A REPORT ON “BALANCE OF PAYMENTS”

CONCEPT QUESTIONS
BALANCE OF PAYMENTS 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 theme on account of goods imported and services received from the capital transferred to non-residents or foreigners. - Reserve Bank of India The above definition can be summed up as following: - Balance of Payments is the summary of all the transactions between the residents of one country and rest of the world for a given period of time, usually one year. The definition given by RBI needs to be clarified further for the following points: A. Economic Transactions An economic transaction is an exchange of value, typically an act in which there is transfer of title to an economic good the rendering of an economic service, or the transfer of title to assets from one economic agent (individual, business, government, etc) to another. An international economic transaction evidently involves such transfer of title or rendering of service from residents of one country to another. Such a transfer may be a requited transfer (the transferee gives something of an economic value to the transferor in return) or an unrequited transfer (a unilateral

gift). The following are the basic types of economic transactions that can be easily identified: 1. Purchase or sale of goods or services with a financial quid pro quo – cash or a promise to pay. [One real and one financial transfer]. 2. Purchase or sale of goods or services in return for goods or services or a barter transaction. [Two real transfers]. 3. An exchange of financial items e.g. – purchase of foreign securities with payment in cash or by a cheque drawn on a foreign deposit. [Two financial transfers]. 4. A unilateral gift in kind [One real transfer]. 5. A unilateral financial gift. [One financial transfer]. B. Resident The term resident is not identical with “citizen” though normally there is a substantial overlap. As regards individuals, residents are those individuals whose general centre of interest can be said to rest in the given economy. They consume goods and services; participate in economic activity within the territory of the country on other than temporary basis. This definition may turnout to be ambiguous in some cases. The “Balance of Payments Manual” published by the “International Monetary Fund” provides a set of rules to resolve such ambiguities. As regards non-individuals, a set of conventions have been evolved. E.g. – government and non profit bodies serving resident individuals are residents of respective countries, for enterprises, the rules are somewhat complex, particularly to those concerning unincorporated branches of foreign multinationals. According to IMF rules these are considered to be residents of countries in which they operate, although they are not a separate legal entity from the parent located abroad. International organisations like the UN, the World Bank, and the IMF are not considered to be residents of any national economy although their offices are located within the territories of any number of countries.

the term BOP seems to be somewhat obscure. Current Account Capital Account IMF SDR Allocation Errors & Omissions Reserves and Monetary Gold BALANCE OF TRADE . draws attention to the word ‘payments’ in the term BOP. as Yeager says. The truth is that the BOP statements records both payments and receipts by a country. Similarly the word ‘balance’ in the term BOP does not imply that a situation of comfortable equilibrium. B. The various components of a BOP statement are: A. and is recorded as a negative item. E. the BOP records each transaction as either a plus or a minus. Also in case of statistical discrepancy the difference amount is adjusted with errors and omissions account and thus in accounting sense the BOP statement always balances. more appropriate to regard the BOP as a “balance of international transactions” by a country. it means that it is a balance sheet of receipts and payments having an accounting balance. for example.To certain economists. since it records both transactions and the money flows associated with those transactions. this gives a false impression that the set of BOP accounts records items that involve only payments. Yeager. it is a credit If a transaction involves spending of foreign currency it is a debit and is recorded as a plus item. F. The BOP is a double entry accounting statement based on rules of debit and credit similar to those of business accounting & book-keeping. Like other accounts. It is. C. The general rule in BOP accounting is the following:a) b) If a transaction earns foreign currency for the nation. D.

Balance of trade may be defined as the difference between the value of goods and services sold to foreigners by the residents and firms of the home country and the value of goods and services purchased by them from foreigners. then we describe the situation as one of balance of trade deficit. one thing is certain i. There is n doubt that the balance of merchandise trade is of great significance to exporting countries. Such a country in the course of doing that might be forced to . we say that there is balance of trade equilibrium or balance. the difference between the value of goods and services exported and imported by a country is the measure of balance of trade. Surplus is regarded as favourable while deficit is regarded as unfavourable. if the former exceeds the latter. and if the later exceeds the former. take for example. Regardless of which idea is adopted. However. If two sums (1) value of exports of goods and services and (2) value of imports of goods and services are exactly equal to each other.e. some economists define balance of trade as a difference between the value of merchandise (goods) exports and the value of merchandise imports. Because. Meade – a Nobel Prize British Economist. making it the same as the ‘Goods Balance” or the “Balance of Merchandise Trade”. the case of a developing country. we say that there is a balance of trade surplus. but still the BOT as defined by J. which might be importing vast quantities of capital goods and technology to build a strong agricultural or industrial base. Meade has greater significance. E. Should this then be taken to imply that a passive trade balance (an excess of debits over credits) is necessarily a sign of undesirable state of affairs in a country? The answer is “no”. E. The above mentioned definition has been given by James. that balance of trade is a national injection and hence it is appropriate to regard an active balance (an excess of credits over debits) as a desirable state of affairs. In other words.

The service account includes investment income (interests and dividends). There is no reverse flow entailed in the BOP on current account transactions. BALANCE OF CURRENT ACCOUNT BOP on current account refers to the inclusion of three balances of namely – Merchandise balance. . Services balance and Unilateral Transfer balance.experience passive or adverse balance of trade and such a situation of passive balance of trade cannot be described as one of undesirable state of affairs. BOP on current account is also referred to as Net Foreign Investment because the sum represents the contribution of Foreign Trade to GNP. military transactions and service transactions (invisibles). This would therefore again suggest that before drawing meaningful inferences as to whether passive trade balances of a country are desirable or undesirable. remittances and other transfers for which no specific services are rendered. financial charges (banking and insurances) and transportation expenses (shipping and air travel). Unilateral transfers include pensions. In other words it reflects the net flow of goods. services and unilateral transfers (gifts). The net value of the balances of visible trade and of invisible trade and of unilateral transfers defines the balance on current account. Thus the BOP on current account includes imports and exports of merchandise (trade balances). we must also know the composition of imports which are causing the conditions of adverse trade balance. tourism. It is also worth remembering that BOP on current account covers all the receipts on account of earnings (or opposed to borrowings) and all the payments arising out of spending (as opposed to lending).

” A deficit on the basic balance could come about in various ways. when profits. will reduce or perhaps reduce the deficit. On the other hand. dividends etc are paid to foreign investors. The short term capital account balance is not included in the basic balance. This is perhaps for two main reasons: a) Short term capital movements unlike long term capital movements are relatively volatile and unpredictable. dividends and interest payments which will improve the current account and so. ceteris paribus.g. which were considered as the most stable elements in the balance of payments. It is defined as the sum of the BOP on current account and the net balance on long term capital. countries don’t have a separate short term capital account as they constitute a part of the “Errors and Omissions Account. Long term capital flows are relatively more durable and therefore they qualify to be treated along side the current account transactions to constitute basic balance. The long term capital outflow will. in the future. suppose that the basic balance is in deficit because a current account deficit is accompanied by a deficit on the long term capital account. They move in and out of the country in a period of less than a year or even sooner than that.BASIC BALANCE The basic balance was regarded as the best indicator of the economy’s position vis-à-vis other countries in the 1950’s and the 1960’s. a basic balance surplus consisting of a deficit on current account that is more than covered by long term borrowings from abroad may lead to problems in future. . generate profits. b) In many cases. which are not mutually equivalent. It would therefore be improper to treat short term capital movements on the same footing as current account BOP transactions which are extremely durable in nature. A worsening of the basic balance [an increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit] was seen as an indication of deterioration in the [relative] state of the economy. E.

a deficit or surplus in the BOP is to consider the net monetary transfer that has been made by the monetary authorities is positive or negative. there is an outflow) then the BOP is said to be in deficit. which is the so called – settlement concept. The settlements approach is more relevant under a system of pegged exchange rates than when the exchange rates are floating. but if there is an inflow then it is surplus. THE CAPITAL ACCOUNT 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. These official settlements are thus seemed as the accommodating item. Transactions in the capital account reflect a change in a stock – either assets or liabilities. If the net transfer is negative (i. all other being autonomous.THE OFFICIAL SETTLEMENT CONCEPT An alternative approach for indicating. The later source is of particular importance when other monetary authorities hold the domestic currency as a part of their own reserves. The monetary authorities may finance a deficit by depleting their reserves of foreign currencies. A country whose currency is used as a reserve currency (such as the dollars of US) may be able to run a deficit in its balance of payments without either depleting its own reserves or borrowing from the IMF since the foreign authorities might be ready to purchase that currency and add it to its own reserves. . by borrowing from the IMF or by borrowing from other foreign monetary authorities.e. The basic premise is that the monetary authorities are the ultimate financers of any deficit in the balance of payments (or the recipients of any surplus).

the most obvious being the purchase of the ‘second home’ in another country. as is the transfer of funds from the ‘parent company in order that the ‘subsidiary’ company may itself acquire assets in its own country. a firm or individual that holds a bank account with another country and increases its balance in that account will be engaging in short term investment. On the other hand.It is often useful to make distinctions between various forms of capital account transactions. An obvious example is the purchase of shares in a foreign company or of bonds issued by a foreign government. between portfolio and direct investment and by the term of the investment (i. The distinction between short term and long term investment is often confusing. The distinction between private and official transaction is fairly transparent. an individual buying a long term government bond in another country will be . Direct investment is the act of purchasing an asset and the same time acquiring control of it (other than the ability to re-sell it). The basic distinctions are between private and official transactions.e. except for noting that the bulk of foreign investment is private. Portfolio investment by contrast is the acquisition of an asset that does not give the purchaser control. Such portfolio investment is often distinguished by the period of the loan (short. although in many cases only the short and long categories are used). There are of course some examples of such transactions by individuals. The acquisition of a firm resident in one country by a firm resident in another is an example of such a transaction. multinational corporations being especially important. even if its intention is to keep that money in that account for many years. short or long term). but usually relates to the specification of the asset rather than to the length of time of which it is held. Loans made to foreign firms or governments come into the same broad category. For example. medium or long are conventional distinctions. and need not concern us too much. Such business transactions form the major part of private direct investment in other countries.

That capital outflows appear as a negative item in a country’s balance of payments. usually in order to realise a profit or reduced costs. and capital inflows as positive items. would appear as a negative item in the capital account for the purchasing firm’s country. An autonomous transaction is one undertaken for its own sake in response to the given configuration of prices.making a long term investment. exchange rates. often causes confusions. It does not take into account the situation elsewhere in the BOP. Portfolio investments may also be identified as either private or official. interest rates etc. Transactions are said to Autonomous if their value is determined independently of the BOP. as would the purchase of an (imported) good. and as a positive item in the capital account for the other country. An alternative nomenclature is that capital flows are ‘above . according to the sector from which they originate. Accommodating capital flows on the other hand are determined by the net consequences of the autonomous items. whether it is direct or portfolio investment. even if that bond has only one month to go before the maturity. The net value of the balances of direct and portfolio investment defines the balance on capital account. The purchase of an asset in another country. The purchase of a foreign asset would then involve the transfer of money to the foreign country. and so must appear as a negative item in the balance of payments of the purchaser’s country (and as a positive item in the accounts of the seller’s country). One way of avoiding this is to consider that direction in which the payment would go (if made directly). ACCOMMODATING & AUTONOMOUS CAPITAL FLOWS Economists have often found it useful to distinguish between autonomous and accommodating capital flows in the BOP. An accommodating transaction on the other hand is undertaken with the motive of settling the imbalance arising out of other transactions.

Essentially the distinction between both the capital flow lies in the motives underlying a transaction. the export of some good). For example a short term capital movement could be a reaction to difference in interest rates between two countries. then such a transaction should be labelled as autonomous. and that most short term capital movements are accommodating. Whether that is a reasonable approximation to the truth may depend in part on the policy regime that is in operation. The BOP is said to be in surplus if autonomous receipts are greater than the autonomous payments and in deficit if vice – a – versa. Whether the BOP is in surplus or deficit depends on the balance of the autonomous items. and as such should be classified as accommodating. which are almost impossible to determine. If those interest rates are largely determined by influences other than the BOP. since all entries in the BOP account must come under one of the two headings. that the great majority of trade in goods and of long term capital movements are autonomous. to assume. For example what is an autonomous item under a system of fixed exchange rates and limited capital mobility may not be autonomous when the exchange rates are floating and capital may move freely between countries. There is nevertheless a great temptation to assign the labels ‘autonomous’ and ‘accommodating’ to groups of item in the BOP.e. Other short term capital movements may occur as a part of the financing of a transaction that is itself autonomous (say. We cannot attach the labels to particular groups of items in the BOP accounts without giving the matter some thought. BALANCE OF INVISIBLE TRADE . so that we shall not go far wrong by assigning those labels to the various components of the BOP accounts.the line’ (autonomous) or ‘below the line’ (accommodating). i. Obviously the sum of the accommodating and autonomous items must be zero.

A positive sum is regarded as favourable to a country and a negative sum is considered as unfavourable. They basically include 1) transportation. profits. They are invisible in the sense that service receipts and payments are not recorded at the port of entry or exit as in the case with the merchandise imports and exports receipts. BALANCE OF VISIBLE TRADE . The service account records all the service exported and imported by a country in a year. and insurance receipts and payments from and to the foreign countries. Accordingly services transactions are regarded as invisible items in the BOP.Just as a country exports goods and imports goods a country also exports and imports what are called as services (invisibles). banking. 3) expenses of students studying abroad and receipts from foreign students studying in the home country. 2) tourism. travel services and tourist purchases of goods and services received from foreign visitors to home country and paid out in foreign countries by home country citizens. “Balance of Invisible Trade” is a sum of all invisible service receipts and payments in which the sum could be positive or negative or zero. The service transactions take various forms. 4) expenses of diplomatic and military personnel stationed overseas as well as the receipts from similar personnel who are stationed in the home country and 5) interest. Unlike goods which are tangible or visible services are intangible. Both constitute earning and spending of foreign exchange. Except for this there is no meaningful difference between goods and services receipts and payments. dividends and royalties received from foreign countries and paid out to foreign countries. Goods and services accounts together constitute the largest and economically the most significant components in the BOP of any country. The terms are descriptive as well as prescriptive. These items are generally termed as investment income or receipts and payments arising out of what are called as capital services.

. Valuation at C. The difference between the total of debits and credits appears in the “Net” column. depending on the reliability of the reported information. The entry for net errors and omissions often reflects unreported flows of private capital.” It is used to balance the statement because in practice it is not possible to have complete and accurate data for reported items and because these cannot.O.F. therefore. usually experience great difficulty in providing reliable information.’ Otherwise there would be either a positive or negative goods balance. and it covers all transactions related to movable goods where the ownership of goods changes from residents to non-residents (exports) and from non-residents to residents (imports). in particular. depending on whether we have receipts exceeding (negative). payments (positive) or payments exceeding receipts ERRORS AND OMISSIONS Errors and omissions is a “statistical residue. Exports valued on F. The valuation should be on F. Data for these items are obtained from the various forms that the exporters have fill and submit to the designated authorities. This is the ‘Balance of Visible Trade. Developing countries.’ In visible trade if the receipts from exports of goods happen to be equal to the payments for the imports of goods. is a forced choice due to data inadequacies.B basis are the credit entries. though inappropriate. although the conclusions that can be drawn from them vary a great deal from country to country.B basis so that international freight and insurance are treated as distinct services and not merged with the value of goods themselves.I. and even in the same country from time to time. Imports valued at C. ordinarily have equal entries for debits and credits.I.O.F are the debit entries.Balance of visible trade is also known as balance of merchandise trade. we describe the situation as one of zero “goods balance.

The changes in the country’s reserves must of course reflect the net value of all the other recorded items in the balance of payments. Indeed most countries hold a proportion of their reserves in accounts with foreign central banks. and it is the discrepancy between the changes in reserves and the net value of the other record items that allows us to identify the errors and omissions. a wide variety of transactions that occur within a given period of (usually 12 months). but the last payment will not made until the contract has been completed. with the inevitable errors that occur when samples are used. Finally. In others problems may arise when one or other of the parts of a transaction takes more than one year: for example wit a large export contract covering several years some payment may be received by the exporter before any deliveries are made. and changes in that part of the reserves of other countries that is held in the country concerned. as when goods are smuggled. as gold. Dishonesty may also play a part. there are changes in the reserves of the country whose balance of payments we are considering. These changes will of course be recorded accurately. Reserves are held in three forms: in foreign currency. if at all. Note that reserves do not have to be held within the country. in which case the merchandise side of the transaction is unreported although payment will be made somehow and will be reflected somewhere in the accounts. In some cases there is such large number of transactions that a sample is taken rather than recording each transaction. usually but always the US dollar.Errors and omissions (or the balancing item) reflect the difficulties involved in recording accurately. Similarly the desire to avoid taxes may lead to under-reporting of some items in order to reduce tax liabilities. and as Special Deposit Receipts (SDR’s) borrowed from the IMF. UNILATERAL TRANSFERS .

Private transfers. There no well worked out theory to explain the behaviour of this account because these flows depend upon political and institutional factors. on the other hand. An American pensioner who is settled after retirement in say Italy and who is receiving monthly pension from America is also a private unilateral transfer causing a debit flow in the American BOP but a credit flow in the Italian BOP. These are government to government donations or gifts. There is no repayment obligation attached to these transfers because they are not borrowings . Unilateral transfer consist of two types of transfers: (a) government transfers (b) private transfers. And countries which render foreign economic assistance on a massive scale can expect huge deficits in their unilateral transfer account. are receipts which the residents of a country receive ‘for free’. Receipts from abroad are entered as positive items. Foreign economic aid or assistance and foreign military aid or assistance received by the home country’s government (or given by the home government to foreign governments) constitutes government to government transfers. The government donations (or aid or assistance) given to government of other countries is mixed bag given for either economic or political or humanitarian reasons. Countries that attract retired people from other nations may therefore expect to receive an influx of foreign receipts in the form of pension payments. are funds received from or remitted to foreign countries on person –to –person basis. for BOP 9but a debit item in the US BOP). Unilateral transfer receipts and payments are also called unrequited transfers because as the name itself suggests the flow is only in one direction with no automatic reverse flow in the other direction.Unilateral transfers or ‘unrequited receipts’. A Malaysian settled in the United States remitting $100 a month to his aged parents in Malaysia is a unilateral transfer inflow item in the Malaysian BOP. grants and reparation receipts and payments to foreign countries. The United States foreign aid to India. payments abroad as negative items. Thus the unilateral transfer account includes all gifts. without having to make any present or future payments in return.

Credits Current Account 1. 3. Other services sold abroad e. Gover nment grants abroad. Government grants received from abroad Capital Account 3. Other investments of foreigners in the home country d. Investments in foreign securities c. Invisible Imports (Purchase of Services) a. ILLUSTRATE THE ITEMS WHICH FALL UNDER CAPITAL ACCOUNT AND CURRENT ACCOUNT WITH EXAMPLES. Foreign tourist expenditure in country d. Foreign long-term investments in the home country (less redemptions and repayments) a. Capital Account 3. Other services purchased from abroad e. Merchandise Exports (Sale of Goods) 2. Debits Current Account 1. Private remittances abroad b. Invisible Exports (Sale of Services) a. Unilateral Transfers a. Transport services sold abroad b. Insurance services sold abroad c. Merchandise Imports (purchase of Goods) 2.and lending’s but gifts and grants exchanged between government and people in one country with the governments and peoples in the rest of the world. Long-term investments abroad (less redemptions and repayments) a. Pension payments received from abroad c. Income paid on loans and investments in the home country. Private remittances received from abroad b. Other investments abroad d. Pension payments abroad c. Transport services purchased from abroad b. Incomes received on loans and investments abroad. Tourist expenditure abroad d. Insurance services purchased c. Direct Investments abroad b. Government loans to foreign countries . 3. Direct investments in the home country b. Foreign investments in domestic securities c. Foreign Governments’ loans to the home country. Unilateral Transfers a.

Restrictions on inessential imports as long as the foreign exchange position is not very comfortable.4. which are of prudential nature. . Accordingly CAC refers to the freedom to convert local financial assets into foreign financial assets and vice – a – versa at market determined rates of exchange. 2. An appropriate industrial policy and a conducive investment climate. Following are the prerequisites for CAC: 1.S. Adequate foreign exchange reserves. CAC is coexistent with restrictions other than on external payments. 6. CAPITAL ACCOUNT CONVERTIBILITY (CAC) While there is no formal definition of Capital Account Convertibility. Maintenance of domestic economic stability. 4. the committee under the chairmanship of S. It also does not preclude the imposition of monetary / fiscal measures relating to foreign exchange transactions. 5. Short-term investments abroad. Tarapore has recommended a pragmatic working definition of CAC. the rest of the world. or by. 4. It is associated with changes of ownership in foreign / domestic financial assets and liabilities and embodies the creation and liquidation of claims on. Comfortable current account position. 3. An outward oriented development strategy and sufficient incentives for export growth. Foreign short-term investments in the home country.

2. This point is further elaborated below. But they do let us see what is happening so that we can reach our own conclusions. one needs a set of accounts that shows the accumulation of debts. 3. Below are 3 instances where the information provided by BOP accounting is very necessary: 1. Taken in . Judging the stability of a floating exchange rate system is easier with BOP as the record of exchanges that take place between nations help track the accumulation of currencies in the hands of those individuals more willing to hold on to them. When exchange rates are market determined. In the short run. banks and government agencies.DESCRIPTIVE QUESTIONS DISCUSS THE RELEVANCE / IMPORTANCE OF THE BOP STATEMENTS? BOP statistics are regularly compiled. raising questions about the ease of defending the fixed exchange rate in a future crisis. Basically. A set of BOP accounts supplies this information. BOP deficit or surpluses may have an immediate impact on the exchange rate. nor do they tell us what is causing what. The BOP statement contains useful information for financial decision makers. A set of BOP accounts is useful in the same way as a motion picture camera. The accounts do not tell us what is good or bad. the repayment of interest and principal and the countries ability to earn foreign exchange for future repayment. BOP records all transactions that create demand for and supply of a currency. published and are continuously monitored by companies. To spot whether it is becoming more difficult for debtor counties to repay foreign creditors. These exchanges again show the extent to which a currency is accumulating in foreign hands. BOP figures indicate excess demand or supply for the currency and the possible impact on the exchange rate. Judging the stability of a fixed exchange rate system is also easier with the same record of international exchange.

a country facing a current account deficit may raise interest to attract short term capital inflows to prevent depreciation of its currency. exports (like sales of a business) are credits. An elementary rule that may assist in understanding these conventions is that in such transactions it is the movement of a document. it is therefore a debit. not of the money that is recorded. they may conform or indicate a reversal of perceived trends. As in business accounting the BOP records increases in assets (direct investment abroad) and decreases in liabilities (repayment of debt) as debits. and decreases in assets (sale of foreign securities) and increases in liabilities (the utilisation of foreign goods) as credits. For instance. BOP accounts are intimately with the overall saving investment balance in a country’s national accounts. and imports (like the purchases of a business) are debits. Continuing deficits or surpluses may lead to fiscal and monetary actions designed to correct the imbalance which in turn will affect exchange rates and interest rates in the country. The BOP has . They also signal a policy shift on the part of the monetary authorities of the country unilaterally or in concert with its trading partners. In nutshell corporate finance managers must monitor the BOP data being put out by government agencies on a regular basis because they have both short term and long term implications for a host of economic and financial variables affecting the fortunes of the company. since it records both transactions and the money flows associated with those transactions.conjunction with recent past data. An investment made abroad involves the import of a documentary acknowledgement of the investment. For instance. IN THE ACCOUNTING SENSE THE BOP ALWAYS BALANCES! The BOP is a double entry accounting statement based on rules of debit and credit similar to those of business accounting & book-keeping. Countries suffering from chronic deficits may find their credit ratings being downgraded because the markets interpret the data as evidence that the country may have difficulties its debt.

Thus it is clear that if we record all the entries in BOP in a proper way. So that in accounting sense the BOP will be in balance. (except for errors and omissions). In general credits may be conceived as receipts and debits as payments. The procedure is to offset changes in reserves against changes in the other items in the table so that the grand total is always zero. Current Account 1. debits and credits will always be equal.one important category that has no counter part or at least no significant counter part in business accounting. Such a transaction is entered in the BOP as a credit for exports and as a debit for the capital account. Items G. A transaction entering the BOP usually has two aspects and invariably gives rise to two entries. international gifts and grants and other so called transfer payments. an export against cash payment may result in an increase in the exporting country’s official foreign exchange holdings. For instance. However this is not always possible. one a debit and the other a credit. A BOP statement (revised) includes the following sub accounts. Private Credits Debits Net . In particular the change in a country’s international reserves in gold and foreign exchange is treated as a debit if it is an increase and a credit if it is a decrease. i. as shown in the table below.e. usually one year. Both aspects of a transaction may sometimes be appropriate to the same account. DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS Balance of Payments is the summary of all the transactions between the residents of one country and rest of the world for a given period of time. Merchandise a. Often the two aspects fall in different categories. For instance the purchase of a foreign security may have as its counter part reduction in official foreign exchange holdings.

Official a. Transfer Payments a. Official b. Loans b. IMF & SDR Allocation (A+E) M. Miscellaneous Total Capital Account (1+2+3) I. sale of goods abroad. The current account consists of two major items. Short Term 3.b. Travel b. i. (a) merchandise export and imports and (b) invisible imports and exports. Total Current Account. On the other hand. namely. Amortisation c. Government 2. merchandise imports.e. IMF J. are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Insurance d. Capital Account 2.e. Private a. Miscellaneous 3. Long Term b. Capital Account. Errors & Omissions N. Reserves and Monetary Gold Current Account The current account includes all transactions which give rise to or use up national income. Transportation c. SDR Allocation K. Private Total Current Account (1+2+3) H. Invisibles a. Government (not included elsewhere) f. Capital Account. Merchandise exports . Merchandise exports i. Banking 4. purchase of goods abroad. are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. Investment Income e. IMF & SDR Allocation (B+C+D) L.

Other Accounts The IMF account contains purchases (credits) and repurchases (debits) from the IMF. Transfers payments refer to unrequited receipts or unrequited payments which may be in cash or in kind and are divided into official and private transactions. SDRs – Special Drawing Rights – are a reserve asset created by the IMF and allocated from time to time to member countries. Important invisible exports include sale abroad of services like insurance and transport etc. purchase of services are debit entries. if an American firm invests rupees 100 million in India. Capital Account The capital account separates the non monetary sector from the monetary one. from the central bank and the commercial bank. Within . while important invisible imports are foreign tourist expenditures in the home country and income received on loans and investment abroad (interests or dividends). The capital account consists of long term and short term capital transactions. which are directly involved in framing or implementing monetary policies.e.e. are credit entries and invisible imports i. Private transfer payments cover such transactions as charitable contributions and remittances to relatives in other countries. that is to say. this transaction will be represented as a debit in the US BOP and a credit in the BOP of India. For instance. The main component of government transfer payments is economic aid in the form of grants. Invisible exports i. the trading or ordinary private business element in the economy together with the ordinary institutions of central or local government. sale of services. Capital outflow represents debit and capital inflow represent credit.and imports form the most important international transactions of most of the countries.

then apart from errors and omissions. it is important to decide what is the optimal way of grouping the various accounts within the BOIP so that an imbalance in one set of accounts will give the appropriate signals to the policy makers.” Errors and omissions (or the balancing item) reflect the difficulties involved in recording accurately. Obviously. Reserve assets consist of RBI’s holdings of gold and foreign exchange (in the form of balances with foreign central banks and investment in foreign government securities) and government’s holding of SDRs. it must always balance. if it is negative e . It is used to balance the statement because in practice it is not possible to have complete and accurate data for reported items and because these cannot. the terms “deficit” or “surplus” cannot refer to the entire BOP but must indicate imbalance on a subset of accounts included in the BOP. therefore. Errors and Omissions is a “statistical residue. The Reserve and Monetary Gold account records increases (debits) and decreases (credits) in reserve assets. ordinarily have equal entries for debits and credits. if at all. In the language of an accountant e divide the entire BOP into a set of accounts “above the line” and another set “below the line.” If the net balance (credits-debits) is positive above the line we will say that there is a “balance of payments surplus”. The “imbalance” must be interpreted in some sense as an economic disequilibrium. a wide variety of transactions that occur within a given period of (usually 12 months).certain limitations it can be used to settle international payments between monetary authorities of member countries. If the balance of payment is a double entry accounting record. HOW WILL YOU IDENTIFY A DEFICIT OR SURPLUS IN BALANCE OF PAYMENTS? / MEANING OF “DEFICIT” AND “SURPLUS” IN THE BALANCE OF PAYMENTS. Since the notion of disequilibrium is usually associated within a situation that calls for policy intervention of some sort. An allocation is a credit while retirement is a debit.

Accommodating capital flows on the other hand are determined by the net consequences of the autonomous items. An autonomous transaction is one undertaken for its own sake in response to the given configuration of prices. as a criterion to decide whether a transaction should go above or below the line. The critical question is how to make this division so that BOP statistics. It does not take into account the situation elsewhere in the BOP. usually in order to realise a profit or reduced costs. The principle distinction between “autonomous” transaction and “accommodating” or compensatory transactions. . will be economically meaningful.will say there is a “balance of payments deficit. The Basic Balance which shows the relative deficit or surplus in the BOP. The items below the line can be said to be a “compensatory” nature – they “finance” or “settle” the imbalance above the line. Transactions are said to Autonomous if their value is determined independently of the BOP.” The net balance below the line should be equal in magnitude and opposite in sign to the net balance above the line. The terms “balance of payments deficit” and “balance of payments surplus” will then be understood to mean deficit or surplus on all autonomous transactions taken together. interest rates etc. Suggestions made by economist and incorporated into the IMF guidelines emphasis the purpose or motive a transaction. The other measures of identifying a deficit or surplus in the BOP statement are: Deficit or Surplus in the Current Account and/or Trade Account. exchange rates. An alternative nomenclature is that capital flows are ‘above the line’ (autonomous) or ‘below the line’ (accommodating). in particular the deficit and surplus figures. An accommodating transaction on the other hand is undertaken with the motive of settling the imbalance arising out of other transactions.

Thus it is very much evident that a deficit in the basic balance is a clear indicator of worsening of the state of the country’s BOP position. will reduce or perhaps reduce the deficit. and thus can be said to be undesirable at the very outset. dividends and interest payments which will improve the current account and so. This deficit in long term capital account could be clearly observed in a developing country’s which might be investing heavily on capital goods for advancement on the agricultural and industrial fields.g. which are not mutually equivalent. This can be explained as follows: A deficit on the basic balance could come about in various ways. on further thoughts. ceteris paribus. It is defined as the sum of the BOP on current account and the net balance on long term capital. E. SHORT NOTES . However. a deficit in the basic balance can also be understood to be desirable. in the future. which were considered as the most stable elements in the balance of payments. Thus a deficit in basic balance can be desirable as well as undesirable. suppose that the basic balance is in deficit because a current account deficit is accompanied by a deficit on the long term capital account. This long term capital outflow will. as it clearly depends upon what is leading to a deficit in the long term capital account. A worsening of the basic balance [an increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit] is seen as an indication of deterioration in the [relative] state of the economy. generate profits.A DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR UNDESIRABLE! The basic balance was regarded as the best indicator of the economy’s position vis-à-vis other countries in the 1950’s and the 1960’s.

. This is not necessarily the case however. cost from transportation. Imports accordingly are entered as negative items. In many cases the payment for imports and exports will result in transfer of money between the trading countries. i. or simply as the balance of trade. For example a UK firm importing a good from US may settle its debt by instructing its UK bank to make a payment to the US account of the exporter. In the later it will appear as the part of the capital account since the UK firm has reduced its claims on the US bank.e. The net balance of exports and imports of services is called the balance of invisible trade in the UK statistics. insurance cost etc are included.f. The balance of imports and exports of the former is referred to in the UK accounts as the balance of visible trade in other countries it may be referred to as the balance of merchandise trade. Exports whether of goods or services are by convention entered as positive items in the account. It helps in distinguishing between factor and non-factor services. Exports are normally calculated f.BALANCE OF PAYMENTS (Refer to Concept Questions) CURRENT ACCOUNT The current account records exports and imports of goods and services and unilateral transfers.o. transportation. In the former case the financial side of the transaction will appear in the UK BOP account as part of the net change in UK foreign currency reserves. then it may make payment to the US exporter from that account.b i.e. BOP accounts usually differentiate between trades in goods and trade in services. If the UK firm holds a bank account in the US. insurance etc are not included whereas imports are normally calculated c. Invisible trade is a much more heterogeneous category than is visible trade.i.

which consist in the main of interest. are on the other hand payments for inputs. That is.Trade in the later of which shipping. profits and dividends. as gold. usually but not always the US dollars. CAPITAL ACCOUNT (Refer to Concept Questions) OFFICIAL RESERVES ACCOUNT Official reserve account forms a special feature of the capital account. Note that the reserves do not have to be held . Exports and imports of such services will depend in large part on the accumulated stock of past investment in and borrowing from foreign residents. banking and insurance services and payments by residents as tourists abroad are usually the most important. exports and imports are flows of outputs whose values will be determined by the same variables that would affect the demand and supply for goods. Factors services. Unilateral transfer forms a major part of the current account. and as Special Deposit Receipts (SDRs) borrowed from the IMF. It refers to unrequited receipts or unrequited payments which may be in cash or in kind and are divided into official and private transactions. are receipts which the residents of a country receive ‘for free’. The net value of the balances of visible trade and of invisible trade and of unilateral transfers defines the balance on current account. Receipts from abroad are entered as positive items. Unilateral transfers or ‘unrequited receipts’. These reserves are held in three forms: in foreign currency. is in economic terms little different from trade in goods. payments abroad as negative items. without having to make any present or future payments in return. This account records the changes in the part of the reserves of other countries that is held in the country concerned.

when a nation sells gold to acquire foreign currencies that it can use to meet the deficit in the balance of payments. For example. a deficit will normally cause a reduction in these assets. The change in the reserves account measures a nation’s surplus or deficit on its current and capital account transactions by netting reserve liabilities from reserve assets. The IMF account contains purchases (credits) and repurchases (debits) from the IMF.by the country. Reserve assets consist of RBI’s holdings of gold and foreign exchange (in the form of balances with foreign central banks and investment in foreign government securities) and government’s holding of SDRs. . Indeed most of the countries hold a proportion of the reserves in accounts with foreign central banks. An allocation is a credit while retirement is a debit. For most of the countries. SDRs – Special Drawing Rights – are a reserve asset created by the IMF and allocated from time to time to member countries. The Reserve and Monetary Gold account records increases (debits) and decreases (credits) in reserve assets. there is a correlation between balance-ofpayments deficits and reserve declines. for instance. A drop in reserves will occur. Within certain limitations it can be used to settle international payments between monetary authorities of member countries. a surplus will lead to an increase in official holdings of foreign currencies and/or gold.

Geoffrey Reed International Economics .Lindert International Economics .C P Kindelberger International Economics .BIBLIOGRAPHY Balance of Payments .H G Mannur .P G Apte International Economics .Francis Chernuliam International Economics .Paul Madson International Financial Management .

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