External Sector & Economic Institutions

To buy oil from abroad India must pay in dollars, not rupees. So the country keeps a war-chest of foreign money called foreign exchange reserves (forex reserves), held and managed by the Reserve Bank of India under the RBI Act 1934 and FEMA 1999. Reserves are our insurance: they let us pay for imports and defend the rupee when it falls too fast. Their adequacy is judged by import cover — how many months of imports they can finance.

• Foreign Currency Assets (FCA) — mainly US dollars, euro, pound, yen held as deposits and foreign government securities. This is by far the largest component.
• Gold — monetary gold held by the RBI.
• Special Drawing Rights (SDRs) — the IMF's reserve asset, a basket-based unit allotted to member countries.
• Reserve Tranche Position (RTP) with the IMF — India's quota contribution that it can draw on unconditionally.

Who gains when the rupee depreciates? Exporters gain — a foreign buyer paying the same dollars now hands over more rupees, so Indian goods look cheaper abroad. Importers lose — every barrel of crude and every tola of gold costs more rupees, which pushes up domestic inflation. Students studying abroad and Indians travelling out also lose. When the rupee appreciates, the effects reverse exactly.

• Current account convertibility — FULL since 1994. In August 1994 India accepted the obligations of Article VIII of the IMF Articles of Agreement, making the rupee fully convertible for trade, travel, education, medical treatment and remittances.
• Capital account convertibility — only PARTIAL. Moving money abroad to buy assets is still regulated (limits, routes, approvals). The Tarapore Committee (first report 1997, second 2006) laid down a phased road-map; India has moved cautiously and deliberately kept controls, which is one reason it escaped the worst of the 1997 East Asian crisis.

Foreign money can enter India in two very different moods. One comes to build a factory and stay; the other comes to buy shares and leave when it likes. Telling these two apart — FDI and FPI — is the heart of this topic.

• Automatic route: the foreign investor needs no prior approval from the Government or the RBI — only post-facto reporting. Most sectors are on this route today.
• Government (approval) route: prior approval of the concerned administrative ministry is required, typically in sensitive sectors.
• Sectoral caps: the policy fixes a maximum percentage of foreign equity in sensitive sectors — defence, insurance, print media, multi-brand retail and banking are the standard examples. The exact numbers are revised often, so learn the idea of a cap and which sectors are sensitive rather than chasing figures.

Money also flows out. Overseas Direct Investment (ODI) is investment by Indian companies in joint ventures and wholly-owned subsidiaries abroad — the Tata, Mahindra and pharmaceutical acquisitions you read about. Indian firms may also raise loans abroad through External Commercial Borrowings (ECB) — commercial loans, buyers' credit and foreign-currency bonds taken from non-resident lenders. ECBs are cheaper than domestic loans but create foreign-currency debt, so the RBI regulates them tightly through limits on amount, end-use and minimum average maturity.

Composition of trade means what we buy and sell; direction means with whom. India's composition has changed dramatically since independence — we once exported raw jute, tea and cotton and imported machinery; today we export manufactured and knowledge-based goods and services. The direction has shifted too: from Britain and the erstwhile USSR towards Asia, the Gulf and the USA.

Because oil and gold imports are so heavy, India's merchandise trade balance (exports minus imports of goods) is persistently negative — a trade deficit. But do not stop there: our services surplus (IT exports) plus remittances offset much of it, which is why the current account deficit is always smaller than the trade deficit. That single sentence answers a whole family of questions.

• The Foreign Trade Policy (FTP) is announced by the Ministry of Commerce and Industry and administered by the Directorate General of Foreign Trade (DGFT) under the Foreign Trade (Development and Regulation) Act, 1992. It sets out export promotion schemes, duty remission and procedures.
• Special Economic Zones (SEZs) are duty-free enclaves treated as foreign territory for trade operations and tariffs, created to boost exports. Asia's first Export Processing Zone was set up at Kandla (Gujarat) in 1965; the modern framework comes from the SEZ Act, 2005.

• The World Bank Group has five arms: IBRD (1944) — loans to middle-income countries; IFC (1956) — lends to the private sector; IDA (1960) — soft, near-interest-free credit to the poorest countries; ICSID (1966) — settles investment disputes; MIGA (1988) — provides political-risk guarantees/insurance.
• IDA is called the "soft loan window" of the World Bank. India was for decades among IDA's largest borrowers; it has since graduated from IDA-only status.

The WTO runs on two bedrock non-discrimination principles. Most Favoured Nation (MFN) means a member must treat all other members equally — a concession given to one must be given to all. National Treatment means once a foreign good has entered the market, it must be treated no worse than a domestic good. Its Dispute Settlement Body is what gives the WTO teeth, unlike GATT which had no binding mechanism. India's standing concern at the WTO is food security: our public stockholding for minimum support prices and the public distribution system is challenged as a trade-distorting subsidy. At the Bali Ministerial (2013) India secured a "peace clause" shielding such stockholding from challenge until a permanent solution is found — a demand India continues to press.

• BRICS — Brazil, Russia, India, China, South Africa. The term BRIC was coined by economist Jim O'Neill (2001); the first summit was held in 2009 (Yekaterinburg, Russia) and South Africa joined in 2010, making it BRICS. It created the NDB and a Contingent Reserve Arrangement.
• G20 — the premier forum for international economic cooperation, formed in 1999 (finance ministers) and upgraded to leaders' summits in 2008 after the global financial crisis. India held the G20 Presidency in 2022–23 and hosted the Leaders' Summit in New Delhi in September 2023.
• SAARC — South Asian Association for Regional Cooperation, established at Dhaka in 1985, secretariat at Kathmandu (Nepal), 8 members (Afghanistan joined in 2007). Its trade arm is SAFTA. Progress has been slow because of India–Pakistan tensions.
• BIMSTEC — Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation, formed in 1997, secretariat at Dhaka (Bangladesh), 7 members (India, Bangladesh, Myanmar, Sri Lanka, Thailand, Nepal, Bhutan). It excludes Pakistan, which is why India increasingly prefers it as a regional platform and links it to the "Act East" policy.

A liberalised economy needs referees. Once the State stopped running everything, it had to start regulating it — so India built a set of sector regulators, each guarding one market and its investors. You have already met the RBI (banking and money) in the previous chapter; here are the others.

• NABARD — National Bank for Agriculture and Rural Development, set up on 12 July 1982 on the recommendation of the CRAFICARD (B. Sivaraman) Committee; headquarters Mumbai. It is the apex refinance institution for agriculture and rural development — it does not usually lend to farmers directly, but refinances cooperative banks, Regional Rural Banks and other lenders, supervises them, and funds rural infrastructure through the Rural Infrastructure Development Fund (RIDF).
• SIDBI — Small Industries Development Bank of India, set up in 1990, headquarters Lucknow; the apex institution for financing and promoting the MSME sector.
• EXIM Bank — Export-Import Bank of India, set up in 1982, headquarters Mumbai; finances and promotes India's foreign trade, including buyers' credit and lines of credit to friendly countries.

Money must also be shared between the Centre and the states, and that is a constitutional job, not a NITI Aayog one. Under Article 280 the President constitutes a Finance Commission every fifth year to recommend (a) the distribution of the net proceeds of shareable central taxes between the Centre and the states — vertical devolution, (b) the allocation among the states — horizontal devolution, and (c) grants-in-aid to states under Article 275. Its recommendations are advisory, not binding, but are conventionally accepted. The 15th Finance Commission (chair: N. K. Singh) recommended a 41% share of the divisible pool for the states.