Trade, Capital Flows and the Balance of Payments

The reforms pursued since 1991 have deepened global integration of the Indian economy in terms of a rising share of trade and an even more dramatic transformation of services trade as well as the emergence of the country as one of the most attractive destinations for and important source of FDI flows. Analysis shows however that opportunities for product and market diversification remain to be fully exploited to sustain growth and create more jobs. Despite healthy trade surpluses earned by services as India emerged as a global hub for ICT outsourcing, the balance of payment situation has again entered into a period of stress due to a dramatic widening of the merchandise trade deficit. While India now has the comfort of sizeable foreign exchange reserves unlike in 1991, this is an important policy challenge needing an immediate response. Export competitiveness needs to be strengthened through appropriate exchange rate management and opportunities for strategic import substitution need to be exploited by leveraging India’s large domestic market size using industrial policy measures. Revival of manufacturing to substitute lumpy imports of manufactured goods will not only help in addressing the current account deficits but also create jobs for skilled and unskilled workers helping in poverty reduction. While farsighted policies have led India becoming a part of emerging broader regional economic arrangement, Indian industry has to learn to exploit the opportunities provided by preferential access to East Asian markets rather than passively grant market access.