Balance of payments

class 12

1. Balance of payments Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

2. Meaning of BoP A balance of payment account is a systematic record of all economic transactions between residents of a country and the rest of the world carried out in a specific period of time BoP records a country’s inflows and outflows of foreign exchange in a fiscal year In short BOP account is a summary statement of transactions in foreign exchange in a year Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

3. Structure BoP account , like a typical business account, is based on double entry system Contains two sides ---Credit side and Debit side Any transaction which brings in foreign exchange (currency) is recorded on credit side and given a positive sign (+) Any transaction that cause a country to low foreign exchange is recorded onb debit side and is given a negative (-) sign Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

4. Credit (inflow of foreign exchange) Debits ( outflow of foreign exchange) Exports of goods (Visible items) imports of goods Exports of services (invisibles) Unilateral transfer(gifts, remittances…) Import of services Unilateral ( Paid to foreigners …) Capital receipts capital payments Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

5. Account of a country’s Balance of Payment Credits Debits Row 1 Exports of goods 550 Row 5 Imports of goods 800 Row 2 Exports of services 150 Row 6 Imports of services 50 Row 3 Unilateral transfers (gifts , received from foreigners) 100 Row 7 unilateral transfer ( gifts paid to foreigners) 80 Row 4 capital receipts 200 Row 8 Capital payments 70 Total Receipts 1,000 Total Payments 1,000 Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

6. Features of BoP Systematic record of all economic transactions It includes all transactions It it constructed on double entry system BoP account is broadly divided into two sub-account Current account and the Capital account Current account ( first three items ) Capital account (fourth item ) Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

7. Balance of Trade ( BoT ) Balance of trade  is the net difference of Import and export of all visible items between the normal residents of a country and rest of the world. Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

8. Surplus or Deficit BOT Balance of trade may be surplus or in deficit or in equilibrium If value of export of goods (visible items) is more than the value of imports of goods, balance of trade is said to be positive or favorable or surplus In case the value of export of goods is less than the value of imports of goods, the balance of trade is said to be negative or unfavorable or deficit Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

9. Difference between BOT and BOP BOT BOP 1 It records transactions relating to goods only 1 It records transactions relating to both goods and services 2 It does not record transactions of capital nature 2 It records transactions of capital nature which cause flow of foreign exchange 3 It is a narrow concepts as it is only one part of BOP account 3 It is wider concepts as it includes balance of trade, balance of services, balance of unilateral transfers and balance of capital transactions 4 It may be favorable , unfavorable or in equal 4 It always remains in balance 5 Deficit in BOT can be met by BOP 5 Deficit in BOP cannot be met through BOT 6 It is not true indicator of economic relations or economic prosperity of a country 6 It is true indicator of economic performance of an economy Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

10. Current account and Capital account Current account records export and imports of goods, export and import of services, and unilateral transfers during a year Capital account records Borrowings and lending to an from abroad Investments to and from abroad Changes in foreign exchange reservews Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

11. Difference between/components current account and capital account Components of Current Account Components of Capital Account 1. Visible items (import and export of goods). 1. Foreign Direct investment. 2. Invisible items (import and export of services). 2. Loans. 3. Unilateral transfers. 3. Portfolio investment. 4.Income receipts and payments from and to abroad. 4. Banking capital transactions. 5. These are the transactions which do not affect         the assets or liabilities position of the country. 5. These are the transactions which affect                    assets or liabilities position of the country. 6. It is a flow concept. 6.It is a stock concept. Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

12. Official Reserve Account Official Reserve Account : The  official reserve account  is a part of the capital  account , are the foreign currency and securities held by the central bank of a country and used to balance the payments from year-to-year. The  reserves  increase in case of a trade surplus and decrease when there is a trade deficit. Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

13. Balance of payment always balances This balance is expressed in accounting sense BOP accounts are prepared on the basis of system of double entry under which receipts side are always equal to payment side The balance of current account need not be equal (surplus or Deficit ) The point to be noted here is that a deficit or surplus in current account is balanced by an equal amount of surplus or deficit in capital account Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

14. Autonomous and Accommodating items in BOP Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

15. Autonomous items in BOP These refer to international economic transactions that take place due to some economic motives like earning income and profit maximization They have nothing to do with foreign exchange payments ,they are irrespective of whether BOP is favorable or unfavorable , they are, therefore called autonomous items It is autonomous transactions which make deficit or surplus in BOP These items are generally called ‘ above the line items ’ in BOP Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

16. Accommodating items in BOP These refer to transactions that take place to cover deficit (or Surplus) arising from autonomous transactions These items are also called ‘ below the line items ’ Mind, accommodating items do not cause movement of goods and services across the border. Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

17. Significance of Distinction The significance of this distinction is that deficit /surplus in BOP occurs due to deficit/surplus in autonomous transactions only Accommodating truncations are made to cover up deficit/surplus in autonomous transactions Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

18. Causes of disequilibrium in BOP Economic factors Political factors Social factors Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

19. Measures of correcting disequilibrium in BOP Export promotion Devaluation of domestic currency Exchange control Depreciation Reducing inflation Impost restriction and import substitution Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

20. Foreign exchange rate Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

21. Meaning Foreign exchange means foreign currency All currencies other than domestic currency of a given country Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

22. Foreign exchange rate The rate at which currency of one country can be exchanged for currency of another country is called the rate of foreign exchange It is the price of a country’s currency in terms of other country’s currency It is also called as external value of currency Nominal vs real exchange rate Nominal exchange rate is the price of foreign currency in terms of domestic currency Real exchange rate is the relative price of foreign goods in terms of domestic goods Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

23. Foreign exchange market The market in which national currencies of various countries are converted, exchanged or traded for one another is called foreign exchange market . It is not any physical place It includes banks, specialized foreign exchange dealers, brokers and official government agencies Spot market and forward market Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

24. Spot market A market that handles only spot transactions or current transaction in foreign exchange is called spot market If operation is daily nature, it is called spot market or current market The exchange rate that prevails in the spot market for foreign exchange is called Spot rate Spot rate of exchange refers to the rate at which foreign currency is available on the spot Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

25. Forward market A market in which foreign exchange is bought and sold for future delivery is known as forward market Which are contracted today but implemented sometimes in future Exchange rate that prevails in a forward contract for purchase or sale of foreign exchange is called forward rate A forward contract is entered into for two reasons ; To minimize risk of loss due to adverse change in exchange rate i.e., hedging To make a profit i.e. speculation Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

26. Sources of demand for foreign exchange To purchase goods and services by domestic residents from foreign countries To purchase financial assets by domestic residents in a foreign country To invest directly in shops , factories, buildings in foreign countries To send gifts and grants abroad To undertake foreign tours To speculate on the value of foreign currencies To make payments of international trade Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

27. Relationship between rate and demand There is inverse relationship between price of foreign exchange and demand for foreign exchange When exchange rate rises, demand for foreign exchange falls and when exchange rate of foreign currency falls its demand rises Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

28. Reasons for rise in demand for foreign currency when its price falls When price of foreign currency falls, imports from the country become cheaper When foreign currency become cheaper in terms of domestic currency , it promotes tourism When price of foreign currency falls , it has negative effect on export of home country Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

29. Reason for fall in demand When price of foreign exchange rises, imports form that country become costly, as a result , imports fall leading to fall in demand for foreign currency When foreign currency becomes costlier in terms of domestic currency , it discourages tourism to foreign country Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

30. Sources of supply of foreign exchange (say US dollars) When foreigners purchase home country’s (India) goods and services through exports When foreigners invest in bonds ad equity shares of the home country When currency dealers and speculators cause flow of foreign currency in the domestic economy When Indian workers working abroad send their savings to families in India (remittances ) Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

31. Relationship between rate of foreign exchange and supply There is direct relationship between price of foreign exchange and supply of foreign exchange Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

32. Reasons for increase in supply when rate of foreign exchange rises A rise in foreign exchange rate makes home country’s goods cheaper to foreigners , as a result, foreign demand for goods increases leading to increase in India's exports Again a rise in foreign exchange rate renders home country’s currency cheaper which attracts foreigners and promote tourism Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

33. How is rate of foreign exchange determined ? Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

34. Fixed vs Flexible exchange rate Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

35. Fixed exchange rate Fixed exchange rate is the rate which is officially fixed in terms of other currency by the government / Central bank The rate is not influenced by market forces Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

36. Flexible (floating ) exchange rate Flexible exchange rate is the rate which is determined by market forces of demand and supply in the foreign exchange market There is no official intervention . Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

37. Managed floating exchange rate Managed floating exchange rate in essence is flexible exchange rate which is determined by market forces but called managed floating exchange rate because The central bank influences the rate through intervention to reduce fluctuations in the rate When foreign exchange rate is too high, central bank starts selling foreign currency from its reserve of foreign exchange On the other hand when exchange rate is too low, central bank start buying foreign currency in the market. Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

38. Appreciation vs Revaluation of currency Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A., ˃

39. Appreciation of a currency Appreciation is the increase in value of domestic currency in terms of foreign currency when exchange rate is freely determined by forces of demand and supply Thus , it makes domestic currency more valuable indicating less of domestic currency is required to buy the foreign currency . Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

40. Revaluation of currency When a country raises the value of its currency in terms of foreign currency under a fixed rate regime The effect of revaluation is the same as that of appreciation Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

41. Depreciation vs Devaluation Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A., ˂

42. Depreciation of a currency Depreciation of the currency is the fall in value of domestic currency in terms of foreign currency under a system of market determined rate of exchange Depreciation of domestic currency means higher price of foreign currency in terms of domestic currency Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

43. Devaluation of a currency Devaluation is fall in value of domestic currency in terms of foreign currency under a fixed exchange rate system When government of a country officially lowers the value of its currency in terms of foreign currency , it is called devaluation Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

44. Any questions ? Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,

45. Thank you Madan Kumar M.A.,M.A.,B.Ed.,M.Phil.,M.B.A.,