13. Balance of Payments (BoP)
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13. Balance of Payments (BoP)
13.1 What is the Balance of Payments?
The Balance of Payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world over a period, usually a year or a quarter. It is a flow concept.
Term |
Meaning |
Balance of Trade (BoT) |
Value of merchandise (goods) exports minus imports. It is only one part of the current account |
BoP |
Records goods, services, income, transfers and capital flows together |
International Investment Position (IIP) |
A stock concept: the value of a country's external financial assets and liabilities at a point of time |
Autonomous transactions |
Done for their own sake, such as trade and investment |
Accommodating transactions |
Done to cover a gap, such as drawing down reserves or borrowing from the IMF |
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13.2 Structure of the BoP
Account |
Components |
Current Account |
Goods (merchandise exports and imports), Services (software, business services, travel, transport), Primary income (compensation of employees, interest, dividends and profits) and Secondary income (remittances and other transfers) |
Capital Account |
Small capital transfers and the purchase or sale of non-produced assets |
Financial Account |
Foreign Direct Investment, Portfolio investment, Other investment (external commercial borrowings, banking capital including NRI deposits, trade credit) and Reserve assets |
Net errors and omissions |
The balancing item for mistakes and missing data |
Identity: Current account balance + Capital and financial account balance + Errors and omissions + Change in reserves = 0.
A current account deficit (CAD) must be financed by net capital inflows or by drawing down foreign exchange reserves.
Invisibles
Invisibles are services, income and transfers. They are called "invisible" because they are not physical goods.
13.3 India's BoP Pattern
India has a persistent merchandise trade deficit, because imports of crude oil, gold, electronics and coal are larger than exports.
This is partly offset by a large services surplus, led by IT and business services, and by remittances from Indians abroad. India is among the world's largest recipients of remittances.
The primary income account is usually in deficit, because of interest and dividend payments to foreign investors and lenders.
India had a current account surplus in 2020-21, when imports fell sharply during COVID-19.
Oil prices and gold imports are the largest swing factors for the CAD.
How a CAD is financed
Source |
Nature |
FDI |
Stable, long-term inflows; the best way to finance a deficit |
Foreign Portfolio Investment (FPI) |
Money invested in shares and bonds; volatile and called "hot money" because it can leave quickly |
External Commercial Borrowings (ECBs) |
Loans by Indian firms from foreign lenders |
NRI deposits |
Deposits from non-resident Indians in Indian banks, such as FCNR(B) accounts |
Reserves |
Drawing down foreign exchange reserves when inflows fall short |
A sudden stop in inflows can cause a sharp fall in the rupee. In 2013 (the "taper tantrum"), the RBI opened a special swap window for FCNR(B) deposits to attract dollars.
13.4 The 1991 BoP Crisis
By mid-1991, foreign exchange reserves fell to a level that covered only about three weeks of imports.
Causes: large fiscal and current account deficits, the Gulf War oil price shock, loss of remittances and political uncertainty.
India pledged gold abroad, took a loan from the IMF and in July 1991 devalued the rupee in two steps (about 9% and 11%).
The crisis led to the economic reforms of 1991 (LPG).
13.5 Foreign Exchange Reserves
Component |
Meaning |
Foreign currency assets |
The largest part; mainly foreign government securities and deposits |
Gold |
Held by the RBI, partly in India and partly abroad |
Special Drawing Rights (SDRs) |
International reserve asset created by the IMF; valued using a basket of US dollar, euro, Chinese yuan, Japanese yen and British pound |
Reserve Tranche Position (RTP) |
India's quota deposit at the IMF that it can draw on without conditions |
The reserves are held and managed by the RBI, which uses them to curb sharp swings in the rupee and to meet external obligations.
Import cover (reserves expressed in months of imports) is one measure of adequacy, along with the ratio of short-term external debt to reserves.
13.6 Exchange Rate
The exchange rate is the price of one currency in terms of another. A rise in the rupee price of a dollar means the rupee has depreciated; a fall means it has appreciated.
Term |
Meaning |
Depreciation / appreciation |
Fall or rise in a currency's value in a market-determined (floating) system |
Devaluation / revaluation |
Deliberate official reduction or increase in the value of a currency in a fixed system |
NEER |
Nominal Effective Exchange Rate: the rupee's value against a basket of currencies, weighted by trade |
REER |
Real Effective Exchange Rate: NEER adjusted for inflation differences. A rising REER means the rupee is becoming overvalued and exports less competitive |
J-curve effect |
After depreciation, the trade deficit may first widen and then improve |
Marshall-Lerner condition |
Depreciation improves the trade balance only if the sum of export and import demand elasticities is greater than one |
Effects of a weaker rupee
Exports become cheaper for foreigners, which can raise export volumes.
Imports become costlier, which can push up inflation, especially for oil and gold.
Foreign-currency debt becomes costlier to repay.
Evolution of the exchange rate regime
Period |
Regime |
1947 to 1971 |
Fixed rate; the rupee was linked to the pound sterling; the rupee was devalued in 1966 |
1971 to 1991 |
Linked to a basket of currencies (from 1975) |
1991 |
Two-step devaluation in July |
March 1992 |
Liberalised Exchange Rate Management System (LERMS): a dual exchange rate |
March 1993 |
Unified market-determined exchange rate |
Since 1993 |
A managed float: the market sets the rate, and the RBI steps in to reduce volatility rather than to defend a fixed level |
13.7 Convertibility of the Rupee
Type |
Position in India |
Current account convertibility |
The freedom to buy or sell foreign currency for trade and other current transactions. India accepted Article VIII of the IMF Agreement in August 1994, so the rupee is fully convertible on the current account |
Capital account convertibility |
The freedom to move capital in and out. India has partial capital account convertibility; the Tarapore Committees (1997 and 2006) suggested a phased approach with conditions such as a lower fiscal deficit and inflation |
FEMA, 1999 replaced FERA, 1973, and came into force on 1 June 2000. It treats violations as civil offences, unlike FERA, which was more criminal in nature.
13.8 External Debt
External debt is the amount owed by residents to non-residents, to be repaid in foreign currency or goods and services.
The Ministry of Finance publishes the Status Report on India's External Debt.
Components include commercial borrowings, NRI deposits, multilateral and bilateral loans, trade credit and short-term debt.
Common indicators: external debt to GDP, debt service ratio and the share of short-term debt.
13.9 Trade Policy and Recent Measures
Measure |
Key Point |
DGFT and the FT(D&R) Act, 1992 |
The Directorate General of Foreign Trade, under the Commerce Ministry, administers India's foreign trade policy |
Foreign Trade Policy 2023 |
In effect from 1 April 2023, without a fixed end date; focuses on export hubs, e-commerce exports and ease of doing trade |
RoDTEP |
Refund of Duties and Taxes on Exported Products; refunds embedded taxes that are not otherwise returned |
EPCG |
Export Promotion Capital Goods scheme: capital goods imported at reduced duty against an export obligation |
Export Promotion Mission (2025) |
Approved by the Cabinet in November 2025 with an outlay of Rs 25,060 crore from 2025-26 to 2030-31. It has two parts: Niryat Protsahan (trade finance for MSMEs) and Niryat Disha (non-financial support such as branding and compliance) |
Rupee trade settlement |
From July 2022 the RBI allowed trade to be invoiced and settled in rupees through Special Rupee Vostro Accounts |
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