Balance

of
Payments

The Balance of Payments

The components of the balance of
payments:

Current account
Capital account
Errors & Omissions
Official financing/Settlement

Oil & Gold

Oil = 33% of import bill
Oil + gold = 45% of import bill.

Impact on Indian
Economy

$1 /barrel = $0.9 Billion import bill.

Overall, $9.5 billion less burden on
Current Account (2014-15)
Same way $10 per Oz Gold => $130
million less
So, CAD, inflation both moderated
4

Exchange Rates regimes

1. Fixed
2. Floating (Flexible)

Fixed Exchange Rate Regime (Upto March 1992)

Authorized dealers
under FEMA

$1 = Rs.10

$1 = Rs.11
(Devaluation.)

Devaluation: Fixed Exchange Rate Regime (Upto March 1992)

Devaluati
on
increases
EXPORTS

Authorized
dealers under

Devaluation vs Depreciation

Rupee: Devaluation || Depreciation

$ = Rs.

Fixed
Floating
Devaluatio Deprecati
n
on

Fixed Floati
ng
1$
1$
1$
1$

=
=
=
=

10;
50
50;
10

Devaluatio
n
Revaluatio
n

Deprecatio
n
Appreciatio
n

Managed Floating exchange rate

I
interfere
to
prevent
Sudden
volatility
purchase
of Rs.
$1=50
$1=40
Not good
for exports

Managed Floating exchange rate

I
interfere
to
prevent
Equilibrium
Reset
volatility
To
$1 = Rs.50

Floating Exchange rate

RBI doesnt intervene to control exchange
rate
Free market, supply-demand
But then- too much volatility in exchange
rate.
Hence real-life: Managed floating RBI
intervenes to reduce volatility

managed Floating exchange rate

I
interfere
to
prevent
Sudden
volatility
purchase
of $$
$1=50
$1=60
Not good
for imports

Floating Exchange Rate (Problem of volatility)

Volatility
$1 = 50
$1 = 60
$1 = 65

Authorized dealers
under FEMA

Floating Exchange Rate (Problem of volatility)

Volatility
$1 = 50
$1 = 60
$1 = 65

Bu
y
Ap st $$ t
pr o p o
ec
n iatio

Authorized dealers
under FEMA

Managed floating exchange rate regime

FIXED
Exchange Rate
Regime

Floating
Exchange Rate
Regime

Managed Floating
Exchange Regime
(Most countries use this)

'J-Curve Effect'
a curve initially falls, but then rises to higher than
the starting point.
a country's trade balance initially worsens
following a depreciation of its currency.
more costly imports and less valuable exports, lead
to a bigger initial deficit
Gradually low-priced exports rise, more expensive
imports fall
The trade balance eventually improves to better
levels compared to before devaluation.
19

CONVERTIBILITY
Why convertibility?
Current Account convertibility
Capital Account convertibility

Why restrictions on convertibility?

1. Central bank cannot manage floating
exchange rate regime all the time
2. Otherwise Forex-reserve will get
empty
3. Hence quantitative restrictions on
rupee-conversion to foreign currency
4. Two types: based on purpose:
5. (1) current (2) capital

Current Account Convertibility

Full Current Account Convertibility:

Definition
When Rupee is fully convertible
into another currency,
for current account transactions.
And vice-versa.
Some Restrictions under FEMA

Floating Exchange Regime

Indian Rupee is Fully
convertible on Current
Account

Capital Account Convertibility

??

Capital Account convertibility ($1 =

Rs.50)

Rs. 50
Billion

$1
billion

Rs
Bi . 5
ll i 0
on

Indian Rupee is not

Fully convertible on
Capital Account

Current
Account C.
When Rupee is
fully
convertible
into another
currency, for
CURRENT
account
transactions.

Capital
Account C.
When Rupee is
fully
convertible
into another
currency, for
CAPITAL
account
transactions.