The structure of the balance of payments

For many A level students this is their least favourite topic. Don't panic! All will be made clear! The key point is to understand the distinction between the current account and the capital account and understand the link between them. Here goes then! The balance of payments measures all flows of money between the UK and the rest of the world. The current account records the movements of all goods and services into and out of the UK. The capital account measures all capital flows carried out by individuals, firms and governments (usually for investment purposes

The current account The current account records the movement of all goods and services into and out of the UK. Some of you may be thinking, "what happened to the visibles and invisibles?" While some examiners might let you get away with using these terms, these old terms have not been used officially for almost five years!

Trade in goods
The visible section is now called the trade in goods section. Both names are equally easy to remember. This section records all trade in goods, hence the name! Another way of thinking about it is that all goods are visible, hence the old name. There are hundreds of different items that fall under this category. Oil is one of the biggest, especially given that the UK has been a net exporter of oil for the last 20 years. All manufactured goods are included, like cars, all household appliances, computers and anything else you can think of. Textbooks often refer to 'semimanufactures'. These are items that have not quite become finished manufactures. Car parts might be an example. All raw materials that are needed for any production process are also included, as are all food items. If the UK sells a Rover car (made in Britain) to someone in a French car showroom, then this is called an export and appears as an inflow of money (+) in the 'trade in goods' section of the current account. If Renault (the French car company) sell a car to someone in a British car showroom, then this is called an import and appears as an outflow of money (-) in the same section. It is very important to follow the money. When the UK exports a car, the car may well go abroad, but the payment for the car flows into the UK, hence the plus sign (+) in the current account. When the UK imports a French Renault, the car

comes into the UK, but the payment flows out of the country, hence the minus sign (-) in the current account. The 'trade in goods' balance is often referred to as the trade balance. Adding up the total value of exports of goods and subtracting the total value of imports of goods calculate this. In the case of the UK, this balance is nearly always negative, so it is known as the trade deficit; the UK always imports more goods than it exports.

Trade in services
In the days of 'visible' and 'invisible', services, investment income and transfers were all lumped in together in the 'invisibles' section. The current account only had two sections: visible and invisible. Trade in services is now a separate section, as are the other two categories (see next two sub-sections). Although it is not quite so easy to picture international trade in services (only about 20% of all services are potentially tradable), good examples include financial services (e.g. banking and insurance), transport services (particularly shipping), law, accountancy, management consultancy and tourism. Again, it is important to follow the money. Unlike the 'trade in goods' section, where the good goes one way and the money goes the other, with the 'trade in services' section the money tends to follow the service. If a British person goes on holiday to France flying with Air France, all payments will count as imports because the money flows out of the UK (-). The payment for the flight goes back to France, and any money actually spent on food, drink and hotels ends up in France.

Investment income
This also used to be under the old 'invisibles'. You may know it as 'IPDs' or interest, profit and dividends. The new title of investment income makes sense because interest, profit and dividends are all forms of income earned on investments. Interest is earned on bank deposits and government bonds, profit is earned from investments in a business enterprise and dividends are earned annually on shares. The key point to note here is that these incomes (annual flows of money) are derived from invested capital (stocks of wealth) that appears in the capital account. This is the crucial link between the current and the capital accounts. Interest is earned on money invested in the 'other investment' section of the capital account, and the bonds in the 'portfolio investment' section of the capital account (see the green line on the diagram above). Profit is earned on

money invested in businesses in the 'direct investment' section of the capital account (see the red line of the diagram above). Dividends are earned from the investment in shares that appear in the 'portfolio investment' section of the capital account (see the blue line on the diagram above).

Transfers
This also used to be under the old 'invisibles'. Transfers are now separated into a separate section because they are different in the sense that they do not reflect any actual trade. This section is split into two; government transfers and transfers made by other sectors. Government transfers include contributions to the EU (most of which is used for the Common Agricultural Policy or CAP) and foreign aid. These are flows of money out of the UK (-). The 'other sectors' section many highlights the transfer of assets by individuals to foreign bank accounts. The capital account The Capital account measures all the short term and long term monetary transactions between the UK and the rest of the world. Generally, these flows of money are associated with saving and investment, but speculation has become a big part of the account in recent years. Officially, the name has changed to 'Capital and Financial Accounts', but examiners seem to be happy for you to use 'capital account', probably because it is a lot less hassle to write down under exam conditions! Here are the four main sections.

Direct investment
This refers to money that flows across national boundaries for the purpose of investing in a business enterprise. Essentially, it records the transfer of ownership of UK or foreign businesses. It also records money invested abroad for a new business venture. When Marks & Spencer build a new store in, say, Hong Kong, this will count as an outflow of money from the UK (-) in the direct investment section of the capital account. When Nissan built its factory in Sunderland, this counted as an inflow of money (+) in the same section. Note that earnings from these investments (profit) appear in the investment income section of the current account. The initial investment by M & S in Hong Kong will appear as a one off outflow of money from the UK (-) in the capital account, but each subsequent year M & S should make profits (hopefully!). These will appear as inflows of money into the UK (+) in the investment income section of the current account.

Portfolio investment
This is money that flows across national boundaries for the purpose of investing in shares and bonds. If someone in the UK buys some shares in an American company, this will count as an outflow of money from the UK (-) in the portfolio investment section of the capital account. If an American buys some shares in a British company, this will count as an inflow of money into the UK (+) in the same section Again, note that the earnings from these shares and bonds (dividends and interest) will appear, in subsequent years, in the investment income section of the current account. For as long as the UK citizen holds onto the American shares, he will receive an annual dividend, which will represent an inflow of money into the UK (+) on the investment income section of the current account.

Other investment
This section can be quite hectic because it includes short-term 'hot money' banking flows. It also includes net government borrowing from foreigners.

Official reserves
This refers to the reserves of gold and foreign currencies held by the Bank of England for use by the government. The government might use some of their reserves to artificially manipulate the value of the pound; although this rarely happens any more because the pound is freely floating and the government do not seem particularly keen to intervene in currency markets. After the last government's horrific experience of trying to defend the pound within the Exchange Rate Mechanism, all governments since have left the pound alone to find its own level in the currency markets. Net errors and omissions Theoretically, the net errors and omissions item should always equal zero. That it rarely does reflects the fact that it is very difficult to collect all of the data required for the balance of payments in a totally accurate fashion. Millions of pieces of information have to be collected from around the world. There is often a time lag as well. It is interesting to note that when past figures for the balance of payments are revised as the years go by, the figures for 'net errors and omissions' get smaller and smaller as the errors are found and corrected.

India's Balance of Payments (2008-09)

BALANCE OF PAYMENT
Shrinking foreign trade
INDIAs trade deficit during the first three months of current fiscal year (200910) on a balance of payments (BoP) basis was large due to the steeper decline in the pace of exports than that of imports The trade deficit on a BoP basis in Q1 (US$ 26.0 billion) was, however, less than that in Q1 of 2008-09 (US$ 31.4 billion). This is revealed in e report of the countrys central banking authority Reserve Bank of India

The key features of Indias BoP that emerged in Q1 of fiscal 2009-10 were:
(i) The decline in exports which started since October 2008 continued during the first quarter of 2009-10. Import payments, on a BoP basis, also continued its declining trend mainly due to lower oil import bill; (ii) Private transfer receipts remained buoyant and increased by 9.4 per cent to US$ 13.3 billion during Q1 of 2009-10. Exports of software services, however, declined during Q1 of 2009-10; (iii) Despite net invisibles surplus at US$ 20.2 billion, the large trade deficit (US$ 26.0 billion) mainly on account of sharp decline in exports led to a current account deficit of US$ 5.8 billion in Q1 of 2009-10 (US$ 9.0 billion during Q1 of 2008-09); (iv) With the revival in capital inflows to India, particularly foreign investments, the capital account showed a turnaround from a negative balance in last two quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10; (v) Portfolio investment witnessed a sharp turnaround from net outflows of US$ 2.7 billion in Q4 of 2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-10; (vi) NRI deposits also witnessed higher inflows reflecting the positive impact of the revisions in the ceiling interest rate on NRI deposits; (vii) There was a marginal increase in reserves on BoP basis (i.e., excluding valuation) during Q1 of 2009-10. However, the foreign exchange reserves including valuation increased by US$ 13.2 billion during Q1 of 2009-10 implying that the increase in reserves during this period was mainly due to valuation gains as the US dollar has depreciated against major currencies.

Major Items of India's Balance of Payments (US$ million)

(2007-08) (PR) Exports Imports Trade Balance Invisibles, net Current Account Balance Capital Account* 166163 257789 -91626 74592 -17034 109198 (2008-09) (P) 175184 294587 -119403 89587 -29817 9737 April-June (200809) (PR) 49120 80545 -31425 22406 -9019 11254 38789 64775 -25986 20179 -5808 5923 April-June (200910) (P)

Change in Reserves# (+ indicates -92164 increase;- indicates decrease)

20080

-2235

-115

Invisibles
(i) During Q1 of 2009-10, invisibles receipts declined marginally, while invisibles payments recorded a positive growth). In net terms, the invisibles balance at US$ 20.2 billion was lower than that in the corresponding period of the previous year (US$ 22.4 billion), though higher than that in Q4 of 2008-09 (US$ 19.3 billion).

Invisibles Receipts
(i) Invisibles receipts registered a marginal decline of 0.7 per cent in Q1 of 200910 (as against a higher growth of 30.3 per cent in Q1 of 2008-09) on account of a decline in almost all categories of services except insurance and financial services and a decline of 20.3 per cent in investment income receipts. (ii) Exports of software services declined by 11.5 per cent during Q1 of 2009-10 as against an increase of 37.6 per cent in Q1 of 2008-09. According to the NASSCOM, software services exports are projected to grow by 4 to 7 per cent to US$ 48 to 50 billion during the financial year 2009-10. (iii) Travel receipts at US$ 2.3 billion during Q1 of 2009-10 declined by 8.7 per cent as against an increase of 19.9 per cent in Q1 of 2008-09 reflecting a slowdown in tourist arrivals in the country since November 2008. According to the data released by the Ministry of Tourism, foreign tourist arrivals declined by 1.8

per cent in Q1 of 2009-10.

Invisibles Payments
(i) Invisibles payments recorded a positive growth of 11.9 per cent in Q1 of 200910 (13.5 per cent in Q1 of 2008-09) mainly due to growth in payments under services and income account. In the services account, however, payments under travel, transportation, G.N.I.E. and software services recorded a negative growth in Q1 of 2009-10. (ii) Investment income payments (include mainly the interest payments on commercial borrowings, external assistance and non-resident deposits, and reinvested earnings of the foreign direct investment (FDI) enterprises operating in India) increased marginally to US$ 4.4 billion during Q1 of 2009-10 (US$ 4.1 billion in Q1 of 2008-09) mainly due to increased reinvested earnings of FDI companies in India (Table 8).

Invisibles Balance
(iii) A combined effect of decline in invisibles receipts and increase in invisibles payments led to marginally lower net invisibles (invisibles receipts minus invisibles payments) at US$ 20.2 billion in Q1 of 2009-10 than that in the corresponding period of the previous year (US$ 22.4 billion) (Table 3). At this level, however, the invisibles surplus financed about 77.7 per cent of trade deficit during Q1 of 2009-10 (71.3 per cent during Q1 of 2008-09).

Current Account Deficit

i) Despite net invisibles surplus, the large trade deficit mainly on account of sharp decline in exports led to a current account deficit of US$ 5.8 billion in Q1 of 200910 (US$ 9.0 billion during Q1 of 2008-09).

Capital Account and Reserves i)

The gross capital inflows to India revived during Q1 of 2009-10 as compared to the last two quarters of 2008-09 manifesting confidence in Indias long-term growth prospects. The gross inflows were, however, at US$ 78.5 billion as compared to US$ 90.9 billion in Q1 of 2008-09 mainly led by inflows under FIIs, FDI and NRI deposits. Gross capital outflows during Q1 of 2009-10 stood lower at US$ 71.8 billion as against US$ 79.7 billion in Q1 of 2008-09. (ii) With the revival in capital inflows to India, particularly foreign investments, the capital account showed a turnaround from a negative balance in last two quarters of 2008-09 to a positive balance of US$ 6.7 billion during Q1 of 2009-10 (US$ 11.1 billion in Q1 of 2008-09). (iv) Net FDI inflows (net inward FDI minus net outward FDI) amounted to US$ 6.8 billion in Q1 of 2009-10 (US$ 9.0 billion in Q1 of 2008-09). Net inward FDI stood at US$ 9.5 billion during Q1 of 2009-10 (US$ 11.9 billion in Q1 of 2008-09). Net outward FDI stood at US$ 2.6 billion in Q1 of 2009-10 as compared with US$ 2.9

billion in Q1 of 2008-09.

(v) During Q1 of 2009-10, FDI to India was channeled mainly into manufacturing sector (19.2 per cent), real estate activities (15.6 per cent), financial services (15.4 per cent), construction (12.2 per cent) and business services (11.7 per cent). Mauritius continued to be the major source of FDI during Q1 of 2009-10 with a share of 48.9 per cent followed by USA at 12.8 per cent. (vi) Portfolio investment primarily comprising foreign institutional investors (FIIs) investments and American Depository Receipts (ADRs)/Global Depository Receipts (GDRs) witnessed a sharp turnaround from net outflows of US$ 2.7 billion in Q4 of 2008-09 to net inflows of US$ 8.3 billion during Q1 of 2009-10. During 2009-10, the sharp increase in FII inflows could be attributed to the recovery of domestic stock market in line with international stock markets, better corporate performance, political stability and comparatively better growth prospects. (vii) The gross disbursements of short-term trade credit was US$ 10.1 billion during Q1 of 2009-10 almost same in Q1 of 2008-09. The repayments of shortterm trade credits, however, were very high at US$ 13.2 billion in Q1 of 2009-10 (US$ 7.8 billion in Q1 of 2008-09). As a result, there were net outflows of US$ 3.1 billion under short-term trade credit during Q1 of 2009-10 (inflows of US$ 2.4 billion in Q1 of 2008-09). (viii) Banking capital mainly consists of foreign assets and liabilities of commercial banks. NRI deposits constitute major part of the foreign liabilities. Banking capital (net), including NRI deposits, were negative at US$ 3.4 billion during Q1 of 200910 as against a positive net inflow of US$ 2.7 billion during Q1 of 2008-09. Among the components of banking capital, NRI deposits witnessed higher inflows of US$ 1.8 billion in Q1 of 2009-10 (net inflows of US$ 0.8 billion in Q1 of 2008-09) reflecting the positive impact of the revisions in the ceiling interest rate on NRI deposits.

Balance of Payments (BoP) Merchandise Trade

Exports (i) The decline in exports which started since October 2008 continued during the first quarter of 2009-10. On a BoP basis, Indias merchandise exports recorded a decline of 21.0 per cent in Q1 of 2009-10 as against an increase of 43.0 per cent in Q1 of 2008-09. (ii) As per the data released by the Directorate General of Commercial Intelligence and Statistics (DGCI&S), merchandise exports declined by 26.4 per cent in Q1 of 2009-10 as against a higher growth of 37.4 per cent in Q1 of 2008-

09, reflecting fall in demand worldwide due to the global economic crisis.

EXPORTS & IMPORTS (April-August, FY 2009-10)

In $ Million Exports including re-exports 2008-09 2009-10 Growth 2009-10/2008-2009 (percent) Imports 2008-09 2009-10 Growth 2009-10/2008-2009 (percent) Trade Balance 2008-09 2009-10 -60732 -38171 -256200 -185393 153691 102300 648041 497108 92959 64129 -31.0 391841 311715 -20.4 In Rs Crore

-33.4

-23.3

Imports
(i) Import payments, on a BoP basis, also continued its declining trend. Imports declined by 19.6 per cent in Q1 of 2009-10 as against a positive growth of 42.9 per cent in Q1 of 2008-09. (ii) According to the data released by the DGCI&S, the decline in imports is mainly attributed to the sharp fall in oil import payments due to lower crude oil prices during Q1 of 2009-10 (US$ 63.9 per barrel in Q1 of 2009-10 as against US$ 119 per barrel in Q1 of 2008-09). POL imports recorded a sharp decline of 56.9 per cent during Q1 of 2009-10 as against a sharp increase of 74.2 per cent during Q1 of

2008-09. As per the data released by the Ministry of Petroleum & Natural Gas, Government of India, POL imports showed a decline of 45.1 per cent during Q1 of 2009-10 despite a quantity growth of 10 per cent mainly due to lower crude oil price.

iii) According to the DGCI&S data, out of the total decline in imports of US$ 26.7 billion in Q1 of 2009-10 over the corresponding previous quarter, oil imports declined by US$ 16.8 billion (share of 63.1 per cent in the decline in total imports during Q1 of 2009-10 as against 59.8 per cent share in total increase in imports during Q1 of 2008-09), while non-oil imports decreased by US$ 9.8 billion (share of 36.9 per cent in the decline in total imports during Q1 of 2009-10 as against 40.2 per cent share in total increase in imports during Q1 of 2008-09).

Inflows & Outflows from NRI Deposits and Local Withdrawals (In $ million)
Inflows 2006-07 (R) 2007-08 (PR) 2008-09 (P) 2008-09 (Q1) (PR) 2009-10 (Q1) (P) 19914 29401 37,089 9063 11172 15593 29222 32,799 8249 9354 Outflows Local Withdrawals 13208 18919 20,617 5157 5568

P: Preliminary, PR: Partially revised. R: revised

Variation in Reserves (i) The increase in foreign exchange reserves on a BoP basis (i.e., excluding valuation) was US$ 115 million in Q1 of 2009-10 (as against an accretion to reserves of US$ 2,235 million in Q1 of 2008-09). However, the foreign exchange reserves including valuation increased by US$ 13.2 billion during Q1 of 2009-10 implying that the increase in reserves during this period was mainly due to valuation gains as the US dollar has depreciated against major currencies. [A Press Release on the sources of variation in foreign exchange reserves is separately issued]. (ii) At the end of June 2009, outstanding foreign exchange reserves stood at US$ 265.1 billion