Have Acche Din Arrived? Part 11

Have Acche Din Arrived? Part 11: Foreign Trade

By Seshadri Kumar

One thing that the BJP government and its supporters in the media like to brag about is the fact that the current account deficit (CAD) is much lower in the Modi Sarkar than it was in the UPA II government. This is often touted as a great achievement and an example of good management of the economy. Spokespersons and supporters of the government also boast about the incease in foreign exchange reserves (ForEx), as well as the increase in foreign direct investment (FDI).

Let us examine these claims, and see if our “din” are truly any more “acche” on the foreign trade front because of the Modi Sarkar than they were.

Basic Concepts

To do that, we first need to understand all the components of foreign exchange and foreign trade.

1) We import goods and services, and we export them. If we export more than we import, we are said to have a trade surplus. If we import more than we export, we are said to have a trade deficit.
2) Imports and exports result in the movement of foreign currency. The Indian rupee is not a floating currency, and hence we have to deal with dollars, euros, or other freely tradeable currencies. We have a limited supply of foreign exchange. Exporting more helps us build our foreign exchange reserves (ForEx), and so we would like to have a trade surplus. Unfortunately, however, India usually has a trade deficit.
3) One of the major reasons for our trade deficit is our dependence on crude oil. We do not have sufficient oil reserves, and so import most of our oil. Thus, our trade deficit has two parts: an oil deficit and an non-oil deficit. The oil deficit is directly dependent on the international price of oil.
4) Foreign exchange enters and exits the country through individuals as well – these are clubbed under the heading of “Invisibles.” There are many components of Invisibles, including tourism income, but two major heads are remittances from Indians living abroad (known as “private transfers”) and sums paid to Indians working abroad, notably in the software services sector (known as “miscellaneous non-factor services.”) Invisibles result in a net income of foreign exchange to India, and therefore counter the trade deficit in the balance sheet.
5) The sum of the trade deficit (negative) and the invisibles (positive) gives us the “current account.” If this amount is negative, it is called a current account deficit, or CAD, and is reported as a positive quantity. It is usually reported as a percentage of GDP, as are most quantities related to foreign trade. This is because both imports and exports proportionally increase as the GDP, and hence the size of the economy, increases.
6) Similar to the current account, which is concerned with transactional cash flows, there is another account in foreign trade, known as the capital account. The capital account deals with capital flows, and has many components. Two of the main heads are foreign direct investment (FDI) and foreign portfolio investment (FPI). FDI happens when a foreign entity invests in a business in India (may be partly or completely foreign-owned). This is a good thing for India as jobs are created in India. FPI is when foreign institutional investors (FII) invest in the Indian share and bond market for higher returns on their money. FDI is a long-term investment in a country since it is not very easy to pull out your money if you have an establishment with workers, a workplace, a market presence, and so on; FPI is not as desirable because foreign investors can very quickly pull out of the Indian share and bond markets. FDI can happen with foreigners coming in to India, as well as in reverse, with Indians going abroad, as when Tata bought Corus Steel. For the last 20 years or so, however, India has been a strong destination for FDI. In addition, the capital account also includes NRI deposits, commercial borrowings, and external assistance.
7) The sum of the capital account and the current account is called the balance of payments (BoP). It can be a positive BoP if there is a surplus of foreign exchange, and a negative BoP if there is a deficit. If there is a negative BoP, our ForEx reserve is depleted by that much. If there is a BoP surplus, then we have excess foreign exchange (ForEx) for the year. The ForEx surplus is added to the country’s total ForEx reserves.

One can simply state that an important goal of any country is to increase its ForEx reserves. How is this done?

To put it in simple arithmetic, if we denote exports by EX; imports by IM – of which we say oil imports are OIM and non-oil imports are NIM; then the Trade Deficit, TD, is given by

TD = IM – EX= OIM + NIM – EX

The CAD is the difference between the TD and the Invisibles I (which are generally a positive contribution to foreign exchange)

CAD = TD – I

The Capital Account Surplus (CAS) is composed of FDI, FPI, and Other Inputs (OI):


where we count all the terms on the right as positive if they enter the country. The balance of payments, BoP, is the difference between the Capital Account Surplus and the Current Account Deficit:


And therefore the full equation giving the Balance of Payments, which feeds into foreign exchange reserves, is:

BoP = FDI + FPI + OI – OIM – NIM + EX + I

So we can see that to increase the BoP, we would like high foreign direct investment, high foreign portfolio investment and other inputs, a high level of exports, low oil imports and non-oil imports, and high invisibles.

The total foreign investment (TFI) is given by


With this background, let us see how the Modi Sarkar has done relative to other governments. In the interests of space, I will not cover each contributor to the BoP, but we can look at some of the most important ones.

Comparison of Regimes

To start the discussion, let us review our foreign exchange position. From having a balance of payments crisis in 1991, when we had only enough foreign exchange for a few months, India has come a long way. At the start of the Vajpayee (NDA) government, our foreign reserves were $41 billion (inflation-adjusted to 2010 dollars). The NDA government added $87 billion, UPA I added $127 billion, UPA II added $28 billion, and the Modi Sarkar, in just 4 years, has added $87 billion (all in inflation-adjusted constant 2010 dollars). On a per-year basis, that works out to roughly $17.4 billion for NDA, $25.4 billion for UPA I, $5.6 billion for UPA II, and $21.75 billion for Modi. That is certainly creditable performance by the Modi Sarkar, and almost matches the high watermark set by UPA I. UPA II is an outlier with much lower ForEx collections. We can understand these numbers by looking at the constituents of the BoP in Table 1. These are given in terms of percentages of GDP.

The balance of payments was strongly positive for the NDA and UPA I, and this led to foreign exchange surpluses, which increased the ForEx reserve, as we have already seen. The BoP during UPA II was almost zero, and this is why the foreign exchange addition to the reserve was so small during UPA II. We will examine the reasons for this below.

The current account deficit was high during the later years of UPA I and the first 4 years of UPA II. It went down during the Modi years.

The Modi sarkar’s overall current account surplus is not as good as the UPA’s; we see that the Modi Sarkar’s FDI performance is better, but its FPI performance is not as good. The total foreign investment in the Modi years is better than that in UPA I, but not as good as UPA II. The reason the Modi Sarkar has a better BoP performance than UPA II is because of the high CAD of the UPA II. Why is this so?

Look at the constituents of the CAD. The trade deficit really shoots up during the UPA I and UPA II years, but the CAD is held down because the invisibles also rise in those years. This is due to high remittances from the Indian diaspora which seems to have gone up during UPA years but down during the Modi years. This can be seen by looking at the Invisibles.

The trade deficit, in turn, is caused by rises in both the oil imports and the non-oil imports. Both rise during the UPA years and then go down during the Modi years. Why is this so?

The cause of the oil imports is fairly clear. Oil prices went as high as $140 a barrel in 2008 and also were high at prices near $100 a barrel until July 2014, when they suddenly fell, reaching a low of $35 a barrel in June 2016, before beginning to rise again. Even at the start of the UPA I government, oil was selling at about $75 a barrel. Oil prices during the Modi Sarkar haven’t reached the price levels that existed at any point during UPA rule. This is why the trade balance reached such astronomical levels during UPA.

The decrease in non-oil imports during the Modi Sarkar is a different phenomenon, and likely relates to the fact that business is down during the Modi Sarkar. This is corroborated by various other indicators, such as a lowering of GFCF from 36% of GDP to 32.2%, a lowering of industrial output, lower production of steel, and various other factors discussed in previous installments. So even though our import costs are lower, this is not a cause for celebration, because it indicates lower economic growth and a slowing manufacturing sector.

Exports are significantly higher during the UPA years than during the Modi years. However, the oil prices were so significantly higher during the UPA years that they overcame the higher exports to increase the trade deficit.

The Effect of Oil Prices

To understand the effect of the high oil prices on foreign trade, let us look at the ratio of the cost of oil import as a percentage of GDP. For the NDA, UPA I, UPA II, and Modi Sarkar, this value was 3.1%, 6.0%, 7.8%, and 4.6%. What would happen if the value of 4.6% (and hence the average oil price during the Modi Sarkar) were to hold during the UPA I, UPA II, and NDA governments? (note that the oil prices were lower during NDA, and so this would make things worse for them, but the point of this exercise is to compare UPA and the Modi Sarkar.)

I performed this exercise, and the results can be seen in Table 2.

Note how the CAD for the UPA years have practically shrunk to zero (UPA I actually has a small current account surplus with these oil prices!) The trade deficit has shrunk from 7.0 and 9.1 during UPA I and UPA II to 5.7 and 5.9, respectively, and the Balance of Payments has grown for the UPA years from 3.0 and 0.4 (UPA I and II) to 4.4 and 3.6, respectively – that gives a huge surplus to the foreign exchange reserves. The Modi Sarkar’s numbers do not change much because we are using the average prices during the Modi Sarkar anyway. It can be seen that the Modi Sarkar has a significant CAD of 1.2 compared to the nearly zero CAD for the UPA governments if the crude prices had been at this level all along.

How much it adds to the ForEx reserve can also be calculated. If oil prices were, on average, the same during UPA I and UPA II as they have been during the Modi years, the additions to India’s ForEx reserves for UPA I and UPA II would have been $277 billion and $333 billion instead of $127 billion and $28 billion, respectively – something of the order of a $50 billion addition every year (all in inflation-adjusted 2010 dollars). Compare this to our total foreign exchange reserve today, which is $370 billion at constant 2010 dollar prices. The huge oil bill is the reason that India’s foreign trade looks so bad for UPA II. Had the oil prices been low as for the Modi Sarkar, the foreign exchange reserve would have been far greater than it is today.


The conclusions on the performance of the Modi Sarkar on foreign trade, relative to previous administrations, on various parameters is:

1. Exports: Drastically down.
2. Foreign Direct Investment: Good performance but slowing in recent years. This could indicate that foreign investor confidence in Modi’s rule and in India’s potential is waning.
3. Total Foreign Investment: Performance almost on par with UPA II.
4. Trade Deficit: Performance looks much better, but this is because of very favourable crude prices.
5. Current Account Deficit: Performance is good and on par with UPA I, but this is because of favourable crude prices. Essentially, the Modi Sarkar got lucky.
6. Balance of Payments: Better than UPA II but not as good as UPA I or NDA. Again, largely because of favourable crude prices.
7. ForEx addition: Good, coming close to UPA I, much better than UPA II, and better than NDA. Again, helped greatly by low crude prices.

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