Context: India’s balance of payments (BoP) is in better shape now compared to previous years. This improvement is primarily due to the relatively low Current Account Deficit. While India’s forex reserves have declined slightly in the recent past, they still remain at a comfortable level.
Relevance of the Topic: Prelims: Balance of payments; Current Account Deficit; Forex Reserves.
Balance of Payments:
The balance of payments (BoP) of a country is a systematic record of all economic transactions between the residents of the reporting country and residents of foreign countries during a given period of time.
| Balance of Payments | |
| Current Account | Capital Account |
| - Exports/Imports - Net factor Income from Abroad -Remittances and other Transfers | - Foreign Investment (FPI/FDI) - External Commercial Borrowings - Non-Resident Bank Deposits |
- India typically experiences a Current Account Deficit (CAD), which is often balanced by a Capital Account Surplus. This means that when the capital account surplus exceeds the current account deficit, it results in an overall positive balance of payments, contributing to an increase in foreign exchange (forex) reserves.
- Conversely, if the capital account surplus does not sufficiently cover the current account deficit, it can lead to a negative BoP, resulting in a depletion of forex reserves.
What are Forex Reserves?
- Foreign exchange reserves refers to the reserves of the RBI kept in the form of Foreign Currency Assets, Gold, SDR and Reserve Tranche Position with the International Monetary Fund (IMF).
- Forex reserves are kept as a cushion against any potential balance of payment related crisis.
- In India, the Reserve Bank of India Act 1934 enables the RBI to act as the custodian of foreign reserves.
- Forex reserves accrete when there is positive BoP, while negative BoP may deplete the forex reserves.
Dynamics of Forex Reserves in India:
- In recent years, India has witnessed accretion of forex reserves in most of the years while depletions happened only in some, such as 2011-12, 2018-19 and 2022-23.
Also Read: Foreign Exchange Reserves
Capital Account Vulnerability:
- India’s BoP problems today stem mainly from the capital account but not current account. CAD levels have been moderated over the period and they can be financed through capital flows.
- However, net foreign direct investment (FDI) flows into India dropped by around 62% to $10.58 billion in 2023-24 (FY24) — the lowest since 2007 — from $27.98 billion the previous year. This was mainly on account of higher repatriation of capital and Indian companies’ investments abroad. Net FPI flows, by contrast, hit a record $44.08 billion in 2023-24.