KIIT SCHOOL OF MANAGEMENT KIIT UNIVERSITY BHUBANESWAR 751024

A REPORT ON BALANCE OF PAYAMENT AND STRUCTURAL ADJUSTMENT PROGRAMME

Submitted to:
PROF. SNIGDHA TRIPATHY

Complied by:
GROUP 6 (SECTION D)
Priyanka Sinha Preetam Kumar Manisha Kumari Himangshu Konwar Razique Anwar Shashank Shekhar Ayushman Arpita Singhania

Preetam Kuma Manisha Kumari Himangshu Konwar

Shashank Shekhar Ayushm

CONTENT

Sl. No.
1 2 3 4 5 6 7 Introduction: BOP Component of BOP Factor and Causes of Bop

Topics

Page No.

1 2-3 4-6 7 7 8-9 10

Definition of Structural adjustment program Function of Structural adjustment program Balancing Mechanism Structural Change

8 9

Structural Adjustment Program Observation

11 12

BALANCE OF PAYMENTS
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 good, services, financial capital, and financial transfer. 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. 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 counter-balanced 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 certain 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. Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country's currency and other currencies. Then the net change per year in the central bank's foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be set by the market, and the central bank's foreign exchange reserves do not change.

COMPONENTS OF BOP
The balance of payment has two accounts, namely, current account and capital account: The Current Account includes all transactions which give rise to or use up national income. The Current Account consists of two major items, namely: 1) Merchandise exports and imports, 2) Unilateral transfer. Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. Merchandise imports, i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Unilateral transfers are included in the current account of a nation's balance of payments. A transfer of funds from one account to another, where both accounts are held by the same individual, may occur for purposes of financial planning or better investment returns. Examples of such transfers would be funds transferred from a checking account to a savings account that offers higher rates of interest or from a savings account to an IRA. Most banks enable such inter-account transfers to be conducted online.

In Macroeconomics and international finance, the capital account (also known as financial account) is one of two primary components of the balance of payments, the other being the current account. Capital Account: The Capital Account consists of short- terms and long-term capital transactions A capital outflow represents a debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a debit in the US balance of payments and a credit in the balance of payments of India. The payment of interest on loans and dividend payments are recorded in the Current Account. Foreign investment: When a person invests outside the country for a certain amount of profit is called foreign investment. Foreign direct investment: FDI refers to long term capital investment such as the purchase or construction of machinery, buildings or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the capital account. If a nation's citizens are investing in foreign countries, that's an outbound flow that will count as a deficit. After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than as capital. Loan: It is another source of long term finance. A country can take loan from another country to maintain its flow of business. Commercial borrowing, External Assistance & banking capital transaction: These all are sources of long term finance.

BOP CRISIS-FACTORS AND CAUSES

There are many factor and causes which support the balance of payment crisis. 1. Ever Expanding Trade Gap: Trade deficit is the result of trade gap, i.e., gap due to a big rise in imports against a small growth in exports of the country over the years. As a matter of fact, eighties onwards country's expenditure on imports has risen at an alarming rates due to the following reasons: (i) Import Liberalization: Due to import liberalization during the eighties there has been a quantum jump in imports of capital goods and modern technology. The new economic and trade policies of 1991 have favored a further liberalization of imports. (ii) Increase in Import Intensity: The pattern of industrial development and growth of national income during the seventh plan led to a higher propensity to import. There has been a growth in import demand for consumer durables. (iii) Import of Oil: Petroleum oil and lubricants (POL) has been the single most important item in India's import bill. During seventies and eighties constituted nearly one-third of total (iv) Imports of the Country. Due to scarcity created by drought conditions, time to time, the country had to import essential items such as cereals and edible oils on a large scale.

(v) Rising Prices of Imports: The country's import bill has been rising due to rising prices of goods in. international markets. Especially, oil prices have been arbitrarily hiked by the oil supplying countries. For instance, in 1986, the average nominal price of crude oil was about US 13.8 a barrel. This had gone up to US 18 a barrel in 1987. Similarly, prices of fertilizers, etc., also have gone up. (vi) Deterioration in the Exchange Rate of Rupee: The external value of rupee in term of US dollar has continuously depreciated over the years. Rupee was devalued in 1991. As a result, the country had to pay high prices of imports in rupee terms. Consequently, had the value of imports of the country gone up this would not have posed a problem as our exports would have kept an equal price. Actually, rate of growth imports was much faster than that of out exports. That is to say, our exports are not sufficient to finance our imports. On account of slow rise in export earnings of the country, the trade-gap has widened, consequently, trade-deficit has increased over the years. 2. Rising Current Account Deficit: As a consequence of rising trend in trade deficit, India's current account BoP deficit has also increased sharply from an average of 1.3 per cent of GDP in the Sixth Plan to 2.7 per cent of GDP in 1988-89. The main factor contributing to the rising current account deficit is decline in the growth of net invisible earnings. The country's earnings from invisibles declined sharply from Rs. 4311 cores in 1-980-81 to Rs. 1,025 crores in 1989-90. Net invisibles earnings financing only 24 per cent of trade deficit during the seventh plan as against financing over 60 per cent of trade deficit in the sixth plan. In fact, net invisibles which financial over 90 per cent of trade deficit in 1978-79 financial only 14 per cent in 1989-90. Further owing to deterioration in the invisibles account the overall current deficit in 1990-91 at 7.3 billion was 1.4 billion higher than in the previous year. Another factor decline is migrants' remittance from abroad. Moreover, the country's repayment obligation and debt servicing to the IMF and other sources of external public debt adds to current account BoP deficit. In 1993-94, that current account deficit came down to $ 0.8 billion from $ 3.6 billion in 1992-93. 3. Deficits on Capital Transactions: In recent years, there has been the growing deficit on capital account due to country's rising obligations to meet amortisation payments. The situation is worsened due to a fall in the availability on concessional aid to finance the deficits and flattering out a private remittance.

Recently to ease the situation, the government has resorted to external commercial borrowings, assistance from IMF and MRI deposits, invitation to foreign capital and encouragement to direct foreign investment. These constitute substantial future liabilities. Bimal Jalan, a noted economist, thus, writes that, the economy is plunged into a crisis when these sources of financing the BoP deficits dried up. To quote him "the roots of the crisis, therefore, do not lie in impart liberalisation per se but on overall framework of macroeconomic policies including fiscal policy, which permitted an expansion of internal demand for the home market without generating adequate exports." India's balance of payment position was highly precarious in 1990-91. The country was caught in a vicious circle of low reserves, low credit rating and poor capacity to raise resources. The situation was no better in the beginning of 1991-92. To deal with the problem the government had to compress imports and also to find, sources of exceptional financing to meet the current account deficit. 4. Remedies and Suggestions: Solution to the balance of payments problem requires a package deal of measures. The government of India took several steps for correcting the BoP in recent years. Important lines of action involved. I. Acquisition of Foreign Currency:

In May 1991, for the first time, the government sold 20 tonnes of gold to a Swiss Bank for acquiring foreign currency, with the condition that it would be repurchased after six months. In July 1991, the RBI shipped about 47 tonnes of gold to the Bank of England as security to raise foreign currency from England and Japan. In short, by such gold transactions the government raised 600 million for foreign exchange crisis management in the mid- 1991. II. Devaluation:

In July 1991, the government of India virtually devalued Indian rupee by a downward adjustment of its exchange rate by about-18.20 per cent in terms of major currencies such as US Dollar, UK Pound Sterling, German Mark, Japanese Yen, French Franc in two stages. The step was meant to boost exports and curb imports. III. Compression of Imports:

To relieve the pressure of foreign exchange imports were compressed through certain monetary measures. The RBI imposed a each margin of 50 per cent on imports other than those of capital goods, in October 1990. In March 1991, the each margin was raised to 133.3 per cent. It was further enhanced to 200 per cent in April 1991. Besides, the RBI imposed a 25 per cent surcharge on interest on credit for imports, in May 1991. IV. Encouragement to Inflow of Funds from Abroad:

Since mid-seventies there has been a continuous flow of private remittances from abroad. But, as compared to other countries this has not been very significant in India's case. The country has been

getting foreign assistance at concessional rates from international institutions such as IMF, World Bank and IDA, and also from countries such as USA, the UK, France, Germany, USSR etc. In recent years, however such concessional loans were not easily and adequately available. Hence, the government had to resort to high lost loans through external commercial borrowings and deposits of non-resident Indians (NRIs). In October 1991, the government introduced the Indian Development Bank Scheme and the Immunity Scheme for repatriation of funds hold abroad. These schemes are to encourage the inflow of capital funds in India. Under the new liberalized policy of 1991, the government also encourages the direct foreign investment. To meet the BoP deficits in 1991, India approached the IMI for accommodation under the Compensator and Contingency Financing Facility (CCFF) and first credit trance. In March 1991, India drew 1.025 billion under the CCFF and 789 million under the first credit trance. In July 1991 and September 1991 further drawls were made. Besides, a steady arrangement was also negotiated.

STRUCTURAL ADJUSTMENT POLICIES

Structural Adjustment Policies are economic policies which countries must follow in order to qualify for new World Bank and International Monetary Fund (IMF) loans and help them make debt repayments on the older debts owed to commercial banks, governments and the World Bank. Although SAPs are designed for individual countries but have common guiding principles and features which include export-led growth; privatization and liberalization; and the efficiency of the free market. SAPs generally require countries to devalue their currencies against the dollar; lift import and export restrictions; balance their budgets and not overspend; and remove price controls and state subsidies. Devaluation makes their goods cheaper for foreigners to buy and theoretically makes foreign imports more expensive. In principle it should make the country wary of buying expensive foreign equipment. In practice, however, the IMF actually disrupts this by rewarding the country with a large foreign currency loan that encourages it to purchase imports. Balancing national budgets can be done by raising taxes, which the IMF frowns upon, or by cutting government spending, which it definitely recommends. As a result, SAPs often result in deep cuts in programmers like education, health and social care, and the removal of subsidies designed to control the price of basics such as food and milk. So SAPs hurt the poor most, because they depend heavily on these services and subsidies. SAPs encourage countries to focus on the production and export of primary commodities such as cocoa and coffee to earn foreign exchange. But these commodities have notoriously erratic prices subject to the whims of global markets which can depress prices just when countries have invested in these so-called 'cash crops'.

By devaluing the currency and simultaneously removing price controls, the immediate effect of a SAP is generally to hike prices up three or four times, increasing poverty to such an extent that riots are a frequent result. The term "Structural Adjustment Program" has gained such a negative connotation that the World Bank and IMF launched a new initiative, the Poverty Reduction Strategy Initiative, and makes countries develop Poverty Reduction Strategy Papers(PRSP). While the name has changed, with PRSPs, the World Bank is still forcing countries to adopt the same types of policies as SAPs.

BALANCING MECHANISMS
One of the three fundamental functions of an international monetary system is to provide mechanisms to correct imbalances. Broadly speaking, there are three possible methods to correct BOP imbalances, though in practice a mixture including some degree of at least the first two methods tends to be used. These methods are adjustments of exchange rates; adjustment internal prices of nation along with its levels of demand; and rules based adjustment Improving productivity and hence competitiveness can also help, as can increasing the desirability of exports through other means, though it is generally assumed a nation is always trying to develop and sell its products to the best of its abilities. Rebalancing by changing the exchange rate: An upwards shift in the value of a nations currency relative to others will make a nations exports less competitive and make imports cheaper and so will tend to correct a current account surplus. It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. Conversely a downward shift in the value of a nations currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports, thus helping to correct a deficit Exchange rates can be adjusted by government in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance. When a country is selling more than it imports, the demand for its currency will tend to increase as other countries need the selling countrys currency to make payments for the exports. The extra demand tends to cause Rebalancing by adjusting internal prices and demand: When exchange rates are fixed by a rigid gold standard or when imbalances exist between members of a currency union such as the Eurozone, the standard approach to correct imbalances is by making changes to the domestic economy. To a large degree, the change is optional for the surplus country, but compulsory for the deficit country. In the case of a gold standard, the

mechanism is largely automatic. When a country has a favourable trade balance, as a consequence of selling more than it buys it will experience a net inflow of gold. The natural effect of this will be to increase the money supply, which leads to inflation and an increase in prices, which then tends to make its goods less competitive and so will decrease its trade surplus.. On the other hand, if a country has an adverse BOP its will experience a net loss of gold, which will automatically have a deflationary effect, unless it chooses to leave the gold standard. Prices will be reduced, making its exports more competitive, and thus correcting the imbalance. Rules based rebalancing mechanisms: Nations can agree to fix their exchange rates against each other, and then correct any imbalances that arise by rules based and negotiated exchange rate changes and other methods. The Bretton Woods system of fixed but adjustable exchange rates wanted additional rules to encourage surplus countries to share the burden of rebalancing, as he argued that they were in a stronger position to do so and as he regarded their surpluses as negative externalities imposed on the global economy. Keynes suggested that traditional balancing mechanisms should be supplemented by the threat of confiscation of a portion of excess revenue if the surplus country did not choose to spend it on additional imports.

STRUCTURAL CHANGES
Under Structural Change we have two sub categories: 1. Short Term Changes and, 2. Long Term Changes. 1. Short Term Changes: Two step downward adjustment the exchange and the rate of rupee was made effective on 1 July 1991. This effectively translated into devaluation of 18-19% against major international currencies. This was coupled with liberalization of the trade regime and lower import tariffs. Due to currency devaluation the rupee fell from 17.50 per dollar in 1991 to 26 per dollar in 1992. 2. Long Term Changes: A high level committee on balance was setup in December 1999. Liberalized exchange rate management system move to single market based exchange rate system. Macroeconomics stabilization focus to basically improve efficiency and spur exports

 Fiscal correction- Its lowering of government spending. Trade policy reforms- Import tariff reduced and some restriction were also been removed. Industrial policy reforms- Earlier there was so many restriction for Private Companies to get a License and by this policy there was an end of license raj. Public sector reforms- The autonomy and efficiency was improved. And there was transparent operation that are relatively free of corruption.

STRUCTURAL ADJUSTMENTS
Structural adjustments are the policies implemented by the International Monetary Fund (IMF) and the World Bank (the Breton Woods Institutions) in developing countries. These policy changes are conditions for getting new loans from the International Monetary Fund (IMF) or World Bank, or for obtaining lower interest rates on existing loans. Conditionalitys are implemented to ensure that the money lent will be spent in accordance with the overall goals of the loan. The Structural Adjustment Programs (SAPs) are created with the goal of reducing the borrowing country's fiscal imbalances. The bank from which a borrowing country receives its loan depends upon the type of necessity. The SAPs are supposed to allow the economies of the developing countries to become more market oriented. This then forces them to concentrate more on trade and production so it can boost their economy. Through conditionalitys, Structural Adjustment Programs generally implement "free market" programs and policy. These programs include internal changes (notably privatization and deregulation) as well as external ones, especially the reduction of trade barriers. Countries which fail to enact these programs may be subject to severe fiscal discipline. Critics argue that financial threats to poor countries amount to blackmail; that poor nations have no choice but to comply. Since the late 1990s, some proponents of structural adjustment such as the World Bank, have spoken of "poverty reduction" as a goal. Structural Adjustment Programs were often criticized for implementing generic free market policy, as well as the lack of involvement from the country. To increase the borrowing country's involvement, developing countries are now encouraged to draw up Poverty Reduction Strategy Papers (PRSPs). These PRSPs essentially take the place of the SAPs. Some believe that the increase of the local government's participation in creating the policy will lead to greater ownership of the loan programs, thus better fiscal policy. The content of these PRSPs has turned out to be quite similar to the original content of bank authored Structural

Adjustment Programs. Critics argue that the similarities show that the banks, and the countries that fund them, are still overly involved in the policy making process. IMPACT: Some of the Impact of structural adjustment can include:

Cutting expenditures, also known as austerity. Focusing economic output on direct export and resource extraction, Devaluation of currencies, Trade liberalization, or lifting import and export restrictions, Increasing the stability of investment (by supplementing foreign direct investment with the opening of domestic stock markets), Balancing budgets and not overspending, Removing price controls and state subsidies, Privatization, or divestiture of all or part of state-owned enterprises, Enhancing the rights of foreign investors vis-a-vis national laws, Improving governance and fighting corruption.

OBSERVATION

Acceleration of GDP growth to 6.7% in the period 1992-97 was the highest ever achieved over five years, Sum of external current t payment is received as the ratio to GDP from 1991-2001, Manufacturing achieved average real growth of 11.3% from1993-97, Private investment showed a high growth of 16.3% per annum 1992-97.