Balance of Payments

Balance of Payments
• 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.
• Individual – individuals, business organization,
government agency and other institutions
 Balance Of Payment : Definition
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.
- Reserve Bank of India
 Balance of Payments
• Sources – credits
• Uses – debits
• Reveals whether a country has a net surplus or deficit.
• Surplus – receipts is more than spending
• Sources
– exports of goods and services
– Sale of foreign assets
– Foreign loans/borrowings etc
• Uses
– Import of goods and services
– Purchase of foreign assets
– Foreign lending etc
 Balance of Payments
• Record of Payments to & Receipts from Foreign
Entities
– Double-entry bookkeeping system.
• Every transaction has two entries – a credit (+) and
a debit (-)!
– Payment = Debit (-)
– Receipt = Credit (+)
– Multiple Accounts
• Current Account (CA) ,Capital/Financial Account
(KA) and official reserves account.
– Is a summary (net) record of flows, not stocks
 The General Rule in BOP Accounting
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.
 A country has to deal with other
countries in respect of the following

1. Visible items which include all types of physical

goods exported and imported.

2. Invisible items which include all those services

whose export and import are not visible. e.g.
transport services, medical services etc.

3. Capital transfers which are concerned

with capital receipts and capital
payment.
 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 than the
BOT is favourable
and if imports are greater than exports then it is
unfavourable
Balance of Trade V/s Balance of
Payment
The Balance of Payment takes into account all the
transaction with the rest of the worlds

The Balance of Trade takes into account all the trade

transaction with the rest of the worlds
BoP Vs BoT
 The various components of a BOP
statement

1. Current Account

2. Capital Account

3. Reserve Account

4. Errors & Omissions

 Current Account Balance
• BOP on current account is a statement of actual
receipts and payments in short period.
• It includes the value of export and imports of both
visible and invisible goods. There can be either
surplus or deficit in current account.
• The current account includes:- export & import of
services, interests, profits, dividends and unilateral
receipts/payments from/to abroad.
• BOP on current account refers to the inclusion of three
balances of namely – Merchandise balance, Services
balance and Unilateral Transfer balance
 Types of Balances
Trade Balance
Merchandise: exports - imports of goods
Services: exports - imports of services

Income Balance
Net investment income: net income receipts from assets
Net international compensation to employees: net compensation of
Employees
Net Unilateral Transfers
Gifts from foreign countries minus gifts to foreign countries
 Capital Account Balance
 The capital account records all international transactions
that involve a resident of the country concerned
changing either his assets with or his liabilities to a
resident of another country. Transactions in the capital
account reflect a change in a stock – either assets or
liabilities.
 It is difference between the receipts and payments on
account of capital account. It refers to all financial
transactions.
 The capital account involves inflows and outflows
relating to investments, short term borrowings/lending,
and medium term to long term borrowing/lending.
 Capital Account Balance
 There can be surplus or deficit in capital
account.
 It includes: - private foreign loan flow,
movement in banking capital, official capital
transactions, reserves, gold movement etc.
 These are classifies into two categories-
o Direct foreign investments
o Portfolio investments
o Other capital
 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 re- purchase (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.
 Errors and Ommissions
 The entries under this head relate mainly
to leads and lags in reporting of
transactions

 It is of a balancing entry and is needed to

offset the overstated or understated
components.
India- BoP
 National Income Accounting
• GDP: National Spending = National Income
– Y=C+I+G+X–M
– Y = GDP; C = Consumption; I = Physical Investment; G = Government
Spending; X = Exports; M = Imports
– C + I + G = Domestic Absorption (spending on domestic output)
– (X – M) = Trade Balance = Net Exports
• Trade Balance = Nat’l Income less Domestic Absorption
– X – M = Y – (C + I + G)
• Trade Balance = Net Domestic Saving
– Y = C + Saving + Taxes = C + I + G + X – M
– X – M = (S – I) + (T – G)
– Trade Imbalances must be met with International Borrowing or
Lending, i.e., trade deficit  borrow from rest of world.
• Note  No Causation Implied!
 Disequilibrium In The Balance Of
Payments
A disequilibrium in the balance of payment
means its condition of Surplus Or deficit
 A Surplus in the BOP occurs when Total
Receipts exceeds Total Payments. Thus,
BOP= CREDIT>DEBIT

 A Deficit in the BOP occurs when Total

Payments exceeds Total Receipts. Thus,
BOP= CREDIT<DEBIT
Causes of Disequilibrium In The Bop
 Cyclical fluctuations
 Short fall in the exports
 Economic
Development
 Rapid increase in
population
 Structural Changes
 Natural Calamites
 International Capital
Movements
Measures To Correct Disequilibrium
in the
1. Monetary Measures :-
BOP
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.
Measures To Correct Disequilibrium
in the BOP
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
devaluation 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.
Measures To Correct Disequilibrium
in the BOP
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.
 Measures To Correct Disequilibrium
in the BOP
II. Non- Monetary measures :-
a) Export Promotion
To control export promotions the country may adopt
measures to stimulate exports like:
 export duties may be reduced to boost exports
 cash assistance, subsidies can be given to exporters to
increase exports
 goods 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.
 Measures To Correct Disequilibrium
c) Import Control in the BOP
•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
India’s BoP
 BoP - Terms
– Primary income
• Includes incomes from interest, profits, dividends
generated from foreign investment and also migrant
remittances i.e. payments from people living and
working overseas
– Secondary income
• Includes spending on military aid, overseas
development aid
 BoP - Statistics
• The current account balance recorded a surplus of 0.9 per cent of GDP in 2020-21
as against a deficit of 0.9 per cent in 2019-20 on the back of a sharp contraction in
the trade deficit to US$ 102.2 billion from US$ 157.5 billion in 2019-20. •
• Net invisible receipts were lower in 2020-21 due to increase in net outgo of
overseas investment income payments and lower net private transfer receipts,
even though net services receipts were higher than a year ago.
• • Net FDI inflows at US$ 44.0 billion in 2020-21 were higher than US$ 43.0 billion
in 2019-20.
• • Net FPI increased by US$ 36.1 billion in 2020-21 as compared to US$ 1.4 billion
a year ago.
• • External commercial borrowings to India recorded inflow of US$ 0.2 billion as
compared with US$ 21.7 billion in 2019-20.
• • In 2020-21, there was an accretion of US$ 87.3 billion to foreign exchange
reserves (on a BoP basis).
India’s Forex Reserves
 Importance of Balance Of Payments

1. BOP records all the transactions that create demand

for and supply of a currency.
2. Judge economic and financial status of a country in the
short-term
3. BOP may confirm trend in economy’s international
trade and exchange rate of the currency. This may
also indicate change or reversal in the trend.
4. This may indicate policy shift of the monetary
authority (RBI) of the country.
5. BOP may confirm trend in economy’s international
trade and exchange rate of the currency. This may
also indicate change or reversal in the trend.