Indian Economy

Model Answer

Definition of Balance of Payments (BoP)

The Balance of Payments (BoP) is a systematic record of all economic transactions between the residents of one country and the rest of the world over a specific period. It includes imports and exports of goods, services, capital flows, and transfer payments like foreign aid and remittances. The BoP helps assess the economic health of a country by tracking how much it is earning and spending internationally.

Components of the Balance of Payments

1. Current Account:
   The current account records all transactions related to the import and export of goods, services, and transfer payments. It is divided into three sub-components:
   • Balance of Trade (BoT): Represents the net export or import of goods (visible items).
   • Balance of Invisibles: Includes trade in services such as tourism, software services, and financial services.
   • Transfer Payments: Involves remittances, gifts, and grants received without any corresponding return payment.
2. Capital Account:
   The capital account tracks the purchase and sale of assets, including foreign direct investment (FDI), foreign portfolio investment (FPI), loans, and remittances from Non-Resident Indians (NRIs).
3. Official Reserve Account:
   This account records changes in the country’s reserves, such as foreign currencies, gold, Special Drawing Rights (SDRs), and its reserve position in the International Monetary Fund (IMF).
4. Errors and Omissions:
   This is a balancing item that accounts for any discrepancies due to the difficulty in recording all international transactions accurately.

Consequences of a BoP Deficit

A BoP deficit occurs when a country’s spending exceeds its earnings from abroad. This can have several negative implications:

• Increased External Debt: The country may borrow money to cover the deficit, leading to a rise in debt.
• Depreciation of Currency: A deficit often leads to a weakening of the domestic currency, making imports more expensive and contributing to inflation, especially in countries like India where oil is heavily imported.
• Inflation: As the value of the currency decreases, the cost of imports rises, potentially leading to inflation.
• Economic Vulnerability: A BoP crisis can erode investor confidence, leading to reduced foreign investment and capital flight.

For example, during the 1991 Indian economic crisis, India faced a BoP deficit and had to pledge gold reserves to secure loans from the IMF, which led to economic liberalization (Source: IMF, 1991).

Model Answer

Factors Limiting India’s Export Competitiveness

India’s export potential is significantly constrained by several key factors:

1. Higher Tariffs on Intermediate Goods: A major obstacle to India’s export competitiveness is the high tariff on intermediate goods, which make up about 70% of anti-dumping duties. These duties increase production costs for downstream industries, ultimately affecting the pricing of finished export goods. This, in turn, makes Indian products less competitive in global markets.
2. Traditional Export Basket: India’s export basket is largely dominated by low-value, traditional products such as textiles and raw materials, which account for around 70% of its exports. These goods target markets that represent only 30% of world trade, many of which are declining in demand. India’s lack of diversification into higher value-added products limits its export potential.
3. High Logistics Costs: India’s logistics costs are approximately 16% of GDP, significantly higher than those of China (10%) and the U.S. (8%). These high costs erode the competitiveness of Indian exports, making them less price-competitive in international markets (Source: Ministry of Commerce).
4. Complex Business Ecosystem: The trade environment in India is marked by bureaucratic red tape, complex taxation laws, power subsidies, and high non-tariff barriers. These factors increase the cost of doing business and hinder the ease of exporting.
5. Lack of Sector-Specific Export Strategies: India’s export policy lacks a targeted, sector-specific approach. There is a need for customized strategies that cater to the unique strengths and challenges of various industries and international markets.

Measures to Boost Export Competitiveness

1. Decentralized Export Strategy: The government should adopt a more state-specific, decentralized export policy. Encouraging states to compete in export promotion will foster innovation and tailored industrial policies, enhancing export performance.
2. Aggressive Participation in Global Value Chains (GVCs): India must ramp up its involvement in GVCs by focusing on labor-intensive manufacturing, which will create more job opportunities and boost exports of network products.
3. Enhance Export Ecosystem: Efforts like the PM Gati Shakti initiative, the Trade Infrastructure for Export Scheme (TIES), and the Remission of Duties or Taxes on Export Products (RoDTEP) should be fully implemented to streamline exports and reduce barriers (Source: Ministry of Commerce).
4. Boost Domestic Manufacturing: Encouraging domestic manufacturing through lower corporate tax rates, PLI schemes, and infrastructure development can significantly increase the supply of competitive products for export.
5. Move Away from Protectionism: India should adopt a more open trade policy, forging preferential trade agreements and regional trading arrangements, especially in light of the growing trend of the China-plus-one strategy.

By addressing these issues and implementing targeted measures, India can significantly enhance its export competitiveness and contribute more to global economic growth. These steps will help the country achieve its target of $1 trillion in merchandise exports by 2027-28 and $1 trillion in services exports by 2030.