BOP.Chapter 1

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Chapter Two

International FinancialManagement

Chapter Objectives:

Understanding BALANCE OF PAYMENT


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Principles Of Balance Of Payments

BOP is a systematic record of all economic transaction

between the residents of a given country and the residents of

other countries.

BOP account is based on the standard double entry system

of bookkeeping.

Any transaction which is source of foreign currency is a

credit entry. They are recorded with plus sign.

Any transaction which is a use. Example imports,

Borrowing money etc is a debit entry. They are recorded with

minus sign. Slide 1


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Sources of foreign exchange Credit Entry

Export of goods.

Export of services like travel, insurance etc.

Capital inflow into the country Borrowings.

Transactions reducing the external purchasing powe

of the country is recorded as Debit Entry

Imports of goods

Capital outflow - Lending

Slide 2


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Components of BOP

BOP statement is divided into three major groups of accounts

CURRENT ACCOUNT

CAPITAL ACCOUNT

ERRORSAND OMISSIONS

Slide 3


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CURRENT ACCOUNT

1. MERCHANDISE

a. Exports (on free On Board)

b. Imports (Cost, Insurance Freight

2. INVISIBLES

Services

i. Travel

ii. Transportation

iii. Insurance

iv. G.n.i.e

v. Miscellaneous

b. Transfers

vi. Official

vii. Private

c.Investment Income

Slide 4

DR CR


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CAPITAL ACCOUNT

1.Foreign Investment

2.Loans

3.Banking Capital

4.Rupee Debt Service

5.Other Capital

ERRORSAND OMISSIONSIt indicates the value of discrepancies. A negative value indicates that receipts

are overstated or payments are understated. Persistently large errors with the

same sign indicate serious weaknesses in the recording of transactions. Slide 5

DR CR


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CURRENT ACCOUNT

Current account records trade transaction and invisibles.

Exports on f.o.b (free on trade) basis are shown as credit.

Imports valued on c.i.f (Cost Insurance Freight) basis are shown as debit.

Invisibles comprises the value of services rendered by resident to non-resident.

G.n.i.e implies govt not included elsewhere. Funds received from foreign govt for the

maintenance of their embassy, consulates etc in India are shown as Credit Entry.

Payment made to foreign consultant for professional services rendered by him will

appear as debit item.

Transfers are of two types Official & Private.

Official Contribution by govt of India to International Institution Dr

Private Cash remittances by non-resident Indians for their family maintenance in

India.

Slide 6


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CAPITAL ACCOUNT

All financial transactions are recorded in capital account

Foreign Investment Investment made by foreign residents in the

acquisition of physical assets in India is a Foreign Direct Invt. Cr Entry.

When a Foreign country portfolio investor directly purchases financial assetsin the Indian securities market it is termed as Foreign Portfolio Invt.Dr Entry

Loans Disbursements received by Indian resident entities are Cr Entry.

While repayment of loan is recorded as Dr Entry.

Rupee Debt Service Is defined as the cost of meeting interest payments and

regular contractual repayments of principal of a loan with any administrative

charges in rupees by India.

Slide 7


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EXCHANGE RATE MECHANISM

Exchange rate is formally defined as the value of one currency in

terms of another country.

Types of Exchange Rate Mechanism are

Fixed Exchange Rate System

Floating Exchange Rate System

Slide 8


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Types of Fixed Rate System are

Currency Board System

Target zone arrangement

Monetary Union

Slide 9


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Types of Fixed Rate System are

Currency Board System Under currency board system, a

country fixes the rate of its domestic currency in terms of a

foreign currency and its exchange rate in terms of other currenciesdepends on the exchange rates between the other currencies.

Target Zone arrangement A group of countries sometimes get

together and agree to maintain the exchange rates between their

currencies within a certain band around fixed central exchange

rates.

Monetary Union Under this system a group of countries agree to

use a common currency instead of their individual currencies.


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Types of Floating Exchange Rate System

Free Float

Under this system the exchange rates between currencies arevariable. These rates are determined by the demand and supply

for the currencies.

Managed Float

Uncertainties increase the risk associated with International trade

and thus reduce overall efficiency of the world economic system.

In order to reduce these inefficiencies central bank generally

intervene in the currency markets to smoothen the fluctuations.


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FACTORSAFFECTING THE COMPONENTS OF BOP

ACCOUNT

Exports of goods & services

1. Prevailing Exchange rate of the domestic currency Lower

value lower international price increase demand for exports

hence high demand for the domestic currency.

2. Inflation rate

3. World price of commodity

4. Income of foreigners

5. Trade barriers


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FACTORSAFFECTING THE COMPONENTS OF BOP

ACCOUNT

Imports of goods & services

1. Value of domestic currency.

2. Level of domestic income.

3. International Prices

4. Inflation Rate

5. Trade barriers


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HISTORY OF MONETARY SYSTEM

Following are the Monetary System

The Gold Standard

Bretton Woods System

Post Bretton Woods System

The European Monetary System


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The Gold Standard

a) Gold standard was followed from 1870 1914.

a) Due to first world war in 1914 it was discontinue.

a) The exchange rate between two currencies was determined on

the basis of the rates at which the respective currencies could

be converted into gold.


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Bretton Woods System

a) In 1944 representatives of 44 countries met in Bretton Woods

(USA) and a agreement to establish a new monetary system

known as Bretton WoodsS

ystem.

b) Two new institutions were to be established namely the IMF &

World Bank.

c) Terms of agreement were all member countries were required

to subscribe to IMF capital. The subscription was to be in the

form of gold (1/4) and balance in its own currency.

d) Each countries quota was decided by IMF as per the position in


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POST BRETTON WOODS SYSTEM

Principles of exchange rate management was adopted

a) A member country neither should manipulate exchange rate toprevent correction in BOP nor it should use it to gain

competitive advantage in International market.

b) A member country should prevent short term movements in the

exchange rates which could hamper international transactions.


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THE EUROPEAN MONETARY UNION

a) The treaty of Rome was signed by Belgium, France, German,

Italy, Netherlands etc to form European Economic Community.

b) In the same year it adopted a Common Agriculture Policy

(CAP) under which uniform prices were set for farm products.

c) Structure of EEC.

d) EMS was quite similar to the Bretton Woods System with the

exception that instead of the currencies being pegged to the

currency of one of the participating nations, a new currency

was created for the purpose.

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BOP.Chapter 1