(b) The effect of trade liberalization on the balance of payments (Cont.)

262. As an initial indication, upon the removal of import restrictions, if the percentage share of imports of products that are currently subject to import restrictions rises to the level reached by products that are no longer subject to such restrictions, the additional import bill from the removal of import restrictions would have been approximately US$30.6 billion in 1996-97, as compared to the total merchandise import bill for that year of US$43.5 billion. The above figures, however, could be disputed, and a sensitivity analysis of the removal of import restrictions was presented in the table that follows. The sensitivity analysis showed that depending upon the assumption made about the likely percentage share of imports in total value of consumption of 5.00 per cent, net addition to imports, in terms of 1996-97 values, would range upwards of US$3 billion.

Table 3

Sensitivity analysis of QR removal, 1996-97

(Percent share and US$ billion)

Percentage share of imports in total value of consumption	Net addition to imports (US$ billion)
3.42	0.0
5.00	3.2
7.50	8.3
10. 00	13.3
12.50	18.4

Note: Exchange rate US$ = Rs. 37.50.

Source: The Government of India.

263. Another important factor that was likely to affect the behaviour of the trade deficit was the marked deceleration in export growth over the last two years. ¹⁹⁶ This deceleration had been caused by a number of factors including the following: a slowdown in the expansion of world trade; ¹⁹⁷ and an inability to switch export production in response to changes in the pattern of world demand. The prospects of recovery of world trade appeared particularly remote after the South-East Asian currency crisis. The South-East Asian currency crisis also almost certainly would affect India's export competitiveness, especially because the South East Asian economies were direct competitors with respect to both commodities and markets for Indian exports.
264. Besides the anticipated low growth of exports, an analysis of the evolution of Indian imports pointed to some potential areas of concern on the trade account. As would be expected with any process of global integration, both export-to-GDP and import-to-GDP ratios had shown secular increases. Merchandise exports which accounted for 6.2% of GDP in 1990-91, had grown to account for 9.9% of GDP in 1995-96. The import-to-GDP ratio over the same period had risen from 9.4 to 13.3%. But these averages understated the growing importance of foreign trade in the economy. A more accurate picture would be obtained if these ratios were calculated using the annual change in exports and imports as a proportion of the annual change in GDP. The annual change in exports as a proportion of the annual change in GDP had increased from 15.3% in 1991-92 to 18.6% in 1995-96. Over the same period, however, the same ratio for imports increased far more steeply, from 6.2% to 25.7%.
265. India's rising trade deficit has not resulted in a significant deterioration of its current account deficit only because of the steady improvement in the invisibles account. After registering a nominal surplus of US$1.6 billion in 1991-92 amounting to 0.7% of GDP, the surplus on the invisibles account went up to US$5.7 billion in 1994-95 and further to US$8.5 billion in 1996-97, amounting to 1.7 and 2.4% of GDP respectively. Perhaps the most significant aspect of this improvement had been the sharp increase in net private transfers. This form of inflow which was US$3.8 billion or 1.7% of GDP in 1991-92, had by 1996-97, risen to more than US$11.5 billion, amounting to 3.3% of GDP. However, it was believed that unexpectedly high private transfers in 1996-97 were largely due to the inflow of a large part of the redemption proceeds of India Development Bonds (issued during the balance-of-payments crisis in 1991) on maturity. Consequently, it was unlikely that private transfers will be as high in subsequent years.
266. The influence of private transfers on the overall invisibles balance was significant because of the relative stagnation of the other major components on the invisibles account. Thus, improvement in the invisibles account was attributable to net private transfers, which were highly unpredictable. In particular, recent increases in net private transfers had been attributed to terminal repatriation by Indian workers abroad. This implied that such transfers were likely to decline steeply in the future. Therefore, private transfers could not be depended on to finance India's trade deficit. This was corroborated by the Planning Commission's estimates for the Ninth Plan period which indicated that the balance on the invisibles account was likely to be just half the present level. It was this feature of India's current account deficit during the 1990s, i.e., where a large and growing trade deficit was financed essentially through private transfers, that raised serious doubts about the sustainability of the current account deficit. Thus, even the IMF had indicated that in the next few years, India's current account deficit could increase to about 3% to 4% of the GDP from the present level of 1.1%. The Ninth Plan projections also indicated a widening of the current account deficit. ¹⁹⁸
267. In recent years, India had been able to finance its current account deficit largely because of increases in portfolio and FDI flows. However, net portfolio flows had declined substantially from US$3.31 billion in 1996-97 to US$1.61 billion in 1997-98 on a balance-of-payments basis. In addition, there had been a net outflow of investment by foreign institutional investors to the extent of US$448.90 million in the first quarter of fiscal 1998-99 based on data from the Securities and Exchange Board of India. There were a number of factors that could adversely affect these flows:

(i) In the wake of the South-East Asian financial crisis, capital issues abroad by Indian companies had been adversely affected.

(ii) The legislatively mandated imposition of economic sanctions on India by the United States and other steps taken by some industrialized countries in regard to postponement of fresh approvals of bilateral and multilateral assistance to India would also affect inflows of foreign capital.

(iii) Moody's Investors Service ("Moody�s"), one of the leading international private credit rating agencies, had lowered India's foreign currency country ceiling for long term debt and notes to Ba2 from Baa3 and had downgraded the foreign currency country ceiling for short term debt to Non-Prime from Prime-3. Moody's had also lowered the long term foreign currency deposit ceiling to Ba3 from Ba1. Other private international private credit rating agencies were likely to follow. Such downgrading would adversely affect the ability of Indian corporate entities to borrow abroad. It would also affect other types of foreign investment in India.

268. Since independence in 1947, India had faced serious balance-of-payments crises in the late 1950s, the mid-1960s, the late 1970s and the early 1990s. India currently faced significant infrastructural bottlenecks that were hindering it in maintaining a reasonable rate of economic growth. A significant proportion of the necessary investment would need to come from foreign sources both to cover the savings gap and to finance the necessary imports. In addition, analysis of India's balance-of-payments outlook even for the short term indicated that India was likely to face simultaneous pressures on the external front from a number of sources. According to the latest figures, the foreign currency assets held by the Reserve Bank of India had already declined by US$1.87 billion in the first quarter (June 26, 1998) of fiscal 1998-99. For all these reasons, India believed that the immediate elimination of its import restrictions would create a serious balance-of-payments problem.

(c) The balance-of-payments situation

269. The United States considered that even if (contrary to the views expressed in Section III(D)(9) below) the IMF's findings were insufficient to establish that India did not meet the requirements of Article XVIII:B, additional evidence from public sources, including Indian Government sources, settled the question.
270. On the basis of IMF data, from the US$2.1 billion low, Indian foreign reserve holdings have increased to US$ 4.2 billion in 1991, US$6.3 billion in 1992, US$10.7 billion in 1993, US$20.3 billion in 1994, US$20.8 billion in 1996 (a slight dip to US$18.6 billion occurred in 1995), US$25.0 billion in 1997 and US$26.9 billion in March 1998. ¹⁹⁹ The United States emphasized that India had moved to overall balance-of-payments surplus in the 1990s as it had simultaneously taken strong action to open its market to imports and experienced rapid economic growth. Again, on the basis of latest publicly available data from the IMF, India's real gross domestic product rose at an average annual compound rate of 6.6 per cent in the five years between 1991 and 1996. Nominal goods exports have been rising at an annual compound rate of 13.7 per cent between 1991 and 1997 (annualized from first three quarters) rising from US$17.6 billion to an annualized US$38.1 billion. ²⁰⁰
271. In the view of the United States, import-market opening measures by India in the 1990s had undoubtedly reduced product market distortions in India and helped improve the efficiency of production and investment. In turn, a more open and successful Indian economy had helped support growing international confidence in management of the Indian economy and in India�s successful economic future. Such confidence had, of course, been important, not only to India�s healthy economic performance in the 1990s, but also to its balance-of-payments surplus position in recent years. Against the background of India�s economic performance in this decade, the United States found it difficult to understand on what grounds India could suggest that the additional market opening represented by withdrawal of import restrictions that were no longer justifiable on balance-of-payments grounds would necessarily threaten a balance-of-payments crisis.
272. The United States also quoted statements made by India's new Finance Minister, Yashwant Sinha, during his visit to the United States. On 13 April, the Finance Minister had stated that "the macroeconomic fundamentals were strong. Our foreign exchange reserves were substantial, our currency markets orderly, our external debt well under control and the East Asian crisis did not engulf India" ²⁰¹ On 15 April, Mr. Sinha stated "India has a strong foreign exchange reserve position and the process of economic reforms is on. It is because of these strong economic fundamentals that while the rest of East Asia is experiencing a financial meltdown, India has remained largely untouched" ²⁰² A press release of the Reserve Bank of India dated 1 April, announced that during the year 1997-98, the foreign currency assets of the RBI increased by US$3.5 billion, including a US$2.5 billion increase since 16 January 1998. ²⁰³ Since 1990, as a consequence of the strength of the Indian balance-of-payments position and government actions to deal with that strength, India's foreign reserve holdings had risen dramatically.
273. The United States considered that even if the IMF�s findings were insufficient to establish that India did not meet the requirements of Article XVIII:B, additional evidence from Indian sources settled the question. In addition to the press releases cited above, other Indian government sources, addressed to the world financial community and to actual and potential investors, confirmed the strength of India�s balance-of-payments position. The Government of India�s Basic Document for the January 1997 consultations in the Balance-of-Payments Committee confirmed the strength of India�s balance-of-payments position and showed that the previous increase in the trade deficit occasioned by the removal of quantitative restrictions had in fact been accompanied by a substantial increase in India�s reserves:

"India�s external balance of payments have improved since the crisis in 1991. After registering a decline in the dollar value of exports in 1991-92, the country has witnessed an annual export growth of about 20 per cent in dollar terms during 1993-96. Imports, in dollar terms, have also increased at a rapid pace by 22.9 per cent in 1994-95 and by 26.8 per cent in 1995-96. In spite of an increasing trade deficit, buoyant invisible receipts and capital inflows allowed foreign exchange reserves to grow from a low of one billion dollar to almost $ 21 billion at end-March 1995. Reserves declined to $17 billion at end March 1996 and recovered partially by increasing to a level of $19.5 billion by end-November, 1996." ²⁰⁴

274. The United States cited a statement entitled "Monetary and Credit Policy for the First Half of 1998-99," in which Dr. Bimal Jalan, Governor of the Reserve Bank of India, noted the success of using macroeconomic policy instruments to manage India�s external position in the wake of the Asian financial crisis. Specifically, Dr. Jalan noted:

"The developments in some of the Asian currencies gave rise to significant pressures on the exchange rate of the rupee in the second half of the year. Keeping these developments in view, a package of monetary measures was introduced on January 16, 1998. ...

"The impact of January measures on the external position of the country has been favourable. During 1997-98, the foreign currency assets of the Reserve Bank increased by US$3.6 billion - from US$22.4 billion on March 31, 1997 to US$26.0 billion on March 31, 1998. Inclusive of gold and SDR, the total foreign exchange reserves stood at US$29.4 billion on March 31, 1998, representing an increase of US$2.9 billion over March 31, 1997. Since January 16, 1998, the foreign currency assets have increased by US$2.5 billion up to March 31, 1998." ²⁰⁵

275. The United States added that the Reserve Bank of India had taken the same position. In the "Assessment and Prospects" chapter of its 1996/97 Annual Report, the Reserve Bank of India had written:

"The distinct strengthening of the balance of payments since 1991-92 has resulted in a healthy build-up of foreign exchange reserves. The level of foreign exchange reserves (including gold and SDRs) rose to US$ 29.9 billion by August 14, 1997 equivalent to seven months of imports and well above the conventional thumb rule of reserve adequacy (three months of imports). In the context of the changing interface with the external sector and the importance of the capital account, reserve adequacy needs to be evaluated in terms of indicators other than conventional norms. By any criteria, the level of foreign exchange reserves appears comfortable. They are equivalent of about 25 months of debt service payments and 6 months of payments for imports and debt service taken together. Thus, even if exchange market developments accentuate the leads and lags in external receipts and payments, the reserves would be adequate to withstand both cyclical and unanticipated shocks. Furthermore, in the context of fluctuating capital flows, it is useful to assess the level of reserves in terms of the volume of short-term debt which can be covered by the reserves. At the end of March 1997, the ratio of short-term debt to the level of reserves amounted to a little over 25 per cent. The strength of our foreign exchange reserves can be gauged from the fact that the ratio of short-term debt to reserves was 220 per cent for Mexico, 150 per cent for Indonesia, 64 per cent for Argentina, 50 per cent for Thailand and 30 per cent for Malaysia at the end of 1995. Furthermore, the level of reserves exceeds the total stock of short-term debt and portfolio flows which taken together, constitute a little less than 75 per cent of the level of reserves. It is necessary to keep these different criteria in view while determining the desired level of reserves.

"The recent strengthening of India's balance of payments has enabled the country to accept the obligations of Article VIII of the International Monetary Fund which prohibits all restrictions on payments in relation to current account transactions." ²⁰⁶

276. In summary, in the view of the United States, the facts overwhelmingly confirmed that India had not been experiencing a serious decline in its reserves; that India had not been faced with the threat of a serious decline in its monetary reserves; that India�s reserves had not been inadequate or at a very low level; and that the removal of the quantitative restrictions would not subject India to a situation in which it would be threatened with or experience a serious decline in the level of its monetary reserves.
277. The United States recalled that although India had argued that it required time to plan for adjustment to the removal of the challenged measures, India had been well-aware of the concerns of many of its trading partners concerning these massive restrictions since at least 1994. India�s response, made in 1994, is recorded as follows:

"The [Balance-of-Payments] Committee noted that, if the balance of payments showed sustained improvement, India's aim was to move to a régime by 1996/97, in which import licensing restrictions would only be maintained for environmental and safety reasons." ²⁰⁷

278. The United States added that India�s reserves had increased from US$20.3 billion in 1994 to US$25.0 billion in 1997. India had had three years to plan for the elimination of the measures. However, by 1997, the measures had not been eliminated. Furthermore, the IMF advised India in a Committee meeting in January of 1997, of its factual determination that India lacked any balance-of-payments justification for the restrictions now at issue in this dispute.
279. Finally, the United States noted that, as India itself pointed out, Article 21 of the DSU provided that if it was impracticable to comply immediately with the recommendations and rulings of the DSB the Member concerned was to have a reasonable period of time in which to do so. ²⁰⁸ Article 21, however, also provided that this period was to be determined by the Dispute Settlement Body, the parties to the dispute, or as a last resort by an arbitration � not by the Panel. The issue of the amount of time that India should or should not have to implement the rulings and recommendations of a panel was a separate procedure.

To continue with The balance-of-payments situation

¹⁹⁶ In fact preliminary data for the current year, i.e. 1997-98, would suggest that export growth had actually turned negative.

¹⁹⁷ World trade experienced a halving of growth rate in 1996 compared to the preceding year.

¹⁹⁸ Ninth Plan projections indicate that for the period as a whole, the current account deficit as a percentage of the GDP is expected to be about 2.1%.

¹⁹⁹ International Financial Statistics, International Monetary Fund Statistics Department.

²⁰⁰ Ibid.

²⁰¹ Press Release, Consulate General of India, New York, "Finance Minister Addresses the Asia Society In New York", Monday, 13 April 1998.

²⁰² Press Release, 15 April 1998, Indian Embassy.

²⁰³ Press Release, Reserve Bank of India, April 1998.

²⁰⁴ WT/BOP/16, 8 January 1997, para. 40.

²⁰⁵ Statement by Dr. Bimal Jalan, Governor, Reserve Bank of India on "Monetary and Credit Policy for the First Half of 1998-99," 29 April 1998, at paras. 11, 12.

²⁰⁶ The Annual Report on the Working of the Reserve Bank of India (for the year July 1, 1996 to June 30, 1997), Chapter VII "Assessment and Prospects," paras. 7.23 and 7.24 (emphasis added).

²⁰⁷ GATT document BOP/R/221, 1 December 1994.

²⁰⁸ DSU, Article 21.3.