Understanding RBI's BoP review

The recently released RBI First Quarter Review of Monetary Policy 2009-10 and the accompanying 'Macroeconomic and Monetary Developments First quarter review 2009-10 have indicated that on the basis of Balance of Payments (BoP) the export growth for 08-09 has declined by over 22% to 5.4% and also the import growth has declined by over 21% during the same period.

Trade deficit, BOP, Current account, Capital account so on and so forth make up the content of the document released by the RBI. Most of us may read the same saying 'it's for the economists and not for me" or it does not have any impact on my personal life so why bother.

Well, true to some extent but a simple understanding of these concepts could help us understand the economy better and in turn create a stable financial life for ourselves too. After all we are as much a part of the Indian Economy as Montek or Pranab!

Balance of Payment demystified:

The BoP of India is an indicator of the cash flow (money flow) between India and all the other countries of the world with whom we have trade/business transactions. If we look from a broad perspective we can categorize the different ways in which money flows between India and other countries into four categories namely,

• Export and Import of physical goods or commodities (handicrafts exported to china, the Malaysian carpet you recently purchased, cardamom from Kerala to the United States all form part of this trade)
• Export and Import of Services (Infosys providing software solutions to a client in Chile, a consultant based in London providing consultancy to the Delhi metro all form part of this flow)
• Transactions involving only money: These are those business transactions where there are no goods or service involved but only money changes hands either in the form of Rupees or any other currency (Loans, investments in the stock market, venture funding etc. form part of this component)
• Transfer of money by Indians or foreigners from India to abroad or from abroad to India. (the money that you sent during your assignment in Germany to your parents forms part of this component)

India's Balance of Payment is calculated by taking into account two broad categories, which cover the categories discussed above:

• Current account balance (exports, imports and net invisibles)
• Capital account balance (capital outflow, capital inflow)

The current account flow is a sum of the trade balance (exports-imports) and net invisibles (invisible receipts-invisible payments). Invisibles are nothing but transactions without any tangibility in terms of what is being exchanged.

For example, software. When you sell a Laptop its tangible but, the software on the same laptop is intangible or not visible, hence, the usage of the word 'Invisibles' to denote services, private transfers and investment income.

In the case of India, software, private transfers, non-software services, investment income, transportation, travel and insurance form the most significant components of Invisible receipts in that order.

On the payments side, non-software services is the largest component of invisible payments.

The capital account flow is mainly made up FDI (inward and outward), portfolio investments (FIIs and American Depository Receipts), international assistance, external borrowings, banking capital and short term trade credits.

Trade deficit is the difference between exports and imports of goods. A positive deficit implies more exports and a negative implies more imports.

But, we must realize that it is not easy to explain what is good for the country and what is not good. It all depends on the state of the economy at that particular point in time.

The last year-FY 2008-09

• Current account: Trade deficit increased to 10.3% of GDP or $119.4 billion compared to 2007-08. But in the last quarter of 08-09 the current account has shown a surplus. Meaning the total inflow has surpassed the outflow. The reason for this is being cited as the lower oil prices and also a reduction in other imports.
• Invisibles: The net invisibles have shown a positive growth of 7.7% GDP or $89.6 billion. What this in effect means is that whatever deficit was seen in trade was in a large way compensated by the invisible receipts. Software exports, private transfers and transportation have helped boost the receipts. At the same time Invisible payments have shown a drop of over $1 billion during the same period mainly due to a drop in software imports and investment income.
• The India Shining story: The most positive take away from the BoP for 2008-09 is the Capital account. The FDI inflows and NRI deposits have shown tremendous growth implying a greater confidence in the Indian economy in the long term and gives us the confidence that we are on the right track albeit slowly. NRI deposits were at $4.3 billion reflecting the higher yield possible in India than elsewhere.

Portfolio investment showed a great level of outflow due to the panic created by the global financial situation. FII's withdrew capital and the activity level in the ADR arena too was less.

The most exciting part is that during the last quarter FDI, FII inflow and NRI deposits have shown positive growth implying a return to the good times. These have been a result of the monetary policies and the fundamentally strong Indian economy especially in the long term.