Balance of Payments-Class Lecture

8/7/2019 Balance of Payments-Class Lecture

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Balance of Payments (BOP)Balance of Payments (BOP)


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ItIt isis aa systematicsystematic statementstatement ofof allall economiceconomic transactionstransactions ofof aa countrycountrywithwith thethe restrest ofof thethe worldworld duringduring aa periodperiod ofof time,time, usuallyusually oneone yearyear..

ItIt cancan alsoalso bebe defineddefined asas

AA systematicsystematic accountingaccounting ofof allall economiceconomic transactionstransactions betweenbetween thethe

residentsresidents ofof aa nationnation andand thethe restrest ofof thethe worldworld duringduring aa periodperiod ofof time,time,usuallyusually oneone yearyear..

TheThe systemsystem whichwhich isis generallygenerally adoptedadopted isis doubledouble entryentry bookbook keepingkeeping..In this accounting system, both sides of a transaction debit and

credit are recorded.

Economic transactions include all such transactions that involve thetransfer of the title or ownership of goods, services, money, and assets.


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WhileWhile somesome transactionstransactions involveinvolve physicalphysical transfertransfer ofof goods,goods, money,money, andand assetsassets alongalong

withwith thethe transfertransfer ofof title,title, inin somesome transactions,transactions, physicalphysical isis notnot necessarynecessary..

ForFor exampleexample

EvenEven ifif profitprofit ofof aa subsidiarysubsidiary ofof aa foreignforeign subsidiarysubsidiary isis heldheld oror reinvestedreinvested withinwithin thethe

countrycountry itit isis located,located, itit isis deemeddeemed toto bebe paidpaid toto thethe parentparent companycompany abroadabroad..

WhatWhat isis importantimportant isis thethe transfertransfer ofof titletitle.. NotNot thethe physicalphysical transfertransfer ofof whatwhat isis

transactedtransacted..

TheThe termterm residentsresidents meansmeans thethe nationalsnationals ofof thethe reportingreporting countrycountry..

DiplomaticDiplomatic staff,staff, foreignforeign militarymilitary personnel,personnel, tourists,tourists, migratorymigratory workersworkers andand thethe

branchesbranches ofof thethe foreignforeign companiescompanies areare notnot treatedtreated asas residentsresidents eveneven thoughthough theythey

workwork andand operateoperate inin thethe reportingreporting countrycountry..


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PurposePurpose

To take the stock of countrys foreign receipts and payment obligations and of assetsand liabilities arising out of international economic transactions with a view to

correct.

Accounting serves a very useful purpose in so far as it yields necessary information

on the strength and weaknesses of the country in international economic relations.

By analysing BOP accounts of past years, one can find the overall gains and losses

from the international economic transactions. It can be ascertained that whether

composition or direction of international trade and capital movements have

improved or caused deterioration in the economic condition of the country.

BOP statements give warning signals for future policy formulation. For example,

building foreign exchange reserves on borrowed funds increases international

indebtedness which might lead to financial bankruptcy.


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ForFor preparingpreparing thethe BOPBOP accounts,accounts, economiceconomic transactionstransactions betweenbetween aa

countrycountry andand thethe restrest of of thethe worldworld areare groupedgrouped intointo twotwo broadbroad

categoriescategories

(i)(i) CurrentCurrent TransactionsTransactions

(ii)(ii) CapitalCapital TransactionsTransactions

CurrentCurrent transactionstransactions includeinclude exportexport andand importimport ofof goodsgoods andand services,services,

ii..ee..,, visiblevisible andand invisibleinvisible trade,trade, unrequitedunrequited receiptsreceipts andand paymentspayments inin thethe

currentcurrent yearyear..

CapitalCapital transactionstransactions includeinclude inflowsinflows andand outflowsoutflows ofof capitalcapital includingincluding

foreignforeign investments,investments, andand goldgold andand foreignforeign exchangeexchange reservesreserves..


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The distinctive features of the two kinds of transactions areThe distinctive features of the two kinds of transactions are

1.1. CurrentCurrent transactionstransactions changechange thethe currentcurrent levellevel ofof consumptionsconsumptions ofofthethe countrycountry oror changechange thethe currentcurrent levellevel ofof itsits nominalnominal income,income,

whereaswhereas capitalcapital transactionstransactions changechange thethe capitalcapital stockstock of of thethe

countrycountry..

2.2. WhileWhile currentcurrent transactionstransactions areare ofof flowflow nature,nature, capitalcapital transactionstransactions

areare mostlymostly ofof stockstock naturenature..


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Current AccountCurrent Account

All the transactions included in the current account have their credit

and debit counterparts.

The credit column shows the receivables and the debit column shows

the payables.

The balance of each item is shown under net balance column.


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TransactionsTransactions CreditCredit DebitDebit Net BalanceNet Balance

(+) or ((+) or (--))

1.Merchandise1.Merchandise ExportsExports ImportsImports ..

2. Foreign Travel2. Foreign Travel EarningsEarnings PaymentsPayments ..

3.Transportation(Shipping*)3.Transportation(Shipping*) EarningEarning PaymentsPayments

4. Insurance Premium4. Insurance Premium ReceiptsReceipts PaymentsPayments

5. Banking5. Banking ReceiptsReceipts PaymentsPayments ....

6. Investment Income6. Investment Income ReceiptsReceipts PaymentsPayments ..

7. Government (Purchase and7. Government (Purchase and

sale of Goods and Service)sale of Goods and Service)

ReceiptsReceipts PaymentsPayments

8. Miscellaneous**8. Miscellaneous** ReceiptsReceipts PaymentsPayments

Balance of Payments: Current account (As suggested by IMF and currently

followed in India

* Added to the IMF list, ** Includes motion picture royalties, Telephone and

Telegraph services, Fees for Copyrights and consultancy, etc.

Current Account Balance: Surplus/Deficit


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The items of theThe items of the Current AccountCurrent Account are also classified asare also classified as

Visible ItemsVisible ItemsExport and import of goods, called merchandise tradeExport and import of goods, called merchandise trade

Invisible itemsInvisible items

All other itemsAll other items

Unrequited TransfersUnrequited Transfers

To give a separate treatment to the unilateral transfers like foreign gifts, donations,

military aid, technical assistance, and so on.

The sum of the visible net and invisible net gives the balance on the

current account. It is called current account balance.

The current account balance is transferred to the capital account.The current account balance is transferred to the capital account.


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Balance of TradeBalance of Trade

The net balance of the visible trade, that is, the difference between exports (X) andThe net balance of the visible trade, that is, the difference between exports (X) and

imports (M) of goods is called Trade Balance.imports (M) of goods is called Trade Balance.

If X>M, Trade SurplusIf X>M, Trade Surplus

andand

If M>X, Trade DeficitIf M>X, Trade Deficit

The Sum of the Visible Net and Invisible Net is called Current Account Balance.The Sum of the Visible Net and Invisible Net is called Current Account Balance.

If sum of the entries in the credit column is greater than that of the debit column,If sum of the entries in the credit column is greater than that of the debit column,

it shows ait shows a Current account surplusCurrent account surplus..

If sum of credit items is less than that of the debit items, it shows a Current

Account Deficit.


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Capital AccountCapital Account

The broad items are

1. Short-term Capital Movements2. Long-term Capital Movements

3. Inflow and Outflow of gold and foreign exchange reserves

Short-term capital movements include

(a) Purchase of short-term securities (Treasury bills, commercial

bills and acceptance bills)

(b) Speculative purchase of foreign currency

(c) Cash balance held by foreigners for such reasons as war, political

uncertainty, etc.


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LongLong--term Capital Movementsterm Capital Movements includeinclude

(a)(a) Direct Investment in shares, bonds, real estate or physical assets like plant,Direct Investment in shares, bonds, real estate or physical assets like plant,

building and equipment in which the investor holds a controlling power.building and equipment in which the investor holds a controlling power.

(b)(b) Portfolio Investment, including all other stocks and bonds, e.g., govt.Portfolio Investment, including all other stocks and bonds, e.g., govt.

securities, securities of firms which do not entitle the holder with a controllingsecurities, securities of firms which do not entitle the holder with a controlling

power.power.

(c)(c) Amortisation of Capital, i.e., repurchase and resale of securities sold to theAmortisation of Capital, i.e., repurchase and resale of securities sold to the

foreignersforeigners

Direct Import and Export of capital goods fall under the category of FDI.Direct Import and Export of capital goods fall under the category of FDI.

It is important to note that export of capital is a debit item because it causes

outflow of Foreign exchange, and import of capital is a credit item as it results

in inflow of foreign exchange.


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Gold and Foreign Exchange ReservesGold and Foreign Exchange Reserves

Maintained to stabilise the exchange rate of the currency and to makeMaintained to stabilise the exchange rate of the currency and to makepayments in case there is payment deficit on current account.payments in case there is payment deficit on current account.

The foreign exchange reserves increase or decrease depending on theThe foreign exchange reserves increase or decrease depending on the

net balances of other transactions.net balances of other transactions.


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Items of TransactionItems of Transaction 19901990--9191 19951995--9696 20002000--0101

A. Current AccountA. Current Account

1. Imports (c.i.f)1. Imports (c.i.f)

2. Exports (f.o.b)2. Exports (f.o.b)

27,91527,915

18,47718,477

43,67043,670

32,31132,311

59,26459,264

44,89444,894

3. Trade Balance3. Trade Balance --9,4389,438 --11,35911,359 --14,37014,370

4. Invisibles4. Invisibles

(a) Receipts(a) Receipts

(b) Payments*(b) Payments*

(c) Net Receipts(c) Net Receipts

7,4647,464

7,7067,706

--242242

17,67617,676

12,21612,216

5,4605,460

34,78634,786

24,00624,006

10,78010,780

Current Account Balance[3+4(c)]Current Account Balance[3+4(c)] --9,6809,680 --5,8995,899 --35903590

B. Capital AccountB. Capital Account

(i) Foreign Investment (net)(i) Foreign Investment (net)

(ii) Loans(ii) Loans

(a) External Assistance (net)(a) External Assistance (net)

(b) Commercial Borrowings (net)(b) Commercial Borrowings (net)

(iii) Banking (net receipts and payments)(iii) Banking (net receipts and payments)

(iv) Rupee Debt Services(iv) Rupee Debt Services

(v) Other Capital Transactions (net)(v) Other Capital Transactions (net)

(vi) Errors and Omissions(vi) Errors and Omissions

103103

2,2042,204

3,3293,329

682682

--1,1931,193

1,9311,931

132132

4,6044,604

867867

1,3341,334

762762

--962962

--2,5372,537

600600

5,8625,862

410410

3,8423,842

811811

--617617

--290290

--588588

5. Total Capital Account[ (i) to (vi)]5. Total Capital Account[ (i) to (vi)] 7,1887,188 4,6784,678 10,01810,018


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Items of TransactionsItems of Transactions 19901990--9191 19951995--9696 20002000--0101

7. Overall Balance (5+6)7. Overall Balance (5+6) --2,4922,492 --1,2211,221 5,8565,856

8. Monetary Transactions8. Monetary Transactions

(a) IMFTransactions(a) IMFTransactions

(net=purchase(net=purchase--repurchase)repurchase)

(b) SDR Allocation(b) SDR Allocation

(c) Increase (+)/Decrease ((c) Increase (+)/Decrease (--)on reserves)on reserves

(d) Total (a+b+c)(d) Total (a+b+c)

1,2141,214

----

1,2781,278

2,4922,492

--1,7151,715

------

2,9362,936

1,2211,221

--2626

--------

--5,8305,830

--5,8565,856

*Including interest and service payments on loans and credit.

Source: Economic Surveys,-2000-01 and 2003-2004, Ministry ofFinance, Govt. of India, pp. 570-71

Overall Balance= Current Account Balance- Capital account balance

The overall balance needs to be cleared by the end of the accounting year.

If BOP deficits (or even surplus) are of large magnitude and increase over year, then theIf BOP deficits (or even surplus) are of large magnitude and increase over year, then the

BOP is said to be in disequilibrium.BOP is said to be in disequilibrium.

BOP disequilibrium, especially of deficit nature has been a matter of great concern forBOP disequilibrium, especially of deficit nature has been a matter of great concern for

both the policy makers and economists.both the policy makers and economists.


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Disequilibrium in BOPDisequilibrium in BOP

Since BOP accounting follows double entry book-keeping system, the two sides of

the BOP accounts are always in balance. So BOP statement shows that BOP isalways in balance.

A close look at the BOP accounts reveals that a deficit in the current accounts is

offset either by a surplus on the capital accounts or by running down the gold and

foreign exchange reserves.

A surplus in the current account is offset by a matching decrease on the capital

account resulting in loans or depletion in gold and foreign exchange reserves.

The statements above do not mean that BOP is always in balance and there is nosurplus or deficit.

There is often a deficit or a surplus in BOP. In economic terminology, this is called

disequilibrium in BOP.


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TheThe BOPBOP disequilibriumdisequilibrium isis assessedassessed onon thethe basisbasis ofof thethe differencedifference betweenbetween

thethe Autonomous andand Inducedtransactionstransactions..

AutonomousAutonomous TransactionsTransactions areare thosethose thatthat areare carriedcarried outout onon theirtheir ownown withwith aa

viewview toto consumingconsuming moremore oror makingmaking profitprofit.. TheThe autonomousautonomous transactionstransactions taketake

placeplace onon bothboth currentcurrent andand capitalcapital accountsaccounts..

OnOn thethe CurrentCurrent AccountAccount,, merchandisemerchandise exportsexports andand importsimports ofof goodsgoods areareautonomousautonomous transactionstransactions..

OnOn thethe CapitalCapital AccountAccount,, exportsexports andand importsimports ofof longlong--termterm capitalcapital areare

autonomousautonomous transactionstransactions..

AlsoAlso thethe shortshort--termterm flowsflows motivatedmotivated byby aa desiredesire toto investinvest abroadabroad areare

autonomousautonomous transactiontransaction..


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OnOn thethe CurrentCurrent AccountAccount,, IfIf receiptsreceipts fromfrom exportsexports ofof goodsgoods andand paymentspayments forfor importsimportsofof goodsgoods areare alwaysalways equalequal inin valuevalue terms,terms, therethere willwill bebe nono otherother transactionstransactions..

ButBut isis theythey areare notnot equal,equal, somesome balancingbalancing transactionstransactions areare requiredrequired.. BalancingBalancingtransactionstransactions areare inin thethe formform ofof internationalinternational borrowingsborrowings oror lendinglending thatthat leadlead toto shortshort--termterm capitalcapital inflowsinflows oror outflowsoutflows..

ThisThis kindkind ofof internationalinternational borrowingborrowing andand lendinglending areare notnot mademade forfor theirtheir ownown sake,sake,butbut forfor makingmaking paymentspayments forfor deficitsdeficits inin BOTBOT..

SuchSuch transactionstransactions areare calledcalled inducedinduced oror accommodatingaccommodating transactionstransactions..

TheThe unrequitedunrequited itemsitems likelike gifts,gifts, donationsdonations andand aidaid areare voluntaryvoluntary andand areare treatedtreated asasautonomousautonomous transactionstransactions..

OnOn thethe CapitalCapital AccountAccount,, shortshort--termterm capitalcapital movements,movements, forfor instance,instance, goldgold andandaccommodatingaccommodating capitalcapital flowsflows onon accountaccount ofof thethe autonomousautonomous transactionstransactions areare inducedinducedtransactionstransactions..


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Adjustment of BOP Disequilibrium

In the assessment of BOP positions, only autonomous transactions are taken into

account.

If total receipts from and payments for autonomous transactions are equal, the BOP

is in equilibrium.

If total receipts from and payments for autonomous transactions are substantially

unequal, it means BOP disequilibrium.

If autonomous receipts are much greater than autonomous payments, it gives

disequilibrium ofsurplus nature.

If foreign payment requirements exceed foreign receipts, to a considerable extent, it

gives BOP disequilibrium ofdeficitnature.


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AA BOPBOP disequilibriumdisequilibrium ofof surplussurplus naturenature resultsresults inin increaseincrease inin capitalcapital

accountaccount surplussurplus andand reflectsreflects ultimatelyultimately inin thethe formform of of increaseincrease inin

foreignforeign exchangeexchange reservesreserves..

AA BOPBOP disequilibriumdisequilibrium ofofdeficitdeficit naturenature leadsleads toto salesale ofof foreignforeign assets,assets,

ifif any,any, oror borrowingborrowing abroadabroad whichwhich resultsresults inin foreignforeign indebtednessindebtedness..

InIn casecase therethere isis currentcurrent accountaccount deficit,deficit, itit hashas toto bebe financedfinanced eithereither byby

salesale ofof foreignforeign assetsassets oror byby netnet borrowingborrowing.. SoSo

Current account deficit= Net capital inflowCurrent account deficit= Net capital inflow

CurrentCurrent accountaccount deficitdeficit (or(or surplus)surplus) hashas toto bebe adjustedadjusted inin thethe capitalcapital

accountaccount..


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AA currentcurrent accountaccount deficitdeficit cancan bebe financedfinanced byby borrowingborrowing abroadabroad..

IfIf foreignforeign loansloans areare notnot available,available, thethe CentralCentral bankbank hashas toto sellsell foreignforeign currencycurrency toto thethe

privateprivate sectorsector forfor makingmaking paymentpayment abroadabroad.. ThisThis reducesreduces thethe foreignforeign exchangeexchange reservereserveheldheld byby centralcentral bankbank..

TheThe decreasedecrease inin officialofficial foreignforeign exchangeexchange reservereserve givesgives thethe measuremeasure ofof BOPBOP deficitdeficit..

So,So,

BOP deficit= decrease in official foreign exchange reserveBOP deficit= decrease in official foreign exchange reserve

In the previous slide of Indias BOP we have seen the figures of year 2000In the previous slide of Indias BOP we have seen the figures of year 2000--01.01.

In this year, the decrease in Indias foreign exchange reserve by USIn this year, the decrease in Indias foreign exchange reserve by US $ 5830 million$ 5830 million

shows BOP disequilibrium of deficit nature.shows BOP disequilibrium of deficit nature.

However, if goes by the overall BOP balance of US $ 5856 million, Indias BOPHowever, if goes by the overall BOP balance of US $ 5856 million, Indias BOP

was in surplus in 2000was in surplus in 2000--01.01.


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Documents

Balance of Payments-Class Lecture