Knowledge Nugget UPSC- BoP, Current account, capital account, rupee

Let’s get back to basics: understand BoP, its components, forex reserve, and look at the BoP crisis of 1991.

Key takeaways:

1. The Balance of Payments (BoP) is essentially a ledger of a country’s transactions with the rest of the world. As Indians trade and transact with the rest of the world, money flows in and out of the country.

2. The BoP shows how much money went out of the country and how much money came in. All the money coming into the country is marked positive and all the money going out is marked negative. The BoP matters because it captures the relative demand of the rupee vis-à-vis the demand for foreign currencies.

3. Let’s understand this through an example. Assume that there are only two countries in the world, India and the US. Every time an Indian wanted to buy an American good or service, or to invest in the US, they would have to hand over a certain number of rupees to first buy the dollars needed to complete that transaction.

4. In the end, the exchange rate would be determined by the relative demand of the two currencies — if Indians demanded more dollars than Americans demanded rupees, the ‘price’ (or the exchange rate) of the dollar relative to the rupee would go up.

5. Constituents of the BoP: It has two main ‘accounts’ — Current Account and Capital Account.

(i) Current Account: It records transactions that are of a ‘current’ nature. There are two subdivisions of the current account: the trade of goods, and the trade of services.

(a) The trade or merchandise account refers to the export and import of physical goods (cars or wheat or gadgets, etc), which determines the ‘balance of trade’. If India imports more goods than it exports, it is running a trade deficit, which is shown by a negative sign.

(b) Trade of services: It is made up of ‘Invisibles’ trade as it refers to trade in services and other transactions that are typically ‘not visible’ in the same way as trade of goods. It includes services (e.g., banking, IT, tourism, etc.); transfers (e.g., Indians working in foreign countries sending back money to families back home); and incomes (such as the income earned from investments).

(ii) Capital Account: The capital account captures transactions that are less about current consumption and more about investments, such as Foreign Direct Investment (FDI) and Foreign Institutional Investments (FII).

6. When there is a BoP surplus — net of current and capital account — implying billions of dollars coming into the country, the RBI sucks up these dollars and adds to its foreign exchange reserves. If the RBI did not do this, the rupee’s exchange rate would appreciate — and undermine the competitiveness of India’s exports.

7. Harish Damodaran in The Indian Express has written that India has a structural CAD problem in its external balance of payments (BOP) transactions. In the last 25 years and more, there have been only four fiscal years (April-March) of surpluses on the current account: 2001-02 ($3.4 billion), 2002-03 ($6.3 billion), 2003-04 ($14.1 billion) and 2020-21 ($23.9 billion). In all other years, the current account has been in deficit.

8. From a strictly BOP perspective, the CAD has rarely posed problems for the Indian economy, while actually falling from $25.3 billion in April-September 2024 to $15.1 billion in April-September 2025.

9. The rupee’s slide in the past one year and recent depreciation amid the rise in oil prices and fears over inflation in the wake of the West Asia conflict, has been more courtesy of the capital, not current, account of the BOP, writes Damodaran.

10. Forex reserves were at $709.75 billion as of March 13, 2026, according to RBI data This can cover roughly over 12 months of imports, which is considered very comfortable — anything above 8–10 months is typically strong by global standards.

BEYOND THE NUGGET: BoP crisis in 1991

1. The ongoing West Asian conflict is not the first instance of India facing pressure on the rupee and foreign exchange reserves. Since the 1991 balance of payments crisis in India, the country has encountered similar stresses on multiple occasions.

2. In 1991, during the balance of payments crisis, India’s foreign exchange reserves had fallen to critically low levels — barely enough to cover about 2–3 weeks of imports. Since then, the Asian financial crisis, global financial crisis, the taper tantrum in the US, the COVID pandemic and the Russia-Ukraine war have put pressure on the rupee and forex reserves.

3. A sharp jump in oil prices in August 1990 had led to an acute economic crisis, turning the balance of payment situation unmanageable, depleting foreign exchange reserves along with massive capital outflows and pushing India closer to a possibility of default.

4. By mid-1991, the BoP crisis turned into a crisis of confidence in the country’s ability to manage the BoP. Signs of the payment crisis became evident in the second half of 1990–91 when the Gulf war led to a sharp increase in the oil prices.

5. The crisis then forced the government — led by then Prime Minister PV Narasimha Rao and Finance Minister Manmohan Singh — to announce the new Industrial Policy Resolution, abolition of most trade licences, full rupee convertibility on the current account, and opening up the country to foreign direct investment.

Post Read Question

With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (UPSC CSE 2014)

1. Balance of trade

2. Foreign assets

3. Balance of invisibles

4. Special Drawing Rights

Select the correct answer using the code given below:

(a) 1 only

(b) 2 and 3

(c) 1 and 3

(d) 1, 2 and 4

(2) Consider the following actions which the Government can take: (UPSC CSE 2011) 

1. Devaluing the domestic currency.

2. Reduction in the export subsidy.

3. Adopting suitable policies which attract greater FDI and more funds from FIIs.

Which of the above action/actions can help in reducing the current account deficit?

(a) 1 and 2

(b) 2 and 3

(c) 3 only

(d) 1 and 3

(Sources: How to read India’s Balance of Payments, Why the rupee has a capital account problem, Iran war stress on rupee: How India has used forex reserves to tide over past global uncertainties, Rupee breaches the 90-mark: What’s driving the slide against the dollar)

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