Economist’s Column India's Crisis on external front

By Prabirjit Sarkar

Economist Column Indian's crisis in external front, is liberilisation the answer? Ringside View For a third alternative Loud Thinking Reeling under fear.

Since the early 1950s till the early 1990s, Indian policy makers had been nourishing the goal of Socialist pattern of society. They had been following the development planning strategy of the former Soviet Russia in a mixed economic framework. Since July 1991, in the face of an unprecedented foreign exchange crisis, Indian economy has been experiencing an IMF-World Bank dictated regime of liberalisation. It is a new regime - a departure from the earlier model of state controls and 'mixed' economy. The term, 'New Economic Policy' or NEP is often used to describe the policies of the new regime.

Now the question is what kind of economic compulsion led India to the path of this new regime. The next question that is addressed here is what is the performance of the NEP regime compared to the pre-NEP scenario. The present paper seeks to answer these questions with the help of an analysis of Indian economy, particularly trade and payments scenario since the 1970s.

For a statistical analysis of Indian economic scenario under NEP, we need sufficiently large number of observations. Hence monthly data on Indian trade, production and prices are analysed. The sources of data are IMF International Financial Statistics, various issues (1979-97) and RBI Bulletin, various issues (1977-98).

The period of study of this monthly data starts at January 1980 and ends in July-December, 1997. Annual data on selected items of India's balance of payments (since 1970) have also been collected from RBI Bulletin (1977-98).

First, consider the trend-behaviour of India's exports and imports (valued in US $) in the pre-NEP period, January 1980 to June 1991.

Fitting a log-linear trend equation to the dollar values of India's exports (XDL), the trend rate of growth is estimated to be 0.94 per cent per month.Through the same procedure, the trend rate of growth of the dollar values of imports (MDL) is estimated to be 0.56 per cent per month.In view of a lower rate of growth of imports, the percentage of dollar import bill that is paid for by export proceeds [(= XDL x 100 / MDL),X/M] rose at the statistically significant rate, 0.39 per cent per month during the pre-NEP period studied here:

However, there is very weak evidence of a trend-improvement in the dollar values of balance of trade, BTDL (the time coefficient is significant at 10.6 per cent level) 3: Now the question is whether the balance of trade series shows any change in its trend-behaviour-whether there is any sign of deepening crisis at any point of time before the NEP period. The question is sought to be answered with the aid of the CUSUM Squares test. It shows no significant evidence of structural change in the series.

That is to say, throughout the decade preceding NEP, there is no sign of deepening crisis in India's balance of trade. The same conclusion holds good for the series of export-import ratio, X/M.

On the basis of annual data available from the RBI Bulletin (1994, p. S1142), the scenario of the 1970s can be brought into the picture. In the financial year, 1972-73, there was a trade surplus of $132 million. After the first oil price shock, the trade deficit mounted up and reached $1.5 billion mark by 1974-75.

In 1976-77, there was again a surplus of $76 million. Since then, after the second oil price shock, the situation had been worsening steadily and in 1980-81 the deficit touched the record figure $7.4 billion. After this record deficit, the situation did not worsen further.

With an exception in 1985-86, exports as a percentage of imports rose steadily: from the record low of 53 per cent in 1980-81, it rose to 75 per cent in 1990-91.

Moreover, as a percentage of India's NNP at factor cost, the balance of trade deficit fell steadily from 5.3 per cent in 1980-81 to 2.5 per cent in 1990-91. The average of the 11 year period was 3.5 per cent.

The situation was different for India's invisible trade. Data available in RBI Bulletin (1977-98, Table 32) show that during the period 1973/74 - 1989/90,

India had surplus on invisible account. From a small deficit during 1970-72, the balance of invisible trade (Net Invisibles) started showing a rising surplus. By 1980-81,the surplus touched the record figure, $5.5 billion.

Due to the growing surplus on invisible account in the 1970s, India did not face much the problem of payment imbalance on current account. In the late 1970s, there was even an annual average current account surplus of more than $1 billion.

Growth of surplus on the invisible account owes much to the growth of net private transfers, mainly remittance from the Indian workers employed in the petrodollar-rich Gulf countries. There was more than ten-fold increase in net private transfers - it became $3 billion in 1980-81.

Besides, there was some growth of surplus on travel and transport accounts. Even there was a steady decline in the deficit in net investment income (mainly net interest and service payments). The situation changed in the 1980s. With the declining prosperity of the Gulf countries, inflows of foreign exchange through net private transfers stagnated; but there was no evidence of decline.

Apart from a sluggish growth in net private transfers, the surplus from travel account declined during the first half of the 1980s. The situation changed later. The net inflow from transport account was positive in the 1970s; it became negative in the 1980s. The most important factor was the growing deficit in net investment income. Since 1982-83, the deficit on this account had been growing steadily: from $294 million, the deficit crossed the $1 billion mark in 1987-88 and reached the record figure $3.8 billion in 1990-91.

The most part of the deficit on this account was due to a mounting burden of interest and service payments; it reached the $3 billion mark by 1989-90. The cause of this growing deficit in net investment income lies in India's capital account. There was a rapid growth of official loan in the 1980s: from an average of less than $2 billion during 1980/81-1983/84, the figure crossed the $3 billion mark in 1985-86 and the $5 billion mark in the next year; it reached $6.8 billion in 1990-91(see Figure 4).

Accordingly, the net outflow due to amortisation rose from an average of $737 million during 1980/81-1983/84 to $2 billion in 1986-87 and further to $2.4 billion in 1990-91. There was also rapid growth of net inflows on account of private longterm capital. A merger value of net outflow in the 1970s was turned into a net inflow in 1980-81; by 1988-89, the net inflow reached the $3 billion mark.

In view of all these, the surplus on net invisibles declined steadily in the 1980s. The decade, the 1980s, started with a record $5.5 billion surplus and ended with a merger surplus of $615 million. In the last financial year before the 1991 crisis, 1990-91, there was a deficit of $242 million on invisible account. Accordingly, the current account deficit soared high from $2 billion to $4 billion between the start and end of the decade, the 1980s(Figure 1). In 1990-91, the current account deficit crossed the $6 billion mark. This deficit was 2.6 per cent of India's NNP at factor cost.

As for the behaviour of India's foreign exchange reserves (excluding reserve position in the IMF, SDRs & Gold), FOREX, it declined during the first three years of the 1980s, followed by a recovery during the next three years. After this phase, there was a regular decline:

From $6.8 billion at the end of January 1980 and $5.8 billion at the end of November 1985,FOREX reached the figure $1.2 billion at the end of December1990.

There was a temporary recovery in the first three months of 1991, followed by a sharp fall in the next three months. In June 1991, India's FOREX touched the rock bottom; it was only $1.1 billion. It is this alarming FOREX position which prompted India to approach the IMF/World Bank for help. Accordingly, India had to follow their Structural Adjustment Programmes (SAP). India's NEP is nothing but the IMF/World Bank-dictated SAP.

Actually the process of 'liberalisation' started in the early 1980s when the IMF during the regime of Indira Gandhi sanctioned a 5 billion SDR EFF loan. To some extent, the deepening of the crisis in the current account of India's balance of payments was a fallout of this process of liberalisation.

In the 1980s, the net inflow of private long-term capital picked up along with the inflow due to official loans. This led to a rising deficit on account of investment income.

Moreover, throughout this decade, there was a deficit on account of transport services while in the earlier decade there was a surplus on this account. In fact, under NEP, the deficit grew sharply : from $109 million in 1990-91, the deficit rose to $360 million in 1991-92 and further to $586 million in 1992-93. Of course, there was the lagged effect of the second oil price shock and an accumulation of balance of trade deficit in the early 1980s which prompted India to seek EFF loan. But the crisis would not deepen much since the oil price had already started declining.

After a discussion of the pre-NEP scenario, what we intend to do is to study the behaviour of some of the macro variables of Indian economy under NEP or SAP. We have export and import data over the period, January 1980-December 1997. The period of study can be sliced into two sub-periods pre-NEP period(January 1980 - June 1991) and NEP period(July 1991 - December 1997).

Intercept and slope dummies are added to the trend equation to examine whether there was any change in intercept and slope parameters under NEP. Fitting the dummy variable regression to the dollar values of India's exports (XDL)it is observed that the growth of the dollar values of India's exports did not accelerate under NEP.The dollar value of India's imports(MDL) shows no sign of deceleration; rather there is some evidence of acceleration.

For the balance of trade series(BTDL), dummies are added to a linear trend; the estimates of the coefficients of the intercept and slope dummies show that the trendlessness of the balance of trade series of the pre-NEP period gave way to a trend deterioration during the NEP period.

The present study can be extended to cover India's production and price scenario. The dummy variable regression is fitted to the series of industrial production index(IIP) over the period, January 1980-November, 1997 for which data are available. It shows that the index of India's industrial production exhibited a monthly rate of growth of 0.56 per cent during the pre-NEP period and there was no sign of acceleration under NEP. The CUSUMSQ test shows no structural break at any point of time after the start of NEP.

There is strong evidence of accelerated inflation under NEP. The index of consumer price index exhibited an average monthly rate of growth of 0.66 per cent during the pre-NEP period(January 1980-June 1991); the rate of growth accelerated during the NEP period (July 1991-July 1997) for which data are available in IMF International Financial Statistics(1979-97).

The acceleration of the rate of price inflation can be attributed to different policies followed under NEP such as devaluation, price increases through administrative fiats etc. In view of this acceleration in inflation. The real effective exchange rate of Indian Rupee(export-weighted) changed its pre-NEP(January 1980-June 1991) course of steady depreciation in spite of substantial devaluation under NEP (July 1991-October 1997).

However, the nominal effective exchange rate(export-weighted, NEX) continued to depreciate without any structural shift under NEP(July1991- October 997)11: To sum up, the present study has analysed India's foreign trade data since January 1980 and found no evidence of deepening crisis in India's balance of trade in the 1980s. The current account payments deficit soared high in the 1980s due to a steady decline in the surplus on invisible account which was to some extent a fallout of the process of 'liberalisation' of the 1980s.

Analysis of available data shows that India's exports did not pick up under NEP and the balance of trade data show no sign of improvement; rather the data show some sign of worsening in the balance of trade scenario due to an acceleration in the growth of imports. The series on the index of industrial production shows no sign of acceleration. But inflation picked up. Hence, real effective exchange rates tended to appreciate in spite of substantial nominal devaluation.

All these observations should be read with the fact that there is accumulation of huge external debt. India is now the third largest debtor nation(after Brazil and Mexico). There is no indication from which it can be said that the process of debt accumulation will be halted in near future. Rather the debt crisis is expected to deepen further as production and exports did not accelerate while imports showed some tendency to pick up(the latter tendency is likely to gain more strength with the increasing 'liberalisation' under NEP).

Centre for Studies in Social Sciences Calcutta