Abstract:

The US-China trade war started in 2018 and it hasn’t ended even though there has been a change in the US administration. These two countries have great importance in the world trade and any changes in policies with respect to it affect the whole world. This report studies the impact US-China trade war on the stock market of various countries during the period 2018-19.

Overview:

The two giant economies of world USA and China have been in constant growth trade relations since 1970s. These trades accelerated after China entered World Trade Organization in 2001. The US has consistently imported from China their onwards and the bilateral trade deficit in of US rose to $375.6 billion in 2017. During Donald Trump administration, US started imposing tariffs and trade barriers on China in hope to reduce the trade deficit and provide market for home grown industries. The imposition of tariffs escalated quickly resulting countries taking some drastic measures which in-turn converted into a trade war.

This imposition of tariffs had ripple effects around the world. Some countries benefitted to some extent from it and some countries paid the similar price via tariff hikes. By 2019, the US had placed tariffs on about $350 billion in Chinese imports, while China had countered with duties on US exports worth more than $100 billion. The tariffs were imposed to reduce the trade deficit, but in 2020, the US-China trade deficit hit a new high of $915.8 billion and the goods and services deficit hit a new high, the most since 2008. The decision to impose tariffs affected consumers, the importing firm also absorbed some cost The US consumers paid the price in the end of all the tariffs imposed onto China. The impact on US producers with significant exposure to Chinese markets was also captured in stock market valuations. The equity price performance of US companies with high sales to China underperformed relative to US businesses exposed to other international markets, after tariffs linked to the $34 billion retaliation list by China were implemented.

                     Impact of US Tariffs on Sales                  

   Tariffs affecting top 10 importing sectors

The above charts show impact of tariffs onto top 10 imports of US from China. The sectors which import the maximum in terms of $ are telecom and electrical industry, computer industry and households’ items.

First, Trade Policy uncertainty about trade policy affects investment decisions of companies. If it were 100% certain that the tariffs stay in place, the producer in the import competing sector could raise investments and if it were sure there would be an agreement about the reduction of tariffs to pre-trade conflict levels, the producer in the exporting sector could raise investments. If it is uncertain what will happen, companies in both sectors will wait with investing. This slows down the whole manufacturing cycle ultimately hurting parties on both sides.

Second, the trade policy uncertainty had a much larger impact on the stock market than on investment itself, the S&P 500 fell by 2.5% on March 22, 2018, the day the US announced higher tariffs on 50 billion dollars of Chinese imports. Many companies listed on the stock market have substantial commercial business outside of the US which were also heavily affected by the new tariffs. This uncertainty has weighed on investor confidence around the world and has contributed to losses. In 2018, Hong Kong’s Hang Seng index fell more than 13% and the Shanghai Composite slumped nearly 25%. Both indices have recovered some ground and were up 12% and 16% respectively 2019 (Fig-1: Shows the performance of US and China stock index)

                                    Impact of Trade war on Stock Market of US & China

 Impact of US-China trade war on other countries:

The trade war between the United States and China had a significant worldwide impact, with some countries benefiting while others suffered the brunt of the consequences, and some economies remaining unchanged.

While trade flows between the US and China dropped, trading prospects for other countries increased. Here, we have picked a few countries to analyze the impact of the trade wars:

Vietnam:

During the US-China trade war, Vietnam was one of the countries that benefitted as US, over the years, has been the biggest market for Vietnam’s exports, and China was the 2^nd largest source for Vietnam’s imports.

Vietnam’s exports rose to around $290.4 billion, and the country saw a trade surplus of $34.78 billion with the US. Meanwhile, Vietnam faced a trade deficit of $24.17 billion with China in 2018. However, Vietnam spent US$57.98 billion on imports during the first quarter of 2019. Additionally, there a GDP growth of 7% majorly due to manufacturing, consumption, and tourism. The expansion of manufacturing helped in gaining more investors and thus aided in increased exports including apparels, furniture, shoes, seafood to the US.

While there is an increase of exports to US to a large extent (by 27.3% in 1^st half of 2019), the increase to exports to China was only 0.3%. Vietnam’s exports to China mainly consisted of electronics, semiconductors, apparels, furniture.

There is a benefit as the effect of tariffs on the Chinese goods consumed are also produced and consumed in Vietnam. Therefore, such products were exported to the US, and gain market share from Chinese goods subjected to tariffs, while exporting to US. This led to increase in FDIs, expanding the job market.

Another benefit was that the companies based in China shifted production operations to Vietnam. However, investors are finding it strenuous as the quality of manufacturing and sourcing materials are not at par with China.

Despite the jump in exports and investments, Vietnam also saw a negative impact as it faced similar tariffs as China due to the increasing trade surplus with the US. Vietnam is also not immune to US taxes.

China’s rampant exports to the country would lead to an increase of Vietnam’s trade deficit with China, and Vietnam’s domestic firms will face difficulty from rising competition from Chinese goods. Due to the trade wars, if China decides to consume the exports instead of exporting to other countries, Vietnam will find it challenging to export to China.

                                                        Vietnam-US Trade (2017-2019)                               

                                     
                                                        Vietnam-China Trade (2017-2019)                                       

Taiwan:

Taiwan was also one of the countries that benefitted from the US-China trade wars due to the effect of trade diversion, gaining unexpected earnings of $4.2 billion in 2018-2019. The country earned the most out of office machinery equipment by gaining around $2.8 billion dollars.

Due to increasing labor charges, productivity challenges, IP rights violations, Taiwan had already begun shifting its operations from China back to Taiwan. Therefore, now those goods turned from made-in-China to made-in-Taiwan. Additionally, Taiwanese investors invested back NT$610 billion from China back to Taiwan.

Taiwan had initially faced a loss due to steel and aluminum tariffs, but as it is a rich ICT hub, it gained the most in precision engineering products and electronics ($2,941.6 million, and $310.7 million) the effects of trade diversion was made up for. However, Taiwan also faced negative effects in services like Business, transportation, trade, finance ($58.323 million, $36.6 million, $25.3 million, $24.5 million).

In 2018, Mainland China was Vietnam’s largest trading partner (with 23.9% total trade, 18.6% Taiwan imports).

US was Taiwan’s 2^nd largest trading partner (with 11.8 % of total trade and 12% of Taiwan imports), the countries had a total transaction in goods and services of $94.5 billion – with $40.3 billion in exports, $54.2 billion imports, where Taiwan faced a trade deficit of $13.9 billion. Taiwan’s GDP grew to 2.96% in 2019 from 2.79% in 2018.

                          

                   
                              Goods exported from Taiwan – overall (Source: Statista.com)

Mexico:

As Mexico is a country of low tariffs, it was viable for companies to move their production from China to Mexico during the trade wars between US and China.

The global economy was facing a slowdown as there was a decrease in investment in manufacturing, but due to the shift of operations to Mexico, the country had opportunity to grow through employment, investment, and market.

Due to the effects of increased tariffs imposed by US on China, Mexico replaced China as a major trade partner in 2019 as the value of Mexico exports to US increased as compared to China

Mexico exported a total goods and services of US$ 361 billion to the US (majorly automobiles with reciprocating piston engine – where Mexico’s US market share rose 15%, and China’s dropped 9%; raw materials), and imported a total goods and services of US$ 235 billion (majorly petroleum) million in 2019.

When it comes to China though, the scale tips considerably to China as Mexico exports to China was only US$ 7.1 billion, whereas China’s exports to Mexico was around US$ 93 billion. However, there is a steady increase from US$ 6.7 billion in 2017

Mexico did benefit from the trade war, as the resulting exports of China to US reduced, opportunities grew for Mexico. Additionally, China started using Mexico as an export platform to reach US as the tariff for exporting from Mexico was lesser than the 25% tariff of exporting directly from China

However, Mexico’s GDP declined by -0.177% and entered recession in early 2019 as the country couldn’t handle the slow industrial output, and decreased business investments

                                       
     
Conclusion:

Bottom line for the US-China trade war is that both the countries being economic superpower share huge stake in fostering open trade and investment. Any geopolitical disputes among these countries will have and had serious repercussions on countries all over the globe. Some countries may have benefited from this, but majority of the countries had to face some difficult time. Both the countries risk losing billions of dollars’ worth of money which could have contributed to their GDP due to this trade war. US’s changes in trade policy could have been based purely on politics and to reduce the China’s economic growth and its growing importance in the world economy. Since it has not benefited any of the two countries. The China’s government in its turn has a goal to achieve leadership in robotics, biotechnology, and artificial intelligence. It will provide financial support to high-tech industries and will do everything possible not to let the US stop or slow down the modernization and digitalization of the China’s economy.                 

References:
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U.S. trade deficit hits record high in 2020: The Biden administration must prioritize rebuilding domestic manufacturing | Economic Policy Institute
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Full article: US-China trade war and China’s stock market: an event-driven analysis
The failure of Trump’s trade and manufacturing policy | Economic Policy Institute

Economists tried hard to predict and prepare for the risks due to the pandemic in 2021. But their predictions didn’t work out. They are again trying hard to predict what 2022 has in store for economies across the world, amid new variants of COVID-19, inflations, hard Brexit, a fresh euro crisis, rising food prices, energy crunches, and peak oil prices. Let us now look at some of these potential risks that can pose global economic threats in the year of 2022.

Omicron and Lockdowns

Though it is early to predict how deadly the new variant of COVID-19, the Omicron can be, though, more contagious than the earlier variants, it may also prove to be less deadly. This can help the world get back to the pre-covid levels of spending, thus increasing the demand and supply of goods. A rebalancing of these spending levels can help and boost global growth upto 5.1%

On the other hand, all of this can be proven to be our wishful thinking. A more contagious and deadly variant can loom on economies across the world, pushing countries into the toughest 2021 restrictions and making economic growth sluggish in 2022.

In such a scenario, demand and supply will fall, workers will be kept out of labor markets leading to worse supply chain and logistic problems. Such scenarios are already evident in the Chinese city of Ningbo which is home to one of the world’s busiest airports, now seeing fresh lockdowns. A new wave of COVID-19 can push the already hit traveling industry into a reel of losses.

Inflation

With post-COVID-19 recovery and supply chain bottlenecks, the widespread surge in power and energy sectors, the costs have been rising, leading to global inflation. The inflation of the US is currently at around 7% contrary to the forecast of 2% by the end of the year 2021. Such major misses in controlling the inflation rates are very much possible with potential causes like Omicron, wage rates which are already rising at a rapid pace in the US. Tensions between Russia and Ukraine can lead to a surge in gas prices.

Similarly, in India though RBI expects the inflation to ease in 2022, the inflation might rebound to 6% in early 2022 due to unexpected higher prices of food, core commodities and services. RBI has been doing a great work in inflation targeting which is evident from the fact that the inflation stayed within the RBI’s target range of 2%-6% for a fifth straight month. But how well inflation in India can be targeted and curtailed in 2022 remains to be seen.

Disruptive weather conditions due to climate change may continue to rise food prices increasing the Wholesale Price Index, worsening the Global Hunger Index of developing countries. India stands at 101^st out of 116 countries with a score of 27.5 which depicts a level of hunger that is serious.

Source: Website of globalhungerindex.org

Source: Website of globalhungerindex.org

Uncertain Federal Reserve Policies

Uncertain Federal Reserve Policies concerning managing inflation rates is one of the biggest risks global economies are facing. While the causes are driven by complex factors beyond disrupted supply chains and increased consumer spending, there is no doubt that the solution lies with the Federal Reserve and its Chairman Jerome Powell. The White House might raise taxes to control inflation since other programs to control inflation have not been showing impressive results.

Adding to the risks are already-elevated asset prices. The S&P 500 Index is near bubble territory, and surging home prices suggests that the housing-market risks are bigger than during the sub-prime crisis back in 2007 which might lead to a recession at the start of 2023.[SJ2] 

Federal Reserve policies also influence the RBI. Increase in Fed interest rates narrows the spread between US and Indian government bonds leading to pulling out of money by foreign investors from Indian Government Securities. This might push RBI to increase interest rates in the country to prevent outflow of Foreign Portfolio Investments (FPI) from Indian Bond Market which will weaken the rupee further leading to inflation.

Once the US dollar strengthens further as interest rates of dollar denominated securities might begin to move higher. This will lead to decline in rupee.

Impact of Fed Lift-off on Emerging Markets

To curtail repercussions of COVID-19, USA has been buying bonds and securities in large scale, a process called as Quantitative Easing, which helps in inducing liquidity in its economy. This increased liquidity in the economy helps lower the interest rates, encourages businesses to invest more and consumers to spend more, thereby increasing the aggregate demand. However, this might lead to the central bank running into the risk of higher inflation and hence in September 2021, US Fed Reserve hinted at starting to reduce its large-scale asset purchases, a process known as ‘tapering’ which may lead to higher interest rates in 2022. The tapering process would affect the supply and demand dynamics which can lead to short-term volatility in certain market segments and raise the interest rates. This would mean a global risk aversion as global investors pulls out their money from emerging markets and invest in ‘safe-haven’ assets like gold and US treasury instruments, bringing back the memories of the “taper tantrum” episode of 2013.

Countries like India, the emerging markets, might take the brunt of such taper tantrums due to reduction in funds infused by Fed and increases fed fund rate which will impact the availability and cost of overseas finance of Indian companies. After signals of hike in interest rates in June, the benchmark Sensex fell 461 points or 0.87% The rupee also lost 0.75 paisa or 1% against the dollar during the time.

China’s Great Wall of Debt

In the third quarter of 2021, China’s economy has slowed down due to the weight of the Evergrande (a real estate company that bears $300 billion in liabilities), repeated COVID lockdowns, and energy shortages. This slowed down the economic growth to 0.8% on contrary to the world accustomed economic growth pace of 6%

While the energy crunch caused by high coal costs and inflexibility in electricity prices might show signs of easing in 2022, the ‘Zero-COVID strategy’ of Beijing might call for more lockdowns. According to some government statements, the plan of Chinese government to curtail the Evergrande real estate slump is to manage a controlled implosion by selling off some of Evergrande assets while limiting the damage to homebuyers, businesses and without bringing down the epic property boom of China. But with the dire situation in real estate, the sector which contributes to a quarter of China’s GDP and worth $52 trillion, China’s economy might have to fall further.

On the flip side of the coin, what can go right in 2022?

Amid lockdowns due to new variants of COVID-19, tapering process of US and other developed countries, higher inflation rates and uncertain monetary policies to curtail it, what can go right in 2022?

Globally, households are sitting on trillions of dollars of excess money saved from cutting down on spending during the pandemic during lockdowns. If the world is back to pre-covid times and that money gets spent, boosting the consumer spending, demand, and supply and hence the growth would accelerate.

In China, investments in green energy and affordable housing which is already stated in the country’s 14^th Five Year Plan could increase investments. Asia’s Regional Comprehensive Economic Partnership – which includes 2.3 billion people and 30% of global GDP can boost exports in the region.

Countries have been recovering surprisingly rapidly, proving economists wrong in their predictions of sluggish recoveries. This can be true next year, too like in 2021.

There hasn’t been any industry that COVID-19 hasn’t impacted and one of the most impacted sectors in the economy was the Oil and Gas Industry. The Oil Price fell to an all-time low of negative $37.63 on the WTI (West Texas Intermediate) index in April 2020, there was an excess of supply and for that time, there was no need to produce any more oil. All OPEC and OPEC+ countries together decided to reduce their production of Oil and Gas by about 10 million barrels per day. This decrease in production revisited a question in the minds of many in the energy sector… Have we reached Peak Oil?

What is Peak Oil?

Peak Oil is defined as the moment at which the global oil production will reach its maximum rate after which it will gradually decline. This happens as the rate of extracting new reserves becomes more expensive. This puts a strain on the existing resources which are being rapidly exploited and will be depleted if new sources are not found faster than the rate of depletion of current resources. So, the fear of Oil getting completely depleted was genuine, thus sparking a deluge of multiple experts trying to predict. This was a major concern till new technologies were developed and there was a strong need to develop renewable sources of energy due to the rise in the realization of the Global Warming phenomenon in the late 1970s.

Fig 1: Hubbert’s Peak Oil Model

Peak Oil Demand

It was always assumed that the ‘supply’ of oil would eventually come to an end. Due to scarcity, the oil prices would increase, making Oil Expensive. In the past 40 years or so for every 1 barrel of oil consumed, 2 new were discovered and could be recovered at an economic rate. In recent research by Industry experts, it was found that the oil required for the world till the year 2050 was available twice over and due to abundance in technology, this value will increase multifold. This tells us that the world will not fall short on Oil any time soon and there might never be a shortage of oil as earlier predicted. It also means that most of the identified recoverable sources of oil may never be recovered.  Due to the world moving towards renewable sources of energy, the dependence on conventional sources like oil, gas, and coal is reducing as you read this.

The world is still dependent on conventional sources like Oil, Gas, and Coal to achieve its energy requirements, however, there is now a shift towards more renewable sources of energy and now it is evident that the demand for Oil will gradually decrease. The moment in time when the demand for oil reaches its maximum and then starts reducing, it is called Peak Oil Demand.

Fig 2: Projections for Peak Oil Demand

The next question which comes to mind is When will Peak Oil supply occur?

Analysis has been done and potential dates ranging from 2028-2040 have been estimated. The range is very large and there are many factors that are responsible for the determination of Peak Oil Demand. Due to the new Environmental Protocols and with the proper observance of these regulations and promises, this date can take place even earlier. The world is already preparing for peak oil demand in terms of energy, but we are yet to understand the economic impacts of this phenomenon.

Impact on the Oil Market

With this shift in recognition from apparent scarcity to proven abundance, the behavior of oil-producing economies will change. It will cause the Oil market to become even more competitive than it is now. The Oil market hasn’t been behaving normally over the past decade as high-cost producers are able to compete with low-cost producers even if the high-cost oil has a multifold price difference as compared to low-cost oil. By the law of competitive markets, these high-cost producers should have been shut down or should have been driven out of the market.

This has not happened as the low-cost producers have rationed their resources to be able to produce over the next 100 years. This made sense in a scarce market, however, since the market has now shifted to being abundant this method of rationing will not work. In an abundant market, the low-cost producers will now try to force out the high-cost producers from the market. In such a market, the money in the bank is more valuable than the oil in the ground. This means that the low-cost producers would have to utilize the “high-volume, lower price” model to stay relevant in the market, this model heavily benefits the consumers. For the high cost to somehow survive in this highly competitive market they would have to give very lucrative contracts so that they can continue this business.

Both these models have problems, for the low-cost model, there is an operational problem as it becomes difficult for any producer to suddenly up their production even by 50%. Whereas for the high-cost producers there is a risk of their resources being depreciated in exchange for their contracts due to the lower price of oil.

Economic forces and dynamics take a lot of time to take effect, so for this situation to become a market norm it will take some time to become more competitive and will face significant challenges before these forces have their full effect.

Conclusion

Peak Oil Demand is a huge rage in the energy sector. The fact that the demand for oil will eventually reduce is not going to change. Rather than finding the date of the peak, the shift in paradigm needs to be shown more concern. The world will still need large quantities of oil at least for the next few decades.

The shift from an era of perceived scarcity to an age of abundance will result in a highly competitive market environment. This will result in oil-producing countries starting diversifying in order to survive in a world without Oil. The rate of this diversification as well as how much it is diversified will impact the oil prices in the coming few decades. However, it is unlikely that these changes will ever cause the major oil producing economies to have heavy fiscal deficits and the average price of oil will depend more on the social cost rather than the technical cost of production

.Peak Oil Demand is an interesting phenomenon and will result in the change of the energy sector in the coming few years. The decrease in the demand for oil will not only change the way energy is consumed but also be a factor for change for the better.

Author
Abishek Jeremy Lobo
Editor, TJEF

Historically the Indian Financial Markets have had certain hot investments that everyone wants to invest in. For the longest time, it was Gold, then came Real-Estate and Cryptocurrency. But the last decade was dominated by Private Equity and Venture Capital Investments. These investments have flooded the markets with billions of dollars, funding innovative ideas, honing entrepreneurial skills and creating a multitude of wealth for those brave enough to make these risky investments.

History of PE/VC in India

Preceding 1997, the Indian private value market was tiny and generally dependent on official financing from the Government and multilateral organizations like World Bank, IFC, CDC and DFID. The growth was seen during beginning of the dotcom boom with the entry of foreign institutional financial backers (FIIs) VC financing was first introduced in India during the year 1975 with the setting up of Industrial Finance Corporation of India (IFCI) supported Risk Capital Foundation (presently known as IFCI Venture capital Fund

Limited). In 1976, a seed capital plan was presented by The Industrial Development Bank of India (IDBI). In March 1987, IDBI introduced a venture capital fund scheme for financing ventures seeking development of indigenous technologies/adaptation of foreign technology to wider domestic applications. Similarly, ICICI in association with UTI formed a venture capital subsidiary Technology Development and Information Company of India (TDICI) for financing technology oriented innovative companies. In mid-80’s all the three Indian financial institutions viz IDBI, ICICI, IFCI started investing equity in small technological companies.

Let’s breakdown the growth on PE/VC into multiple Phases:

	Phase -I Pre – 1995	Phase – II 1995-1997	Phase – III 1998-2001	Phase – IV 2002-2009	Current 2010-2021
Number of Active PE Funds	8	20	50	75	3000 +
Total Investments (US$ Mil)	~30	~125	~3,000	~7,000	~240,000
Stages & Sectors	Seed, early stage and development – diversified	Development – diversified	Early stage and Development – telecom and IT	Growth/ Maturity – tech, financial services, infra and industrials	Growth/ Maturity/ Credit/ Distress/ Buyout/ Platform – financial services, infra, RE, tech, healthcare, consumer
Primary Sources of Funds	World Bank, Government	Government	Overseas Institutional	Overseas Institutional	Overseas Institutional/ Domestic
No. of Transactions	~20	~65	~548	~1,500	~7,000

The Last Decade (2010 – 2020)

This decade saw PE/VC investments develop at a CAGR of 19% from a base of US$ 8.4 billion out of 2010 to US$ 47.6 billion every 2020 and spread its wings across all venture classes. The combined worth of PE/VC investments between 2011-2020 added up to US$ 232.4 billion, which is over two times the worth recorded in the previous decade. This decade saw numerous changes in the Indian PE/VC industry concerning the deal type, deal size, and industries.

Top Large PE/VC Deals between 2010-2020

Brief Analysis of Sectoral Performance (2010-2020)

The PE/VC investment activity in India has been dominated by four-five sectors that accounted for 2/3^rd of all investments by volume and value. Some of the key trends were as follows:

• Technology has been the most preferred sector over the years.
• While e-commerce sector was among the preferred sectors throughout the decade, the deals were much smaller in the initial years.
• Financial services and real estate have consistently been among the top five preferred sectors for PE/VC investments.
• Infrastructure sector has received a disproportionate share of capital despite very few deals over the decade.
• Media and entertainment sector has seen an uptick in deal activity in recent years, though the deal sizes are rather small.
• Healthcare was among the preferred sectors in the initial years but fell behind in the latter half of the decade. This is expected to change after the Government’s focus on increasing healthcare investments and renewed interest from PE/VC funds in the healthcare sector post the pandemic.

Outlook for the Next Decade

• Technology enabled businesses will see disproportionate share of investments: 

As technology takes over all parts of business and life, it has turned into a significant tool for disturbing the status quo. Considering recent patterns, early movers in technology-empowered organizations are relied upon to get a disproportionate share of the market. Accordingly, organizations that are at the cutting edge of innovation will doubtlessly have an upper hand, and PE/VC reserves are understanding that. The previous year has shown us the sort of valuations techempowered business can order, and their capacity to be stronger to financial shocks.

• Environmental, Social, and Corporate Governance (ESG) focused investing:

Investors are using these non-monetary variables as a component of their analysis to distinguish risks and opportunities. The Covid pandemic, specifically, has escalated conversations about the interconnectedness of sustainability and the financial system. Many funds have already

incorporated ESG policies in their investment decisions, a trend which will grow stronger in the next decade. Indian PE/VC investors will in time, be expected to make ESG an integrated part of a company’s DNA and its operations.

• New sectors to emerge as frontrunners for PE/VC investments: 

Most conventional areas are being upset by innovation and new business models have arisen. The most conspicuous among them for the following decade appear to be edtech, fin-tech, health tech, EVs, independent transportation and customised media and amusement. These sectors will play an instrumental role in the upcoming decade.

• https://www.ventureintelligence.com/
• https://www.vccircle.com/
• https://www.ey.com/en_in/private–equity/the–rise–of–private–equity–in–india–in–the–last–decade

The Balance of Payment crisis in 1991 is undoubtedly, one of the most critical events to take place in the history of Indian economy and politics. The valiant effort in managing the crisis by the then incumbent government, steered India onto the path of economic liberalisation and prosperity. 

In hindsight, this watershed event can be viewed as a blessing in disguise for India. The confluence of bureaucracy, academia, institutions worked so well to pull India out of the crisis trench. Simplistically, one can understand that India went into the pitfall of the BoP crisis as it was unable to pay off its debts. But sometimes, it is fascinating to delve into the ‘why’ part of such an even happened. Why did India descend into such a situation? What were the warning signs? Did the policy was adequate enough to prevent the systemic risk, etc?

These were some pertinent questions that led me to delve deeper into the reasons and get a better understanding of it. Let us traverse through the series of the following activities that led to the creation of the crisis.

India had been significantly under pervasive administration control and its economy policy exhibited a strong inward orientation until early 1980s. The first half of 1980 saw a large increase in the central government’s deficit, primarily on account of high expenditure levels especially on agricultural subsidies, defence, and interest payments. On external account, higher imports dominated over exports. The Current Account Deficit (CAD) widened extensively due to higher import bill. The dependence on commercial financing increased significantly. The debt service ratio reached almost 30% (i.e. India had already used 30% of the total borrowed funds) in the late 1980s. The fiscal deficit as a percentage of GDP escalated to 9.4% in 1990-91 as against the average of 6.3% in the first half of 1980s. The increase in the money supply contributed to rise in the inflation and exerted pressure on the BoPs. The bulk of the outflow of funds amounted to nearly US$ 1 billion during April-June 1991. During 1988-1990, external commercial borrowings rose. The reliance on non-resident deposits continued with interest rates rising above the international levels. The perception towards external financing to be a stable source of funds resulted to be a whammy.  India faced large external and internal financial imbalances and was vulnerable to external shocks around 1990.

India’s tendency to extensive reliance on external financing and resorting to financing on commercial terms during 1980s resulted in relatively high debt at the end of the decade. The official reserves were drawn from 5 months of imports in the mid-1980s to a little over 2 months of imports at the end of 1989-90. Reserves declined by 71.2% from Aug 1990 to Jan 1991 (US$ 3 billion to US$ 896 million). The gross official reserves stood at US$ 5.8 billion (1.3 months of imports) by March 1991 despite purchase of US$ 1.8 billion from IMF in January 1991. Inflation rose to 12% while CAD widened to 3%. 

The situation exacerbated further due to sudden outbreak of the gulf war, annexation of Kuwait, higher oil prices, loss of workers’ remittances, policy slippage, domestic political unrest, postponement of the general elections followed by the resignation of the government in power in March 1991. The withdrawal of NRI deposits intensified during

1991-92. Exports stagnated largely due to slack in demand in key markets in Eastern Europe and the Middle East industrial nations. India’s sovereign credit rating was seriously downgraded. The burden fell mainly on monetary adjustments and direct import compression measures. 

By the mid-1991, the BoP crisis turned into a crisis of confidence and India’s default on its debt obligations seemed as a certain possibility in June 1991. India’s external liabilities stood at US$ 68.8 billion at end March 1992.

Management of the crisis and its resolve

The crisis presented the policymakers with the opportunity to pursue liberalization. The then Prime Minister P.V. Narasimha Rao roped in Dr Manmohan Singh as the Finance Minister to undertake economic reforms and embarked upon a historic economic transition of India along with their administration by abolishing License Raj and introducing liberalisation. 

Here are the key highlights of the reforms-

• Industrial licensing was abolished (except for 18 industries). 80% of the industry was taken out of the clutches of the licensing framework.
• Reforms in capital market, trade, infrastructure, and financial sector took place.
• Automatic approval of FDI was done up to 51%. 
• Public sector units were given more autonomy. Disinvestments in many PSU units were initiated.
• Investment caps on large industrial houses were removed. MRTP act was revoked to foster capacity expansion and diversification.
• Exporters were permitted to open Foreign Currency Accounts.
• Access to foreign technology was liberalized.
• Import licensing was abolished. 
• Import duties were sharply reduced.

In October 1990, RBI imposed higher cash margins of 50% on imports, other than capital goods, for those against foreign sources of credit. In 1991, the cash margins increased further to 133% and 200% in March and April respectively. The government imposed surcharges of 25% on prices of petroleum products and also raised customs duties. RBI imposed 25% surcharge on interest on bank credit for imports. The measures undertaken resulted in significant import compression. Though it proved to be counterproductive as it affected exports. 

The Rupee (₹) was devalued by 18% in 2 phases- on July 1^st and July 3^rd ,1991. The dual exchange rate system was introduced in 1992 to contain the exchange rate volatility. The large outflow of funds was recouped to a large extent by subscription to India Development Bonds (IDBs) aggregating US$ 1.62 billion with bonds having elongated maturities. India received financing from World Bank, ADB and Japan aggregating US$ 1billion. Aid-India consortium committed aid during 1991-92 amounting to US$ 6.7 billion for India. The value of the gold holdings with RBI was at US$ 3.5 billion during 1991-92. The RBI in consultation with the government evaluated the value of the gold reserves to raise foreign exchange resources. The arrangement to utilise gold was done with the intention to be temporary as well as reversible.  As means of raising resources, RBI in 1991 pledged 47 tons of gold with Bank of Japan (BoJ) and Bank of England (BoE) to raise a loan of US$ 405.0 million. United bank of Switzerland (UBS) purchased approximately 20 tons of gold and paid a consideration of US$ 200 million to the government. Finally, the IMF approved credit tranche amounting to US$ 2.2 billion to be availed in instalments over 20 months under the 1991-93 stand by arrangement subject to the conditionality imposed by IMF. 

The successful management of the BoP crisis succinctly shows the vigour of the government under the leadership of P.V. Narasimha Rao that India was in no way to default on its debt obligations. The government was adamant to rebuild the sovereign rating of India and restore the market confidence on the Indian economy. The measures were taken prudently to weed out the crisis gradually. The co-ordinated financial aid received by India from global financial institutions was the result of strategic negotiations and collegial relationship nurtured between Indian administration and the institutions over the period of crisis. The incipient impact of the reforms undertaken was evident as the foreign exchange reserves had climbed to US$ 9.8 billion by the end of 1992-93 and economic growth had recovered to 4.0 percent. The fiscal deficit reduced from 8.4% in 1990-91 to 5% of GDP in 1993-94. In 2003, India successfully repaid its debt that it received from the IMF under the 1991-93 stand by arrangement. Through the end of the decade, India didn’t have to borrow. 

As the times have progressed, India has become a favourable destination for the FPIs, FDIs. The world is converging in India. It currently ranks 5^th on the list of the world’s biggest economies. It has gained the precious tag of the” fastest growing economy” among the major economies in the world. So much for an economy that once faced the risk of defaulting on its debt commitment, gaining the title of the  fastest growing economy in 2018-19 is a feat unprecedented and a matter of pride for us fellow Indians.