Balance of Payments

Balance of Payments Nations continually carry out economic, commercial and financial transactions between residents of one nation and rest of world in the form of :-- exchange of goods for goods-- goods for services-- services for services-- goods and services for money etc. Summary of these transactions for a period carries great economic significance for the nation. The systematic record of all economic transactions between residents of a country and rest of world in a given period is called the Balance of Payment. 3/21/20101Presentation by Prof. H.Ganguly.3/21/2010Presentation by Prof. H.Ganguly.2 BOP is a double entry system statement of followings : -- all receipts for goods exported -- all services rendered -- capital received by residents* of the nation -- and payments made by residents* for goods imported and services received in addition to capital transferred to non-residents and foreigners. * Residents mean individuals , businesses and govt. agencies. -- Military personnel, diplomats, tourists and workers who emigrate temporarily are considered residents of the country of their citizenship. BOP statistics are published monthly by RBI in India. These are analysed by bankers, businessmen, economists foreign exchange traders etc. to know international economic performance of the country.3/21/2010Presentation by Prof. H.Ganguly.3 On the other hand, Balance of Trade considers the value of exports and imports of visible items i.e. merchandise only.-- It does not take into account trade of invisible items.-- Thus Balance of Trade is a sub-set of Balance of Payment. Components of Balance of Payment * B.O.P. on Current account * B.O.P. on Capital account * Unilateral Payment accounts * Official Settlement accounts3/21/2010Presentation by Prof. H.Ganguly.4 * Balance Of Payment on Current Account -- It includes value of exports and imports of visible items and receipts and payments on invisibles i.e. services like banking, insurance, travel, tourism, transportation etc. -- Balance of Payment on current account is added to determine nations Gross Domestic Product (GDP). * Balance of Payment on Capital Account -- It comprises of i) Private capital (both long and short-term) : Long- term with maturity period of more than one year and short-term with maturity of one year or less. -- Long-term private capital includes Foreign Investments ( both Direct and Portfolio), long term loans, foreign currency deposits and unclassified capital account receipts of foreign currency, SDRs etc. 3/21/2010Presentation by Prof. H.Ganguly.5 ii) Banking capital covers the external financial assets and liabilities of commercial and co-operative banks who deal in foreign exchange.Official capital are RBIs holding of foreign currency, SDRs etc. on behalf of Govt. of India in the form of loan, miscellaneous receipts, payments etc. -- Capital outflow from home country to foreign countries is treated as debit and inflow of capital from foreign countries to home country is treated as credit. Inflow on Curr. a/c bal. Import cover of cap. account as %age of GDP For. Exch.(months)93-94 $ 9.882 b. (-) 0.4 % 8.6 months 97-98 7.867 (-) 1.4 % 6.902-03 10.640 n.a. n.a.05-06 24.238 (-) 1.1% 11.63/21/2010Presentation by Prof. H.Ganguly.6 * 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. * 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, debits comprise of official purchases of foreign currencies and other assets. Balance on Current Account consist of exports and imports of goods and services plus net unilateral transfers. 3/21/2010Presentation by Prof. H.Ganguly.7 Equilibrium in Balance of Payment of Nations -- When demand for and supply of foreign currency in a nation in a given period are equal it is viewed as equilibrium position in BOP. -- But in case of most of nations, it is not so i.e. they either enjoy a surplus BOP or deficit. It represents disequilibrium in Balance of Nations. Disequilibrium in BOP are caused by : * Economic factors * Political factors and * Sociological factors.3/21/2010Presentation by Prof. H.Ganguly.8 * Economic Factors may cause 1) Development Disequilibrium 2) Cyclical Disequilibrium 3) Secular disequilibrium and 4) Structural Disequilibrium 1. Development Disequilibrium -- Developing countries mostly take up activities like establishment of industries, infrastructure etc. which require greater imports of capital goods, machinery etc. In addition it also shoots up imports of consumer goods on account of increase in per capita income and aggregate demands. -- Thus increased developmental activities result in greater outflow of foreign currency leading to deficit in BOP.3/21/2010Presentation by Prof. H.Ganguly.92. Cyclical Disequilibrium Due to fluctuations in business cycle in a country , value of imports of consumer goods and then consumer goods go up or down periodically, both of which lead to disequilibrium in BOP. 3. Secular Disequilibrium It mostly happens in developed countries where disposable income of people are very high. It raises in turn the cost of production and price of goods and services. -- Consequently, developed countries prefer to outsource goods and services from other countries where quality of goods is high and cost of production is low. -- It may lead to secular disequilibrium in BOP of nation. 3/21/2010Presentation by Prof. H.Ganguly.10 4. Structural Disequilibrium-- Sometimes notable shift comes in nature of economy of countries e.g. from agricultural to manufacturing or services. -- These may call for structural changes in developing alternative items, sources of supply, changes in transport channels and also costs.-- These structural changes may enhance imports of capital goods and consumer goods resulting in deficits in BOP. Indias BOP Disequilibrium due to Structural Changes Between 1999-2000 & 2000-2001, structural changes in Indias economy increased POL imports from $ 5.64 b. to $ 9.77 b. ; electronic goods from $ 1.47 b. to $ 2.05 b. etc. 3/21/2010Presentation by Prof. H.Ganguly.11 * Political Factors -- Political uncertainties, instability, internal disturbances, external wars etc. create threatening situation for local industry and investments. In such cases domestic production declines leading to increase in imports and outflow of capital -- It results in deficit in BOP as it happened in Sri Lanka, Pakistan etc. * Social Factors -- Changes in culture, taste, preference, fashion etc. bring about changes in nature of import of consumer items first, followed by capital goods leading to deficit in BOP. 3/21/2010Presentation by Prof. H.Ganguly.12 Correction of BOP Disequilibrium When BOP becomes surplus, nations enjoy the same as it offers a number of desirable situation like increased purchasing power and influence in global market. -- In cases of disequilibrium due to deficit, countries adopt measures to eliminate the same completely, if not possible at least reduce it. 1. Automatic Correction of BOP Disequilibrium -- Deficit in BOP indicates that demand for foreign exchange is higher than its supply in the nation. -- It leads to devaluation of local currency in relation to the foreign currency. Thereby imports become costlier and exports cheaper. So imports get reduced and exports are increased. Thereby outflow of FE is reduced and income is increased leading to automatic restoration of equilibrium. 3/21/2010Presentation by Prof. H.Ganguly.13 2. Deliberate Measures Govt. also adopts certain measures to control deficit BOP called Deliberate Measures as indicated. A. Monetary Measures * Reduction in Money Supply : -- RBI takes to control credit so that money supply in the country is reduced which leads to decline in income, purchasing power, aggregate demand and consumption. -- Thus imports decline and hence outflow of foreign currency. In turn exports grow and inflow of foreign currency to set right BOP disequilibrium. * Interest Rate Adjustment : Inflow of FE in deficit BOP nation falls, so liquidity falls. So on short term basis Interest rate is raised leading to investments and loans coming from foreign nations improving BOP scenario. 3/21/2010Presentation by Prof. H.Ganguly.14 * Devaluation In case of deficit BOP, purchasing power of local currency reduces, the Govt. delebarately devalues currency. Thus imports become costlier and exports cheaper. Hence increased exports and reduced imports balance the disequilibrium of BOP. * Exchange Control Exporters are to surrender the foreign exchange earned to RBI through authorised dealers and importers are to draw foreign exchange from authorised dealers. -- Through suitable policies from time to time, Govt. of India and RBI control imports to reduce deficit of BOP. B. Trade Measures These measures try to restore equilibrium through increasing exports and/or reducing imports. 3/21/2010Presentation by Prof. H.Ganguly.15 * Export Promotion Measures Govt. of India endeavour to boost exports by reducing export duties, providing incentives, encouraging EOUs, forming EPZs, FTZs etc. * Import Control Measures Import control measures include ways and means of restricting imports through duties, quotas, licences etc. C. Miscellaneous Measures Govt. of India tries to remove BOP disequilibrium by assortment of means like a) Attracting Foreign Investments both FDI and FPI b) Attracting NRI deposits c) Promoting tourism d) Negotiating Foreign currency loans etc.3/21/2010Presentation by Prof. H.Ganguly.16 Structure of Indias BOP Statement Credit Debit Net A. Current Account I. Merchandise i) Private ii) Govt. II. Invisibles 1. Non-monetary gold 2. Travel 3. Transportation 4. Insurance 5. Investment Income 6. Govt. not included anywhere 7. Miscellaneous 8. Transfers Receipts / Payments i) Official ii) Private Total Current Account ( I + II ) 3/21/2010Presentation by Prof. H.Ganguly.17 Indias BOP Account (contd.)Credit Debit Net B. Capital Account 1. Private i) Long-term ii) Short-term 2. Banking 3. Official i) Loans ii) Amortisation iii) Miscellaneous Total Capital account (1 + 2 + 3 )I.M.F.S.D.R. Allocation Capital Account, I.M.F. & S.D.R. Allocation 3/21/2010Presentation by Prof. H.Ganguly.18 Indias BOP Account (Contd.) Credit Debit NetTotal Current Account, Capital Account,I.M.F. & S.D.R. Allocation

G. Errors & Omissions

H. Reserves and Monetary Gold