International Trade and Capital Flows into India: Do Pattern of Flows Matter?

Following the Balance of Payments (BOP) crisis of 1991, Government of India has implemented numerous reforms related to the external sector through trade policy reforms, abolition of tariff wall and reduction in tariff rates, abolition of license raj, widening open general license, liberalized exchange rate management system (LERMS) and so on. Objectives of the above mentioned outward oriented policy is to enhance the volume of trade, to import capital and technology without any restrictions, to promote current account flows and to increase the inflow of capital and foreign exchange reserves and keep Balance of Payments sustainable. After the implementation of liberalisational measures in the external sector, India's volume of trade and capital inflows has increased at high growth rate simultaneously current account position has been worsening and debt creating capital inflows are also increasing particularly since 2004–05. This paper analyses the sustainability of India's current account and capital account over the last two and half decades in the view point of pattern of flows. Based on the empirical results, this study found that there has been a worsening trend in merchandise trade created high level of trade deficit but favorable pattern of traded commodities led India's current account deficit sustainable. Similarly, the study also found that there has been an immense capital inflow creates sustainable BOP, but the pattern is not much favour as what the policy maker expects. In recent years, the inflow of debt creating capital inflows are increasing and puts strain on debt service ratio. So, this study suggested that the government of India needs to take appropriate measures to control the import of gold and unnecessary and finished goods to curb trade deficit. Also the government of India needs to concentrate more on attracting non-debt creating capital inflows like FDI, Portfolio investment to keep current account and capital account surplus and sustainable.