Chapter 1-B

International Flow of Funds Balance of Payments

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Balance of Payments

How the cross-border flow of funds is recorded in different countries by the monetary authorities.
The statement is a macro-economic one called BOP.
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Structure of BOP
Lists receipts and payments international transactions. of a countrys

Credit balance receipts of foreign exchange from abroad. Debit balance payments in foreign exchange to foreign residents.

Both are equal if entries properly done.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Structure of BOP Compartmentalised into 2 heads. Current account Transfer of real income

Capital account Transfer of funds, without any shift in real income.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Current Account Transactions

Receipts and payments of foreign exchange

Receipts 1. Export of Goods effects flow of foreign exchange into the country
2. Invisibles Non-merchandise trade. Receipts and payments for trade in services like travel and tourism, transport, etc., investment income like interest and dividend, and unilateral transfers, like pension, remittances, gifts, etc. for which no specific services are rendered. Unlike exports and imports, in unilateral transfers flow of funds are in one direction that is direction of payment. 3. Non-monetary movement of gold
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Current Account Transactions

Payments 1. Import of Goods causes outflow of foreign exchange from the country 2. Invisibles 3. Non-monetary movement of gold

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Current Account Transactions

Difference between exports and imports is balance of trade (BOT). Export exceeds import BOT is surplus Import exceeds export BOT is deficit Chapter-1 Problems.doc Problem-1

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Current Account Transactions

Movement of gold may be monetary or nonmonetary. Monetary movement sale or purchase that influences international monetary reserves.

Non-monetary movement sale and purchase is done for industrial purposes that are shown in the current account, either separately or with trade in merchandise.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Current Account Transactions

On account of these transactions, if credit side is greater than debit side, balance of current account turns surplus. For the reverse, it shows a deficit.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

Capital Account Transactions

Long term and short term inflow and outflow of funds under capital account receipt and payment. Long term transactions maturity periods of over 1 year

Short term transactions Less than 1 year

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

Credit side Official and private foreign borrowings, net of repayments, direct and portfolio investment and short term investment into the country. Bank balances of non-residents held here.

Debit side Disinvestment of capital invested here, investments abroad, loans to foreign governments and parties, bank balances held abroad.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

Credit side of current account + credit side of long term capital account transactions, compared with Debit side of current account + long term capital account,

Difference = Basic Balance

May be negative or positive

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

Table-2.1 indicates a deficit basic balance of $ 5 billion. (to be photocopied page-16) In India and many other countries, basic balance is not shown in the BOP statement.

Debit and credit sides of the short term capital account transactions added.
Then Capital account is balanced. Chapter-1 Problems.doc Problem-2
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

After balancing, errors and omissions (statistical discrepancy) are mentioned. Compare both sides. Difference is the overall balance

Errors and omissions may be due to

Data collection difficulties Different sources having different approaches Some figures based on estimates, like travel and tourism on basis of sample cases.
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

Example: Trade figures compiled by RBI differ from that of Director-General of Commercial Intelligence and Statistics Movement of capital may precede or follow transactions for finance. Example: Payment for goods shipped in March may be received in April. March figure on shipment will differ from that based on actual payment. Prof. Suprio Ghatak, Amity Business School, Amity University Haryana
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Capital Account Transactions

When overall balance is deficit, monetary authorities arrange for capital flows. Like official borrowings or purchases (drawings) from IMF.

Accommodating or compensatory capital flow, if taken for meeting BOP deficit.

Autonomous capital flow takes place regardless of such considerations.
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Capital Account Transactions

Foreigner paying back the loan or inflow of FDI is an appropriate example. Autonomous capital inflow goes above-the-line. Accommodating capital inflow goes below-the-line.

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Home Work
Chapter-1 Problems.doc Problem-3

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Self-Study
Official Reserves Account Equilibrium, Disequilibrium and Adjustment Pages 18 to 20 Chapter-2 IFM by V. Saran

Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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Assignment-2
1. 2. Discuss Capital Account Convertibility Discuss the following cases.

a) Case Study-1 Indias BOP During Liberal Economic Regime b) Case Study-2 Capital Account Convertibility in India Pages-26 to 36
Prof. Suprio Ghatak, Amity Business School, Amity University Haryana

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