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International Finance

1.Introduction:

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.

Like other accounts, the BOP records each transaction as either a plus or a
minus. The general rule in BOP accounting is the following:-

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.

The BOP is a double entry accounting statement based on rules of debit
and credit similar to those of business accounting & book-keeping, since it
records both transactions and the money flows associated with those
transactions. 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.

International Finance

Balance of Payment is a standard double entry accounting record to capture all
transactions of an economy with the Rest of the World.

It is a statistical statement showing:

a. Transactions in goods and services between an economy and rest of the
world.

b. Changes of ownership and changes in country’s monetary, gold, SDRs, claims
and liabilities to the rest of the world.

c. Unrequited transfers and counterpart entries that are needed to balance, in
the accounting sense.

2. The BOP Components
The various components of a BOP statement are:

A. Current Account

B. Capital Account

C. IMF

D. SDR Allocation

E. Reserves and Monetary Gold

F. Errors and omissions

Components of Balance of Payments

International Finance

Items Credit Debit Net
I] Current Account

1. Merchandise:
-Private
-Government
2. Non-Monetary Gold Movement
3. Invisibles

Total Current Account (1+2+3)

II] Capital Account

1. Private:
-Long Term
-Short Term

2. Banking
3. Official
-Loans
-Amortization
-Miscellaneous

Total Capital Account (1+2+3)

*Basic Balance

III] Reserves Account

1. IMF

2. SDR Allocation

3. Reserves and Monetary Gold

IV] Errors and Omissions

International Finance

A. Structure of Current Account
1] Merchandise (Trade of Visible items)

-Private
-Government

2] Non Monetary Gold Movement

3] Invisibles

- Trade in services
- Investment income
- Government not classified elsewhere
- Transfer Payments
- Unilateral Payments

Total Current Account (1+2+3)

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.
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.

BOP on current account is also referred to as Net Foreign Investment
because the sum represents the contribution of Foreign Trade to GNP.

Thus the BOP on current account includes imports and exports of
merchandise (trade balances), military transactions and service transactions
(invisibles). The service account includes investment income (interests and
dividends), tourism, financial charges (banking and insurances) and
transportation expenses (shipping and air travel). Unilateral transfers include
pensions, remittances and other transfers for which no specific services are
rendered.

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). There is no reverse flow entailed
in the BOP on current account transactions.

we describe the situation as one of zero “goods balance. .O.F.F are the debit entries. Valuation at C. depending on whether we have receipts exceeding payments (positive) or payments exceeding receipts (negative). Exports valued on F.’ Otherwise there would be either a positive or negative goods balance. The quantum of gold that is held by monetary authority as a part of International reserves is classified as financial asset. is a forced choice due to data inadequacies. Balance Of Trade The difference between the value of goods and services exported and imported by a country is the measure of balance of trade.I. This is the ‘Balance of Visible Trade. Cr > Dr = surplus and visa versa Balance Of Visible Trade Balance of visible trade is also known as balance of merchandise trade. While this commodity gold is traded by residents and non-residents. Non monetary gold movements: Traditionally gold is treated as both a commodity and a financial asset.B basis so that international freight and insurance are treated as distinct services and not merged with the value of goods themselves. though inappropriate. Data for these items are obtained from the various forms that the exporters have fill and submit to the designated authorities.’ In visible trade if the receipts from exports of goods happen to be equal to the payments for the imports of goods. 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). All the other gold that is with residents is commodity.O.I.B basis are the credit entries. In India Monetary authority is RBI. The difference between the total of debits and credits appears in the “Net” column. Imports valued at C. it is recorded in this account which is a part of the Current Account. It is simply import/ export transaction of gold by any one other than monetary authority. The valuation should be on F. International Finance Identify a deficit or a surplus in Current account.

Non-Monetary Gold movements current account. and insurance receipts and payments from and to the foreign countries. Monetary authority might sometimes acquire gold from residents to increase gold that forms part of international reserves. Except for this there is no meaningful difference between goods and services receipts and payments. “Balance of . 2) tourism. This process is called as Monetiasation of Gold. Hence it is a debit to reserve account. Both constitute earning and spending of foreign exchange. banking. These items are generally termed as investment income or receipts and payments arising out of what are called as capital services. Accordingly services transactions are regarded as invisible items in the BOP. The service account records all the service exported and imported by a country in a year.e. If it is reverse process i. debiting Non Monetary Gold Movement and crediting “ Reserves” it is called Demonetisation of Gold. profits. They basically include 1) transportation. In this process commodity category gets transferred to financial asset category. 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. 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. International Finance Monetisation and Demonetisation of Gold: it may be observed that :Reserves and Monetary Gold” part of Balance of Payments accounts for monetary gold. 3) expenses of students studying abroad and receipts from foreign students studying in the home country. 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 Invisible Trade Just as a country exports goods and imports goods a country also exports and imports what are called as services (invisibles). The service transactions take various forms. monetary authority sells gold. Goods and services accounts together constitute the largest and economically the most significant components in the BOP of any country. dividends and royalties received from foreign countries and paid out to foreign countries.

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. 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. on the other hand. Private transfers. without having to make any present or future payments in return. grants and reparation receipts and payments to foreign countries. There is no repayment obligation attached to these transfers because they are not borrowings and lending’s but gifts and grants exchanged . And countries which render foreign economic assistance on a massive scale can expect huge deficits in their unilateral transfer account. Thus the unilateral transfer account includes all gifts. International Finance Invisible Trade” is a sum of all invisible service receipts and payments in which the sum could be positive or negative or zero. The terms are descriptive as well as prescriptive. There no well worked out theory to explain the behaviour of this account because these flows depend upon political and institutional factors. are receipts which the residents of a country receive ‘for free’. are funds received from or remitted to foreign countries on person –to – person basis. Countries that attract retired people from other nations may therefore expect to receive an influx of foreign receipts in the form of pension payments. for BOP 9but a debit item in the US BOP). 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. 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. These are government to government donations or gifts. The United States foreign aid to India. payments abroad as negative items. Unilateral Transfers Unilateral transfers or ‘unrequited receipts’. A positive sum is regarded as favourable to a country and a negative sum is considered as unfavourable. Unilateral transfer consist of two types of transfers: (a) government transfers (b) private transfers. 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.

multinational . as is the transfer of funds from the ‘parent company in order that the ‘subsidiary’ company may itself acquire assets in its own country. between portfolio and direct investment and by the term of the investment (i. except for noting that the bulk of foreign investment is private. The basic distinctions are between private and official transactions. It is often useful to make distinctions between various forms of capital account transactions. Such business transactions form the major part of private direct investment in other countries. Transactions in the capital account reflect a change in a stock – either assets or liabilities.e.LONG TERM -SHORT TERM 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. B. The acquisition of a firm resident in one country by a firm resident in another is an example of such a transaction. International Finance between government and people in one country with the governments and peoples in the rest of the world. Structure of capital a/c CAPITAL A/c PRIVATE SECTOR BANKING SECTOR OFFICIAL SECTOR CAPITAL FLOWS CAPITAL FLOWS CAPITAL FLOWS . short or long term). 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). and need not concern us too much. The distinction between private and official transaction is fairly transparent.

International Finance corporations being especially important. On the other hand. as would the purchase of an (imported) good. even if that bond has only one month to go before the maturity. One way of avoiding this is to consider that direction in which the payment would go (if made directly). There are of course some examples of such transactions by individuals. The purchase of an asset in another country. according to the sector from which they originate. Loans made to foreign firms or governments come into the same broad category. whether it is direct or portfolio investment. and capital inflows as positive items. 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). often causes confusions. The purchase of a foreign asset would then involve the transfer of money to the foreign country. Portfolio investment by contrast is the acquisition of an asset that does not give the purchaser control. medium or long are conventional distinctions. The net value of the balances of direct and portfolio investment defines the balance on capital account. and as a positive item in the capital account for the other country. although in many cases only the short and long categories are used). For example. an individual buying a long term government bond in another country will be making a long term investment. Cr > Dr = surplus and visa versa . but usually relates to the specification of the asset rather than to the length of time of which it is held. Such portfolio investment is often distinguished by the period of the loan (short. would appear as a negative item in the capital account for the purchasing firm’s country. Portfolio investments may also be identified as either private or official. the most obvious being the purchase of the ‘second home’ in another country. The distinction between short term and long term investment is often confusing. That capital outflows appear as a negative item in a country’s balance of payments. Identify a deficit or a surplus in Capital account. 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. even if its intention is to keep that money in that account for many years. An obvious example is the purchase of shares in a foreign company or of bonds issued by a foreign government.

Banking Capital: This covers changes in assets and liabilities of commercial banks. disbursement of loans to non-residents. In case of RBI. 3. repatriation of Indian investments abroad i.e. capital inflows. it is a surplus and if debits exceed credits it is a deficit. rest are long term capital flows. 2. investment by foreigners in shares of Indian companies. repayment of loans to residents by non- residents. repatriation of foreign investments in India. Decrease in assets is credit and decrease in liabilities is debit. Official Capital Flows: This includes transactions of Government of India (GOI) and RBI that affect foreign financial assets and liabilities of Government of India. Banking sector capital flows. Assets are the balances held by foreign branches of Indian banks in India. investment by residents in foreign properties and assets. 1. private banks as well as co-operative banks that are authorized to deal in foreign exchange. government and private) and by term to maturity of the original claim. Short-term capital flows pertain to claims with maturities upto a year. on credit side. Even transactions of GOI with International Monetary Fund are excluded and recorded separately. If credits exceed debits. Increase in assets is debit and Increase in liabilities is credit. The capital outflows are recorded on the debit side such as investment by residents in shares abroad. This includes government banks. Accommodating & Autonomous Capital Flows . Increase in assets (decrease in liabilities) is debit. The transactions are grouped by the institutional sector (banking. International Finance The capital account consists of financial transactions that lead to changes in foreign assets and liabilities of the economy. Official sector capital flows taken together is Capital account. Decrease in assets (increase in liabilities) is credit. It means capital inflow is credit and capital outflow is debit. official reserve assets are excluded as they are covered under “Reserves and Monetary Gold”. The net balance between the debit and credit entries under the private sector capital flows. Private Sector Capital Flows: This consists of loans received by private entities (other than banks) in India from non-residents.

The BOP is said to be in surplus if autonomous receipts are greater than the autonomous payments and in deficit if vice – a – versa. interest rates etc. Transactions are said to Autonomous if their value is determined independently of the BOP. For example what is an autonomous item under a system of fixed exchange rates and limited capital . usually in order to realise a profit or reduced costs. Other short term capital movements may occur as a part of the financing of a transaction that is itself autonomous (say. Essentially the distinction between both the capital flow lies in the motives underlying a transaction. since all entries in the BOP account must come under one of the two headings. which are almost impossible to determine. i. that the great majority of trade in goods and of long term capital movements are autonomous.e. There is nevertheless a great temptation to assign the labels ‘autonomous’ and ‘accommodating’ to groups of item in the BOP. Obviously the sum of the accommodating and autonomous items must be zero. International Finance Economists have often found it useful to distinguish between autonomous and accommodating capital flows in the BOP. If those interest rates are largely determined by influences other than the BOP. An alternative nomenclature is that capital flows are ‘above the line’ (autonomous) or ‘below the line’ (accommodating). Accommodating capital flows on the other hand are determined by the net consequences of the autonomous items. For example a short term capital movement could be a reaction to difference in interest rates between two countries. Whether the BOP is in surplus or deficit depends on the balance of the autonomous items. the export of some good). then such a transaction should be labelled as autonomous. and as such should be classified as accommodating. It does not take into account the situation elsewhere in the BOP. so that we shall not go far wrong by assigning those labels to the various components of the BOP accounts. An autonomous transaction is one undertaken for its own sake in response to the given configuration of prices. Whether that is a reasonable approximation to the truth may depend in part on the policy regime that is in operation. and that most short term capital movements are accommodating. exchange rates. to assume. An accommodating transaction on the other hand is undertaken with the motive of settling the imbalance arising out of other transactions. We cannot attach the labels to particular groups of items in the BOP accounts without giving the matter some thought.

generate profits. 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. in the future. The long term capital outflow will. E. This is perhaps for two main reasons: a) Short term capital movements unlike long term capital movements are relatively volatile and unpredictable.” A deficit on the basic balance could come about in various ways. dividends etc are paid to foreign investors. The short term capital account balance is not included in the basic balance. dividends and interest payments which will improve the current account and so. when profits. They move in and out of the country in a period of less than a year or even sooner than that. . On the other hand. 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.g. suppose that the basic balance is in deficit because a current account deficit is accompanied by a deficit on the long term capital account. 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. which were considered as the most stable elements in the balance of payments. will reduce or perhaps reduce the deficit. which are not mutually equivalent. 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. 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. It is defined as the sum of the BOP on current account and the net balance on long term capital. ceteris paribus. International Finance mobility may not be autonomous when the exchange rates are floating and capital may move freely between countries. b) In many cases. countries don’t have a separate short term capital account as they constitute a part of the “Errors and Omissions Account.

Errors and Omissions is a “statistical residue. as gold. These reserves are held in three forms: in foreign currency. and as Special Deposit Receipts (SDRs) borrowed from the IMF. The Reserve and Monetary Gold account records increases (debits) and decreases (credits) in reserve assets. E. Within certain limitations it can be used to settle international payments between monetary authorities of member countries. The IMF account contains purchases (credits) and repurchases (debits) from the IMF. The IMF SDR & RESERVES AND MONETARY GOLD A/C. . International Finance BASIC BALANCE. usually but not always the US dollars.total of the credit column of both current A/c and capital A/c and the totals of the debits of both these accounts. Reserves Account Official reserve account forms a special feature of the capital account. D. CR DR Inflows outflows (A) Current A/C xxx xxx (B) Capital A/C xxx xxx (A+B)Basic balance xx xxx (C) Reserves xx xxx basic A/C surplus BOP bal xx xx basic A/C deficit C. Indeed most of the countries hold a proportion of the reserves in accounts with foreign central banks. Note that the reserves do not have to be held by the country. This account records the changes in the part of the reserves of other countries that is held in the country concerned. 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. SDRs – Special Drawing Rights – are a reserve asset created by the IMF and allocated from time to time to member countries.” Errors and omissions (or the . An allocation is a credit while retirement is a debit.

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. usually experience great difficulty in providing reliable information. a wide variety of transactions that occur within a given period of (usually 12 months). Developing countries. Finally. F. and changes in that part of the reserves of other countries that is held in the country concerned. ordinarily have equal entries for debits and credits. but the last payment will not made until the contract has been completed. The entry for net errors and omissions often reflects unreported flows of private capital. depending on the reliability of the reported information. if at all. International Finance balancing item) reflect the difficulties involved in recording accurately. and as Special Deposit Receipts (SDR’s) borrowed from the IMF. and even in the same country from time to time. ordinarily have equal entries for debits and credits. therefore. ERRORS AND OMISSIONS Errors and omissions is a “statistical residue. Similarly the desire to avoid taxes may lead to under-reporting of some items in order to reduce tax liabilities. as when goods are smuggled. 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. Dishonesty may also play a part. Reserves are held in three forms: in foreign currency. therefore. Errors and omissions (or the balancing item) reflect the difficulties involved in recording accurately. a wide variety of transactions that occur within a given period of (usually 12 months). usually but always the US dollar. with the inevitable errors that occur when samples are used. if at all. although the conclusions that can be drawn from them vary a great deal from country to country.” 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. 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. in particular. there are changes in the reserves of the country whose balance of payments we are considering. as gold. In some cases there is such large number of transactions that a sample is taken rather than recording each transaction. Note that reserves do not have .

. Private remittances abroad from abroad b. 3. 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. Tourist expenditure expenditure in country abroad d. Other investments of c. Insurance services sold b. Short-term investments investments in the home country. abroad. Foreign short-term 4. Unilateral Transfers a. International Finance to be held within the country. Foreign long-term investments 3. Long-term investments abroad in the home country (less (less redemptions and repayments) redemptions and repayments) a. Private remittances received a. Government grants received c. Foreign tourist c. Merchandise Imports (purchase Goods) of Goods) 2. Pension payments abroad abroad c. Transport services abroad purchased from abroad b. Foreign investments in b. Capital Account Capital Account 3. Income paid on loans and loans and investments abroad. Foreign Governments’ d. Other services purchased abroad from abroad e. Pension payments received from b. Direct Investments home country abroad b. Unilateral Transfers 3. Other services sold d. Direct investments in the a. Invisible Exports (Sale of 2. Government loans to loans to the home country. CREDITS DEBITS Current Account Current Account 1. These changes will of course be recorded accurately. Insurance services abroad purchased c. foreign countries 4. 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. Other investments foreigners in the home country abroad d. Gov from abroad ernment grants abroad. Merchandise Exports (Sale of 1. Illustrate the items which fall under capital account and current account with examples. Invisible Imports (Purchase of Services) Services) a. investments in the home country. Investments in foreign domestic securities securities c. Incomes received on e. Transport services sold a.

They also signal a policy shift on the part of the monetary authorities of the country unilaterally or in concert with its trading partners. Continuing deficits or surpluses may lead to fiscal . a country facing a current account deficit may raise interest to attract short term capital inflows to prevent depreciation of its currency. When exchange rates are market determined. Judging the stability of a fixed exchange rate system is also easier with the same record of international exchange. they may conform or indicate a reversal of perceived trends. nor do they tell us what is causing what. 2. 3. In the short run. The 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. the repayment of interest and principal and the countries ability to earn foreign exchange for future repayment. 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. The BOP statement contains useful information for financial decision makers. BOP figures indicate excess demand or supply for the currency and the possible impact on the exchange rate. For instance. BOP accounts are intimately with the overall saving investment balance in a country’s national accounts. Basically. Below are 3 instances where the information provided by BOP accounting is very necessary: 1. But they do let us see what is happening so that we can reach our own conclusions. 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. A set of BOP accounts is useful in the same way as a motion picture camera. published and are continuously monitored by companies. banks and government agencies. 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. Taken in conjunction with recent past data. The accounts do not tell us what is good or bad. one needs a set of accounts that shows the accumulation of debts. International Finance 3. A set of BOP accounts supplies this information. BOP deficit or surpluses may have an immediate impact on the exchange rate. BOP records all transactions that create demand for and supply of a currency. This point is further elaborated below.

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. For instance. International Finance and monetary actions designed to correct the imbalance which in turn will affect exchange rates and interest rates in the country. since it records both transactions and the money flows associated with those transactions. However this is not always possible.e. an export against cash payment may result in an increase in the exporting country’s official foreign exchange holdings. 4. i. An elementary rule that may assist in understanding these conventions is that in such transactions it is the movement of a document. Imp questions: 1. Such a . and decreases in assets (sale of foreign securities) and increases in liabilities (the utilisation of foreign goods) as credits. international gifts and grants and other so called transfer payments. it is therefore a debit. An investment made abroad involves the import of a documentary acknowledgement of the investment. one a debit and the other a credit. A transaction entering the BOP usually has two aspects and invariably gives rise to two entries. not of the money that is recorded. Often the two aspects fall in different categories. 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. The BOP has one important category that has no counter part or at least no significant counter part in business accounting. As in business accounting the BOP records increases in assets (direct investment abroad) and decreases in liabilities (repayment of debt) as debits. (except for errors and omissions). and imports (like the purchases of a business) are debits. 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. In general credits may be conceived as receipts and debits as payments. For instance. exports (like sales of a business) are credits. 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.

suppose that the basic balance is in deficit because a current account deficit is accompanied by a deficit on the long term capital account. on further thoughts. in the . It is defined as the sum of the BOP on current account and the net balance on long term capital. which are not mutually equivalent. 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. This can be explained as follows: A deficit on the basic balance could come about in various ways. Both aspects of a transaction may sometimes be appropriate to the same account. a deficit in the basic balance can also be understood to be desirable. E.g. For instance the purchase of a foreign security may have as its counter part reduction in official foreign exchange holdings. In accounting sense BOP always balances. Thus it is clear that if we record all the entries in BOP in a proper way. A  Double entry accounting record to capture all transactions  Current A/C deficit are matched with capital A/C surplus and visa versa  Reserves A/c 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. So that in accounting sense the BOP will be in balance. However. and thus can be said to be undesirable at the very outset. This long term capital outflow will. 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. International Finance transaction is entered in the BOP as a credit for exports and as a debit for the capital account. debits and credits will always be equal. 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. which were considered as the most stable elements in the balance of payments.

000 Merchandise Imports 1. Numericals 1. The following balance of payments information is available for a particular economy: Decline in foreign exchange reserves 500 Long term Capital Inflow (net) 600 Merchandise Exports 2. generate profits.500 Total 5. 2. ceteris paribus.500 Export of Services 3.000 Hence there is surplus on current account by Rs.500 Export of Services 3.500 Calculate short-term capital account. 1. Thus a deficit in basic balance can be desirable as well as undesirable.000 - Import of Services .000 4. Change in foreign = Balance in Current + Balance in short term + Balance in long term Reserves Account capital account Capital Account Surplus is denoted by ‘+’ sign while deficit by ‘-’ sign Therefore solving by above formula we get.000 .000 - Merchandise Imports .000 Therefore. -500 = 1000 + Balance in short term capital account + 600 -500 = 1600 + Balance in short term capital account . International Finance future. dividends and interest payments which will improve the current account and so.4.000 Import of Services 2. 1. Credit – Debit = 5. will reduce or perhaps reduce the deficit. as it clearly depends upon what is leading to a deficit in the long term capital account.000/- Now. Solution: From the above data balance in the current account is determined as follows Particulars Credit Debit (Inflow) (Outflow) Merchandise Exports 2.000 = 1.

58 FDI in the country 191 - Foreign short term loans investments in the 60 - country Short-term loans and investments abroad . The following data pertains to the balance of payment for India for the year 2000’ Particulars Rs. 2. 451 Total 281 569 Therefore. International Finance Therefore balance in short term capital account = -500-1600 = -2100 Hence short term capital account has net outflow or deficit of Rs. 2100/-. Credit – Debit = 281 – 569 = -288 Hence there is deficit on current account = 288 (Note: Private Remittances have not been included as they are the part of current account of balance of payment) . 60 Direct investment abroad . in crores Government loans from abroad 30 Government loans to abroad 60 Direct investment abroad 58 FDI in the country 191 Foreign short term loans investments in the country 60 Short-term loans and investments abroad 451 Private remittances abroad (Transfer of Payments) 85 Private remittances from abroad 211 Calculate the balance on capital account in the balance of payments accounts of India Solution: Capital Account Particulars Credit Debit (Inflow) (Outflow) Government loans from abroad 30 - Government loans to abroad .

200 Total 4. Change in foreign = Balance in Current + Balance in short term + Balance in long term Reserves Account capital account Capital Account Therefore solving by above formula we get.700 3.700 Therefore.3700 = 1. 2.200 = 650 = long term net inflow of capital . 1000/- Since. 450 = 1000 + (-1200) + Balance in long term capital account Therefore balance in long term capital account = 450 – 1.200 Determine the long-term capital account Solution: The balance in current is a follows: Particulars Credit Debit (Inflow) (Outflow) Merchandise Exports 2.500 Export of Services 2.000 - Merchandise Imports .700 - Import of Services .000 Merchandise Imports 1. International Finance 3. Credit – Debit = 4700 . The following balance of payments data are available for an economy: Increase in foreign exchange reserves 450 Short term Capital Outflow (net) 1.700 Import of Services 2.000 Hence there is surplus on current account by Rs.200 Merchandise Exports 2. 1.000 + 1.500 Export of Services 2.

there’s a deficit on current account: (-) 114 (Since there is no change in foreign exchange reserves. 58 Fairland) Short-term loans raised by Fairland 68 - Total 292 178 Therefore. 80 Government loans given by Fairland . 40 Government loans received by Fairland 23 - Direct investment abroad (made by . International Finance 4. surplus on capital account must have been equal to the deficit on current account) .178 = 114 Hence there is surplus on current account = 114 In other words. Solution: Transactions on Capital Account Particulars Credit Debit (Inflow) (Outflow) FDI in Fairland 201 - Short-term loans given by Fairland . Credit – Debit = 292 . Following details have been extracted from the balance of payments statements of Fairland for the year 2000-2001 Transactions on Capital Account FDI in Fairland 201 Short-term loans given by Fairland 80 Government loans given by Fairland 40 Government loans received by Fairland 23 Direct investment abroad (made by Fairland) 58 Short-term loans raised by Fairland 68 It is also noticed that the balance of foreign exchange reserves as at the end of 2000-01 is exactly equal to the balance as at the beginning of 1999-2000. Calculate the deficit on Current Account.

Particulars Millions of country X’s currency unit Merchandise imports 18. International Finance 5.464 transportation Earnings on loans and investments from abroad 429 Earnings of loans and investments in X by 1. prepare a balance of payments (BoP) statement and answer the following questions:  What is the trade balance on merchandise account?  What is the balance on current account?  What is the balance on long-term capital account?  What will be the entry against the item’s change in country X’s official foreign exchange reserves’ in the BoP? Does this entry represent an increase or decrease in the stock of foreign exchange reserves? . You are given the following balance of payments data for the country X for the calendar year 2000.972 transportation Imports of services including travel and 12.054 foreigner’s Private remittances to abroad (transfers) 85 Private remittances from abroad (transfers) 124 Government loans to abroad 41 Government loans from abroad 18 Direct investments abroad 26 FDI in X 134 Short term loans and investments abroad 288 Foreign short-term loans and investments in X 42 From the data given above.277 Exports of services including travel and 15.191 Merchandise exports 17.

85 Private remittances to abroad (transfers) Total 33.464 transportation Earnings on loans and investments from 429 - abroad . Trade Balance on Merchandise Account = Export – Import = 17. 1.802 31.277 – 18.277 - Merchandise imports . 18. 12. International Finance Solution: Balance of Payments of country X for the year 2001 (All amounts in millions of country X’s currency unit) Particulars Credit Debit (Inflow) (Outflow) Current Account Merchandise exports 17.191 = .914 .972 - transportation Imports of services including travel and .054 Earnings of loans and investments in X by foreigner’s 124 - Private remittances from abroad (transfers) .191 Exports of services including travel and 15.794 Capital Account Government loans to abroad 41 Government loans from abroad 18 Direct investments abroad 26 FDI in X 134 Short term loans and investments 288 abroad 42 Foreign short-term loans and investments in X Total 194 355 1.

008 3. . Overall Balance = Balance on Current + Balance on Capital Account Account = 2. Since the overall balance is favourable.794 = 2. Balance on current account = 33.008 + (– 161) = 1.008 Balance on Capital Account = 194 – 355 = -161 5.847 Therefore.847 millions. this entry represents an increase in the stock of foreign exchange reserves. International Finance 2. Balance on long term capital account = (18 + 34) – (41 + 26) = 152 – 67 = 85 4. Balance on Current Account = 2. change in country X’s official foreign exchange reserves = 1.802 – 31.

456 Total 293 581 Therefore. Government loans from abroad 35 Government loans to abroad 65 Direct investment abroad 60 Foreign direct investments in the country 193 Foreign short-term loans investments in the 65 country Short-term loans and investments abroad 456 Private remittance to abroad (transfers) 78 Private remittances from abroad (transfers) 300 Calculate the balance on capital account in the balance of payments account of the country. Credit – Debit = 293 – 581 = -288 Hence there is deficit in capital account = 288 (Note: Private Remittances have not been included as they are the part of current account of balance of payment and we have been asked to calculate the balance on capital account) . International Finance 6. Solution: Capital Account Particulars Credit Debit (Inflow) (Outflow) Government loans from abroad 35 - Government loans to abroad . 60 FDI in the country 193 - Foreign short term loans investments in the 65 - country Short-term loans and investments abroad . The following data pertains to the balance of payments for a country for the year 2001. 65 Direct investment abroad .

500 Total 4.000) + Balance in long term capital account Therefore balance in long term capital account = 500 – 1. 1.600 Hence there is surplus on current account by Rs. Solution: The balance in current is a follows: Particulars Credit Debit (Inflow) (Outflow) Merchandise Exports 1. The following balance of payments data are available for an economy: Increase in foreign exchange reserves 500 Short-term capital outflow (net) 1.600 + (-1.200 Therefore.600/- Since.000 - Import of Services . International Finance 7.600 + 1.000 Merchandise exports 1.800 – 3. 1. long term net outflow of capital is 100 .700 Export of services 3.700 Export of Services 3.000 = -100 Hence.500 Determine the long-term capital account.000 Import of services 1. Credit – Debit = 4. 500 = 1. 1.800 Merchandise imports 1. Change in foreign = Balance in Current + Balance in short term + Balance in long term Reserves Account capital account Capital Account Therefore solving by above formula we get.800 - Merchandise Imports .800 3.200 = 1.

36 Government loans received by 'x' 8 - Direct Investment abroad (made by 'x') . Short term loans given by 'x' 60 3. there’s a deficit on current account: (-) 100 (Since there is no change in foreign exchange reserves. Government loans received by 'x' 8 5. Direct Investment abroad (made by 'x') 82 6. Government loans given by 'x' 36 4. Credit – Debit = 288 .178 = 110 Hence there is surplus on current account = 110 In other words. Following details have been extracted form the Balance of statement of 'x' for the year 2000-2001 Transactions on Capital Account 1. International Finance 8. Foreign Direct Investment (In 'x') 180 2. 82 Short term loans raised by 'x' 100 - Total 288 178 Therefore. surplus on capital account must have been equal to the deficit on current account) . Calculate deficit on Current Account. Solution: Transactions on Capital Account Particulars Credit Debit (Inflow) (Outflow) Foreign Direct Investment (In 'x') 180 - Short term loans given by 'x' . 60 Government loans given by 'x' . Short term loans raised by 'x' 100 It is also noticed that the balance of foreign exchange reserves as at the end of 2000-01 is exactly equal to the balance as at the beginning of 2000-01.

International Finance 9.500 Total 5. Solution: From the above data balance in the current account is determined as follows Particulars Credit Debit (Inflow) (Outflow) Merchandise Exports 2. 2.000 Therefore.000 - Merchandise Imports . 1000/- Now. The following balance of payments information is available for an economy. Decline in foreign exchange reserves 300 2.900/-. Long-term capital inflow (net) 600 3.000 6. 1. Change in foreign = Balance in Current + Balance in short term + Balance in long term Reserves Account capital account Capital Account Surplus is denoted by ‘+’ sign while deficit by ‘-’ sign Therefore solving by above formula we get.500 5.000 - Import of Services .500 Calculate the short-term capital account.000 4.600 = -1.900 Hence short term capital account has net outflow or deficit of Rs.4000 = 1000 Hence there is surplus on current account by Rs. Credit – Debit = 5000 . Import of services 2. Merchandise imports 1. . -300 = 1000 + Balance in short term capital account + 600 -300 = 1600 + Balance in short term capital account Therefore balance in short term capital account = -300-1. 1. Export of services 3.500 Export of Services 3. 1. Merchandise exports 2.000 4.

What is the balance on the long-term capital account? 4.972 transportation Imports of services including travel and 12.464 transportation Earnings of loans and investments from abroad 429 Earnings of loans and investments in X by 1.054 foreigner’s Private remittances to abroad (transfers) 85 Private remittances from abroad (transfers) 124 Government loans to abroad 43 Government loans from abroad 20 Direct investments abroad 28 FDI in X 126 Short term loans and investments abroad 288 Foreign short-term loans and investments in X 42 From the data given above.You are given the following balance of payments data for country X f6r the calendar year 2001.499 Merchandise exports 17. What will be the entry against the item 'change in country X's official foreign exchange reserves' in the BOP? Does this entry represent an increase or decrease in the stock of foreign exchange reserves? . What is the trade balance on merchandise account? 2. What is the balance on current account? 3. prepare a balance of payments (BOP) statement and answer the following questions 1. (Millions of country X’s currency unit) Particulars Amount Merchandise imports 18.484 Exports of services including travel and 15. International Finance 10.

1.972 - transportation Imports of services including travel and . 18.009 32. 12.464 transportation Earnings on loans and investments from 429 - abroad .499 Exports of services including travel and 15. International Finance Solution: Balance of Payments of country X for the year 2001 (All amounts in millions of country X’s currency unit) Particulars Credit Debit (Inflow) (Outflow) Current Account Merchandise exports 17.102 Capital Account Government loans to abroad 43 Government loans from abroad 20 Direct investments abroad 28 FDI in X 126 Short term loans and investments 288 abroad Foreign short-term loans and 42 investments in X Total 188 359 1.484 - Merchandise imports . 85 Private remittances to abroad (transfers) Total 34.054 Earnings of loans and investments in X by foreigner’s 124 - Private remittances from abroad (transfers) . Trade Balance on Merchandise Account = Export – Import .

907 3.736 Therefore.009 – 32.000 as dividends to the parent company in the USA.Overall Balance = Balance on Current + Balance on Capital Account Account = 1. 00.000 to carry with him. Rs. as usual.359 = -171 11.499 = .000 to Delhi Tourist Agency. (4) The Indian subsidiary of UC Corporation sells a part of its production in other Asians countries for Rs. Since the overall balance is favourable. this entry represents an increase in the stock of foreign exchange reserves. 5.1015 2. 00. (1) UC Corporation of the USA invests in India Rs. change in country X’s official foreign exchange reserves = 1.102 = 1.736 millions. showing clearly all the sub-balances from the following data. He also pays hotel and travel bills of Rs. Balance on current account = 34. 5.000.907 Balance on Capital Account = 188 .000 to modernize its Indians subsidiary. (2) A tourist from Egypt buys souvenirs worth Rs. Balance on Current Account = 1. 3. International Finance = 17.484 – 18. You are required to find out the overall balance. Balance on long term capital account = (20 + 126) – (43 + 28) = 146 – 71 = 75 4. 1.907 + (– 171) = 1. . 3. (3) The Indian subsidiary of UC Corporation remits.

40. 2. 5. 00. 4 1.000 Dividend paid.000(+) Payments Made : Rs.000 BOP Statement A. 1. NIL Balance: Rs. 2 a.no Sources Uses Nature 1 3.000 1.000 from the Indian public to invest in its modernization programme. 5 2. the remaining amount is to be paid after 3 years. 3. 6 a. 00. 5. 00.000 (+) Imports: Rs. (7) An Indian subsidiary of French Company borrows Rs. (6) The Indian company buys a machine for Rs. NIL . 50. 3.000 Direct Foreign Investment.05. 03.. Capital Account Foreign Direct Investment Inflow : Rs. 3.000 Goods exported. 1.000 Goods exported.000 (+) B. 3 5.000 Increase in claim on India.00. 00. Current Account Goods Accounts Exports: Rs.000 Services (invisible) rendered. 6. 40.00. 3.000 (+) Invisible Accounts Payments Received: Rs.000 (+) Outflow: Rs.000 (+) Portfolio Investment Inflow : Rs.000 (+) Outflow: Rs. 1. International Finance (5) The Indian subsidiary borrows a sum of Rs.000 (to be paid back in a year’s time) from German money market to resolve its urgent liquidity problem. 00.00.000 Short-Term borrowing. 5.00.000(-) Balance : NIL Current Account Balance: Rs. b.000 (-) Balance: Rs. 1. b. 3.000 Equipments imported.48.000 from Japan and 60% payment is made immediately. Solution: Sr.

40. 43. 40.000 in the balance of payments. Note: The transaction No. 2. 2. 3.000 (+) Outflow: Nil Balance: Rs.000 (+) There is a net surplus of Rs 5. 5. 43. .000 (+) Overall Balance: Rs.000 (+) (Foreign Direct Investment + Portfolio Investment) Short-term borrowings Inflow : Rs. This means. 5. there will be an increase of reserves by this amount.000 (+) Capital Account Balance: Rs.00. The entire transaction has taken place in Indian rupees within India.7 did not enter into the BOP Statement since this transaction does not involve any foreign country.00.000 (+) Long-Term Capital Account: Rs. 40. International Finance Balance: Rs.

10. 12. 4. A France resident buys a German Treasury bond.2000. FFrs. Expenditure of foreign tourist in France. 1000 7.000 FDI 9 300 Portfolio investment 10 5. France borrows FFrs. A Swiss resident buys a France Treasury bond. 2000. A short-term loan advanced by BNP to a British resident.no Sources Uses Nature 1 5. Solution: Sr. 5000. 5. IBM invests in France. France import goods worth FFrs.000 Unilateral transfer 7 4. 6. 500. 3.000 Portfolio investment . FFrs. FFrs.300. 9. 3800 for short-term. FFrs. FFrs. 8. FFrs. France Telecom invest in India.000 Imports 5 500 Unilateral transfer 6 1.000 Imports 3 2. France makes interest and dividend payments to foreigners.4500.500 FDI 8 2. A American Immigrant working in France remits money to his account in LA. FFrs. FFrs. 4000.000 Exports 2 4. 11. International Finance Case Study: Prepare a BOP statement for France from the following data: 1. 2. 2500. A France working in USA sends a cheque to his wife in Paris worth FFrs.5000. 4000. France export goods worth FFrs.500 Exports 4 2.

800 .800 11. International Finance 11 ---------. -------- 12 3. -----------.800 Short-term borrowings 18.

.500 (+) Imports: Rs. 1. 6.700 (+) Long-Term Capital Account: Rs. 3. Current Account Goods Accounts Exports: Rs. 5.000 (+) B. 300 (-) Balance: Rs. 7. 3800 (+) Outflow: Nil Balance: Rs.500 (-) Balance: Rs.000(-) Balance : Rs. there will be an increase of reserves by this amount.500 (-) Portfolio Investment Inflow : Rs. 1. The entire transaction has taken place in France currency within France. 8.000 (-) Balance: Rs. 4. 4.000 in the balance of payments. Note: The transaction No11 did not enter into the BOP Statement since this transaction does not involve any foreign country. 500 (-) Current Account Balance: Rs.000 (+) Overall Balance: Rs.000 (+) Outflow: Rs. 500 (+) Payments Made : Rs.000 (+) There is a net surplus of Rs 8. 500 (+) Invisible Accounts Payments Received: Rs.1. International Finance BOP Statement: A. 1. This means.200 (+) (Foreign Direct Investment + Portfolio Investment) Short-term borrowings Inflow : Rs.000 (+) Outflow: Rs. 2. Capital Account Foreign Direct Investment Inflow : Rs. 3. 7.800 (+) Capital Account Balance: Rs.

8. 6. Expenditure of foreign tourists in France FFr 2. A French resident buys a German treasury bond FFr 300.000. 4.000. France imports goods worth FFr 4. A Swiss resident buys a French treasury bond worth FFr 5. 2. France Telecom invests in India FFr 4. IBM invests in France FFrs 2. A Bangladeshi immigrant working in France remits money to his account in Dhaka FFr 1. France makes interest and dividend payments to Foreigners FFr 2.500.000. 5. 9. 3. A French working in USA sends a cheque to his wife worth FFr 500.500.000.000. 7. . International Finance Prepare a BoP statement for France from the following data: 1.

000 500 Cash remittance by French working in U.000 Transfer of Payments (by Bangladeshi immigrant working in France) Investment Income 8.800 = . International Finance Balance of Payments Account for France (Amounts in FFr) Credit (Inflow of Debit (Outflow Funds) of Funds) Current Account Balance Import of Goods 4.000 – 11.000 11.S (Unilateral Transfer of Payments) 5.000 4.500 Exports of goods (Purchase made by foreign tourist) Payment of Interests and dividends 2.000 7.000 Foreign Direct Investment (FDI) in France by IBM 300 Investment Abroad Total (2) 2.000 Total (1) Capital Account Balance Foreign investments by France in 4.000 2.1800 .000 1.500 India 2.800 Therefore Balance of Payment = Credit – Debit = 10.800 Total Balance (1+ 2) 10.

4. 1000 7. FFrs. 3. FFrs. 6. Expenditure of foreign tourist in France. A France resident buys a German Treasury bond. FFrs. .300. 500. FFrs. 5. A France working in USA sends a cheque to his wife in Paris worth FFrs. France export goods worth FFrs. 2000. A short-term loan advanced by BNP to a British resident. France borrows FFrs. 4000. 8. France makes interest and dividend payments to foreigners. 2500. FFrs.5000. 9. 12. 2. FFrs.2000. 5000. 4000. International Finance Hence there is deficit in balance of payment of France by 1800 FFr which is unfavourable. A American Immigrant working in France remits money to his account in LA. 10. France import goods worth FFrs. 3800 for short-term. France Telecom invest in India. FFr. Prepare a BOP statement for France from the following data: 1.4500. IBM invests in France. FFrs. 11. A Swiss resident buys a France Treasury bond.

000 Imports 5 500 Unilateral transfer 6 1.500 FDI 8 2. -------- 12 3.500 Exports 4 2.000 Unilateral transfer 7 4.800 . International Finance Solution: Sr.000 FDI 9 300 Portfolio investment 10 5. -----------.800 11.000 Imports 3 2.no Sources Uses Nature 1 5.000 Exports 2 4.800 Short-term borrowings 18.000 Portfolio investment 11 ---------.

500 (+) Imports: Rs. 8. 1. 4. 500 (-) Current Account Balance: Rs. 7.200 (+) (Foreign Direct Investment + Portfolio Investment) Short-term borrowings Inflow : Rs. 4. 2. The entire transaction has taken place in France currency within France. 6.500 (+) Invisible Accounts Payments Received: Rs.000 (+) Overall Balance : Rs. 300 (-) Balance : Rs.000 (+) B. 3. Capital Account Foreign Direct Investment Inflow : Rs. 500 (+) Payments Made : Rs. International Finance BOP Statement: C.500 (-) Balance : Rs. .1. there will be an increase of reserves by this amount. This means. 1.800 (+) Capital Account Balance: Rs. 5. Current Account Goods Accounts Exports: Rs.000 (+) There is a net surplus of Rs 8.000 (+) Outflow : Rs.000 in the balance of payments.500 (-) Portfolio Investment Inflow : Rs. 7.000 (+) Outflow : Rs.700 (+) Long-Term Capital Account: Rs. 3. 1. Note: The transaction No11 did not enter into the BOP Statement since this transaction does not involve any foreign country.000 (-) Balance: Rs.000(-) Balance : Rs. 3800 (+) Outflow : Nil Balance : Rs..