External sector

Balance of Payments
(BOP)
.
 The importance of external
sector in India's economic
development has been well
recognized and reinforced
especially since the initiation
of economic reforms in
1991.
.
 A study of India's external sector
includes a study of a number of
aspects such as-value, composition
direction of foreign trade, trade
policies pursued, balance of payments
status, role of foreign capital, WTO
related issues (such as textile and
patents) etc.
.
 A shift in India's Trade Policy
enabled it to not only overcome
severe BOP crisis (occurred in
1991) but also provide the much
needed resilience to the economy.
.
 In terms of foreign exchange
reserves that present a cushion to
protect an economy from
speculative capital movements,
China tops the list with $2 trillion.
India ranked fourth after Japan
(second) and Russia (third).
Balance Of Payments
 Balance Of Payments
(BOP): The term BOP refers to
the yearly financial
statement of a country for
the transactions in the external
sector with the rest of the
world.
.
 The BOP table has got two
sides (i.e.) Credit and Debit,
hence it can be
conceptualized as ‘balance
sheet’ of the country with
the rest of the world.
.
 Balance of Payment record of a
country has two accounts-------
 a) Current Account
 b) Capital Account.
 While current account in the BOP
record consists of mainly exports
and imports.
.
 Capital account refers to financial
investments, deposits and loans.
 However, current account includes
invisible items (i.e.) receipts and
payments for services such as travel,
insurance, transportation etc.
.
 The capital account is an
accounting measure of the total
domestic currency value of
financial transactions between
domestic residents and rest
of the world over a period of
time.
.
 Capital account can be
divided into three
categories-----------
 1. Direct investment (FDI)
 2.Portfolio Investment
 3.Other Capital Flows
.
 1.Foreign Direct
Investment:
 FDI refers to investment in real
assets like factories, sales offices,
distribution channels etc. by
foreign enterprises.
.
 Equity investment exceeding
10% of stake in a company by
a foreign investor with long-
lasting interest is also known
as FDI.
.
 2.Portfolio Investment:
 Foreign Institutional Investors (FIIs),
Non-Resident Indians (NRIs), and
Persons of Indian Origin (PIOs) are
allowed to invest in the primary and
secondary capital markets in India
through the portfolio investment
scheme (PIS).
.
 Under this scheme,
FIIs/NRIs can acquire
shares/debentures of Indian
companies through the
stock exchanges and SEBI
in India.
.
 Foreign Institutional Investors
(FIIs) registered with SEBI and
NRIs are eligible
------------------------------to
purchase shares and convertible
debentures under the portfolio
investment scheme subject to
certain limits.
.
 The ceiling for overall investment for
FIIs is 24 per cent of the paid up
capital of the Indian company and
10 per cent for NRIs/PIOs.
 The limit is 20 per cent of the paid up
capital in the case of public sector
banks, including the State Bank of
India.
.
 Other Capital Flows:
Represent claims with a
maturity of less than one year
and include bank deposits,
short-term loans, short-term
securities, money market
investments and so on.
.
 Capital account transactions: It
include investment by residents in
shares, debt securities, branches or
subsidiaries of parent firm abroad,
 And investment in real estate abroad
by residents, foreign investment and
non-resident deposits, loans to non-
residents etc.
.
 There is no formal definition of
capital account convertibility
(CAC). The Tarapore
committee set up by the
Reserve Bank of India (RBI) in
1997 to go into the issue of
CAC.
.
 Capital account
convertibility : defined it as the
freedom to convert local financial
assets into foreign financial assets
and vice versa at market
determined rates of exchange.
.
 In simple language what this
means is
that--------------------------------
----- CAC allows anyone to
freely move from local currency
into foreign currency and back.
Current account convertibility
How is Capital account
Convertibility different from
Current account Convertibility?

Current account convertibility

allows free inflows and outflows for all
purposes other than for capital
purposes such as investments
and loans.
.
 In other words, it allows residents to
make and receive trade-related
payments
—--------------------------------------
---------- receive dollars (or any
other foreign currency) for export of
goods and services and pay dollars
for import of goods and services,
.
 make various remittances,
access foreign currency for
travel, studies abroad,
medical treatment and gifts
etc.
.
 In India, current account
convertibility was established
with the acceptance of the
obligations under Article VIII of
the IMF’s Articles of Agreement
in August 1994.
FERA
 The old law on foreign
exchange ------------ the
Foreign Exchange Regulation
Act,1973 ---- controlled all the
foreign exchange transactions,
regardless of the quantum.
.
 Many transactions required the
blessings of the RBI, some
capital account transactions
requiring multiple approvals at
different stages.
FEMA
The Foreign Exchange
Management
Act,1999(FEMA) changed
the very focus of the
exchange control law.
.
 FEMA, it was conceived of as a
piece of legislation ‘to facilitate’
external payments and
promote the orderly
development of the foreign
exchange market.
Advantages and Disadvantages
of Full Convertibility in Capital
Account
 Advantages:
 Corporates are allowed to freely open
offices abroad for promoting their
businesses.
 Banks are allowed to borrow from
overseas market and deploy(arrange)
their funds outside India.
.
 This will strengthen and result in the
growth of indian banks.
 Individuals are allowed to invest in
assets in financial markets abroad,
which will encourage investments.
 Greater confidence levels of global
investors in India.
.
 Disadvantages:
 While liberalization is generally
beneficial, it also greatly heightens
a country’s vulnerability (exposure
or defenselessness) to reversals in
capital flows that can precipitate
(sudden or swift) severe currency
and BOP crisis.
.
 Disadvantages: The
composition of capital flows
must also be closely monitored,
otherwise it can undermine the
very purpose of the capital
account convertibility.
.
 EX- In 1996, five Asian economies
(South Korea, Indonesia, Malaysia,
Thailand and Philippines) received
net private capital inflows
amounting US$93.0 billion
.
 One year later( in 1997), they
experienced an estimated
outflow of $105 billion,
amounting to more than 10%
of the combined GDP of these
economies.
.
 Consequently, three of
these economies( Indonesia,
Thailand, and South Korea) are
in a severe economic crisis.
News Dated 15-04-2009
 India now have the Foreign
Exchange reserves about 250
billion dollars.
 India is nominated as one of the
member in two international
committees at G20 summit.
.
 Foreign Exchange Reserves
250 billion dollars means
25,000 crore dollars, it means
approximately about 12,50,000
crore rupees.