Aspirant Academy

Economy

Balance of Payments

International Trade, Balance of Payments, Foreign Aid & Investment

Paper I · Unit 2 Section 4 of 11 0 PYQs 27 min
Topic Preview Subject Inventory

Public Section Preview

Balance of Payments

3.1 Structure of the Balance of Payments

The Balance of Payments (BoP) is a comprehensive accounting record maintained by RBI, tracking all economic transactions between India and the rest of the world.

Account 1: Current Account

  • Trade in goods (Merchandise/Visible trade): India's persistent deficit
  • Trade in services (Invisible trade): India's large surplus (IT, software, business process)
  • Primary income: Investment income (dividends, profits, interest) — net outflow for India
  • Secondary income (Transfers): Remittances (net inflow for India — $120 billion)

Account 2: Capital Account

  • Capital transfers (debt forgiveness, migrant transfers)
  • Acquisition/disposal of non-produced non-financial assets

Account 3: Financial Account

  • FDI (Foreign Direct Investment): long-term; $70.9 billion inflow (2023–24)
  • FPI/FII (Foreign Portfolio Investment): stocks and bonds; more volatile
  • External Commercial Borrowings (ECBs): Corporate overseas loans
  • NRI deposits: Foreign currency deposits by non-resident Indians
  • RBI's reserve assets (changes in forex reserves)

BoP accounting identity: Current Account + Capital Account + Financial Account + Errors & Omissions = 0

3.2 India's Current Account Deficit (CAD)

India runs a structural current account deficit — it imports more goods than it exports. The deficit is partially offset by services surplus and remittances.

CAD data (% of GDP):

  • 2012–13: 4.8% of GDP — crisis level, triggered currency depreciation (rupee fell to 68/$)
  • 2016–17: 0.6% — benign period (low oil prices)
  • 2022–23: 2.0% — elevated (post-Ukraine war oil price spike)
  • 2023–24: 0.7% — comfortable; aided by falling oil prices and IT export growth

CAD drivers:

  1. Oil imports (~$218 billion crude alone): India imports 85% of its crude oil. When global oil prices rise, CAD widens automatically.
  2. Gold imports (~$45 billion): India is world's 2nd largest gold consumer; gold demand is price-inelastic.
  3. Electronics imports (~$80 billion): Heavy import dependence on China for phones, components — PLI aims to reduce.

CAD financing: Financed by capital account inflows — FDI, FPI, ECBs, NRI deposits. When these flows fall (global risk aversion), pressure on rupee mounts.

3.3 India's Foreign Exchange Reserves

India's forex reserves are the RBI's buffer against currency volatility and external payment obligations.

Composition of forex reserves (April 2025, ~$648 billion):

  • Foreign currency assets (FCAs): ~$565 billion (largest component)
  • Gold: ~$67 billion
  • SDRs (Special Drawing Rights, IMF): ~$18 billion
  • Reserve tranche with IMF: ~$4 billion

Historical trajectory:

  • 1991 (BoP crisis): $1.2 billion — only 3 weeks of imports
  • 2000: $37 billion
  • 2010: $279 billion
  • 2020: $477 billion
  • October 2021: $642 billion (all-time peak)
  • April 2025: $648 billion (near all-time high)

Importance of forex reserves:

  1. Buffer against sudden capital outflows (exchange rate stability)
  2. Import cover: 11+ months at current import rate (threshold: 3 months minimum)
  3. Signals creditworthiness to international investors and rating agencies
  4. Allows RBI to intervene in forex market to prevent excessive rupee volatility