Balane of Payment10 Report

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SEMINAR REPORT

On

BALANCE OF PAYMENT

SUBMITTED TO: SUBMITTED BY:

Lec. Azizinder Sekhon Butta Singh

MBA-I (C)

ROLL NO-5723

SCHOOL OF MANAGEMENT STUDIES

PUNJABI UNIVERSITY, PATIALA


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Acknowledgement

With deep sense of gratitude, I would like to take opportunity to thank my

honorable seminar guide Lec. Azizinder Sekhon. I could not have asked for a more

cooperative guide. Her invaluable and in stinted support has given me the confidence to

do my work. Without her guidance, the seminar report would not have seen the light of

the day. I would also like to thank my friends who have helped me to find out the

suitable material for the report.

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BALANCE OF PAYMENTS

International trade plays a major role in the economic development of a country.

The world is becoming an integrated market place and trade equations are changing

rapidly. Realizing the importance of private capital inflow- outflow for the development

of a country, many countries are taking numerous measures to attract foreign investors

Balance of Payment is a term included in international trade.IMF definition: Balance of payments is a statistical statement that summarizes

transactions between residents & non residents during a period.

The balance of payments of a country is a systematic record of all economic

transactions between the residents of a country and the rest of the world. It presents a

classified record of all receipts on account of goods exported, services rendered and

capital received by residents and payments made by theme on account of goods imported

and services received from the capital transferred to non-residents or foreigners. -

Reserve Bank of India

The above definition can be summed up as following: - Balance of Payments is

the summary of all the transactions between the residents of one country and rest of the

world for a given period of time, usually one year. The definition given by RBI needs to

be clarified further for the following points:

A. Economic Transactions

An economic transaction is an exchange of value, typically an act in which there

is transfer of title to an economic good the rendering of an economic service, or the

transfer of title to assets from one economic agent (individual, business, government, etc)

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To certain economists, the term BOP seems to be somewhat obscure. Yeager, for

example, draws attention to the word payments in the term BOP; this gives a false

impression that the set of BOP accounts records items that involve only payments. The

truth is that the BOP statements records both payments and receipts by a country. It is, as

Yeager says, more appropriate to regard the BOP as a balance of international

transactions by a country. Similarly the word Balance in the term BOP does not imply

that a situation of comfortable equilibrium; it means that it is a balance sheet of receipts

and payments having an accounting balance. Like other accounts, the BOP records each

transaction as either a plus or a minus.

The general rule in BOP accounting is the following:-

a) If a transaction earns foreign currency for the nation, it is a credit and is recorded as a

plus item.

b) If a transaction involves spending of foreign currency it is a debit and is recorded as a

negative item.

The BOP is a double entry accounting statement based on rules of debit and credit

similar to those of business accounting & book-keeping, since it records both transactions

and the money flows associated with those transactions. Also in case of statistical

discrepancy the difference amount is adjusted with errors and omissions account and thus

in accounting sense the BOP statement always balances.

Features of Balance of Payments

1. Systematic Record: It is a systematic record of receipts and payments of a

country with other countries.

2. Fixed period of time: It is a statement of a account pertaining to a given period

of time, usually a year.

3. Comprehensiveness: It includes all the three items, i.e., visible, invisible and

capital transfers. The balance of payments is a comprehensive record of economic

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transactions of the residents of a country with the rest of the World during a given

period of time. The aim is to present an account of all receipts and payments on

account of goods exported services rendered and capital by resident of a country

and goods imported, services received and capital transferred y residents of the

country.

4. Double entry system: Receipts and payments are recorded on the basis of double

entry system. The basic convention applied in constructing a balance of payments

statement is that every recorded transaction is represented by two entries with

equal values. One of these entries is designated a credit with a positive arithmetic

sign; the other is designated a debit with a negative sign. In principle, the sum of

all credit entries is identical to the sum of all debit entries, and the net balance of

all entries in the statement is zero.

5. Self-balanced: From the point of view of accounting, double entry system keeps

automatically debit and credit sides of the accounts in balance.

6. Adjustment of Differences: Whenever there are differences in actual total

receipts and payments, need is felt for necessary adjustment.

7. All items-Government and Non-Government: Balance of Payments includes

receipts and payments of all items government and non-government.

Terminology

Favorable Balance Of Payment s Value of total receipts more than total payments

Adverse Balance Of Payments Value of total receipts less than total payments

Balanced Balance Of Payments Value of total receipts equals total payments

Unrequited receipts Receipts for which nothing has to be paid in return.

Unrequited payments Payments for which nothing is received in return.

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Balance of Trade and Balance of Payments- A Comparative Study

What is Balance of Trade?

There are two main concepts relating to international transactions or receipts and

payment: Balance of Trade and Balance of Payments.

Balance of Trade refers to the balance of difference between the value of total

imports and exports of visible material goods.

In the words of Benham, Balance of Trade of a country is the relation over a

period between the values of her exports and the values of her imports.

A proper record of all material goods exported and imported is kept at the ports,

so they are called visible items. Balance of Trade, as a matter of fact, is a part of balance

of payments. Balance of Trade may be of three kinds:

1. Surplus or Favorable Balance of Trade: A country may have favorable or

surplus Balance of Trade when the total value of the good exported by it is more

than the total value of the goods imported by it. (Exports>Imports)

2. Deficit or Unfavorable Balance of Trade: A country may have unfavorable or

deficitBalance of Trade when the total value of the good imported by it is more

than the total value of the goods exported by it. (Imports >Exports)

3. Equilibrium in Balance of Trade: A country may have equilibriumBalance of

Trade when the total value of the good imported by it is equal to the total value of

the goods exported by it. (Exports=Imports)

Difference between Balance of Trade and Balance of Payments

1. Balance of Payment is a broad term. It includes balance of trade. The latter is

relatively a narrow concept. It is a part of balance of payments.

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2. Balance of trade includes imports and exports of goods alone i.e. visible items. On

the contrary, the balance of payments includes all kind of items, that is import and

export of goods, services and capital. In other words, it includes visible as well as

invisible items. In brief, balance of trade is a part of balance of payments.

3. Balance of trade of a country can be favorable or unfavorable but balance of

payment always balances.

4. Deficit of Balance of trade can be met by balance of payments but deficit of

balance of payments cannot be met by balance of trade.

5. From the point of view of economic analysis balance of payments is more

significant than balance of trade. Every country takes into account items of

balance of payments while formulating its foreign policy. If the liabilities of a

country to other countries are large, it will have great impact on its national

income, employment etc.

In short, the main difference between balance of payments and balance of

trade is that the latter is a partial record of a countrys international trade while the

former is its complete record. Balance of trade is a part of Balance of payments.

Components of Balance of Payment

The Balance of Payments for a country is the sum of the current account, the financial

account and the capital account, and the change in official reserves.

Current Account

It is a record of all international transactions for goods and services.

The current account combines the transactions of the trade account and the services account.

The section covers the flow of goods, services and income in and out of a given country and

also financial aid from governments abroad:

* Trade in goods is also known as trade in visible or tangibles,

* Trade in services is also known as trade in invisibles or intangibles.

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* Income refers not only to the money given back from investments made abroad

(investments are recorded in the financial account but income from investments is recorded

in the current account) but also to the money sent by individuals working abroad that send

money to their families back home (this is usual only in diasporas and developing countries).

It is the sum of net sales from trade in goods and services, net factor income (such

as interest payments from abroad), and net unilateral transfers from abroad. Positive net sales

to abroad correspond to a current account surplus; negative net sales to abroad correspond to

a current account deficit. Because exports generate positive net sales, and because the trade

balance is typically the largest component of the current account, a current account surplus is

usually associated with positive net exports.

The Income Account or Net Factor Income, a sub-account of the Current

Account, is usually presented under the headings "Income Payments", as outflows, and

"Income Receipts", as inflows. If the Income Account is negative, the country is paying more

than it is taking in interest, dividends, etc. For example, the United States' net income has

been declining exponentially since it allowed the Dollar's price relative to other currencies to

be determined by the market to a point where income payments and receipts are roughly

equal. The differences between Canadas Income Payments and Receipts have been declining

exponentially as well since its central bank in 1998 began its strict policy not to intervene in

the Canadian Dollar's foreign exchange. The various subcategories in the Income Account

are linked to specific respective subcategories in the financial account. From here,

economists and central banks determine implied rates of return on the different types of

capital exchanged in the Financial Account. The United States, for example, gleans a

substantially larger rate of return from foreign capital than foreigners from domestic capital.

When analyzing the current account theoretically, it is often written as a

function X of the real exchange rate, p, domestic GDP, Y, and foreign GDP, Y*. Thus the

current account can be written as X (p, Y, Y*). According to theory, the current account X

should increase if (1) the domestic currency depreciates (p increases), (2) domestic GDP

decreases, or (3) foreign GDP increases. Domestic currency depreciation makes domestic

goods relatively cheaper, boosting exports relative to imports. A decrease in domestic GDP

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reduces domestic demand for foreign goods, lowering imports without affecting exports. An

increase in foreign GDP increases foreign demand for domestic goods, increasing exports

without affecting imports.

Current account =

Trade Balance

Net Exports (Exports - Imports) of Merchandise (tangible goods)

Net Exports (Exports - Imports) Services (such as legal and consulting services)

+ Net Factor Income from Abroad (such as interest and dividends)

+ Net Unilateral Transfers from Abroad (such as foreign aid, grants, gifts, etc.)

Structure of current account

Transactions CREDIT DEBITNETBALANCE

-

1.Merchanise export import -

2. Foreign Trade earning payment -

3. Transportation earning payment -

4. Insurance(Premium) receipt payment -

5. Investment Incomedividendreceipt

dividend -payment

6. Government (purchase of goods &services) receipt payment -

CURRENT A/C balance - -Surplus(+)Deficit(-)

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Components of Current Account

Following items are mainly included under capital account:

1. Export and Import of Visible goods: Import and Export of visible materialgoods and precious metals. In other words, all goods included in balance of trade

are the main items of current account.

2. Invisible Items-Services: Import and Export of invisible goods, i.e., different

kinds of services included in current account. Main Invisible services are:-

(i) Services Rendered by Commercial Undertakings: Commercial

undertakings like shipping companies, insurance companies, banks,

etc. belonging to a given country or different countries, exchange their

services among different countries. Exchange their services among

different countries. Exchanges of such services are included in current

account.

(ii) Services of Experts: Every counter avails mostly the services of the

foreign experts like doctors, engineers, soldiers, etc and also puts the

services of its experts at the disposal of the other countries. The

services received from abroad are like imports and the services

rendered to foreign countries are like exports.

3. Traveling: one of the main invisible items of the balance of payments is travels.

These traveling may be of any account for instance, these may be in connection

with business, education, health, conventions or pleasure trip etc. the country

visited to, for it these travels constitute exports and use of foreign transport by the

natives amounts to be imports.

4. Transportation: Movement of goods from one country to the other. Use of

domestic transport by the foreigners amounts to exports and use of foreign

transport by the natives mounts to imports.

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(i.e. short or long term). The distinction between private and official transaction is fairly

transparent, and need not concern us too much, except for noting that the bulk of foreign

investment is private. Direct investment is the act of purchasing an asset and the same

time acquiring control of it (other than the ability to re-sell it). The acquisition of a firm

resident in one country by a firm resident in another is an example of such a transaction,

as is the transfer of funds from the parent company in order that the subsidiary

company may itself acquire assets in its own country. Such business transactions form the

major part of private direct investment in other countries, multinational corporations

being especially important. There are of course some examples of such transactions by

individuals, the most obvious being the purchase of the second home in another

country.

Portfolio investment by contrast is the acquisition of an asset that does not give

the purchaser control. An obvious example is the purchase of shares in a foreign

company or of bonds issued by a foreign government. Loans made to foreign firms or

governments come into the same broad category. Such portfolio investment is often

distinguished by the period of the loan (short, medium or long are conventional

distinctions, although in many cases only the short and long categories are used). The

distinction between short term and long term investment is often confusing, but usually

relates to the specification of the asset rather than to the length of time of which it is held.

For example, a firm or individual that holds a bank account with another country and

increases its balance in that account will be engaging in short term investment, even if its

intention is to keep that money in that account for many years. On the other hand, an

individual buying a long term government bond in another country will be making a long

term investment, even if that bond has only one month to go before the maturity.

Portfolio investments may also be identified as either private or official, according to the

sector from which they originate.

The purchase of an asset in another country, whether it is direct or portfolio

investment, would appear as a negative item in the capital account for the purchasing

firms country, and as a positive item in the capital account for the other country. That

capital outflows appear as a negative item in a countrys balance of payments, and capital

inflows as positive items, often causes confusions. One way of avoiding this is to

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consider that direction in which the payment would go (if made directly). The purchase

of a foreign asset would then involve the transfer of money to the foreign country, as

would the purchase of an (imported) good, and so must appear as a negative item in the

balance of payments of the purchasers country (and as a positive item in the accounts of

the sellers country). The net value of the balances of direct and portfolio investment

defines the balance on capital account.

Accommodating & Autonomous Capital Flows

Economists have often found it useful to distinguish between autonomous and

accommodating capital flows in the BOP. Transactions are said to Autonomous if their

value is determined independently of the BOP. Accommodating capital flows on the

other hand are determined by the net consequences of the autonomous items. An

autonomous transaction is one undertaken for its own sake in response to the given

configuration of prices, exchange rates, interest rates etc, usually in order to realize a

profit or reduced costs. It does not take into account the situation elsewhere in the BOP.

An accommodating transaction on the other hand is undertaken with the motive of

settling the imbalance arising out of other transactions. An alternative nomenclature is

that capital flows are above the line (autonomous) or below the line (accommodating).

Obviously the sum of the accommodating and autonomous items must be zero, since all

entries in the BOP account must come under one of the two headings. Whether the BOP

is in surplus or deficit depends on the balance of the autonomous items.

The BOP is said to be in surplus if autonomous receipts are greater than the autonomous

payments and in deficit if vice a versa. Essentially the distinction between both the

capital flow lies in the motives underlying a transaction, which are almost impossible to

determine. We cannot attach the labels to particular groups of items in the BOP accounts

without giving the matter some thought. For example a short term capital movement

could be a reaction to difference in interest rates between two countries. If those interest

rates are largely determined by influences other than the BOP, then such a transaction

should be labelled as autonomous. Other short term capital movements may occur as a

part of the financing of a transaction that is itself autonomous (say, the export of some

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good), and as such should be classified as accommodating. There is nevertheless a great

temptation to assign the labels autonomous and accommodating to groups of item in

the BOP. i.e. to assume, that the great majority of trade in goods and of long term capital

movements are autonomous, and that most short term capital movements are

accommodating, so that we shall not go far wrong by assigning those labels to the various

components of the BOP accounts. Whether that is a reasonable approximation to the truth

may depend in part on the policy regime that is in operation. For example what is an

autonomous item under a system of fixed exchange rates and limited capital mobility

may not be autonomous when the exchange rates are floating and capital may move

freely between countries.

Items of Capital Account

Main items of capital account are as follows:

1. Private Foreign loan flow: Foreign loans received by the private sector are

counted as credit item and repayments o these loans is counted as debit item.

2. Movement in Banking Capital: Beside central bank, inflow of banking capital is

counted as credit item and out flow as debit item.

3. Official Capital Transactions: Loans received by the public sector from abroad

or International Monetary Fund constitutes credit items and loans repaid debit

items.

4. Reserves, Monetary Gold and SDR: Foreign currency assets of the

government, gold reserves of the central bank, SDR of IMF and similar capital

transactions, etc. are included under credit items and all kinds of payments under

debit items

5. Gold movement: when the central bank of a country buys gold from abroad, itmakes payment to foreign sellers. It is reflected under debit items. On the

contrary, when it sells gold it is reflected under credit items.

6. Miscellaneous: Beside the above items, all other kinds of governmental capital

receipts which also include receipts of the central bank are shown on credit side

and all kinds of payments are shown on debit side.

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Financial Account

The financial account (or Official reserve account) is the net change in foreign

ownership of domestic financial assets. If foreign ownership of domestic financial assets has

increased more quickly than domestic ownership of foreign assets in a given year, then the

domestic country has a financial account surplus. On the other hand, if domestic ownership

of foreign financial assets has increased more quickly than foreign ownership of domestic

assets, then the domestic country has a financial account deficit

The accounting entries in the financial account record the purchase and sale of

domestic and foreign assets. These assets are divided into categories such as Foreign Direct

Investment (FDI), Portfolio Investment (which includes trade in stocks and bonds), and Other

Investment (which includes transactions in currency and bank deposits).

Financial account =

* Increase in foreign ownership of domestic assets - Increase of domestic ownership of

foreign assets

Basic Balance

The basic balance was regarded as the best indicator of the economys position

visa- vis other countries in the 1950s and the 1960s. It is defined as the sum of the BOP

on current account and the net balance on long term capital, which were considered as the

most stable elements in the balance of payments. A worsening of the basic balance [anincrease in a deficit or a reduction in a surplus or even a move from the surplus to deficit]

was seen as an indication of deterioration in the [relative] state of the economy. The short

term capital account balance is not included in the basic balance. This is perhaps for two

main reasons:

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a) Short term capital movements unlike long term capital movements are

relatively volatile and unpredictable. They move in and out of the country in a period of

less than a year or even sooner than that. It would therefore be improper to treat short

term capital movements on the same footing as current account BOP transactions which

are extremely durable in nature. Long term capital flows are relatively more durable and

therefore they qualify to be treated along side the current account transactions to

constitute basic balance.

b) In many cases, countries dont have a separate short term capital account as

they constitute a part of the Errors and Omissions Account. A deficit on the basic

balance could come about in various ways, which are not mutually equivalent. E.g.

suppose that the basic balance is in deficit because a current account deficit is

accompanied by a deficit on the long term capital account. The long term capital outflow

will, in the future, generate profits, dividends and interest payments which will improve

the current account and so, ceteris paribus, will reduce or perhaps reduce the deficit. On

the other hand, a basic balance surplus consisting of a deficit on current account that is

more than covered by long term borrowings from abroad may lead to problems in future,

when profits, dividends etc are paid to foreign investors.

The Official Settlement Concept

An alternative approach for indicating, a deficit or surplus in the BOP is to

consider the net monetary transfer that has been made by the monetary authorities is

positive or negative, which is the so called settlement concept. If the net transfer is

negative (i.e. there is an outflow) then the BOP is said to be in deficit, but if there is an

inflow then it is surplus. The basic premise is that the monetary authorities are the

ultimate financers of any deficit in the balance of payments (or the recipients of any

surplus). These official settlements are thus seemed as the accommodating item, all other

being autonomous.

The monetary authorities may finance a deficit by depleting their reserves of

foreign currencies, by borrowing from the IMF or by borrowing from other foreign

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monetary authorities. The later source is of particular importance when other monetary

authorities hold the domestic currency as a part of their own reserves. A country whose

currency is used as a reserve currency (such as the dollars of US) may be able to run a

deficit in its balance of payments without either depleting its own reserves or borrowing

from the IMF since the foreign authorities might be ready to purchase that currency and

add it to its own reserves. The settlements approach is more relevant under a system of

pegged exchange rates than when the exchange rates are floating.

Balance of Invisible Trade

Just as a country exports goods and imports goods a country also exports and

imports what are called as services (invisibles). The service account records all the

service exported and imported by a country in a year. Unlike goods which are tangible or

visible services are intangible. Accordingly services transactions are regarded as invisible

items in the BOP. They are invisible in the sense that service receipts and payments are

not recorded at the port of entry or exit as in the case with the merchandise imports and

exports receipts. Except for this there is no meaningful difference between goods and

services receipts and payments. Both constitute earning and spending of foreign

exchange. Goods and services accounts together constitute the largest and economically

the most significant components in the BOP of any country.

The service transactions take various forms. They basically include

1) Transportation, banking, and insurance receipts and payments from and to the

foreign countries,

2) Tourism, travel services and tourist purchases of goods and services received

from foreign visitors to home country and paid out in foreign countries by home country

citizens,

3) Expenses of students studying abroad and receipts from foreign students

studying in the home country,

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Errors and Omissions

Errors and omissions is a statistical residue. It is used to balance the statement

because in practice it is not possible to have complete and accurate data for reported

items and because these cannot, therefore, ordinarily have equal entries for debits and

credits. The entry for net errors and omissions often reflects unreported flows of private

capital, although the conclusions that can be drawn from them vary a great deal from

country to country, and even in the same country from time to time, depending on the

reliability of the reported information. Developing countries, in particular, usually

experience great difficulty in providing reliable information.

Errors and omissions (or the balancing item) reflect the difficulties involved inrecording accurately, if at all, a wide variety of transactions that occur within a given

period of (usually 12 months). In some cases there is such large number of transactions

that a sample is taken rather than recording each transaction, with the inevitable errors

that occur when samples are used. In others problems may arise when one or other of the

parts of a transaction takes more than one year: for example wit a large export contract

covering several years some payment may be received by the exporter before any

deliveries are made, but the last payment will not made until the contract has been

completed. Dishonesty may also play a part, as when goods are smuggled, in which case

the merchandise side of the transaction is unreported although payment will be made

somehow and will be reflected somewhere in the accounts. Similarly the desire to avoid

taxes may lead to underreporting of some items in order to reduce tax liabilities. Finally,

there are changes in the reserves of the country whose balance of payments we are

considering, and changes in that part of the reserves of other countries that is held in the

country concerned. Reserves are held in three forms: in foreign currency, usually but

always the US dollar, as gold, and as Special Deposit Receipts (SDR) borrowed from the

IMF. Note that reserves do not have to be held within the country. Indeed most countries

hold a proportion of their reserves in accounts with foreign central banks. The changes in

the countrys reserves must of course reflect the net value of all the other recorded items

in the balance of payments. These changes will of course be recorded accurately, and it is

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the discrepancy between the changes in reserves and the net value of the other record

items that allows us to identify the errors and omissions.

Unilateral Transfers

Unilateral transfers or unrequited receipts, are receipts which the residents of a

country receive for free, without having to make any present or future payments in

return. Receipts from abroad are entered as positive items, payments abroad as negative

items. Thus the unilateral transfer account includes all gifts, grants and reparation receipts

and payments to foreign countries. Unilateral transfer consist of two types of transfers:

(a) government transfers (b) private transfers. Foreign economic aid or assistance and

foreign military aid or assistance received by the home countrys government (or given

by the home government to foreign governments) constitutes government to government

transfers. US foreign aid to India, for BOP 9but a debit item in the US BOP). These are

government to government donations or gifts. There no well worked out theory to explain

the behavior of this account because these flows depend upon political and institutional

factors. The government donations (or aid or assistance) given to government of other

countries is mixed bag given for either economic or political or humanitarian reasons.

Private transfers, on the other hand, are funds received from or remitted to foreign

countries on person to person basis. A Malaysian settled in the United States remitting

$100 a month to his aged parents in Malaysia is a unilateral transfer inflow item in the

Malaysian BOP. An American pensioner who is settled after retirement in say Italy and

who is receiving monthly pension from America is also a private unilateral transfer

causing a debit flow in the American BOP but a credit flow in the Italian BOP. Countries

that attract retired people from other nations may therefore expect to receive an influx of

foreign receipts in the form of pension payments. And countries which render foreigneconomic assistance on a massive scale can expect huge deficits in their unilateral

transfer account.

Unilateral transfer receipts and payments are also called unrequited transfers

because as the name itself suggests the flow is only in one direction with no automatic

reverse flow in the other direction. There is no repayment obligation attached to these

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transfers because they are not borrowings and lendings but gifts and grants exchanged

between government and people in one country with the governments and peoples in the

rest of the world.

Capital Account Convertibility (CAC)

While there is no formal definition of Capital Account Convertibility, the

committee under the chairmanship of S.S. Tarapore has recommended a pragmatic

working definition of CAC. Accordingly CAC refers to the freedom to convert local

financial assets into foreign financial assets and vice a versa at market determined

rates of exchange. It is associated with changes of ownership in foreign / domestic

financial assets and liabilities and embodies the creation and liquidation of claims on, or

by, the rest of the world. CAC is coexistent with restrictions other than on external

payments. It also does not preclude the imposition of monetary / fiscal measures relating

to foreign exchange transactions, which are of prudential nature.

Following are the prerequisites for CAC:

1. Maintenance of domestic economic stability.

2. Adequate foreign exchange reserves.

3. Restrictions on inessential imports as long as the foreign exchange position is not very

comfortable.

4. Comfortable current account position.

5. An appropriate industrial policy and a conducive investment climate.

6. An outward oriented development strategy and sufficient incentives for export growth.

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Structure and Forms of Balance of payments

Balance of payments is a complete record of the total receipts and payments of a

country in relation to the other countries over a given period of time. Total receipts arecalled credit and total payments are called debit. Structure of balance of payments has

therefore, two aspects as under:

(i) Credit Side and (ii) Debit Side

Credit side includes those values received or likely to be received from abroad. Under

debit side, are included all the payments made to other countries.

BBalanceof Paym ents Sta temen ts

Ite m s Re ce ip ts o r Cre ditsPaym ents o r Deb i tsN et (+) o r (-)

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Structure of Balance of Payments

An Example

Let us consider the following hypothetical situation:

Export of goods Rs.550 Cr.

Import of goods Rs.650 Cr.

Export of services Rs.150 Cr.

Import of services Rs.70 Cr.

Unrequited receipts Rs.100 Cr.

Current A/ c:

Imports of goods (Visible items)Imports of services (Invisibles)

Unrequited payments ( gifts,remittance, indemnities etc. to

foreigners)

Capital A/ c:

Capital payments (lending to,capital repayments to, orpurchase of assets from

foreigners, reduction in stockof gold and reserves of foreign

currency etc.)

Current A/ c:

Imports of goods (Visible items)Imports of services (Invisibles)

Unrequited payments ( gifts,remittance, indemnities etc. toforeigners)indemnities etc. to

Capital A/ c:

Capital payments (lending to,capital repayments to , orpurchase of assets from

foreigners, reduction in stockof gold and reserves of foreign

currency etc.)

Credits Debits

Total Receipts Total Payments

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Unrequited payments Rs.80 Cr.

Capital receipts Rs.200 Cr.

Capital payments Rs.200 Cr.

Current A/c:1) Export of goods 550

2) Export of services 1503) Unrequited receipts 100

Capital A/c:

4) Capital receipts 200

Total receipts1000

Current A/c:

1) Import of goods 6502) Import of services 70

3) Unrequited payments 80

Capital A/c:

4) Capital payments 200

Total payments1000

Credits Debits

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Balance of payments components information sheet

Balance of payments components

Current Account

Goods exports (credits)

Goods are tangibles. In this case, sold to overseas nations and produced in

Australia.

Goods imports (debits)

Goods are tangibles. In this case, produced overseas and purchased by Australians.

___________________

= Net goods (X-M)

___________________

Service exports (credits)

Services include transport, travel, insurance charges, telephone calls, tourist

accommodation, education, computer information services and the like.

In this case, provided by Australians and sold to overseas nations.

Service imports (debits)

As above, but provided by other nations and purchased by Australians

_________________

= Net services (X-M)

_________________

Balance on goods and services = net goods + net services

Income credits

Incomes paid to Australians from overseas sources:

Earnings on investment i.e. income (rent, profits, dividends)

Royalties

Interest

Income debits

As above, but incomes paid by Australians to overseas sources.

________________________

Net income = credits debits

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________________________

Current transfer credits

Transfers of funds into Australia for things such as:

payouts on insurance claims

aid from overseas governments/nations (unless being used to build capital, thus

creating capital accumulation)

pensions received from foreign governments to Australian residents

money sent from overseas relatives

gifts from charities in other countries

work remittances from people working overseas

Current transfer debits

As above, but transfers of funds out of Australia

_________________________________

Net current transfers = credits debits

_________________________________

Balance on Current Account = Balance on goods and services +

Net income +

Net transfers

Capital and Financial Account

Capital Account

Capital transfers credits

Money coming in to Australia for things like:

People migrating and bringing money with them

Aid from overseas where addition is made to the capital stock of the recipient

Purchase and sale of intellectual property rights, including patents, copyrights,

trademarks, franchises, works of art

Selling embassy land

Debt forgiveness (cancellation of debts owed by Australians)

Movements of government savings offshore (into Australian reserves)

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Capital transfersdebits

As for credits, but money going out of Australia

____________________________________

Total on capital account = credits debits

____________________________________

Financial account

Direct Investment

(Buying assets abroad or lending to firms offshore which they control)

Includes:

foreign transactions to fund new investment in Australia or overseas

purchase of more than 10% of shares in an existing Australian company

movement of equity savings

reinvestment of profits

loans to affiliated enterprises

claims on affiliated enterprises

Portfolio Investment

(That is, commercial dealings involving savings movements across national boundaries

into assets which do not give the provider of the savings significant control of the user of

these savings) includes buying land, shares and marketable securities such as Treasury

Bonds, Treasury Notes, certificates of deposit, debentures, unsecured notes (corporate

bonds), other money market instruments, and financial derivatives such as interest rate or

exchange rate swaps which can be easily sold in existing companies.

Other Investment(That is, commercial dealings involving savings but which are not based on securities or

which do not give significant control or involve affiliated companies) includes:

trade credits (short term loans made on trade deals)

loans made to intermediaries, including financial leases

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currency movements and deposits moving between national financial systems

Reserve Assets

(That is, money being moved by the RBA)

Includes:

Monetary gold

Special Drawing Rights (paper gold Created by the IMF to improve the foreign

reserves of member nations)

IMF transactions

_______________________________________

Total on financial account = total of the above

_______________________________________

Balance on Capital Account: add the above totals

(Also: net errors and omissions)

Methods to Measure Balance of Payments

Main methods to measure balance of payments are as follows:

(i) Basic Balance: basic balance comprises of current balance of payments and

short period private illiquid capital balance.

(ii) Net liquidity Balance: In this account are included: basic balance and short

period illiquid capital balance.

(iii) Official Settlement Balance: It includes gross liquid balance and short period

private liquid capital balance.

In terms of a formula it can be clarified as under:

Balance of Trade= Import-Export = a

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(+) Transfer balance of payments = b

(=) Current Balance of Payments = c = (a+b)

+ Long period capital balance = d

= Basic Balance = e = (c+d)

(+) Short period illiquid capital balance = f

(+) SDRs disbursement = g

(+) Errors and Omissions = h

(=) Net Liquid Balance = i = (e+f+g+h)

(+) Short period private liquid capital balance = j

(=) Official Settlement Balance = k = (i+j)

Meaning of DEFICIT & SURPLUS in BOP

If the balance of payment is a double entry accounting record, then apart from

errors and omissions, it must always balance. Obviously, the terms deficit or surplus

cannot refer to the entire BOP but must indicate imbalance on a subset of accounts

included in the BOP. The imbalance must be interpreted in some sense as an economic

disequilibrium. Since the notion of disequilibrium is usually associated within a situation

that calls for policy intervention of some sort, it is important to decide what is the optimal

way of grouping the various accounts within the BOIP so that an imbalance in one set of

accounts will give the appropriate signals to the policy makers. In the language of an

accountant e divide the entire BOP into a set of accounts above the line and another set

below the line. If the net balance (credits-debits) is positive above the line we will say

that there is a balance of payments surplus; if it is negative e will say there is a

balance of payments deficit. The net balance below the line should be equal in

magnitude and opposite in sign to the net balance above the line. The items below the

line can be said to be a compensatory nature they finance or settle the imbalance

above the line.

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The critical question is how to make this division so that BOP statistics, in

particular the deficit and surplus figures, will be economically meaningful. Suggestions

made by economist and incorporated into the IMF guidelines emphasis the purpose or

motive a transaction, as a criterion to decide whether a transaction should go above or

below the line. The principle distinction between Autonomous transaction and

Accommodating or compensatory transactions. Transactions are said to Autonomous if

their value is determined independently of the BOP. Accommodating capital flows on the

other hand are determined by the net consequences of the autonomous items. An

autonomous transaction is one undertaken for its own sake in response to the given

configuration of prices, exchange rates, interest rates etc, usually in order to realize a

profit or reduced costs. It does not take into account the situation elsewhere in the BOP.

An accommodating transaction on the other hand is undertaken with the motive of

settling the imbalance arising out of other transactions. An alternative nomenclature is

that capital flows are above the line (autonomous) or below the line (accommodating).

The terms balance of payments deficit and balance of payments surplus will then be

understood to mean deficit or surplus on all autonomous transactions taken together.

The other measures of identifying a deficit or surplus in the BOP statement are: Deficit or

Surplus in the Current Account and/or Trade Account. The Basic Balance which

shows the relative deficit or surplus in the BOP.

A deficit in BOP is desirable or not!

The basic balance was regarded as the best indicator of the economys position

via a- other countries in the 1950s and the 1960s. It is defined as the sum of the BOP on

current account and the net balance on long term capital, which were considered as the

most stable elements in the balance of payments. A worsening of the basic balance [an

increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit]

is seen as an indication of deterioration in the [relative] state of the economy. Thus it is

very much evident that a deficit in the basic balance is a clear indicator of worsening of

the state of the countrys BOP position, and thus can be said to be undesirable at the very

outset.

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However, on further thoughts, a deficit in the basic balance can also be

understood to be desirable. This can be explained as follows: A deficit on the basic

balance could come about in various ways, which are not mutually equivalent. E.g.

suppose that the basic balance is in deficit because a current account deficit is

accompanied by a deficit on the long term capital account. This deficit in long term

capital account could be clearly observed in a developing countrys which might be

investing heavily on capital goods for advancement on the agricultural and industrial

fields. This long term capital outflow will, in the future, generate profits, dividends and

interest payments which will improve the current account and so, ceteris paribus, will

reduce or perhaps reduce the deficit.

Thus a deficit in basic balance can be desirable as well as undesirable, as it clearly

depends upon what is leading to a deficit in the long term capital account.

In The Accounting sense BOP always balances

The BOP is a double entry accounting statement based on rules of debit and credit

similar to those of business accounting & book-keeping, since it records both transactions

and the money flows associated with those transactions. For instance, exports (like salesof a business) are credits, and imports (like the purchases of a business) are debits. As in

business accounting the BOP records increases in assets (direct investment abroad) and

decreases in liabilities (repayment of debt) as debits, and decreases in assets (sale of

foreign securities) and increases in liabilities (the utilisation of foreign goods) as credits.

An elementary rule that may assist in understanding these conventions is that in such

transactions it is the movement of a document, not of the money that is recorded. An

investment made abroad involves the import of a documentary acknowledgement of the

investment, it is therefore a debit. The BOP has one important category that has no

counter part or at least no significant counter part in business accounting, i.e.

international gifts and grants and other so called transfer payments. In general credits

may be conceived as receipts and debits as payments. However this is not always

possible. In particular the change in a countrys international reserves in gold and foreign

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exchange is treated as a debit if it is an increase and a credit if it is a decrease. The

procedure is to offset changes in reserves against changes in the other items in the table

so that the grand total is always zero, (except for errors and omissions).

A transaction entering the BOP usually has two aspects and invariably gives rise

to two entries, one a debit and the other a credit. Often the two aspects fall in different

categories. For instance, an export against cash payment may result in an increase in the

exporting countrys official foreign exchange holdings. Such a transaction is entered in

the BOP as a credit for exports and as a debit for the capital account. Both aspects of a

transaction may sometimes be appropriate to the same account. For instance the purchase

of a foreign security may have as its counter part reduction in official foreign exchange

holdings. Thus it is clear that if we record all the entries in BOP in a proper way, debits

and credits will always be equal. So that in accounting sense the BOP will be in balance.

Balance of Payments Equilibrium

A Balance of Payments Equilibrium is defined as a condition where the sum of debits

and credits from the Current Account and the Financial Account equal to zero; in other

words, equilibrium is where

Current Account + Financial Account = 0

There is a condition where there are no changes in Official Reserves. When there is no

change in Official Reserves, the balance of payments may also be stated as follows:

Current Account = - Financial Account or

Current Account Deficit (Surplus) = Financial Account Surplus (Deficit)

Canada's Balance of Payments currently satisfies this criterion.

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Disequilibrium in the Balance of Payments

B = R P

Where, B stands for balance of payments,

R denotes receipts from foreigners,

P stands for payments made to foreigners

.A country whose balance of payments is positive is called as surplus country.

.A country whose balance of payments is negative is called as deficit country.

Types of disequilibrium

Cyclical disequilibrium.

Structural disequilibrium.

Short run disequilibrium.

Long run or secular disequilibrium

Cyclical disequilibrium:

It occurs on account of trade cycles. Cyclical fluctuations in demand are caused

by changes in Income, employment, output & price.

Trade cycles follow different paths and patterns in different countries. There are noidentical timings and periodicity of occurrence of cycles in different countries.

No identical stabilization programmes and measures are adopted by different countries.

Income driven demand for imports in different countries is not identical.

Price driven demand for imports differ in different countries.

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Structural disequilibrium:

It is caused because of fluctuation in the demand based on changes in tastes,

fashions, habits, income, economic progress etc.

Structural changes are also produced by variations in the rate of international capital

movements.

Other causes are due to crop failure in prime commodities, shortage of raw materials,

labor strikes etc. leads to reduction in Export.

Short run disequilibrium:

When a country borrows or lends internationally, it will have short run

disequilibrium, as these are usually for short period.

Short run disequilibrium may also emerge if a countrys exceeds its exports in a given

year. It is a temporary one, because later on country will be in a position to correct iteasily by importing more.

Still this disequilibrium can not be justified as it may lead to Long term

disequilibrium. A persistent deficit will tend to reduce its foreign exchange reserves and

country may not be able to raise any more loans from foreigners.

Long run disequilibrium:

It occurs because of accumulation of deficits or surpluses over a long period.

IMF uses the term fundamental disequilibrium to describe a persistent, long run

disequilibrium. It is mainly due to deficits which exist continuously for a long period of

time in a countrys balance of payments.

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Unchecked series of short run disequilibria lead to the fundamental disequilibrium in

long run.

It is caused by persistent deep rooted dynamic changes which slowly takes place in the

economy.

Causes of Disequilibrium

The balance of payments of a country is said to be in equilibrium when the

demand for foreign exchange is exactly equivalent to the supply of it. The balance of

payments is in disequilibrium when there is either a surplus or a deficit in the balance of

payments. When there is a deficit in the balance of payments, the demand for foreign

exchange exceeds the demand for it. A number of factors may cause disequilibrium in the

balance of payments. These various causes may be broadly categorized into:

(i) Economic factors

(ii) Political factors; and

(iii) Sociological factors.

Economic Factors

A number of economic factors may cause disequilibrium in the balance of payments.

These are:

Trade cycle:

Cyclical fluctuations, their phases and amplitudes, differences in different countries,

generally produce cyclical disequilibrium.

Huge development & investment programmes:

Due to huge development and investment programs , Import goes on increasing for

want of capital for rapid industrialization, while exports may not be boosted up to that

extent as these are the primary producing countries.

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Thus, there will be structural changes in the balance of payments and structural

equilibrium will result.

Changing Export demand:

A vast increase in the domestic production of foodstuffs, raw materials, substitute

goods, etc. in advanced countries has decreased their need for import from the

underdeveloped countries. Hence, export demand has considerably changed resulting in

structural disequilibrium.

Similarly, developed countries will loose their market share in underdeveloped

countries, owing to the tendency of underdeveloped nations to self reliance.

Population growth:

High population growth in poor countries has adverse impact on their balance of

payments. Increase in the population increases the needs of these countries for imports

and decreases the capacity of export.

Huge external borrowing:

A country will have adverse balance of payments when it borrows heavily from another

country, while the lending country will have a favorable balance and a deficit balance of

payments.

Inflation:

Rapid economic development, increase in the income & price will adversely affect BOP

position of a developing country.

With increase in income, import requirements will get increased. Also consumption of

the domestic production will be fast. This leads to increase in Import and decrease in

export.

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Certain social factors influence the balance of payments. For instance, changes in

tastes, preferences, fashions, etc. may affect imports and exports and thereby affect the

balance of payments.

Methods of correcting BOP disequilibrium

The various measures used for correcting an adverse balance of payments are of two

kinds: Monetary measures & Non monetary measures

Monetary measures

Deflation

Exchange depreciation.

Devaluation.

Exchange control.

Non-Monetary measures

Tariff import duties.

Import quotas

Export promotion policies and program.

Monetary Measures:

1. Deflation.

Generally, deficit in the BOP occurs due to high imports and low exports. In this situation, country may adopt deflationary or dear money policy by raising

interest rates and restricting credit.

Thus, prices of domestic goods fall which makes exports attractive and imports

relatively costlier.

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Deflation keeps exchange rates unaffected and tries to correct the deficit in the BOP

through domestic changes.

In short, deflation being inexpedient, its side effects are dangerous to a poor country. It

creates more unemployment and poverty.

2.Exchange Depreciation.

This is a correcting method in which external value of the home currency is

depreciated.

Exchange depreciation of a country will tend to cheapen its domestic goods for the

foreigners so that its exports will be boosted, while its imports will be costlier.

The success of this method hugely depends on the cooperation of the foreigners. If all

countries start depreciating their exchange rates then the technique may not prove useful.

This method is not feasible under the present system of IMF of fixed exchange rate

system.

3. Devaluation.

Devaluation is Official decrease in the external value of a currency or good.

Exchange depreciation is based on the market mechanism whereas devaluation is

arbitrary.

Devaluation is undertaken when the currency is found to be unduly overvalued.

If a country has persistent deficit in its BOP, it may devalue its currency with the

permission of IMF.

Once a countrys currency is devalued its exports become cheaper to foreigners and

imports become relatively dearer.

Conditions for successful working of devaluation

A fairly elastic demand.

Structure of exports and imports.

Domestic price stability.

International cooperation.

Coordination of other measures.

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4. Exchange control.

Restrictions on the use of foreign exchange by central banks are called exchange

controls.

During exchange control, all the exporters have to surrender their foreign exchange

earnings to the central bank.

Under exchange control, the central bank releases foreign exchanges only for essential

imports and conserves the rest of the balance.

An exchange control offers no permanent solution to the problem of persistent

disequilibrium.

Non Monetary Measures

1. Discouraging Imports: In order to correct adverse balance of payments, imports are

reduced in the following ways:

(i) Import Duties- In order to discourage imports, their value is raised by

levying new import duties or raising the rate of existing import duties. On

account of these duties not only imports become dearer but their demand also

goes down. Fall in the volume of imports corrects adverse balance of

payments.

(ii) Import Quotas: Imports are curtailed by fixing import quotas. Under import

quota system, either the maximum volume of the value of the imported goods

is fixed by government. By restricting imports in this way balance of

payments is corrected.

(iii) Encouraging Import Substitutions: When substitutes of imported goods areproduced indigenously, it is called import substitution. It brings down the

demand for foreign goods and pressures on adverse balance of payment are

removed to a large extent.

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2. Export Promotion: The best method to correct an adverse BOP is to increase the

volume of exports. All duties or restrictions on exports should be withdrawn and export

industries be given special concessions and facilities. In order to increase the demand for

domestic products in foreign countries, intensive publicity and advertisements should be

undertaken. Indigenous products should be displayed in specially organized Exhibitions

and Trade fairs abroad. Thus production and export capacity of the export industry will

increase and balance of payments position to improve.

3. Encouragement to Foreign Investment: investment of foreign capital in the country

constitutes a credit item and so has a favorable effect on the balance of payment position.

Foreign investment can be attracted by different kinds of incentives and concessions.

4. Attraction to Foreign Tourists: In order to attract tourists, government has to

develop recreation parks and entertainment programmes. Foreign tourists bring along

with them large amount of foreign currency which serves the same purpose as the export

earnings.

5. Liberal Industrial Policy: Introducing an element of liberalization in the industrial

policy goes a long way in encouraging exports and import substitution. Both have a

favorable effect on the balance of payments. Since 1991-92 India has been following the

policy of liberalization.

6. State Trading: Balance of Payments is generally unfavorable in underdeveloped

countries. Under the circumstances, the state can take over the import and export trade

from private importers and exporters. In this way, it can effectively restrict the import of

unnecessary goods and promote the exports. However, this method can be adopted by

those countries only which are not under any pressure from any foreign country.

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Importance of BOP Statements

BOP statistics are regularly compiled, published and are continuously monitored

by companies, banks and government agencies. A set of BOP accounts is useful in the

same way as a motion picture camera. The accounts do not tell us what is good or bad,

nor do they tell us what is causing what. But they do let us see what is happening so that

we can reach our own conclusions. Below are 3 instances where the information provided

by BOP accounting is very necessary:

1. Judging the stability of a floating exchange rate system is easier with BOP as

the record of exchanges that take place between nations help track the accumulation of

currencies in the hands of those individuals more willing to hold on to them.

2. Judging the stability of a fixed exchange rate system is also easier with the

same record of international exchange. These exchanges again show the extent to which a

currency is accumulating in foreign hands, raising questions about the ease of defendingthe fixed exchange rate in a future crisis.

3. To spot whether it is becoming more difficult for debtor counties to repay

foreign creditors, one needs a set of accounts that shows the accumulation of debts, the

repayment of interest and principal and the countries ability to earn foreign exchange for

future repayment. A set of BOP accounts supplies this information.

This point is further elaborated below.

The BOP statement contains useful information for financial decision makers. In

the short run, BOP deficit or surpluses may have an immediate impact on the exchange

rate. Basically, BOP records all transactions that create demand for and supply of a

currency. When exchange rates are market determined, BOP figures indicate excess

demand or supply for the currency and the possible impact on the exchange rate. Taken in

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(iv) Despite low trade deficit, the current account deficit was higher at US$ 12.0 billion

during Q3 of 2009-10 mainly due to lower invisibles surplus.

(v) The current account deficit during April-December 2009 was higher at US$ 30.3

billion as compared to US$ 27.5 billion during April-December 2008.

(vi) Surplus in capital account increased sharply to US$ 43.2 billion during April-

December 2009 (US$ 5.8 billion during April-December 2008) mainly on account of

large inflows under FDI, Portfolio investment, NRI deposits and commercial loans.

(vii) As the surplus in capital account exceeded the current account deficit, there was a

net accretion to foreign exchange reserves of US$ 11.3 billion during April-December

2009 (as against a drawdown of US$ 20.4 billion during April-December 2008).

Balance of Payments for October-December of 2009-10: Sources RBI

Table 1: Major Items of India's Balance of Payments(US$ million)

Item April-June July-September October-December

2008-09(PR)

2009-10(PR)

2008-09(PR)

2009-10(PR)

2008-09(PR)

2009-10 (P)

1 2 3 4 5 6 7

1. Exports 57,454 37,910 53,630 41,915 39,436 44,648

2. Imports 82,731 64,804 92,752 73,810 73,484 75,374

3. Trade Balance (1-2) -25,277 -26,894 -39,121 -31,895 -34,049 -30,726

4. Invisibles, net 22,003 20,534 26,546 19,955 22,381 18,696

5. Current Account Balance(3+4) -3,274 -6,360 -12,575 -11,940 -11,668 -12,030

6. Capital Account Balance* 5,509 6,475 7,841 21,358 -6,214 13,797

7. Change in Reserves# -2,235 -115 4,734 -9,418 17,881 -1,767

(-Indicates increase;+ indicates decrease)

*: Including errors and omissions. #: On BOP basis (i.e., excluding valuation).

P: Preliminary. PR: Partially Revised.

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The major items of the BOP for the third quarter of 2009-10 are set out

below

(i) Indias merchandise exports recorded a growth of 13.2 per cent in Q3 of 2009-10 as

against a decline of 8.4 per cent in Q3 of 2008-09.

(ii) Import payments while, on a BOP basis, registered a growth of 2.6 per cent in Q3 of

2009-10 as compared with an increase of 9.2 per cent in Q3 of 2008-09, grew by 6.6 per

cent on Directorate General of Commercial Intelligence and Statistics (DGCI&S) basis

during the quarter under review. The low growth in imports is mainly attributed to

decline in oil related import payments due to lower international crude oil prices during

the period.

(iii) The trade deficit, on a BOP basis, was lower at US$ 30.7 billion as compared to US$

34.0 billion during Q3 of 2008-09.

(iv) The decline in invisibles receipts, which started in the Q4 of 2008-09, continued

during Q3 of 2009-10. Invisibles receipts registered a decline of 3.1 per cent during the

quarter (as against an increase of 5.4 per cent in Q3 of 2008-09) mainly on account of

decline in business, communication and financial services, and investment income

receipts. Although, software exports recorded a robust growth of 15.3 per cent, services

exports as a whole witnessed a decline of 12.3 per cent during the quarter as against an

increase of 11.8 per cent during the corresponding quarter of 2008-09.

(v) Invisibles payments recorded a growth of 12.9 per cent during Q3 of 2009-10, as

compared with a low growth of 2.4 per cent in Q3 of 2008-09, mainly led by increase in

payments under almost all components of services.

(vi) As decline in services exports was made up by strong private transfers receipts (24.1

per cent in Q3 of 2009-10), net invisibles (invisibles receipts minus invisibles payments)

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recorded a surplus of US$ 18.7 billion in Q3 of 2009-10 (US$ 22.4 billion in Q3 of 2008-

09).

(vii) Size of invisibles surplus in Q3 of 2009-10 was, however, lower than Q3 of

preceding year. Therefore, despite low trade deficit, the current account deficit was

higher at US$ 12.0 billion in Q3 of 2009-10 (US$ 11.7 billion in Q3 of 2008-09).

(viii) Continuing buoyancy in capital inflows mainly led by large inflows under foreign

direct investments, portfolio investments and short-term trade credits resulted in a net

capital account surplus of US$ 14.7 billion during Q3 of 2009-10 as against a net deficit

of US$ 6.1 billion during Q3 of 2008-09.

(ix) Net FDI flows (net inward FDI minus net outward FDI) amounted to US$ 3.9 billion

in Q3 of 2009-10 (US$ 0.4 billion in Q3 of 2008-09). Net inward FDI stood at US$ 7.1

billion during Q3 of 2009-10 (US$ 6.3 billion in Q3 of 2008-09). Net outward FDI

remained lower at US$ 3.2 billion in Q3 of 2009-10 (US$ 5.9 billion in Q3 of 2008-09).

Net portfolio investments were higher at US$ 5.7 billion mainly supported by strong net

inflows by the foreign institutional investors amounting to US$5.3 billion during Q3 of

2009-10.

(x) Net External Commercial Borrowings (ECBs) remained lower at US$ 1.5 billion in

Q3 of 2009-10 (US$ 3.8 billion in Q3 of 2008-09) mainly due to increased repayments

and low disbursements of commercial loans to India. Short-term trade credits to India

recorded a net inflow of US$ 3.3 billion in Q3 of 2009-10 as against a net outflow of US$

4.2 billion during Q3 of 2008-09.

(xi) Net inflows under banking capital was higher at US$ 1.9 billion mainly due to

drawdown of foreign assets of commercial banks and a net inflow of US$ 0.6 billion

under non-resident Indian (NRI) deposits.

(xii) There was an increase in foreign exchange reserves on BOP basis (i.e., excluding

valuation) of US$ 1.8 billion in Q3 of 2009-10 as against a decline of US$ 17.9 billion in

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Q3 of 2008-09. In nominal terms (including valuation changes), foreign exchange

reserves rose by US$ 2.2 billion during Q3 of 2009-10.

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Conclusion

The Balance of Payments is the sum of the Current Account and the Capital Account and the

Financial Account. The Balance of Payments Identity states that:

Current Account + Capital Account + Financial Account + Net Errors and Omissions = Change

in Official Reserve Account

An Account deficit means more money is going out of the country to purchase goods than is

coming in. An 'Account Surplus' is just the opposite by definition, bop account always balances. Yet,

the individual may or may not balance. There in reality gives rise to the widely discussed deficit

surplus arising in bop account a net inflow in account of merchandise trade results in a trade surplus,

while a net outflow, result in trade deficit in the same way, a net inflow after taking all entries in the

current account into consideration is referred to as the current account surplus, and a net outflow as

current account deficit. Significant two way movements in capital flows dominated the Bop outcome

in 2005-6.the strong improvement in India macroeconomic performance created a preferred habitat of

private capital flows which accounted 30.6 percent of global flows to EME and developing countries

in 2006. This was also reflected in an up gradation of the sovereign rating to investment grade during

2003-4.for the first time since 1997-1998.

The presence of a trade deficit or an increase in the trade deficit in a previous month or quarter

is commonly reported as a sign of economic weakness. Similarly, a decrease in a trade deficit, or the

presence or increase in a trade surplus is commonly viewed as a sign of strength in an economy.

Unfortunately, these perceptions and beliefs are somewhat misguided. It is simply not true in

general, that a trade deficit is a sign of a weak economy and a trade surplus is a sign of a strong

economy. Merely knowing that a country has a trade deficit, or that a trade deficit is rising, is not

enough information to say anything about the current or future prospects for a country. And yet, that is

precisely how the statistics are often reported. Thus Trade deficits can be a good thing for less

developed countries. Corporate finance managers must monitor the BOP data being put out by

government agencies on a regular basis because they have both short term and long term implications

for a host of economic and financial variables affecting the fortunes of the company

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Bibliography

Websites

1. http://www.indiabudget.nic.in/es2001-02/chapt2002/chap62.pdf

2. http://www.indiaonestop.com/economy/balanceofpayments/economy-macro-balance%20of

%20payments.htm

3. http://en.wikipedia.org/wiki/Balance_of_payments

4. http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=22270

5. http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-

Account&id=1406517

6. http://www.emsnow.com/newsarchives/archivedetails.cfm?ID=15580

7. http://mpettis.com/category/balance-of-payments/

Books

1. Public Finance and International Trade by T.R. Jain (pages 164-182)

2. International Money and Finance by Michael Melvin (pages 62-69)

3. International Business by Andrew Harrison, Ena Esly, Ertugru (pages 110-112)
http://www.indiabudget.nic.in/es2001-02/chapt2002/chap62.pdfhttp://www.indiaonestop.com/economy/balanceofpayments/economy-macro-balance%20of%20payments.htmhttp://www.indiaonestop.com/economy/balanceofpayments/economy-macro-balance%20of%20payments.htmhttp://en.wikipedia.org/wiki/Balance_of_paymentshttp://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=22270http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-Account&id=1406517http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-Account&id=1406517http://www.emsnow.com/newsarchives/archivedetails.cfm?ID=15580http://mpettis.com/category/balance-of-payments/http://www.indiabudget.nic.in/es2001-02/chapt2002/chap62.pdfhttp://www.indiaonestop.com/economy/balanceofpayments/economy-macro-balance%20of%20payments.htmhttp://www.indiaonestop.com/economy/balanceofpayments/economy-macro-balance%20of%20payments.htmhttp://en.wikipedia.org/wiki/Balance_of_paymentshttp://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=22270http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-Account&id=1406517http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-Account&id=1406517http://www.emsnow.com/newsarchives/archivedetails.cfm?ID=15580http://mpettis.com/category/balance-of-payments/

Documents

Balane of Payment10 Report