Impacts of trade liberalization on balance of payment in some developing countries and experience lessons for vietnam

The purpose of this study is to examine the effects of trade liberalization on balance of payments in a few developing countries and to draw lessons for Vietnam. The motivation for this study is to provide valuable insights into the effects of trade liberalization on exports, which is a crucial factor in shaping the countrys economic policy. The desired result of this essay is to study more deeply about Trade Liberalization on Balance of Payments in some developing countries so that we can better understand this topic to draw lessons for our own country. The findings of this study can potentially benefit policymakers, investors, and businesses in Vietnam. Last but not least, we would like to say many thanks to PhD. Mai Thu Hien for her valuable guidance during our research process. Due to the constraint of time, this report may contain unavoidable mistakes, so we are willing to receive any comments or feedback to perfect the report to the fullest.

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS

INTERNATIONAL FINANCE IMPACTS OF TRADE LIBERALIZATION ON BALANCE OF PAYMENTS IN SOME DEVELOPING COUNTRIES AND EXPERIENCE LESSONS FOR

VIETNAM Instructor: Assoc Prof., PhD Mai Thu Hien

Group:

Hà Nội – 6/2023

TABLE OF CONTENTS

TABLE OF CONTENTS 2

LIST OF FIGURES 3

LIST OF TABLES 4

ABSTRACT 5

INTRODUCTION 6

SECTION 1: LITERATURE REVIEW AND THEORETICAL FRAMEWORK 8

1 Literature Review 8

2 Theoretical Framework 8

2.1 Balance of Payment 8

2.2 Trade Liberalization 10

2.3 Impacts of Trade Liberalization on Balance of Payments 12

SECTION 2: IMPACTS OF TRADE LIBERALIZATION ON BALANCE OF PAYMENTS IN SOME DEVELOPING COUNTRIES 14

1 Impacts of Trade Liberalization on Balance of Payments in China 14

1.1 Current account 16

1.2 Capital account and financial account 18

1.3 Foreign exchange reserves 20

2 Impacts of Trade Liberalization on Balance of Payments in India 22

2.1 Impacts of Free Trade Areas on Balance of Payment in India 22

2.2 Balance of Payment of Inida after joining WTO 27

3 Impacts of Trade Liberalization on Balance of Payments in Vietnam 30

3.1 Impacts of Free Trade Areas on Balance of Payment in Vietnam 30

3.2 Balance of Payment of Vietnam after joining WTO 40

SECTION 3: DISCUSSION AND EXPERIENCE LESSONS FOR VIETNAM 46

1 Result Discussion 46

2 Experience lessons for Vietnam 46

CONCLUSION 49

REFERENCES 51

LIST OF FIGURES

Figure 1: China’s import tariff rates in 2011 14

Figure 2: Balance of payment of China measured in percent of GDP from 2001 to 201515 Figure 3: China’s 2015 current account 16

Figure 4: China’s share in the world trade surged after 2001 17

Figure 5: China’s private capital flows 18

Figure 6: Chinese FX reserves from January 2001 to December 2017 21

Figure 7: Trend of India’s BOP during 1990-91 to 2011-12 30

Figure 8: Vietnam’s Current Account from 1995 to 2010 31

Figure 9: Vietnam’s Current Account from 2012 to 2018 32

Figure 10: Vietnam’s trade balance during 2010-2018 35

Figure 11: Registering foreign direct investment in Vietnam for 12 years (Unit: Billion USD) 38

Figure 12: Proportion of FDI into Vietnam by country in 2016 39

Figure 13: Current Balance and Foreign Exchange Reserves Source 42

Figure 14: Vietnam's balance of payments 2000 – 2016 43

LIST OF TABLES

Table 1: Structural Shift Analysis of India’s BOP (1950-51 to 2000-01) 24

Table 2: India’s BOP during 1990-91 to 2011-12 (values in US $ million) 29

Table 3: Vietnam’s Export and Import Value in 1986-1995 33

Table 4: Vietnam's trade balance in the period 2000-2011 34

Table 5: Service balance of Vietnam from 2000 to 2011 36

Table 6: Income balance of Vietnam from 2000-2011 37

The desired result of this essay is to study more deeply about Trade Liberalization

on Balance of Payments in some developing countries so that we can better understandthis topic to draw lessons for our own country The findings of this study can potentiallybenefit policymakers, investors, and businesses in Vietnam

Last but not least, we would like to say many thanks to PhD Mai Thu Hien for hervaluable guidance during our research process Due to the constraint of time, this reportmay contain unavoidable mistakes, so we are willing to receive any comments orfeedback to perfect the report to the fullest

it facilitates the exchange and integration of economies between countries, raisingnational income and creating jobs for more people Specifically to assist the economy inbecoming stronger and more stable.

Participating in trade liberalization agreements between other countries andregions is a key economic development strategy for developing countries It is clear thatthis is not simply the economic development tendency of impoverished and developingcountries, but also a global one These agreements aid in the reduction of tariff and non-tariff barriers in trade relations with foreign countries, facilitating the development ofgoods exchange rates between countries, regions, and each country's integration andeconomic development This demonstrates that trade liberalization has a massive impact

on each country's balance of payments

From those realities and impacts, the group of students chose the topic "Impacts

of Trade Liberalization on Balance uf Payments in Some Developing Countries and Experience Lessons for Vietnam” to research.

2 Object and Scope

The object of the essay's research is the impact of trade liberalization on the needfor payment in developing countries, namely Vietnam, India and China

3 Research Objective

This research aims at:

- Several domestic and international research are being conducted to better understand the balance of payments

- Explain the theoretical underpinnings of balance-of-payments and tradeliberalization This demonstrates the importance of trade liberalization and thecurrent state of trade liberalization around the world.

- A thorough examination of the impact of trade liberalization on the balance ofpayments

4 Structure

Apart from Abstract, Introduction, Conclusion and References our research hasthree main sections: Section 1 - Literature Review And Theoretical Framework; Section2- Impacts Of Trade Liberalization On Balance Of Payments In Some DevelopingCountries, Section 3- Discussion And Experience Lessons For Vietnam

This report includes the following content:

I Abstract

II Introduction

III Section 1: Literature Review And Theoretical Framework

IV Section 2: Impacts Of Trade Liberalization On Balance Of Payments In Some Developing Countries

V Section 3: Discussion And Experience Lessons For Vietnam

VI Conclusion

VII References

VIII Individual assessment

One stream of the related empirical literature focuses on the effects of trade liberalization

on exports, where the findings are more mixed Some of them show that countries that

embarked on liberalization programs have improved their export performance (Thomas,

Nash, and Edwards, 1991; Ahmed, 2000; and Santos-Paulino, 2002b) The key finding

of these articles is that trade liberalization is an important determinant of exportperformance, but its impact varies across continents Export taxes have a small adverseeffect on export growth, while relative price changes and world income growth showsigns of being expected

There are also empirical research attempts to determine how trade liberalization affects a

country’s imports and generally finds a positive impact (Melo and Vogt, 1984; Bertola

and Faini, 1991; and Santos-Paulino, 2002a) Whereas other articles have found little

evidence of such a relationship (Greenaway and Sapsford, 1994; Jenkins 1996).

2 Theoretical Framework

2.1 Balance of Payment

The balance of payments is a key concept in international economics thatmeasures the economic transactions between a country and the rest of the world over aspecified period Understanding the theoretical framework of the balance of paymentshelps to analyze the factors influencing its components and their implications for acountry's

economic well-being The following sections outline the main theoretical frameworksused to study the balance of payments:

The monetary approach suggests that an increase in the money supply leads toinflation, which, in turn, leads to a depreciation of the currency A depreciation makes acountry's exports more competitive and imports more expensive, thereby improving thetrade balance Conversely, a decrease in the money supply can result in deflation, leading

to an appreciation of the currency and potentially worsening the trade balance

According to the elasticity approach, a depreciation of the currency makes exportscheaper and imports more expensive, leading to an improvement in the trade balance Themagnitude of this improvement depends on the price elasticity of demand for exports andimports If demand for exports and imports is highly elastic, a depreciation can have asubstantial positive impact on the balance of payments

Similarly, changes in income levels can influence the balance of payments Whenincome increases, the demand for imports may rise, potentially worsening the tradebalance Conversely, a decrease in income may lead to a reduction in import demand,improving the balance of payments

In the view of the absorption approach, an increase in domestic absorption,resulting from higher consumption or investment, can lead to increased import demandand potentially deteriorate the balance of payments Conversely, a decrease in domesticabsorption can reduce import demand, leading to an improvement in the balance ofpayments

The absorption approach highlights the importance of considering domesticeconomic activity and its impact on trade flows when analyzing the balance of payments

These theoretical frameworks provide different perspectives on the factorsinfluencing the balance of payments They emphasize the role of monetary factors, priceand income elasticities of demand, and domestic absorption in shaping the balance ofpayments position of a country By employing these frameworks, economists and

policymakers can gain insights into the drivers and implications of changes in the balance

of payments, helping guide policy decisions related to exchange rates, trade policies, andmacroeconomic management

2.2 Trade Liberalization

Trade liberalization, the process of reducing barriers to international trade, hasbeen the subject of extensive research and analysis in the field of economics Theoreticalframeworks provide a foundation for understanding the mechanisms and potentialimpacts of trade liberalization This section outlines the key theoretical frameworks thatcontribute to our understanding of trade liberalization

One of the fundamental theories underlying trade liberalization is the ComparativeAdvantage Theory developed by David Ricardo According to this theory, countriesshould specialize in producing goods and services in which they have a comparativeadvantage, based on differences in resource endowments, technology, and productivity.Trade liberalization enables countries to focus on producing goods and services wherethey have a comparative advantage, leading to increased efficiency and overall welfare

The Heckscher-Ohlin Theory further expands on the concept of comparativeadvantage by emphasizing the role of factor endowments in determining a country'scomparative advantage and trade patterns This theory highlights that countries withabundant resources, such as land, labor, or capital, should specialize in industries thatutilize these resources Trade liberalization facilitates the efficient allocation of resourcesacross countries, allowing them to specialize in industries that align with their factorendowments This specialization enhances productivity, promotes economic growth, andcontributes to overall welfare improvement

New Trade Theories have also emerged to explain trade patterns and the gainsfrom trade beyond comparative advantage Economies of Scale theory suggests thattrade liberalization enables firms to access larger markets, leading to economies ofscale and

lower average costs of production This increased efficiency enhances competitivenessand trade flows.

Product Differentiation and Monopolistic Competition theory highlights the role ofproduct differentiation and market structure in international trade Trade liberalizationfosters competition, innovation, and product diversity, leading to enhanced consumerwelfare and market efficiency The Gravity Model of Trade provides insights into thedeterminants of bilateral trade flows, considering factors such as economic size, distance,and cultural similarities Trade liberalization reduces barriers, increases economicintegration, and influences trade flows based on these determinants

Trade liberalization is also closely linked to economic growth The Export-LedGrowth Hypothesis suggests that trade liberalization can stimulate economic growth bypromoting exports, attracting foreign investment, and facilitating technology transfer Itprovides opportunities for firms to access larger markets, achieve economies of scale, andincrease productivity Import Competition and Productivity theory argue that exposure toimport competition incentivizes domestic industries to improve efficiency, adopt newtechnologies, and increase productivity

Considering the welfare implications of trade liberalization, the Stolper-SamuelsonTheorem examines the relationship between trade liberalization, factor prices, andincome distribution It suggests that trade liberalization can benefit the abundant factor ofproduction while potentially harming the scarce factor, leading to distributional effectsthat require attention Changes in a country's terms of trade resulting from tradeliberalization can impact welfare, with favorable terms of trade leading to increasedpurchasing power and potential welfare gains

In conclusion, the theoretical framework of trade liberalization provides insightsinto the mechanisms and potential impacts of reducing barriers to international trade Theconcepts of comparative advantage, factor endowments, economies of scale, marketstructure, and welfare considerations contribute to our understanding of the implicationsof

trade liberalization By utilizing these frameworks, policymakers and economists canmake informed decisions to promote economic growth, efficiency, and welfare whileaddressing potential distributional effects and ensuring sustainable development

2.3 Impacts of Trade Liberalization on Balance of Payments

The impacts of trade liberalization on the balance of payments, which measures acountry's economic transactions with the rest of the world, are of significant importance

to analyze Trade liberalization can have both positive and negative effects on a nation'sbalance of payments, and understanding these impacts is essential for policymakers andeconomists This section examines the various dimensions of the impacts of tradeliberalization on the balance of payments

One of the key effects of trade liberalization on the balance of payments isobserved in the current account Trade liberalization often leads to an expansion ofexports as domestic industries gain access to larger markets This export growthcontributes positively to the trade balance and thus improves the current account.However, trade liberalization also results in increased imports due to greater competitionand access to a wider range of goods and services This import growth can have anegative impact on the current account balance, potentially offsetting the gains fromexport expansion

Another aspect to consider is the effect of trade liberalization on the terms of trade,which refers to the ratio of export prices to import prices Trade liberalization caninfluence a country's terms of trade, and positive changes, such as higher export pricesrelative to import prices, can improve the current account balance However, the terms oftrade can also be subject to external factors, such as global market conditions orfluctuations in commodity prices, which can impact the balance of payments

In addition to the current account, trade liberalization also affects the capitalaccount of the balance of payments With the removal of trade barriers, countries oftenattract foreign direct investment (FDI) as international firms seek to establish operations

in markets with expanded access The inflow of FDI contributes positively to the

capital

account, leading to an improvement in the overall balance of payments Furthermore,trade liberalization can also stimulate portfolio investment, such as foreign investments instocks and bonds, which can further enhance the capital account However, it is worthnoting that trade liberalization may also result in capital flight, where domestic capitalmoves out of the country due to increased competition or perceived investmentopportunities abroad Capital flight can have a negative effect on the capital accountbalance

Trade liberalization can also have implications for a country's exchange rate,which in turn affects the balance of payments Changes in exchange rates can impact thecompetitiveness of exports and imports For instance, if trade liberalization leads to anincrease in exports, it can put upward pressure on the currency's value, potentiallyimpacting the trade balance and the overall balance of payments

However, it is important to recognize the potential constraints and challengesassociated with trade liberalization on the balance of payments For example, tradeliberalization can increase import dependency, particularly if a country relies heavily onimports for essential goods and services This can put pressure on the balance ofpayments, especially if export growth does not keep pace with the rising imports.Additionally, trade liberalization exposes a country's economy to external shocks, such aschanges in global market conditions or terms of trade The ability to manage these shockseffectively is crucial for maintaining a stable balance of payments

In conclusion, the impacts of trade liberalization on the balance of payments aremulti-faceted While export expansion and increased capital flows can have positiveeffects, import growth, exchange rate dynamics, and external shocks pose challenges.Policymakers and economists need to carefully assess and manage these impacts toensure a sustainable and balanced balance of payments, promoting economic growth andstability

SECTION 2: IMPACTS OF TRADE LIBERALIZATION

ON BALANCE OF PAYMENTS IN SOME DEVELOPING

COUNTRIES

1 Impacts of Trade Liberalization on Balance of Payments in China

One of the most important events showing the trade liberalization process in China

is the WTO accession of China China officially joined the WTO on 11/12/2011 at the4th Ministerial Meeting of WTO member countries in Doha (Quatar) after 15 years of

negotiations (WTO - VCCI Centre, 2011)

China, like other member countries, when joining the WTO, must commit to discrimination among countries; between foreign and domestic individuals andbusinesses, without price controls to protect domestic companies and gradually reducetariff, non-tariff and technical barriers

non-Typically, in 2002, after joining the WTO, China's import tax rate was 12% Asharp decrease compared to the tax rate of 42% before 1994, 17% in 2000 By 2011 thistax rate was only 9.8%

Figure 1: China’s import tariff rates in 2011

Source: Ministry of Finance, General Administration of Customs

Regarding agriculture, which is heavily protected by China, has abolishedsubsidies for agricultural exports, must apply hygiene and food safety standards

In terms of services, China has opened up 104 out of 160 service industries.Opening the service industry to foreign investment and competition, most notablydistribution, telecommunications and financial services At the same time, China is alsostrongly committed to opening up professional services, audiovisual and construction

services (World Trade Organization, 2001)

Changes in balance of payment in China:

Figure 2: Balance of payment of China measured in percent of GDP from 2001 to 2015

Sources: CEIC Data; RBAChina implements a fixed exchange rate mechanism, so the government will ensure

a balanced balance of payments through foreign currency reserves China's balance of

payments has been kept in balance during the years after joining the WTO Whereasbefore, from 1998 to 2000, an imbalance of this balance was recorded, requiring thecompensation of foreign reserves

1.1 Current account

Figure 3: China’s 2015 current account

Source: Wind, SAFESince joining the WTO, China's current account has been in surplus on a largescale

In which, the balance of trade and services accounts for a large proportion, and thecontinuous large surplus plays a decisive role in the surplus of the current account Thiscan easily be explained by the boom in China's imports and exports after its accession tothe World Trade Organization After implementing trade liberalization, all countries areworried that the domestic economy cannot compete with foreign companies and productsand will have a trade deficit

However, China has overcome that difficulty Exports and imports of this countrycompared to the world since the historical milestone of 2001 have continuously increased

sharply and exports have always been larger than imports Whilst, in previous years they

were always low and had a period of trade deficit According to the chart, it can be seenthat only in 2013 import and export increased by 6 times compared to the 90s

Figure 4: China’s share in the world trade surged after 2001

Source: World Bank, CEIC, Morgan Stanley ResearchWith the commitment to reduce taxes when trade liberalization, barriers for importand export are removed, facilitating an increase in both exports and imports With a gooddomestic production, China has avoided a trade deficit China has exerted excellentstrategies to make domestic manufacturing strong enough to compete with foreigncompetitors stronger, better technology, more modern technology as well as effectiveprogressive management

The Chinese government has created many tax stepping stones for imported carsand auto parts Through raising tariffs at these stepping stones, China can raise the cost ofimported cars without violating its WTO accession terms By increasing taxes as above

and creating strict quality control barriers, China makes it difficult to import goods intoits country, so that countries see a decrease in profits from exports to China and mustbring technology to work directly in China In this way, China obtains advancedtechnology from abroad Alternatively, China has used its huge market advantage, goodmanufacturing conditions and cheap labor - characteristics that are extremely attractive toforeign companies - to offer favorable terms to China in import and investmentnegotiations If a German company does not accept China's conditions, there will be other

US companies or other countries ready to enter this lucrative market Example of acontract of nearly 10 billion Chinese dollars signed on December 5, 2005 to buy 150aircraft from Airbus with the condition that Airbus will have to build an aircraft assemblyplant for this contract in China Previously, Boeing had refused this condition and failed

to negotiate with China (VnExpress, 2006) With these efforts, China avoided having

import deficit

1.2 Capital account and financial account

In terms of the capital account of China, we concentrate on direct investment (includingFDI inflow and outflow of ODI – outward direct investment) as it accounted for a highpercentage

Figure 5: China’s private capital flows

Source: CEIC Data, RBAChina's accession to the WTO has caused a boom in foreign direct investment(FDI) According to China's Ministry of Commerce, FDI accounted for more than 60% ofChina's exports in 2005 Before China's accession to the WTO, less than 60% of directinvestment was in the manufacturing sector But after China joined the WTO, FDI intothe manufacturing sector increased and accounted for more than 70% while theproportion of FDI into the real estate sector decreased sharply In agriculture, beforeChina joined WTO, only 1% of FDI accumulated in this sector, but in recent years, the

agricultural share of FDI has increased to 2% (John Whalley, 2006)

China's cheap and abundant labor source along with a large domestic marketpromises to bring a lot of profit to foreign investors In addition, WTO accession ensuresthat foreign companies are not discriminated against in joining and competing withdomestic companies Another reason why FDI is so large is the expectation of a high rate

of return on investment in China (due to rapid productivity growth) Moreover, FDI inflowsare less constrained than other capital flows, especially in the manufacturing industry.This is due to the FDI reform in the early 1990s and China's accession to the WTO in

2001 (Terrie L Walmsley, 2006) China's outward direct investment is significantly

smaller However, it has been on the rise recently, largely reflecting offshore investment

by state- owned enterprises Data from China's National Bureau of Statistics (NBS)shows that about two-thirds of this outbound investment has been directed to economies

in the Asian region, especially Hong Kong, Singapore and Indonesia though Australiaand the United States are also big recipients.”

By sector, China's direct investment tends to be in resources, finance and servicessuch as wholesale and retail For example, 65% of direct investment from China in

Australia is redirected to the resource sector (Australian Bureau of Statistics, 2015)

However, in particular, China's overseas investment increased rapidly, ignoringthe first few years that China's ODI was not really effective, from 2004 to 2013,China's

overseas investments increased 13.7 times, from 45 billion USD to 613 billion USD.

(Nolan, 2013) Since joining the World Trade Organization (WTO), China's economic

potential has grown faster, which is the basis for the country's ODI activities to develop

In addition, China also has many measures to support ODI, such as establishing support

funds for ODI projects (Fund for International Market Development for Small and

Medium Enterprises (2001), Investment Fund in Mining resources (2004), Special Fund for the Risks of Exploration of Mineral Resources Abroad (2005), .) China also

exempts overseas businesses from corporate tax for the first five years after theycome into operation

After the first 5 years, enterprises operating abroad only have to pay 20%corporate income tax (compared to 28% corporate income tax for enterprises operating in

the country) (Brautigam, 2011) China has signed agreements to avoid double taxation

and bilateral investment agreements with countries and regions around the world to

protect the rights and interests of enterprises when investing abroad (Davies, 2011)

1.3 Foreign exchange reserves

Foreign exchange reserves are assets held on reserve by a central bank in foreigncurrencies These reserves are used to back liabilities and influence monetary policy

(Hargrave, 2022) A country's foreign exchange reserves come from a trade surplus and

FDI

After China's accession to the World Trade Organization (WTO) in 2001, thecountry experienced significant changes in its foreign exchange reserves As a result ofits commitment to liberalize its foreign exchange market and develop a more openeconomy, China's foreign exchange reserves saw considerable growth over the past twodecades

One for this growth has been China's tremendous trade surpluses, driven by itsincreasing role as a global manufacturing hub and major exporter WTO membership hasfacilitated China's integration into the global economy, giving its exports a substantialboost This, in turn, has contributed to the accumulation of foreign currency reserves

Another reason for the increase in foreign exchange reserves is China's continued efforts

to maintain a stable exchange rate through market intervention

Moreover, China has been gradually introducing changes to its foreign exchangesystem with the aim of achieving full currency convertibility and further liberalizing itsmarket for foreign investors The government established the China (Shanghai) pilot freetrade zone to test these measures, and if successful, it is expected that the regulators willexpand these liberalizations nationally Such steps are in line with China's commitments

to the WTO and reflect its ongoing progress in adapting its foreign exchange system

However, it is important to note that China's exchange rate did not immediatelyappreciate to the extent that would push firms to invest their foreign exchange earningsdomestically after its WTO accession It took a few years for the market to respond andfor the exchange rate to undergo significant changes

Figure 6: Chinese FX reserves from January 2001 to December 2017

Source: Pictet WM – AA&MR, SAFEAccording to statistical data from the above chart, it shows that China's foreigncurrency reserves increased continuously after joining WTO The People's Bank of

China's

6

foreign exchange reserves peaked at $4 trillion in June 2014, compared with less than

$500 billion a decade earlier China has implemented a foreign exchange policy since

1994 and has had great success in increasing its foreign exchange reserves By the 2000s,this policy was loosened; however, China's foreign exchange reserves are still growing

strongly due to the large trade surplus and FDI capital (Nguyen Thi Ai Linh, 2016)

In summary, the changes in China's foreign exchange reserves after its WTOaccession can be mainly attributed to its strong trade surpluses, increasing exports, andongoing efforts to liberalize its foreign exchange market and maintain a stable exchangerate

2 Impacts of Trade Liberalization on Balance of Payments in India 2.1 Impacts of Free Trade Areas on Balance of Payment in India

The experience of India regarding trade and balance of payments is encouraging.Since India became a member of WTO in 1995, Indian exports have been doubled indollar terms (from US $ 31 billion in 1995-96 to US$ 62 billion in 2003-20004) There is

an evidence of export diversification as the share of exports of agriculture and alliedsectors in total exports came down from 19% in 1990-91 to 12% in 2002-2003.Conversely, the manufactured exports have increased their share from 73% in 1995-96 to81% in the recent period However, imports have continued to increase in pre and postWTO periods The percentage growth in imports stood up at 25% during 2002- 2003 andexpected to rise further on account of increasing oil prices The recent trends reveal anincrease in the share of food and allied products and petroleum in total imports India’scurrent account showed a persistent deficit except in recent years The surplus in currentaccount in recent years has been mainly due to the growth of invisible exports

We have studied the trade and balance of payments of India dividing the country’sexperience since independence into three economic regimes A structural shift analysishas been used which involves estimating a semi-log lime trend equation with interceptand slope dummies The equation is as follows:

𝛽1 t = growth rate of variable for the period, 1950-51 to 1975-76

𝛽2 t = change in the growth rate for the period, 1976-77 to 1991-92 t

𝛽3 t = change in the growth rate for the period, 1992-93 to 1999-2000

Soon after independence, India put in place central planning and the famous Year plans The primary goals of the plans included: transformation of an essentiallyagricultural economy to an industrial one, attaining self-sufficiency and buildingdomestic capabilities in key industrial sectors India chose the process of planning based

Five-on the socialist framework and used the mixed ecFive-onomy approach Government played adominant role in nearly every facet of the economy and practically every economic andbusiness activity required permits or licenses The role of private sector was minimal and

it was barred from many key sectors of the economy Protecting domestic industry fromforeign competition was a major policy objective and restrictions on imports and hightariffs were the order of the day Enormous amounts were invested in large and small publicsector undertakings

Table 1: Structural Shift Analysis of India’s BOP (1950-51 to 2000-01)

Source: G Ramakrisna; India’s Trade Policy: the impacts on Economic Growth, Balance

of Patments and Current Account DeficitUnfortunately these units did not function efficiently resulting in low productivityfor the industrial sector as whole and low returns on the huge investments made duringthe period During the period, until 1971, India followed a fixed exchange rate policywith an exception of the devaluation of the Rupee in 1966 In 1975, India’s exchange ratewas placed on a controlled and floating basis linked to a basket of currencies of its major

trading

partners The inward looking strategy led to several difficulties along with rising tradeand current account deficits The oil shocks of 1973 and 1974 had aggravated the balance

of payments situation

During this period, India’s exports and imports have risen by 6.61% and 5.91%respectively However, trade balance and current account balance have not shown animprovement The growth rate of both the variables is negative and almost equal to zeropercent Except for few years in the 1950s and 1970s, the Current Account Balance(CAB) has shown a continuous decline The improvement in CAB during these years ismainly due to the growth in invisibles The average annual growth of invisibles for thisperiod was 1.12% The trade balance was negligible in 1950-51 as the imports andexports were almost of the same magnitude (647 and 650 crores) but due to massiveincrease in imports by 1955-56, the deficit rose to 133 crores CAB had become positivedue to the invisible transactions During 1960-61 and 1965-66, current account deficit hasincreased from Rs 392 to Rs 511 crores During this period invisibles also fell by 10crores, India was left with no foreign exchange reserves and Current Account Deficit(CAD) had to be financed through loans

The deteriorating Balance of Payments (BOP) performance till 1960 wasattributable to India’s trade policy, which was mainly based on export pessimism Thepolicy based on selfsufficiency laid emphasis only on import substitution ignoring theimportance of exports The declining terms of trade, deteriorating BOP and stagnantexport earnings of 1950s have led India to adopt export promoting measures in 1960s.And in 1966, the Indian Rupee was devalued by 57.6% This has increased exports butimports could not be contained mainly on account of droughts (1965 and 1966)

During these years not only did trade deficit and CAD increase but invisible

earnings also came down Bhagwati and Srinivasan (1975) feel that the export promotion

policies of this period were inefficiently designed and ineffectively implemented The oilshocks of early 1970s had adverse impact as the import expenditure and trade deficit haverisen, but due to significant increase in invisible earnings the CAD has come down But

by

2

1980-81 CAD has increased by four times to that of 1975-76 This was mainly due to thehuge trade deficit (6211 crores) in 1980-81, which was triggered by increase in oil prices.This continued in the later years with negative current account deficits

The late 1980s saw a change in the thinking in terms of experimenting with marketforces and the need for shifting from inward looking strategies These efforts have takenplace in the form of deregulating the restrictions on some of the imports There was aclear policy shift in 1984 as the government eased many of the controls and restrictionsfor the first time in independent India This produced results as exports have risen by13.87% during this period But imports also have risen by 14.51% mainly due to rise inoil prices in 1980-81 Trade and current account deficits have continued to rise as theyhave grown on an average by 1.11% and 4.85% respectively The net earnings frominvisibles have declined during this period by 5.94% The reforms initiated by thegovernment were half- hearted and many of the promised changes never took place

The early nineties saw the country run into a major crisis with foreign currencyreserves running out and a possible collapse of the economy caused by a number offactors: Volume 2, Issue 1, January-June 2011 13 overvalued exchange rate, severeforeign exchange shortages, high inflation (17% in August 1991), large- public andcurrent account deficits, decline in credit rating and foreign lending The new government

in 1991 initiated major structural reforms with the immediate objective of stabilization ofthe economy by lowering inflation, improving the balance of payments situation andreducing fiscal deficits

The policies have been carried out with the encouragement and support of theWorld Bank and the International Monetary Fund During this period, exports andimports have started rising significantly at the rates of 15.07% and 16.43% respectively.Earnings from invisibles have grown by 27.48% In spite of this phenomenal growth,trade deficits and current account deficits have grown by 29.43% and 9.16% respectively.Our analysis on growth rates reveals that barring the external assistance and non-resident Indian deposits

all the variables exhibit a statistically significant change in growth rates during the reformperiod.

2.2 Balance of Payment of Inida after joining WTO

Independent India’s external trade and performance had faced severe threats many

a times The most challenging one was that of 1991.The economic crisis of 1991 wasprimarily due to the large and growing fiscal imbalances over the 1980s India’s balance

of payments in 1990-91 also suffered from capital account problems due to a loss ofinvestor confidence The widening current account imbalances and reserve lossescontributed to low investor confidence putting the external sector in deep dilemma.During 1990-91, the current account deficit steeply hiked to $- 9680 million while thecapital account surplus was far below at $ 7188 million

This led to an ever time high deficit in BoP position of India India initiatedeconomic reforms to find the way out of the growing crisis Structural measuresemphasized accelerating the process of industrial and import de licensing and then shifted

to further trade liberalization, financial sector reform and tax reform Prior to 1991,capital flows to India predominately consisted of aid flows, commercial borrowings, andnonresident Indian deposits Direct investment was restricted, foreign portfolioinvestment was channeled almost exclusively into a small number of public sector bondissues, and foreign equity holdings in Indian companies were not permitted However,this development strategy of both inward-looking and highly interventionist, consisting ofimport protection, complex industrial licensing requirements etc underwent radicalchanges with the liberalization policies of 1991 The post reform period really eased India’sstruggles with regard to external sector

This is evident from the RBI data summarizing the BOP in current account andcapital account The current account which measures all transactions including exportsand imports of goods and services, income receivable and payable abroad, and currenttransfers from and to abroad remained almost negative throughout the post reform periodexcept for the three financial years Until 2000-01, the current account deficit that