In this guide
The balance of payments (BoP) is the accounting record of all economic transactions between a country's residents and the rest of the world over a period. It sounds dry, but it tells a story: how a country pays for its imports, how much it earns from its services, how much its diaspora sends home, and how much it depends on foreign capital. When that story goes wrong, as it did for India in 1991, the consequences are dramatic.
The structure
The BoP has two main parts.
1. The current account
Records transactions that do not create claims on the future.
| Component | What it includes |
|---|---|
| Merchandise trade | Exports and imports of goods — the trade balance |
| Services | Software and IT services, business services, travel, transport, financial services |
| Primary income | Income on investments and employee compensation — interest, dividends, profits flowing in and out |
| Secondary income | Transfers without anything in return — above all, remittances from Indians working abroad |
Services, primary income and secondary income together are often called invisibles.
2. The capital and financial account
Records transactions that create or change claims on assets and liabilities.
| Component | What it includes |
|---|---|
| Foreign direct investment (FDI) | Long-term investment giving a lasting interest or control |
| Foreign portfolio investment (FPI) | Investment in shares and bonds, often short-term and volatile |
| External commercial borrowings (ECBs) | Loans raised abroad by Indian companies |
| Non-resident deposits | Deposits by NRIs in Indian banks |
| Other loans and flows | Government borrowing, trade credit, banking capital |
| Change in reserves | Changes in the RBI's foreign exchange reserves |
Because every transaction has two sides, the BoP always balances in accounting terms. Any gap in measurement is shown as errors and omissions.
India's typical pattern
| Item | Usual position |
|---|---|
| Merchandise trade | Large deficit — India imports more goods than it exports, especially crude oil, electronics, gold and machinery |
| Services | Large surplus, driven by software and business services |
| Remittances | Large surplus — India is the world's largest recipient of remittances |
| Primary income | Deficit — profits and interest paid to foreign investors |
| Current account overall | Usually a modest deficit |
| Capital account | Usually a surplus that finances the current account deficit and adds to reserves |
When is a current account deficit a problem?
A current account deficit (CAD) is not necessarily bad. A growing economy may import capital goods and borrow abroad to invest. The questions are:
- How large is it? A CAD persistently above about 2.5–3 per cent of GDP has often been seen as a warning level for India.
- How is it financed? Stable FDI is safer than volatile portfolio flows or short-term debt.
- What is it used for? Imports that build productive capacity are more sustainable than consumption or gold imports.
- Are reserves adequate? Reserves cover imports and short-term debt in a crisis.
The 1991 crisis
By 1991, India faced a severe BoP crisis:
- a large fiscal deficit and a widening current account deficit through the 1980s;
- rising short-term external debt;
- the Gulf War, which sent oil prices up and cut remittances from Gulf workers;
- political instability and a loss of confidence among lenders and NRIs.
Foreign exchange reserves fell to a level sufficient for only a few weeks of imports. India pledged gold to raise emergency funds and turned to the IMF. The crisis triggered the 1991 economic reforms — liberalisation of trade, industrial policy and foreign investment, and a devaluation of the rupee.
The lesson: a CAD financed by short-term borrowing, combined with low reserves and high fiscal deficits, can quickly become a crisis of confidence.
Foreign exchange reserves
The RBI's reserves consist of foreign currency assets, gold, Special Drawing Rights (SDRs) and India's reserve position in the IMF. India has built up large reserves since 1991, which help:
- cushion against sudden capital outflows;
- let the RBI smooth excessive volatility in the rupee;
- maintain investor confidence.
Holding reserves has a cost, too — the return on reserves is typically lower than the cost of the capital inflows that built them.
Convertibility
- Current account convertibility — the rupee can be freely converted for current account transactions such as trade, travel and remittances. India accepted this under the IMF's Article VIII in 1994.
- Capital account convertibility — the freedom to convert rupees into foreign currency for investment and borrowing. India has liberalised gradually but not fully, preferring caution after watching crises in other emerging economies (such as the Asian financial crisis of 1997).
Practice questions
- Prelims-type: Under which account are remittances recorded? Which components make up India's foreign exchange reserves?
- Mains-type (150 words): Why does India usually run a current account deficit despite large services exports?
- Mains-type (250 words): What were the causes of the 1991 balance of payments crisis, and what lessons does it hold today?
A note on dates and numbers. Exam patterns, vacancies and schedules change from year to year. Always confirm the current details in the latest notification on the Union Public Service Commission website .
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