenses. This coverage has been extended since 1997 to cover various items in the restricted list. India, considering the improvement in its balance of payments committed with her major trading partners to phase out QRs by 2003. However, USA and other developed countries having not been satisfied with India’s commitment filed a case with the Dispute Settlement Board (DSB) against these QRs in May 1997. The DSB had ruled against India and had found that India’s QRs on imports were not justified on balance of payments grounds. It had recommended that India should bring its import regime in conformity with its obligations under WTO agreements; Government of India has accordingly decided to phase out QRs by 2001. The process of removing QRs has started in 1991 and was completed during 2001-02 Export- import policy as the QRs have been eliminated for the remaining 715products. However, the imports of 27 products were placed in the category of state trading. The removal of QRs is the end of an era that was providing protection to domestic production of most of agricultural and industrial products. This obviously was viewed with suspicion, as the domestic production, prices and producer gains would be affected adversely. To avoid some of these problems anti- dumping duties and other non- tariff barriers were planned. The Export-import policy of 2002-07 came out with several institutional, infrastructural and fiscal measures to promote exports helping economic development of the country.

 THE NEW TRADE POLICY (2004-09)

     The recent trade policy of India aims at two important objectives:
(1) to double India’s percentage share of global merchandise trade by 2009
(2) to act as effective instrument of economic development of rural and semi- urban areas.

 The strategy followed would be as follows:
(i)Unshackling of controls;
(ii) Creating an atmosphere of trust and transparency;
iii) Simplifying procedures and bringing down transaction costs;
(iv) Adopting the fundamental principle that duties and levies should not be exported;
(v) Identifying and nurturing different special focus areas to facilitate development of India as a global hub for manufacturing, trading and services.

IMPACT OF TRADE POLICY

The quantification of the impact of the trade policy particularly in terms of tariff reduction and removal QRs is a complex exercise. One way of doing it is to compare the pre and post situation from the viewpoint of several variables.

(a) Trade Policy and Economic Growth: The impact of trade policy on economic growth has provided some evidence of trade liberalization policy influencing economic growth positively.

(b) Trade policy and Balance of payments: The experience of India regarding trade and balance of payments is encouraging. Since India became the member of WTO in 1995, Indian exports have been doubled in dollar terms (from US $ 31 billion in 1995-96 to US$ 62 billion in 2003-20004). There is an evidence of export diversification as the share of exports of agriculture and allied sectors in total exports came down from 19% in 1990-91 to 12% in 2002-2003. Conversely, the manufactured exports have increased their share from 73% in 1995-96 to 81% in the recent period. However, imports have continued to increase in pre and post WTO periods. The percentage growth in imports stood up at 25% during 2002-2003 and expected to rise further on account of increasing oil prices. The recent trends reveal an increase in the share of food and allied products and petroleum in total imports. India’s current account showed a persistent deficit except in recent years. The surplus in current account recent years has been mainly due to the growth of invisible exports.[4]

INDIA’S BALANCE OF PAYMENT

India’s BoP was under stress during 2011-12,as the trade and current account deficit widened. Though capital inflows increased, it fell short of fully financing current account deficit, resulting in drawdown of foreign exchange reserves. The trade deficit increased to US$ 189.8 billion (10.2 percent of GDP) in 2011-12 as compared to US$ 127.3 billion(7.4 percent of GDP) during 2010-11. This increaseof 49.1 per cent in trade deficit in2011-12 was primarily on account of higher increase in imports relative to exports. Net invisible balances showed significant improvement, registering 40.7 percent increase from US$ 79.3 billion in 2010-11 to US$ 111.6 billion during 2011-12. Net invisible balance as per cent of GDP improved to 6.0 percent in 2011-12 from 4.6 percent in 2010-11. The current account deficit widened to US$ 78.2 billion (4.2 percent of GDP) as compared with US$ 48.1 billion (2.8 percent of GDP) in 2010-11. Net capital inflows were higher at US$ 67.8 billion (3.6 percentof GDP) in 2011-12 as compared to US$ 63.7 billion(3.7 percent of GDP) in 2010-11, mainly due to higher FDI inflows and NRI deposits. As the capital account surplus fell short of financing current account deficit, there was a drawdown of reserves (on BoP basis) to the extent of US$ 12.8 billion during 2011-12 as against an accretion of US$ 13.1 billion in 2010-11. As per the latest available data for the first half(H1- April-September 2012) of 2012-13, India’sbalance of payments continued to be under stress This is reflected in the higher current account deficit in H1 (April-September) of 2012-13 than the corresponding period of the previous year, mainly due to worsening of trade deficit reflected in sharper decline in exports than the imports and lower invisibles surplus. The net capital flows in absolute term, were also lower during H1 of 2012-13 vis-à-vis the corresponding period of 2011-12.

 HIGHLIGHTS OF BOP DURING 2012-13

  • During 2012-13, CAD stood at US$ 87.8 billion (4.8 per cent of GDP) as against US$ 78.2 billion (4.2 per cent of GDP) during 2011-12.
  • Burgeoning trade deficit along with significant decline in invisible earnings caused widening of CAD during the year.
  • Decline in invisible earning has essentially been on account of sizeable increase of 21.2 per cent in investment income payments, and only a modest rise in net services receipts in 2012-13.
  • The net inflows under financial account during 2012-13 rose to US$ 85.4 billion from US$ 80.7 billion during the  preceding year mainly on account of higher inflows under FII, non-resident deposits and short term credits and advances.
  • The increase in capital inflows led to an accretion to foreign exchange reserves by US$ 3.8 billion during 2012-13.

BALANCE OF PAYMENTS DURING 2012-13

Burgeoning trade deficit along with significant decline in invisible earnings caused widening of CAD during the year.

Trade in Goods & Services

  • Notwithstanding an improved performance in Q4 (January-March 2013) of 2012-13, trade deficit in 2012-13 remained at an elevated level of US$ 195.7 billion on account of a decline in merchandise exports by 1.1 per cent and rise in imports by 0.5 per cent on a year-on-year basis.
  • Commodity-wise disaggregated figures based on DGCI&S data reveal that the setback in exports was led by decline in exports of manufactured items like engineering goods, textiles, gems & jewellery and also primary products like iron ore and minerals.
  • POL and gold continued to constitute nearly 45 per cent of total merchandise imports during the year.  While POL import rose by 9.3 per cent, gold import declined by 4.8 per cent during 2012-13.
  • Net service receipts grew at a modest rate of 1.4 per cent and amounted to US$ 64.9 billion in 2012-13 (US$ 64.0 billion in 2011-12).
  • While net receipts under travel, transport, software services, financial services, communication services increased, net receipts of insurance, business services recorded a decline during 2012-13.

Primary Income

  • Primary income, comprising mainly of compensation of employees, investment income and other primary receipts, declined considerably to US$ 21.5 billion during 2012-13 mainly on account of larger outflow under investment income.
  • While investment income receipts declined by 12.1 per cent to US$ 6.2 billion in 2012-13 from US$ 7.1 billion in the preceding year, investment income payments rose by 21.2 per cent to US$ 28.8 billion in 2012-13 from US$ 23.7 billion in 2011-12. Rise in investment income payments during this period is largely reflective of sizeable increase in interest payments on growing foreign debt.

Secondary Income

  • Net secondary income receipts, primarily comprising private transfers, increased by 1.4 per cent to US$ 64.4 billion during 2012-13 as compared with a growth of 19.5 per cent in 2011-12.

Current Account Balance

  • Thus, along with burgeoning trade deficit, decline in net invisible earnings due to sharp increase in investment income payments and only a modest rise in net services receipts led to widening of CAD to US$ 87.8 billion in 2012-13 which works out to 4.8 per cent of GDP as compared with 4.2 per cent in 2011-12.

Capital & Financial Account

  • Net inflows under financial account increased from US$ 80.7 billion in 2011-12 to US$ 85.4 billion in the current year, recording a rise of 5.9 per cent in 2012-13.
  • Although net direct investment fell, capital inflows surged mainly on account of an increase in portfolio investment, non-resident deposits and short term credit and advances during this period.
  • While net direct investment moderated to US$ 19.8 billion in 2012-13 from US$ 22.1 billion in 2011-12, net portfolio investment increased to US$ 26.7 billion in 2012-13 from US$ 16.6 billion a year ago. While rise in portfolio investment was essentially due to increase in equity investment, debt investment by foreign institutional investors has been lower as compared to the previous year.
  • During 2012-13 there was an accretion of US $ 3.8 billion in India’s foreign exchange reserves (on a BoP basis) as compared to a drawdown of reserves worth US$ 12.8 billion in 2011-12.

CONCLUSION

Balance of Payment of a country is one of the important indicators for International trade, which significantly affect the economic policies of a government. As every country strives to a have a favourable balance of payments, the trends in, and the position of, the balance of payments will significantly influence the nature and types of regulation of export and import business in particular.

The balance of payments takes into account the exchange of both the visible and invisible terms. Hence, the balance of payments presents a better picture of a country’s economic and financial transactions with the rest of the world than the balance of trade. Nature of Balance of Payments Accounting The transactions that fall under Balance of Payments are recorded in the standard double- entry book-keeping form, under which each international transaction undertaken by the country results in a credit entry and a debit entry of equal size, As the international transactions are recored in the double-entry book-keeping form, the balance of payments must always balance, i.e., the total amount of debits must equal the total amount of credits.

[1] http://en.wikipedia.org/wiki/Balance_of_payments(Last accessed on 24th Feb, 2014)

[2] http://www.rbi.org.in/scripts/SDDS_ViewDetails.aspx?ID=5(Last accessed on 24th Feb, 2014)

[3] http://dgft.gov.in/  (Last accessed on 24th Feb, 2014)

[4] http://economictimes.indiatimes.com/news/economy/foreign-trade (Last accessed on 24th Feb, 2014)

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