Planned Development: Retrospect and Prospect || Development Perspective: Towards the year 2000 || Objectives, Strategies and Pattern of Growth in Seventh Plan || Financing the Plan || Balance of Payments || Framework of Economic Policy

BALANCE OF PAYMENTS

5.1 India adjusted rather well to the second oil shock and the marked deterioration in the international economic environment that followed. The tempo of growth and real investment were maintained during the Sixth Plan period by a strategy designed to avoid crippling cutbacks in imports. This strategy involved reordering of investment priorities and other measures to bring the current account deficit to a sustainable level over the medium term; and necessary balance of payments support for it was obtained from an Extended Fund Facility (EFF) arrangement with the IMF for SDR 5 billion. The success of these measures is reflected in the annual growth of GDP at the targetted rate of 5.2 percent, a sharp drop in reliance on energy imports as also in the current account deficit relative to GDP, and in an improvement of the external payments position permitting India to forego SDR 1.1 billion of the SDR 5 billion contracted under the EFF. During the Seventh Plan, debt service obligations will rise more sharply because of the harder average terms of external debt, including commercial borrowing contracted in recent years, repayments to the IMF, and a substantial fall in concessional aid flows. Once again, therefore, the balance of payments will have to bear the added burden of absorbing adverse external factors, this time in the form of declining net real concessional aid flows and, on average, higher interest rates with shorter maturities attaching to external loans and credits. The process of structural adjustment to strengthen the balance of payments undertaken in the Sixth Plan period will thus need to be intensified in order to forestall the equally undesirable alternative outcomes during the second half of 1980s, namely, excessive external indebtedness or slowing down of growth due to import shortages.

Sixth Plan Experience

5.2 On the whole, the balance of payments performance during the Sixth Plan period was much better than had been initially anticipated. The current account deficit during 1980-85 is now estimated to have been only about two-thirds of the projected amount. That is why, despite a large shortfall in net aid compared to the projected inflow, and only marginally higher other borrowings, foreign exchange reserves actually increased to well above the targetted equivalent of three months' merchandise imports. This favourable outcome is attributable to a variety of factors. Better functioning generally of infrastructure, accelerated replacement of energy imports, progress of import substitution in steel, non-ferrous metals, cement

TABLE 5.1
Balance of Payments 1980-85: Selected Indicators

Sources: Reserve Bank of India and the Ministry of Finance.

1. Excluding gold and SDRs.
2. Planning Commission provisional estimates.

and fertiliser industries, and sustained increase in agricultural output in effect brought about a decline in the volume of bulk imports. They also facilitated the maintenance of selective liberalisation intended to free the economy from some of the counter-productive rigours of import restrictions. The volume growth of non-bulk imports too was much less than had been expected; and total imports, in real terms, increased at an annual rate of just about 3 per cent. At the same time, net invisible earnings substantially exceeded Plan projections, mainly because of the unanticipated and continued buoyancy of expatriate remittances. Finally, the loss imposed by the steep rise in international energy and other import prices in the wake of the second oil shock, though still sizeable, turned out to be somewhat smaller than was earlier foreseen.

5.3 Export earnings, however, fell well short of the target. The disappointing performance of exports is related to an unusual combination of adverse internal and external developments. The growth of Indian exports depends on the expansion of world trade to a significant extent; and, the first three years of the Plan period coincided with the severe international recession of 1980-83 and the accompanying stagnation of world trade. A number of products and product groups, some of them important or dynamic exports, such as engineer-

TABLE 5.2
Balance of Payments Performance 1980-85
(Rs. thousand crores at 1979-80 prices)

ing goods, leather and leather manufactures, and textiles, were also affected by resurgent protectionism in developed market economy countries. Production of export-ables too suffered at times from power shortages, while other types of supply constraints began to appear in the case of such exports as tea and marine products. Finally, poor exports growth could be ascribed to the high cost and diminishing competitiveness of specific products. The operation of all these factors and the predominance of the domestic market reduced the already small share of exports in GDP further. The volume of such fast growing exports as engineering, leather and leather products actually declined; and were it not for the rapid volume growth of garments, chemicals and allied products, gems and jewellery, and expanding volume of unspecified exports, consisting, among others, of diverse agricultural products, total exports in real terms would have fallen significantly over the Plan period.

5.4 The shortfall in exports and the consequent increase in the trade deficit during the Sixth Plan beyond the projected level will not make it easy to deal with likely future balance of payments difficulties, the more so because of the smaller scope for concentration of import substitution in some areas, especially crude oil production. The management of the balance of payments during 1985-90 will have to address this problem, notwithstanding the current high level of reserves and the decline in current account deficit relative to GDP.

Seventh Plan Projections

5.5 The substantial diversification of the commodity composition of exports that has taken place since the mid-1960's* cushions somewhat the impact of commodity market fluctuation on export earnings. All the same since around 1970, exceptionally rapid volume growth of * The degree of diversification is, at present, similar to that of exports from some developed countries. exports has been confined to a small set of products, including engineering goods, chemicals and allied products, gems and jewellery, garments, leather and leather manufactures and marine products. The consequent commodity concentration of incremental exports, though symptomatic of specialisation in line with competitive advantage, could create difficulties in the event of unforeseen protectionist obstacles, or localised supply problems. Although this type of commodity concentration may persist to an extent over the medium term, the proposed policies, emphasizing general strengthening of export competitiveness, will not only help attain the plan export target but also lay the basis for more rapid and diversified export growth in the post plan period.

5.6 A breakthrough in exports leading to a substantial step up in real growth of export earnings is a key element of the foreign trade and payments strategy retained in the Seventh Plan. The volume of exports is projected to rise to nearly 7 per cent annually during 1985-90. This projection has been built up from statistical forecasts, or in some cases, from estimates of availability and domestic demand for different commodities and commodity groups. They have, moreover, been tested with the aid of aggregative analysis of past export performance, and incorporate the likely impact of changes in foreign trade policy within the Plan period. Commodity details of export projections are set out in Table 5.3.

TABLE 5.3
Merchandise Exports (fob)
(Rs. crores at 1984-85 Prices)

'Provisional estimates

5.7 Industrial products will contribute sizeably to the attainment of the target set for exports. But among them, engineering goods, chemicals and allied products ready-made garments and gems and jewellery alone will account for somewhat over half of the projected increase in the volume of exports. These exports, except for gems and jewellery, will expand much more rapidly than GDP during the Plan period. In fact, even in the longer run export growth will have to rely on manufactures and, more important still, on an increasingly wider spectrum of products. For one thing, unlike in the case of agricultural commodities, output growth of manufactures is not constrained by the availability of land, while shortages of raw materials and other inputs can be overcome through recourse to imports. For another, market penetration becomes easier because of their exceedingly small share at present in the world trade in manufactures.

5.8 A much smaller, though still important, proportion of addition to exports is expected from a number of heterogeneous commodities, ranging from metallic ores to oil cakes, which includes a variety of agricultural commodities, (other than plantation products, tobacco and processed foods) such as rice, wheat, fruit and vegetables. The volume of this category of exports, though growing more rapidly than real GDP, is correlated to the latter, partly because, taken together, they are affected less by world market conditions than by internal factors. This relation is assumed to remain unchanged, since further acceleration of export growth may be difficult to attain for the reason, among others, that some of the important products in this group include basic foods, or agricultural commodities competing with them for land, irrigation facilities and other resources.

5.9 The projected volume growth for another class of commodities which include, among others, tea, spices, cotton textiles, leather and leather manufactures, and marine products will not, however, keep pace with the growth of GDP. Such exports are beginning to encounter supply constraints because of increasing domestic demand, or inadequate output growth, or both. Export targets set for them are rather modest, based as they are on realistic assumptions about feasible expansion of production in the medium term through measures to improve productivity; for the full effect of investment to strengthen the production base may be felt only after a period of time. Comparatively modest targets have also been retained in the case of jute manufactures, cotton textiles (mill and handloom), iron ore and unmanufactured tobacco, where the limits to export growth are set primarily by world demand. World exports of cotton textiles are expected to increase at a rather slow pace; and the export volume growth rate projections, though not very high, assume some lowering of projective barriers by developed countries. As for jute manufactures, exports will continue to be affected by competition from synthetic substitutes as well as jute products from other sources.

5.10 Imports during the Seventh Plan period are projected to increase at an annual rate of 5.8 per cent, or only a little more rapidly than the pace of growth of the economy. But the estimated rise in the requirements of bulk imports, which include among others, petroleum, oil and lubricants, metals, newsprint and edible oils, will increase slightly faster than GDP. Demand projections for bulk commodity imports are checked with the aid of commodity specific material balances as well as market clearing consistent with the input-output model. For other imports, consisting of a very large number of disparate commodities and products, a more aggregative method is used to estimate import requirements.

5.11 The demand for petroleum products is forecast to increase by 5.5-6.4 per cent annually; this rise in consumption reflects not only the growth and changing structure of GDP, but also the effects of energy pricing policy and other measures to restrain the growth of demand for petroleum products. The production of crude oil is projected to go up from 29.0 million tonnes in 1984-85 to 34.5 million tonnes in 1989-90, which represents, even in absolute terms, a very much smaller increase in the availability of domestic crude than in the Sixth Plan period. As such, the value* of imports of crude oil and petroleum products, the latter depending on the increase in refining capacity, are estimated to go up from Rs. 3446 crores, or 22 per cent of the total import bill in 1984-85 to Rs. 5136 crores or 25 per cent of it by 1989-90.

5.12 The Plan envisages a substantial increase of some 3.56 million tonnes (in terms of nutrients) in the production of nitrogenous and phosphatic fertilisers. Even so, because of the sharp rise in requirements, there will be a significant increase in imports of manufactured fertilizers; but the demand for imported materials and inputs for fertiliser production, in which the country is deficient, will also go up sizeably. Thus, imports of fertilizers and fertilizer inputs together will increase, on the average, by about 10 per cent annually over the entire Plan period.

5.13 Steel, cement, synthetic and regenerated fibers, newsprint and non-ferrous metals are among the bulk commodities whose imports are expected to decline, or to increase only marginally, with the progress of import substitution. Thus, steel imports (including alloy and special steels) are projected to fall by Rs. 85 crores, their share in total imports dropping from 6.2 to 4.3 per cent between 1984-85 and 1989-90. In the case of cement, *AII values are in constant 1984-85 rupees. complete self-reliance will be attained early in the Plan period, no recourse to imports being projected beyond 1985-86. Domestic production of man-made fibres, too, will rise sufficiently to meet requirements fully, though only in 1989-90. As for newsprint, imports are projected to fall almost by one-third over the Plan period. The rather modest annual increase of 1.6 per cent in imports of non-ferrous metals is attributable to a relatively large rise in the output of zinc and aluminium, aluminium imports even ceasing altogether in the penultimate year of the Plan. Coking coal imports will, however, increase, but being a minor bulk commodity their share in the import bill will still be somewhat less than 1 per cent in 1989-90.

5.14 No foodgrain imports are envisaged because of the existing high level of stocks, expected increase in production and reduced impact of possible droughts with further extension of irrigation. But there is likely to be some decline in import requirements of edible oils, largely because of rapidly increasing domestic demand and insufficient medium-term potential for much more than a commensurate increase in domestic production.

5.15 Non-bulk imports, which include a very wide veriety of often highly differentiated products, at present constitute about half of total imports. Equipment, components and spares, drugs and pharmaceuticals, precision instruments, export-related imports like unpolished diamonds are the important imports falling into this residual category. Though well below unity earlier, the import elasticity of non-bulk imports with respect to GDP is estimated to have risen to 2.17 between 1973-74 and 1981-82. This shift in the import elasticity is attributable partly to the pent up demand for consumption and inventory built-up from the period before the introduction of selective import liberalisation in mid-seventies. Judging by the more recent experience of the Sixth Plan, the relationship between non-bulk imports and GDP is returning to the normal pattern. Accordingly, non-bulk import requirements have been projected on the assumption of an import elasticity of 1.2, which implies an average annual growth of 6 per cent in real terms. The Commodity breakup of the bulk imports in the Seventh Plan is presented in Table 5.4.

5.16 The projected Seventh Plan trade profile does not leave much room for risks entailed by unforeseen developments. Some provision is, therefore, needed for absorbing the effects of unpredictable events and, accordingly, a margin for contingency is built into the overall import forecast. The first such risk is the occurrence of extensive drought. The agricultural sector is being increasingly better equipped to overcome the effects of scanty precipitation, but the residual damage to the economy and the foreign trade sector is still far from being

TABLE 5.4
Merchandise Imports (cif)
(Rs. crores at 1984-85 prices)

•Provisional estimates.
**Net of crude and product exports.
**'Aluminium, copper, zinc, lead. tin and nickle.

negligible. Second, among other things, India's export performance depends significantly on the growth of world trade; and medium-term world trade trends continue to be somewhat uncertain. Third, the loss from worsening of the terms of trade in the Seventh Plan period is likely to be Rs. 700 crores on present indications, or much smaller than the one suffered during 1980-85. India's terms of trade are rather sensitive to international oil prices, which are assumed to remain more or less unchanged in real terms. Finally, projections of net invisible earnings tend to be much less firm as compared to other elements of the balance of payments.

5.17 Expatriate remittances and travel receipts are, by far, the most important elements of net invisible earnings. A substantial proportion of expatriate remittances originates in the oil producing countries of .the Middle East; and unforeseen changes in their development plans and public spending, stemming from uncertainties surrounding the international oil market make it hazardous to forecast the inflow of remittances even over the medium term. The nominal level of expatriate remittances is projected to remain more or less unchanged, thus implying some continuing decline in real terms. Projections of invisible flows also take into account the relatively small, but growing, exports of 'non-traditionals' such as consultancy services and related specialised expertise. On the whole, net invisible earnings are expected to offset somewhat less than half of the deficit on merchandise account, or a much smaller proportion of it than in the Sixth Plan period.

5.18 The growth of tourist arrivals had suffered from the effects of the severe international recession of the early eighties, which had particularly hit the major source markets. With the international market economy countries coming out of the recession, and more importantly, more effective tourist promotion and market penetration efforts, the growth of tourist arrivals should again attain a higher trend rate. In projecting net invisibles, travel receipts are accordingly assumed to increase on average by about 7 per cent annually.

5.19 The deficit on current account, or foreign savings requirements, implicit in the Seventh Plan Projections or merchandise and invisible flows will be Rs. 20,000 crores. The corresponding financing requirements will, however, be higher because of the fall in the import purchasing power of exports resulting from the larger increase in import prices. Additionally, foreign exchange reserves would have to be replenished by Rs. 200 crores over the Plan period so that their level does not fall below the required minimum of three months' merchandise imports.

5.20 The external borrowings programme of Rs. 20,900 crores that is projected will ensure adequate availability of imports to attain the GDP growth target. Its size and composition, moreover, will maintain future debt service obligations within manageable limits. The viability of external borrowing programme is usually assessed in terms of conventional indicators like the ratio of debt service payments to current receipts. Because of the changing export coverage of imports, this debt service ratio does not always correctly indicate the proportion of imports that will have to be financed through external borrowing. Thus, the current account deficit relative to imports, or, more generally, as a proportion of GDP is, in some respects, a better index of the debt service burden. However, judging by both indicators, the borrowing programme does not exceed safe limits; the debt service ratio remains below 20 per cent, and the current account deficit relating to GDP averages to 1.6 per cent over 1985-90.

Balance of Payments Policy

5.21 Sustained and well directed efforts will be needed during the Seventh Plan period to avert renewed scarcity of foreign exchange. Maintaining a viable balance of payments without constraining output growth or capital formation to unacceptable levels will thus be a prime

TABLE 5.5
Balance of Payments Projections 1985-90
(Rs. thousand crores at 1984-85 prices)

strategic concern. As such, the actual deficit on current account, and the manner in which it is financed, will have to be kept close to plan projections and anticipations;otherwise the debt service burden could become so onerous as to reduce the availability of foreign exchange for financing the vital minimum of imports. The trade deficit will need to be adequately contained by a much more rapid growth of exports than in the past. Export development, in fact, acquires particular importance as a means of sustaining sufficient and uninterrupted supplies of imported inputs for smooth functioning of the economy, of activating idle capacity, and of exposing industry increasingly to the more exacting world market. At the same time, the diversification and deepening of efficient import substitution will require continued support, partly because of greater caution to be exercised in the replacement of energy imports by non-renewable domestic resources. Apart from the possibility of replacing imports in certain areas at a relatively low cost in terms of domestic resources, import substitution has the advantage of being less subject to uncertainty than exports. Greater attention will thus need to be paid not only to the expansion of production in competitive lines but also to all-round improvements in productivity and the consequent reduction in import consumption norms. The attainment of the balance of payments objectives of the Seventh Plan is admittedly not an easy task. But it can be accomplished successfully within an appropriate policy frame, even when its full impact would be felt only after a period because of the logistics of, and reaction time to, changes in policy directions. The major constituents of the required policy are spelt out in Chapter 6.