Balance of Payment

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Contents
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About BoP

About BoT
Significance of BoP Functions of BoP

About Current Account

Indias BoP Standards Components of BoP

Equilibrium of BoP
Measures for Controlling of BoP
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What is the Balance of Payments BoP?

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The Balance of Payments is a record of economic

transactions between citizens of one nation and the citizens of the rest of the world over the period of a year. The balance of payments (BOP) records financial transactions made between consumers, businesses and the government in one country with others. It is also a balance sheet of receipts & payments of a country during an accounting year. It takes into account the export and import of both visible and invisible items.
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Balance of Trade
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It deals with exports and imports of visible items only. It takes into account only merchandise exports & imports

only.

On the other hand, Balance of Trade considers the value of exports and imports of visible items i.e. merchandise only. -- It does not take into account trade of invisible items. -- Thus Balance of Trade is a sub-set of Balance of Payment.

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What is the Balance of Payments?

The Balance of Payment must equal zero.

Current Account Plus the

Financial Equals Zero CA + FA = 0 How does this work?

I abbreviate Balance of Payments BOP to remind you that the Balance of Payments must equal 0.

The Current Account shows imports and exports.

The Financial Account shows inflows and outflows of financial capital. 5/1/2014

Debits and Credits

Debit Import Buy Foreign Capital Credit Export Foreign Capital flows in

Debit (-) Any transaction that supplies the countrys currency

Credit (+) Any transaction that creates a demand for the countrys currency

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Significance of BoP
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Income Growth

External orientation
Relationship between trade in goods and services

and direct investment flows Links between the exchange rate and the current and financial accounts International banking transactions Financial market developments External debt situation
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Functions of BoP
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There are several functions of balance of payment: It is used to summarize all international economic transactions for that country during a specific time period, usually a year. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits). BOP is one of the major indicator of a country s status in international trade, with net capital out flow.

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Current Account
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The Current Account consists of four parts: 1. Trade in goods: such as foods, drinks, cars, shoes. This shows the relationship between revenue from exports and costs on imports. Typically the UK spends more on imports than it receives in Exports. This means that they Trade in Goods balance is normally a deficit. 2. Trade in Services: such as aviation or banking. The UK typically has a surplus in these areas, which is different from the trade in goods. This means that we export more services than we import. 3. Investment Income: This covers profits, interest and dividends. For example if a UK citizen owns shares in an American company, the dividend will be sent back to the UK as a credit. 4. Current Transfers: This is simply payments to and from a nation in which there is no transfer of goods of services. This can be for example payments from the UK Government to the EU.
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What does a current account deficit mean?

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Running a deficit on the current account means that

the country is not paying its way in the global economy. There is a net outflow of demand and income from the circular flow of income and spending.

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What are the main Causes of Current Account Deficit ?

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High income elasticity of demand for imports when consumer

spending is strong, the volume of imports grows quickly. because of de-industrialization.

Long-term decline in the capacity of manufacturing industry

Others: -

Decrease in exports: due to Inflation Energy crises Increase in cost of production Backward technology etc

Increase in imports: due to Inflation Decrease in domestic production etc

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Effect on Economy
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If 1- Receipts > Payments surplus or favorable balance of payments positive effect on economy. 2- Payments > Receipts Deficits balance of payments unfavorable for economy

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Structure of Indias BoP Standard

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A. Current Account

I. Merchandise i) Private ii) Govt. II. Invisibles 1. Non-monetary gold 2. Travel 3. Transportation 4. Insurance 5. Investment Income 6. Govt. not included anywhere 7. Miscellaneous 8. Transfers Receipts / Payments i) Official ii) Private Total Current Account ( I + II )

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Contd.
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B. Capital Account

1. Private i) Long-term ii) Short-term 2. Banking 3. Official i) Loans ii) Amortisation iii) Miscellaneous Total Capital account (1 + 2 + 3 ) C. I.M.F. D. S.D.R. Allocation E. Capital Account, I.M.F. & S.D.R. Allocation
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Contd.
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F. Total Current Account , Capital Account , I.M.F. & S.D.R. Allocation . G. Errors & Omissions H. Reserves and Monetary Gold

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Component of BoP
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UNILATERAL TRANSFERS A/C

LONG TERM CAPITAL A/C

SHORT TERM CAPITAL A/C

SERVICES A/C

GOODS A/C

BALANCE OF PAYMENTS

INTERNATIO NAL LIQUIDITY A/C

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Goods Account
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Items of foreign exchange spending's /payments

earnings

and

Includes value of merchandise exports and the value of merchandise imports These are visible items

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Service Account
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Records all the services exported & imported by country in a year Services are intangible (invisible) items in bop Why invisible-??? Because unlike goods, they are not recorded in the port of entry

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Contd.
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Service transactions include

(a) Transportation, banking, insurance receipts &

payments from & to foreign countries. (b) tourism, travel services & tourist purchases of goods & services received from foreign tourists to India and Indian tourists gone abroad.

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Contd.
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(C) Expenses of students studying abroad and receipts from foreign students studying in home country (D) Expenses of military personnel stationed abroad and from similar personnel from overseas who are stationed in the home country

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Unilateral Transfer Account

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This account includes all gifts, grants and reparation receipts and payments to foreign countries Unilateral transfer consist of 2 types of transfers(a) government transfers, (b) private transfers

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Contd.
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(a) Government transfers foreign aids receipts.

Eg:- US FOREIGN AID to INDIA. (b) Private transfers funds received from or remitted to foreign countries on person-toperson basis Eg:- A Indian settled in Australia remitting $100 a month to his aged parents in India is a unilateral (pvt) transfer inflow item in the Indian BOP

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Long term Capital Account

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Includes the amount of capital that has moved into or out of the country in a year. Long-term capital account includes the following categories: (a) private direct investment (B) private portfolio investment (C)government loans to foreign governments

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Contd..
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(a) Private direct investment investments done by

Indian (persons & firms) in foreign countries and vise versa b) Private portfolio investment investments done by Indian citizens and firms in foreign securities or stocks or bonds or shares and vise versa c) Govt loans to foreign investments

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Short term Capital Account

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Bank deposits & other short term payments and credit arrangements fall into this category. Items which fall due on demand or in less than 1 year

These errors include: (a) statistical & recording errors (b) smuggling

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International Liquidity Account

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Records net changes in foreign reserves. Lists international acceptable means international obligations.

of

settling

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UNDERSTANDING INTERNATIONAL LIQUIDITY ACCOUNT

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SURPLUS CASE:- ($ MILLION)

CREDIT (RECEIPTS) DEBIT (PAYMENTS)

1
2 3 4 5 6 7

GOODS ACCOUNT
SERVICES ACCOUNT UNILATERAL TRANSFERS ACCOUNTS LONG TERM CAPITAL ACCOUNT SHORT TERM CAPITAL ACCOUNT INTERNATIONAL LIQUIDITY ACCOUNT BALANCE OF PAYMENTS

1500
500 100 900 500

800
1400 120 400 630

150
3500 3500
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UNDERSTANDING INTERNATIONAL LIQUIDITY ACCOUNT

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Surplus case:- ($ million)

A) B) C)

The logic of $150 million as debit/payment is Purchase of import of gold worth $150 million; or Net addition to accumulation of foreign reserves of $150 million; or Capital lending in the sum of $150 million to other countries on short term or long term basis

DEBIT ENTRY = SURPLUS

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UNDERSTANDING INTERNATIONAL LIQUIDITY ACCOUNT

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DEFICIT CASE:- ($ MILLION)

CREDIT (RECEIPTS) 1 2 3 4 5 6 7 GOODS ACCOUNT SERVICES ACCOUNT UNILATERAL TRANSFERS ACCOUNTS LONG TERM CAPITAL ACCOUNT SHORT TERM CAPITAL ACCOUNT INTERNATIONAL LIQUIDITY ACCOUNT BALANCE OF PAYMENTS 800 1400 120 400 630 DEBIT (PAYMENTS) 1500 500 100 900 500

150
3500 3500
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UNDERSTANDING INTERNATIONAL LIQUIDITY ACCOUNT

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A) B) C)

Deficit case:- ($ million) Deficit is financed by Selling or exporting gold worth $150 million; or Drawing down upon the past accumulated foreign reserves = $150 million; or Borrowing capital in the sum of $150 million on short term or long term basis from friendly countries or international institutions like imf etc

CREDIT ENTRY = DEFICIT

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BoP Schedule - Sample

MAJOR ACCOUNTS CREDITS DEBITS (Payments) Net Surplus (+) or Deficit (-)

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GOODS A/C
SERVICES A/C BALANCE OF TRADE (I + II) UNILATERAL TRANSFERS ACCOUNT BALANCE OF PAYMENTS ON CURRENT A/C (I+II+III) LONG TERM CAPITAL ACCOUNT BASIC BALANCE (I + II + III + IV) SHORT TERM CAPITAL ACCOUNT BALANCE OF PAYMENTS ON CAPITAL ACCOUNT (IV + V) OVERALL BALANCE OF PAYMENTS (B+D) INTERNATIONAL LIQUIDITY ACCOUNT BALANCE OF PAYMENTS ACCOUNTING BALANCE

(Receipts)

200
100

180
250

20
-150

300
300 600 150

430
120 550 120

-130
180 50 30

750
50

670
40

80
10

200 800

160 710

40 90

90
800 800
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Equilibrium in Balance of Payment

-- When demand for and supply of foreign currency in a nation in a given period are equal it is viewed as equilibrium position in BOP. -- But in case of most of nations, it is not so i.e. they either enjoy a surplus BOP or deficit. It represents disequilibrium in Balance of Nations. Disequilibrium in BOP are caused by : * Economic factors * Political factors and * Sociological factors.

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* Economic Factors may cause 1) Development Disequilibrium 2) Cyclical Disequilibrium 3) Secular disequilibrium and 4) Structural Disequilibrium

1. Development Disequilibrium
-- Developing countries mostly take up activities like establishment of industries, infrastructure etc. which require greater imports of capital goods, machinery etc. -- Thus increased developmental activities result in greater outflow of foreign currency leading to deficit in BOP.

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2. Cyclical Disequilibrium Due to fluctuations in business cycle in a country , value of imports of consumer goods and then consumer goods go up or down periodically, both of which lead to disequilibrium in BOP. 3. Secular Disequilibrium It mostly happens in developed countries where disposable income of people are very high. It raises in turn the cost of production and price of goods and services. -- developed countries prefer to outsource goods and services from other countries where quality of goods is high and cost of production is low.
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4. Structural Disequilibrium -- Sometimes notable shift comes in nature of economy of countries e.g. from agricultural to manufacturing or services. -- These may call for structural changes in developing alternative items, sources of supply, changes in transport channels and also costs. -- These structural changes may enhance imports of capital goods and consumer goods resulting in deficits in BOP.

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* Political Factors -- Political uncertainties, instability, internal disturbances, external wars etc. create threatening situation for local industry and investments. In such cases domestic production declines leading to increase in imports and outflow of capital -- It results in deficit in BOP as it happened in Sri Lanka, Pakistan etc. * Social Factors -- Changes in culture, taste, preference, fashion etc. bring about changes in nature of import of consumer items first, followed by capital goods leading to deficit in BOP.

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Correction of BOP Disequilibrium When BOP becomes surplus, nations enjoy the same as it offers a number of desirable situation like increased purchasing power and influence in global market.
1. Automatic Correction of BOP Disequilibrium -- Deficit in BOP indicates that demand for foreign exchange is higher than its supply in the nation. -- It leads to devaluation of local currency in relation to the foreign currency. Thereby imports become costlier and exports cheaper. So imports get reduced and exports are increased. Thereby outflow of FE is reduced and income is increased leading to automatic restoration of equilibrium.
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2. Deliberate Measures Govt. also adopts certain measures to control deficit BOP called Deliberate Measures as indicated. A. Monetary Measures * Reduction in Money Supply : -- RBI takes to control credit so that money supply in the country is reduced which leads to decline in income, purchasing power, aggregate demand and consumption. -- Thus imports decline and hence outflow of foreign currency. In turn exports grow and inflow of foreign currency to set right BOP disequilibrium. * Interest Rate Adjustment : Inflow of FE in deficit BOP nation falls, so liquidity falls. So on short term basis Interest rate is raised leading to investments and loans coming from foreign nations improving BOP scenario.
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* Devaluation In case of deficit BOP, purchasing power of local currency reduces, the Govt. deliberately devalues currency. Thus imports become costlier and exports cheaper. Hence increased exports and reduced imports balance the disequilibrium of BOP. * Exchange Control Exporters are to surrender the foreign exchange earned to RBI through authorized dealers and importers are to draw foreign exchange from authorized dealers. -- Through suitable policies from time to time, Govt. of India and RBI control imports to reduce deficit of BOP. B. Trade Measures These measures try to restore equilibrium through increasing exports and/or reducing imports.
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* Export Promotion Measures Govt. of India endeavor to boost exports by reducing export duties, providing incentives, encouraging EOUs, forming EPZs.
* Import Control Measures Import control measures include ways and means of restricting imports through duties, quotas, licenses etc. C. Miscellaneous Measures Govt. of India tries to remove BOP disequilibrium by assortment of means like a) Attracting Foreign Investments both FDI and FPI b) Attracting NRI deposits c) Promoting tourism d) Negotiating Foreign currency loans etc.
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