(ii) Questions to and replies from the IMF

1(a)(i) As of 18 November 1997, the date of establishment of the Panel, was India experiencing a serious decline in its monetary reserves, or facing a threat thereof?

359. Foreign currency reserves of India�s monetary authorities (the Reserve Bank of India, RBI) stood at US$25.1 billion (excluding gold) on 21 November 1997. ²³⁹ This level represented an increase of US$5.6 billion from a year earlier, and of US$2.8 billion from end�March 1997. ²⁴⁰ Net of forward liabilities, foreign currency reserves stood at US$23 billion at end�November 1997.
360. The establishment of the WTO panel coincided with a period of turbulence in the foreign exchange market in India, with increased fears of further contagion from the financial crisis in east and southeast Asia. The facts are as follows: the rupee faced periodic bouts of downward pressure beginning in August 1997. These pressures intensified in November 1997. The RBI initially intervened heavily in spot and forward markets to prevent large daily fluctuations in the exchange rate that could have provoked bandwagon effects. Faced with a reserve loss of about US$2.6 billion (including forward obligations) during November 1997, and continued pressure on the rupee, the RBI subsequently abandoned active intervention and tightened monetary policy. Thus, with an appropriate macroeconomic policy response and the containment of contagion, India�s foreign currency reserves on 18 November 1997 did not appear to be under a threat of a serious decline. Therefore, the question of whether an imminent threat existed is moot.

1(a)(ii) Was India experiencing an inadequate, or a very low, level of monetary reserves ?

361. At about six months of imports of goods and non�factor services, India�s reserves appeared to provide sufficient external liquidity and a reasonable degree of protection against unforeseen external shocks. In particular, reserves were sufficient to deal with debt service payments and potential outflows of portfolio investment, covering 2� times the amount of maturing debt obligations in the next twelve months and 1� times the stock of short�term debt and cumulative inflows of portfolio investment. Therefore, it is the Fund�s view that the level of foreign currency reserves on November 18, 1997 was adequate.

1(a)(iii) Was India experiencing a reasonable rate of increase in its monetary reserves?

362. Gross foreign currency reserves fell by US$1.9 billion in November 1997. (Net of the RBI�s forward obligations, foreign currency reserves fell by US$2.6 billion that month.) From a broader perspective, however, there has been a reasonable rate of accumulation of reserves since India�s balance-of-payments crisis in 1991. For example, at end�November 1997, reserves were up US$5 billion from a year earlier. (Net of forward obligations, this increase was US$4.5 billion.)

1(b) In connection with responding to these questions, could the IMF indicate what would have constituted a serious decline in India�s monetary reserves, what would have constituted an inadequate, or a very low, level of monetary reserves for India, and what would have constituted a reasonable rate of increase in India�s monetary reserves?

363. A considerable degree of subjective judgment is involved in an assessment of the adequacy of the level and rate of change of reserves. The Fund�s view on this question is based on the size of existing and potential claims on reserves, examined in the context of the country�s economic circumstances. In the case of India, policy has prudently aimed at ensuring that reserve coverage is ahead of the sum of outstanding short�term liabilities (by remaining maturity) and potential outflows of portfolio investment. As of November 1997, short�term liabilities (by remaining maturity) and the stock of portfolio investment (after marking�to�market) were estimated at about US$16 billion. Hence, a decline in reserves to significantly below this level would be considered serious, and such levels could be deemed inadequate or very low. In case reserves were deemed to be inadequate at this threshold, any increase in reserves that would bring them above this level should be considered reasonable.

2(a) Could the IMF provide the Panel with any statistical and other factual information relating to India�s balance of payments and monetary reserves which might be relevant in order to enable the Panel to determine whether, as of 18 November 1997, the quantitative restrictions notified by India as being maintained for balance-of-payments reasons did, or did not, exceed those necessary to forestall the threat of, or to stop, a serious decline in its monetary reserves, or, in case its monetary reserves were inadequate, to achieve a reasonable rate of increase in its reserves?

364. India�s overall balance of payments recorded sizable surpluses in 1996/97 and 1997/98, while the current account deficit remained in the range of 1�1� of GDP (see attached table). However, export performance in dollar terms has weakened. Exports grew by 2�% in dollar terms in 1997/98, compared with 4�% in the previous year, markedly below the growth rates recorded in recent years. In contrast, measured in volume terms the performance of exports has been better. Although the performance of exports is partly explained by weaker demand in world markets and sector�specific factors that are expected to be temporary, it has also reflected structural problems such as infrastructure constraints and the lack of reforms in the small�scale sector. ²⁴¹ Imports rose by 5% in dollar terms in 1997/98 (compared with 10% in 1996/97). Declining oil imports (both in volume and dollar terms) were offset by an increase in non�oil imports (up 12�% for the year), partly in response to the relaxation of some controls on consumer goods imports.
365. Despite the slowdown in exports, the external position has remained manageable. Strong inflows of private capital (both portfolio investment and foreign direct investment) boosted foreign currency reserves in 1996/97 by US$5.3 billion to US$22.4 billion (5� months of imports of goods and non�factor services) at end�March 1997. In 1997/98, robust inflows of portfolio investment in the first half of the year turned to modest net outflows in the second half, responding to changes in investor sentiment toward emerging markets following the Asian crisis. Moreover, higher premia for debt issued overseas by Indian corporations discouraged foreign borrowing. However, rising foreign direct investment, driven by longer term considerations, helped maintain a comfortable reserve position.

2(b) Were there any special factors, within the meaning of GATT Article XVIII:9, affecting India�s reserves and its need thereof, that the IMF considers relevant?

366. With respect to special factors, within the meaning of GATT Article XVIII:9, the Fund understands the following factors to be relevant. With the exception of net forward liabilities totalling US$1.4 billion at end�November 1997, there were neither contingent liabilities nor any unusually high obligations affecting India�s reserves. With regard to prospective developments in debt�service payments, amortization and interest payments in 1997/98 and 1998/99 were expected to return to lower levels after peaking in 1995/96 and 1996/97.

3. Noting that these restrictions relate mainly to consumption goods, would relaxation or removal of the restrictions, as of 18 November 1997, have been likely to produce thereupon "conditions justifying the intensification or institution, respectively, of restrictions under paragraph 9 of Article XVIII" (Ad Note to Article XVIII:11)?

367. The Fund�s view remains as indicated in the statement to the WTO Committee on Balance-of-Payments Restrictions (10-11 June 1997), namely that the external situation can be managed using macroeconomic policy instruments alone. Quantitative restrictions (QRs) are not needed for balance-of-payments adjustment and should be removed over a relatively short period of time. The tariffs applied to previously restricted consumer goods imports could initially be kept close to the top of the existing tariff structure, but should be scaled back according to a pre�announced timetable. A time�bound programme for eliminating the remaining QRs over a relatively short period would reduce distortions to investment and promote an efficient, export�oriented consumer goods sector. The macroeconomic policy instruments would need to be complemented by structural measures such as scaling back reservations on certain products for small�scale units and pushing ahead with agricultural reforms.

4. Have there been any external or internal developments affecting the Indian economy since the date of establishment of the Panel that could lead to a modification of the IMF�s answers to questions 1 to 3?

368. There has been a deterioration in the economic outlook and market sentiment over the past few months, and short�term risks have increased. This deterioration stems from both domestic and external factors. The growth momentum has continued to weaken, the Central Government�s fiscal position worsened in 1997/98, and investor confidence has abruptly eroded. At the same time the external environment has become more uncertain. A deeper and more prolonged recession in East Asia could reduce external demand and make an export recovery more difficult. The imposition of sanctions following the nuclear tests in May 1998 and continued financial turbulence in the region have also resulted in greater external vulnerability, including from changes in market sentiment, although foreign currency reserves remained at a relatively comfortable US$24.1 billion (over 5� months of imports) at end�June 1998. These uncertainties undoubtedly add to near�term risks and will require especially close monitoring while the impact of the sanctions and regional developments work their way through the economy. In sum, on the basis of developments thus far, the balance of payments situation is expected to worsen and a decline in reserves (US$2��4 billion) is anticipated for 1998/99. Nevertheless, it remains the Fund view that the external situation can be managed using macroeconomic policy instruments and that quantitative restrictions are not needed for balance-of-payments adjustment.

5(a) If India immediately removed the remaining quantitative restrictions referred to above, would India need to change its development policy in order not to experience a serious decline in its monetary reserves or the threat of a serious decline in its monetary reserves, or (if India were to have inadequate monetary reserves) in order to achieve a reasonable rate of increase in its reserves?

369. Some problems in import substituting sectors and a temporary decline in reserves cannot be ruled out in the event India immediately removed the remaining QRs. As noted in response to question 2 (a), the recent increase in non�oil imports is partly in response to the relaxation of some of the controls on consumer goods imports over the last year. However, there would also be considerable benefits to such a move, if it were implemented in a phased manner over a relatively short period. First, increased customs revenue from the tariffs applied to previously restricted consumer goods imports would contribute toward deficit reduction and could provide the necessary resources for essential spending in infrastructure and the social sectors. Second, a more competitive, efficient, and quality�conscious consumer goods sector could contribute strongly to export growth. Finally, the structural measures advocated in response to question 3 would improve the allocation of investment, promote efficiency, and enhance the growth prospects of the economy.

5(b) Would serious structural adjustment problems, other than balance of payments problems, be likely to result from the removal of these restrictions?

370. It is the Fund�s judgment that removal of the QRs on consumer goods imports would enhance competitive forces and efficiency in the economy, thus promoting trade and growth. Nevertheless, there would be some inevitable adjustment in protected industries, the consequences of which could be exacerbated by existing rigid labor laws for the organized sector. The removal of import restrictions, however, would also provide fresh impetus for reforms in other areas as the existence of certain controls on the domestic economy (such as for small�scale units) would become less meaningful.

India: Balance-of-payments 1994/95-1997/98^a

(US$ million)

	1994/95	1995/96	1996/1997	Est. 1997/98
Current account balance	-3,369	-5,899	-3,661	-6,100
Trade balance	-9,049	-11,359	-14,299	-15,600
Exports, f.o.b.	26,855	32,311	33,764	34,700
Imports, c.i.f.b	35,904	43,670	48,063	50,300
Oil	5,928	7,526	10,036	7,600
Non-oil	29,976	36,144	38,027	42,700
Non-factor services balance	602	-186	2,407	1,263
Receipts	6,135	7,357	8,615	8,947
Payments	5,533	7,543	6,208	7,684
Net investment income	-3,431	-3,205	-3,250	-4,173
Credits	886	1,429	1,073	1,100
Debits	4,317	4,634	4,323	5,274
Interest	4,099	4,315	4,172	4,829
Dividends	218	319	151	444
Transfers, net	8,509	8,851	11,481	12,410
Private transfers, net	8,093	8,506	11,071	12,060
Grants	416	345	410	350
Capital account balance	9,156	4,678	10,456	10,615
Direct investment, net	1,343	2,133	2,524	3,075
Portfolio investment, net	3,579	2,661	3,310	1,600
FII and other, net	1,742	2,009	1,945	955
GDR issues	1,837	652	1,365	645
External assistance	1,526	833	1,109	1,000
Disbursements	3,191	2,933	3,056	3,058
Amortization	1,665	2,050	1,947	2,058
Commercial borrowing	1,030	1,275	1,009	3,500
Disbursements	4,152	4,252	5,732	5,595
Amortization	3,122	2,977	4,723	2,095
Short-term credit, net	393	49	838	-50
NRI deposits, net	172	1,103	3,536	1,140
Rupee debt	-983	-952	-727	-750
Other capital (including errors and omissions)	2,096	-2,474	-1,143	1,100
Overall balance	5,787	-1,221	6,795	4,515
IMF, net	-1,143	-1,715	-977	-615
Increase in gross reserves (-)	-4,644	2,936	-5,818	-3,900
Memorandum items:
Foreign exchange reserves	20,809	17,044	22,367	25,975
In months of imports	7.0	4.7	5.6	6.2
Export value (in US$ terms; per cent change)	18.4	20.3	4.5	2.3
Import value (in US$ terms; per cent change)	34.3	21.6	10.1	5.2
Exports (in volume terms; per cent change)	13.1	12.7	9.0	11.2
Imports (in volume terms; per cent change)	29.2	13.4	12.1	14.8
Current account (per cent of GDP)	-1.1	-1.8	-1.0	-1.6
External debt (per cent of GDP)	32.6	27.6	25.6	24.8
Debt service ratio (per cent)	26.2	24.2	22.2	22.7

a India's financial year runs from 1 April to 31 March.
b Includes interest on trade finance. Excludes personal imports of gold, silver and jewellery.

Source: Data provided by the Indian authorities; and International Monetary Fund estimates.

(iii) Comments of the Parties on the Replies of the IMF to the Panel�s Questions²⁴²

1. United States

371. The United States considered that the IMF�s answers to the Panel�s questions corroborated the evidence that the United States had previously presented to the Panel and established that India�s balance-of-payments situation does not meet the requirements of Article XVIII:B.

(i) India�s Reserves Are Adequate, Not Seriously Declining, and Not Threatened with Serious Decline

372. The IMF�s replies make it clear that India�s balance-of-payments position does not meet the criteria of the proviso to Article XVIII:9. The IMF has found that, as of 18 November 1997, India was neither experiencing nor threatened with a serious decline in its monetary reserves; had adequate reserves; and was achieving a reasonable rate of accumulation of reserves. ²⁴³ These determinations match those made by the Fund during the consultations in the Committee on Balance-of-Payments Restrictions in January and June 1997. ²⁴⁴ As previously explained, these factual determinations are binding on the Panel pursuant to Article XV:2. In the alternative, even if these determinations were not binding on the Panel, they would constitute evidence that India has not rebutted.
373. Indeed, the IMF�s determinations are fully consistent with the other evidence (including evidence from Indian sources) that the United States has furnished to the Panel. For example, the IMF stressed in particular that at the end of 1997 the Government of India utilized macroeconomic tools appropriately to manage its reserve situation, and that therefore India�s currency reserves did not seriously decline nor were they under threat of serious decline in November of 1997. The IMF�s analysis matches exactly the analysis of Dr. Bimal Jalan, Governor of the Reserve Bank of India, who has explained that India made a successful decision to manage its external financial position through a package of monetary policy measures. The IMF also explained that, as of 18 November 1997, India�s reserves appeared to provide sufficient external liquidity and a reasonable degree of protection against unforeseen external shocks. The IMF reached this conclusion by considering the number of months of import cover represented by India�s reserves; the coverage of short-term debt; and the coverage of portfolio investment. Once again, the analysis of the IMF matches the analysis that the Reserve Bank of India applied when it concluded that the level of reserves in August of 1997 was "by any criteria ... comfortable".
374. India argued that in its current economic situation, it was threatened with a return of balance-of-payments difficulties, but the IMF�s answers to the Panel�s questions make clear that India is incorrect. ²⁴⁵ The IMF found explicitly that in its current situation, India is not threatened with a serious decline in its reserves justifying restrictions under Article XVIII:B. In particular, the IMF explained that, on the basis of developments thus far, a decline in India�s reserves of up to US$4 billion is expected for 1998/99. Such a decline would put India�s reserves at approximately US$20 billion at the end of 1998/99. However, the IMF has also explained that, given India�s current economic circumstances, including the level of India�s short-term liabilities and the potential outflows of portfolio investment, a decline in reserves below US$16 billion would be considered serious (and, if reserves did decline below US$16 billion, any increase above that amount would be a reasonable increase). In this connection it is also worth recalling that India declined to advise the Panel what level of reserves India considers adequate; India is therefore in no position to dispute the IMF�s position on this matter.
375. The IMF�s analysis of India�s balance-of-payments situation is more complete than the analysis presented by India. India focused mostly on India�s trade account. ²⁴⁶ The trade account is only one element of the balance of payments, however, and therefore analysis of the trade account in isolation from the other elements, as India has done, does not allow conclusions to be drawn about the balance-of-payments situation as a whole. In the final two pages of its answer, India did turn to the other components of the balance of payments. In doing so, India suggested that it is possible that private transfers and portfolio flows might decline in the future (and presumably that they might therefore not be adequate to cover India�s trade deficit), but it is important to note that India did not quantify or otherwise relate any possible decline in those flows to the trade account or other aspects of its balance of payments. By contrast, the IMF analyzed the entire balance-of-payments situation, and its conclusions are contrary to India�s assertions. In particular, the IMF considered not only the Indian trade account and existing and likely private transfers and portfolio flows, but, unlike India, the IMF also examined and considered the rise in foreign direct investment into India. On the basis of that analysis the IMF made estimates about the overall expected change in India�s reserve position, which (as described in the preceding paragraph) led the IMF to conclude that the change in India�s reserve position would not amount to a serious decline or an inadequate level of reserves. In summary, therefore, the IMF�s answers contradict India�s assertions and provide a more thorough exploration of the factors relevant to India�s current and projected balance-of-payments position.

To continue with Removal of Restrictions Would Justify Such Restrictions

²³⁹ Data on official reserves are published weekly by the RBI. On 13 November 1997, foreign currency reserves were at US$26 billion. Data on the RBI's outstanding net forward sales or purchases are published monthly.

²⁴⁰ India's financial years runs from 1 April to 31 March.

²⁴¹ Small�scale units are defined as manufacturing units in which investment in plant and machinery is less that Rs 30 million (about US$700,000). These units enjoy special protection from both domestic and international competition. About 800 products are reserved for production by small�scale units. The small�scale sector�s products account for roughly half of all exports.

²⁴² The comments are presented in extenso.

²⁴³ In addition, because the IMF found that India was not threatened with a serious decline in its reserves, it concluded a fortiori that the question of whether India might be threatened with an "imminent" decline was moot.

²⁴⁴ WT/BOP/R/22, 3 March 1997 Op. Cit., para. 8, and WT/BOP/R/32, Op. Cit., paras. 10, 13 (IMF statement).

²⁴⁵ As a separate matter, the United States has previously explained its position that this Panel should only consider India's balance-of-payments position as of July 1997, when the United States initiated this dispute by requesting consultations with India. Alternatively, the Panel should look only at the situation on the date this Panel was established, 18 November 1997. The comments in this paragraph should not be interpreted as a change in the United States' position.

²⁴⁶ India inexplicably returns to this argument about its trade deficit even though the United States pointed out that India's currency reserves have grown over the last several years despite an increasing trade deficit.