me term paper - group 3
TRANSCRIPT
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Group 3Group 3BhuvaneshwariBhuvaneshwari RR PGP 14/206PGP 14/206
ChaitraChaitra JJ PGPPGP 14/14/207207
Chandramohan Nayak MChandramohan Nayak M PGPPGP 14/14/209209
NeeluNeelu KK PGPPGP 14/14/216216
PragyaPragya PP PGPPGP 14/14/221221
MadhusudanaanMadhusudanaan NMNM PGPPGP 14/14/225225
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Overview of the crisis
Balance of Payments the machinery India before the crisis
Events leading to the crisis
The Crisis and recovery
Post Crisis India
Conclusion
Agenda
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Exchange rate was subjected to severe adjustment
Foreign exchange reserves were barely adequate for3 weeks of imports
Was on a brink of default
1990 What happened?
BALANCE OF PAYMENT CRISIS!!!
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An accounting record of all monetary transactions
between a country and the rest of the world
Sources of funds : positive or surplus item
Exports, receipts of loans and investments
Usage of funds : negative or deficit items
Imports or investment in foreign countries
All the components of a BoP sheet must balance: nooverall surplus/deficits.
BoP- An Introduction
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Two primary compositions of a BoP sheet:
Current account
Balance of trade + Factor payments + Cash transfers
Capital account
Reserves account along with the loans and investmentbetween the country and the RoW
BoP = Current account Capital account balancing items
Composition of BoP Sheet
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A visible trade deficit
A nation is importing more physicalgoods than it exports
An overall current account deficit
A basic deficit
Current account plus foreign directinvestment
Types of Deficits
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Rebalancing by changing the exchange rate
Rebalancing by adjusting internal prices anddemand
CA = NS NI
Rules based rebalancing mechanisms
Balancing Mechanisms
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Balance of PaymentsCrisis???
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Currency crisis / balance-of-payments crisis is a
speculative attack in the foreign exchange market
Speculative attack in the foreign exchange marketThe massive selling of a country's currency
assets by both domestic and foreign investors
Countries that utilize a fixed exchange rate are more
susceptible to a speculative attack than countriesutilizing a floating exchange rate because they havelarge amount of reserves necessary to hold the fixedexchange rate in place at that fixed level
What is BoP Crisis?
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But, if a government chooses to maintain a fixed
exchange rate during a speculative attack, they riskthe chance of severe economic depression orfinancial collapse, as illustrated by the Argentine andEast Asian financial crisis
What is BoP Crisis?
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An adaptation of Stephen Salant and Dale
Hendersons model of speculative attacks in gold
market
Sudden speculative attack on fixed exchange rate canbe a result from rational behavior by investors
Occurs when investors foresee that a government is
running an excessive deficit
First Generation Model
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The reason investors attack the currency is that they
expect other investors to attack is true
Second Generation Model
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Deal with how problems in the banking and financial
system interact with currency crisis
Suggests that "over borrowing" by banks to fund moralhazard lending is a form of hidden government debts
Suggests that self-fulfilling panics that hit the financialintermediaries, force liquidation of long run assets
Argues that a currency crisis may cause a banking crisis iflocal banks have debts denominated in foreign currency
Third Generation Model
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Comfortable during the 70s
1973-74 oil shocks aftermath saw increase inforeign aid, private transfers and booming exports
Global trade flourished exports increased
Price levels lower in India compared to othercountries depreciation of Rupee
Private transfers increased seven-fold
Decade of Comfort 70s
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Private transfers helped support 80% of trade deficit
Result : 1978-79 : Current account deficit was just 0.2% of GDP
Aid was higher than financial requirements for thedecade built up reserves
Close of decade: Foreign exchange reserves covering
7 months of imports!
Decade of Comfort 70s
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BO
P upto 1981-82 The second oil shock of 1979 was severe
Increase in POL imports
Exports were decreased due to internationalrecession
These factors led to a Current Account deficit
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BO
P upto 1981-82 During 1982-83 to 1984-85, there was a ease on
pressure on BOP due toDecline in volume growth of imports from an average
rate of 11% to 2%
NetOil imports declined substantially as domesticproduction spurted to 29 million tones after thediscovery of crude oil in Bombay High
Non-POL imports rose at an average rate of 3.6% indollar terms whereas exports increased at rate of3.2% in volume terms
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BO
P upto 1981-82 Invisibles Account deteriorated as interest payments
to service external borrowing acquired a rising trend
Commercial borrowings and non-resident depositsemerged as the important sources of finance
External assistance remained the major source offoreign capital inflow
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Build up to the crisis Second half of the eighties witnessed the building up
of strains on the BOP
Current Account Deficit remained high throughout
Trade deficit occurred despite a increase in exports
Manufactured exports increased during this period
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Build up to the crisis Heavy interest payments on foreign debts
Fiscal deficit 8.2% of GDP
Heavy borrowing from IMF debt-service ratioincreased -13.6% in 1984-85 to 30.9% in 89-90
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Build up to the crisis The genesis of the economic crisis in India, which
surfaced in 1991, lies in the large and persistent
macroeconomic imbalances that developed over the1980s.
The root cause of the crisis was the large andgrowing fiscal imbalance
Large fiscal deficits emerged as a result of mountinggovernment expenditures
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Build up to the crisis Fiscal deficits led to high levels of borrowing by the
government from RBI, with an expansionary impact
on money supply leading directly to high rate ofinflation
The gross fiscal deficit of the government rose from9.0% of GDP in 1980-81 to 10.4% in 1985-86 and to
12.7 % in 1990-91.
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Build up to the crisis These deficits had to be met by borrowings, the
internal debt of the government accumulated
rapidly, rising from 35% of GDP at the end of 1980-81 to 53% of GDP at the end of 1990-91
interest payments increased from 2% of GDP in 1980-81 to 4% in 1990-91
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Build up to the crisis The dynamic interrelationship between the fiscal and
trade deficits, resulted in large current account
deficits in the balance-of-payments In order to meet these large and persistent current
account deficits, large scale commercial borrowingswere undertaken along with contraction of
substantial short-term debt.
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Build up to the crisis The capital account of the balance-of-payments
began experiencing strains after 1986 with the
bunching of repayment obligations to the IMF andsome of the private creditors.
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Build up to the crisis
BOP Deficitleads to
Forex reservesDepletion
ExternalBorrowings
ReducedForeign
Investments
Debt Trap
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1990 1992 Ugly
Series of unfortunate events
Gulf crisis of 1990 increase in oil import bill
Burden of repatriating and rehabilitating of NRIsfrom West Asia
Deterioration of invisible account
Increase in price of oil => overall current accountdeficit in 1990-91 : US $ 9.7 billion
The Crisis
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Important trading partners grew weak US, Russia
World growth declined from 4.5% in 1988 to 2.5% in1991
Result : Export volume growth reduced to 4%
Political turmoil VP Singh governmentoverthrown, Rajiv Gandhi assassination reduced
credibility of India
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Capital Account
problems Foreign reserves very low at $1.2 billion
Overshot IMF SDR reserves
Only option commercial borrowing
Loss of investor confidence - Credit agenciesdowngraded India
Simultaneous outflow of NRI deposits
Serious difficulties in rolling over of short term loans
Current account deficit of $9.7 billion almostimpossible to finance
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Government 2 tasks
Compress imports
Find exceptional financing Unorthodox steps taken Pledging of gold
Adjustment in exchange rate
Structural reforms in trade, industrial and foreign
investment policies Loss of reserves stemmed by less imports
Result : 1991-92 ended with current account deficit ofless than 1% of GDP!
Revival
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Government deficit
Percentage of GDP
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Current Account trends
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Real exchange rate trends
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External debts As a
percentage of GDP
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Foreign exchange
reserves
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conscious policy of industrial de-regulation
exchange rate was devalued
system transformation from discretionary, basket-peggedsystem, to a market-determined, unified exchange rate,following a short intermediate period of dual rates
Anti-export bias in the trade and payments regime was
also reduced substantially A phased reduction in the exceptionally high customs tariffs
A phased elimination of quantitative restrictions on imports
Corrective Policies
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Policies were initiated to encourage both direct and
portfolio foreign investment
Short-term debt was reduced and strict controls put inplace to prevent future expansion Medium-term borrowing from private commercial
sources was made subject to annual caps and minimummaturity requirements
Growth of NRI deposits was moderated through
reduction of incentives Foreign exchange reserves were consciously accumulated
to provide greater insurance against external sectorstresses and uncertainties
Corrective Policies
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Trade and Investment Flows
Surge in exports
Significant rise in foreign direct investment and othercapital flows
Substantial increase in private transfers under thecategory of invisibles in balance of payments account
In ten years, 1991- 2001, Over 37 billion dollars of foreign investment flowed
18 billion $ was direct investment, i.e., an average of 2.2billion $ per year.
Effects ofL
iberalization
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Trade and Investment Flows
Private transfers grew to a level of 10-12 billiondollars in the latter half of 1990s.
Export growth momentum and the exchange ratereforms - the two major factors which helpedcontain the current account deficit in BOP to 1 to
1.5 per cent of GDP between 1991 and 2001
Effects ofL
iberalization
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Balance of Payment Surplus
NRI deposits with the banking system in India on the
rise from 13 billion dollars in 1991-92 to 23.8 billiondollars by March 2001
Balance of payments recorded an overall surplusconsecutively for five years from 1996-97
Indias foreign exchange reserves, barely one billion inthe pre-crisis year reached $ 40 billion (other than goldand SDR) - the average annual addition being 4.5billion dollars
Effects ofL
iberalization
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Balance of Payment Surplus
External sector - growth rates moving up to 11and 20% in the two years ended March 2001
India successfully withstood
the fall-out effects of the Asian financialturmoil in 1997
the economic sanctions imposed by USA andother countries following the nuclear tests inMay 1998t
the sharp rise in international oil prices since
the closing months of 1999.
Effects ofL
iberalization
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Transition from an onerous trade regime to a
market-friendly system encompassing both trade
and current payments Acceleration of GDP growth to 6.7 per cent in the
period 1992-97 was the highest India had everachieved over a five year period
Sum of external current payments and receipts as aratio to gross domestic product (GDP) doubled fromabout 19% in 199091 to around 40% by March 2001
Recovery of the 1990s
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Stabilization measures of 1991-93 restored
macroeconomic stability and fuelled one of the
swiftest recoveries of economic dynamism andbusiness environment seen anywhere in the world inrecent decades
GDP growth recovered to nearly 6 per cent in 1993-
94 and exceeded 7 per cent in each of the next threeyears
Manufacturing recorded average real growth of 11.3per cent in the four years 1993-94 to 1996-97
Recovery of the 1990s
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Export growth in dollar terms averaged 20 per cent
in the three years 1994 1996 and the rates of
aggregate savings and investment in the economypeaked in 1995-96
Real fixed investment rose by nearly 40 %, led by amore than 50 % increase in industrial investment
Private investment showed an astounding averagegrowth of 16.3% per annum during 1992-96
Restoration of confidence and liberalization offoreign investment policies triggered a temporarysurge in foreign capital inflow
Recovery of the 1990s
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External commercial
borrowings
-10 0 10 20 30 40 50
1980-81
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
10.9
25.2
48.1
20.1
36.7
31.8
26.8
30.6
-8.4
9.1
13.6
21
10.6
ECB/TC (%)
1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91
1991-92 1992-93 1993-94 1994-95 1995-96 1996-97
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1993-94: Result of a concious government policy to
maintain a strict control over external indebtness and
resulted favourably in improving the credit rating ofIndia by international agencies.
1994-95: Some private sector power and petroleumcompanies finalizing their financing packages
1995-96: Large demand for borrowing with projectsin petroleum, oil exploration andtelecommunications.
External commercial
borrowings
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External Assistance
0
10
20
30
40
50
60
70
1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97
60.9
36.2 34.6
46.9
36.733.2
26.3
63.9
43.7
18.5 19
29.8
11.7
EXTERNAL ASSISTANCE/TC (%)
1980-81 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91
1991-92 1992-93 1993-94 1994-95 1995-96 1996-97
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Advance release of funds to state governments
Disintermediation of loans to central public sector
units
Setting up of a Project Management Unit (PMU) aspart of the department of Economic Affairs tomonitor ,supervise and strengthen various projects.
In 1994-95 decided not to approach IMF for mediumterm funds.
Measures for utilization
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9
20.2 20.3
5.6 4.5
-3.9
11.6
20.4
-10
-5
0
5
10
15
20
25
1990-91 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00
AxisTitle
EXPORT GROWTH (%)
Export Growth
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14.4
10
21.6
12.1
4.6
-7.1
16.5
-10
-5
0
5
10
15
20
25
1990-91 1993-94 1995-96 1996-97 1997-98 1998-99 1999-00
AxisTitle
GROWTH OF IMPORTS (%)
Growth of Imports
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Can liberalized trade policies land us again in the
problems that we faced few years back?
Market determined exchange rate-lead us to nearlyequilibrium status
Market can provide advanced warning signals
POL imports needs special attention to protect from
external shocks Experts opinion: Maintain 15% annual exports
growth!
Conclusions
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