Balance of Payment

Structure of Balance of payment and elements

1. BALANCE OF PAYMET

2. Balance Of Payment : Definition RBI 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 them on account of goods imported and services received from the capital transferred to non-residents or foreigners .

3. Features It is a systematic record of all economic transactions between one country and the rest of the world. It includes all transactions, visible as well as invisible . It relates to a period of time. Generally, it is an annual statement . It adopts a double-entry book-keeping system. It has two sides : credit side and debit side. Receipts are recorded on the credit side and payments on the debit side.

4. Structure/Components of a BOP statement B.O.P . on Current account B.O.P. on Capital account Unilateral Payment accounts Official Settlement accounts

5. Current Account Main Components 1.Export and Import of Good s   (Merchandise Transactions or Visible Trade) A major part of transactions in foreign trade is in the form of export and import of goods (visible items). Payment for import of goods is written on the negative side (debit items) and receipt from exports is shown on the positive side (credit items ). Balance of these visible exports and imports is known as balance of trade (or trade balance). 2. Export and Import of Services (Invisible Trade ) It includes a large variety of non- factor services (known as invisible items) sold and purchased by the residents of a country, to and from the rest of the world. Payments are either received or made to the other countries for use of these services.

6. Services are generally of three kinds: (a) Shipping, (b) Banking, and (c) Insurance . Payments for these services are recorded on the negative side and receipts on the positive side . 3. Unilateral or Unrequited Transfers to and from abroad   (One sided Transactions ) Unilateral transfers include gifts, donations, personal remittances and other ‘one-way’ transactions. These refer to those receipts and payments, which take place without any service in return. Receipt of unilateral transfers from rest of the world is shown on the credit side and unilateral transfers to rest of the world on the debit side.

7. 4.Income receipts and payments to and from abroad It includes investment income in the form of interest, rent and profit s . Current Account shows the Net Income . Current Account records all the actual transactions of goods and services which affect the income, output and employment of a country. So, it shows the net income generated in the foreign sector. BOP on current account is a statement of actual receipts and payments in short period.

8. Balance on Current Account In the current account, receipts from export of goods , services and unilateral receipts are entered as credit or positive items and payments for import of goods , services and unilateral payments are entered as debit or negative items. The net value of credit and debit balances is the balance on current account . Surplus in current account arises when credit items are more than debit items. It indicates net inflow of foreign exchange . Deficit in current account arises when debit items are more than credit items . It indicates net outflow of foreign exchange

9. Capital Account Capital account of BOP records all those transactions, between the residents of a country and the rest of the world , which cause a change in the assets or liabilities of the residents of the country or its government . It is related to claims and liabilities of financial nature. Capital Account is used to: (i) Finance deficit in current account; or (ii) Absorb surplus of current account. Capital account is concerned with financial transfers. So, it does not have direct effect on income, output and employment of the country .

10. Components of Capital Account 1. Borrowings and landings to and from abroad:   It includes All transactions relating to borrowings from abroad by private sector, government , etc. Receipts of such loans and repayment of loans by foreigners are recorded on the positive (credit) side . All transactions of lending to abroad by private sector and government . Lending abroad and repayment of loans to abroad is recorded as n egative or debit item. 2. Investments to and from abroad: It includes Investments by rest of the world in shares of Indian companies, real estate in India, etc. Such investments from abroad are recorded on the positive (credit) side as they bring in foreign exchange.

11. Investments by Indian residents in shares of foreign companies , real estate abroad, etc. Such investments to abroad be recorded on the negative (debit) side as they lead to outflow of foreign exchange . 3. Change in Foreign Exchange Reserves The foreign exchange reserves are the financial assets of the government held in the central bank. A change in reserves serves as the financing item in India’s BOP. So, any withdrawal from the reserves is recorded on the positive (credit) side and any addition to these reserves is recorded on the negative (debit) side . change in reserves’ is recorded in the BOP It must be noted that ‘account and not ‘reserves’.

12. Balance on Capital Account The transactions, which lead to inflow of foreign exchange (like receipt of loan from abroad, sale of assets or shares in foreign countries, etc.), are recorded on the credit or positive side of capital account . Similarly , transactions, which lead to outflow of foreign exchange (like repayment of loans, purchase of assets or share s in foreign countries, etc.), are recorded on the debit or negative side. The net value of credit and debit balance s is the balance on capital account .

13. Surplus in capital account arises when credit items are more than debit items. It indicates net inflow of capital . Deficit in capital account arises when debit items are more than credit items. It indicates net outflow of capital . Unilateral Transfers Account It comprises of uni -directional transactions like ‘giving of gifts ’. Disaster relief, foreign aids , govt. grants, pension paid to and received by Indian citizens for services rendered abroad.

14. Official Settlements Account It represents official sales of foreign currencies and other reserves to foreign countries or official purchase of foreign currencies or other reserves from foreign countries . Credits here are money received from official sale of foreign currencies and reserves. Similarly, D ebits comprise of official purchases of foreign currencies and other assets.

15. In addition to the above , there are two more elements in BOP, ‘ Errors and Omissions ’. The entries under this head relate mainly to leads and lags in reporting of transactions It is the balancing item , which reflects the inability to record all international transactions accurately . The Reserve Account Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Reserve Account . The IMF account contains purchases (credits) and repurchase (debits ) from International Monetary Fund . Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to time to member countries . It can be used to settle international payments between monetary authorities of two different countries.

16. Structure Of BOP Balance of payments is a c omplete record of Total Receipts and Total Payments of a country in relation to other countries over a given time period . Total Receipts are called CREDIT and Total Payments are termed as DEBIT . Credit side comprises of all those values received from foreign countries. On the other hand , Debit side comprises of all the payments made to other countries . It is maintained in a double entry book keeping system .

17. Structure Of BOP CREDITS DEBITS ITEMS OF CURRENT ACCOUNT Export of Goods Import of Goods Exports of Services Import of Services Unilateral Transfer Receipts (gifts, indemnities from foreigners). Unilateral Transfer Payments (gifts, indemnities from foreigners). Income receipts. Income payments. ITEMS OF CAPITAL ACCOUNT Capital Receipts ( borrowings from capital repayments by or sale of assets to foreigners). Capital Payments ( lending to, capital repayments to or purchase of assets from foreigners).

18. Importance of Balance Of Payments BOP records all the transactions that create demand for and supply of a currency . Judge economic and financial status of a country in the short-term BOP may confirm trend in economy’s international trade and exchange rate of the currenc y. This may also indicate change or reversal in the trend . This may indicate policy shift of the monetary authority (RBI) of the country . BOP may confirm trend in economy’s international trade and exchange rate of the currenc y. This may also indicate change or reversal in the trend .

19. Balance of Trade The difference between a country's imports and its exports . Balance of trade is the largest component of a country's balance of payments. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy. When exports are greater than imports the BOT is favourable and if imports are greater than exports then it is unfavourable

20. Economists use BOT as a statistical tool to help them understand the relative strength of a country's economy versus other countries' economies and the flow of trade between nations . The balance of trade is also referred to as the trade balance or the international trade balance. A trade surplus or deficit, taken on its own, is not necessarily a viable indicator of an economy's health.

21. Many people believe that trade deficit is unfavourable , bad. The numbers must be taken in context relative to the business cycle and other economic indicators. In a recession , countries like to export more , creating jobs and demand in the economy. In a strong expansion , countries prefer to i mport more, providing price competition, which limits inflation without increasing prices Trade deficit is not a good thing during a recession but may help during expansion

22. Examples of Balance of Trade There are countries where it is almost certain that a trade deficit will occur. For example, the United States has had a trade deficit since 1976, in large part due to its imports of oil and consumer products . Conversely , China, a country that produces and exports many of the world's consumable goods, has recorded a trade surplus since 1995 . In 2015, the European Union, Germany, China and Japan all had very large trade surpluses , while the United States, the United Kingdom, Brazil, Australia and Canada had the largest trade deficits.

23. Factors affecting BOT A country's balance of trade is defined by its net exports (exports minus imports) and is thus influenced by all of the factors that affect international trade . These include factor endowments ( labor , land and capital) and productivity, barriers to trade , investment activity and fiscal policy. Demand also affects the balance of trade . The cost of production (land, labor , capital, taxes, incentives, etc.) in the exporting economy vis-à-vis those in the importing economy ; The cost and availability of raw materials, intermediate goods and other inputs;

24. Exchange rate movements ; Multilateral , bilateral and unilateral taxes or restrictions on trade; Non-tariff barriers such as environmental, health or safety standards; The availability of adequate foreign exchange with which to pay for imports; and Prices of goods manufactured at home (influenced by the responsiveness of supply ) Population Growth- To meet their needs, imports become essential and the quantity of imports may increase as population increases.

25. Demonstration Effect - people in the less developed countries imitate the consumption pattern of the developed countries, import will increase, export remain constant. Poor Marketing Strategies- The superior marketing of the developed countries have increased their surplus. The poor marketing facilities of the developing countries have pushed them into huge deficits. Natural Factors - calamities such as the failure of rains or the coming floods may easily cause disequilibrium in the balance of payments by adversely affecting agriculture and industrial production in the country. The exports may decline while the imports may go up causing a discrepancy in the country's balance of payments .

26. Balance of Trade Vs Balance of Payments Basis for Comparison Balance of Trade Balance of Payment Meaning Balance of Trade is a statement that captures the country's export and import of goods with the remaining world. Balance of Payment is a statement that keeps track of all economic transactions done by the country with the remaining world. Records Transactions related to goods only. Transactions related to both goods and services are recorded. Capital transfers Are not included in the Balance of Trade. Are included in Balance of Payment. Which is better? It gives a partial view of the country's economic status It gives a clear view of the economic position of the country Result It can be Favorable , Unfavorable or balanced Both the receipts and payment sides tallies Component It is a component of Current Account of Balance of Payment. Current Account and Capital Account.

27. Measures To Correct Disequilibrium in the BOP 1. Monetary Measures :- a) Monetary Policy The monetary policy is concerned with money supply and credit in the economy . The Central Bank may expand or contract the money supply in the economy through appropriate measures which will affect the prices. b ) Fiscal Policy Fiscal policy is government's policy on income and expenditure. Government incurs development and non - development expenditure,. It gets income through taxation and non - tax sources. Depending upon the situation governments expenditure may be increased or decreased.

28. c) Exchange Rate Depreciation By reducing the value of the domestic currency, government can correct the disequilibrium in the BOP in the economy. Exchange rate depreciation reduces the value of home currency in relation to foreign currency. As a result , import becomes costlier and export become cheaper. It also leads to inflationary trends in the country, d) Devaluation D evaluation is lowering the exchange value of the official currency . When a country devalues its currency, exports becomes cheaper and imports become expensive which causes a reduction in the BOP deficit.

29. e) Deflation Deflation is the reduction in the quantity of money to reduce prices and incomes . In the domestic market, when the currency is deflated, there is a decrease in the income of the people . This puts curb on consumption and government can increase exports and earn more foreign exchange. f ) Exchange Control All exporters are directed by the monetary authority to surrender their foreign exchange earnings , and the total available foreign exchange is rationed among the licensed importers. The license-holder can import any good but amount if fixed by monetary authority.

30. II. Non- Monetary measures :- a) Export Promotion To control export promotions the country may adopt measures to stimulate exports like : E xport duties may be reduced to boost exports C ash assistance, subsidies can be given to exporters to increase exports G oods meant for exports can be exempted from all types of taxes. b) Import Substitutes Steps may be taken to encourage the production of import substitutes. This will save foreign exchange in the short run by replacing the use of imports by these import substitutes.

31. c) Import Control Import may be kept in check through the adoption of a wide variety of measures like quotas and tariffs. Under the quota system, the government fixes the maximum quantity of goods and services that can be imported during a particular time period. 1. Quotas – Under the quota system, the government may fix and permit the maximum quantity or value of a commodity to be imported during a given period By restricting imports through the quota system, the deficit is reduced and the balance of payments position is improved. 2. Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices of imports would increase to the extent of tariff. The increased prices will reduced the demand for imported goods and at the same time induce domestic producers to produce more of import substitutes