BALANCE OF PAYMENT

Systematic record of all its economic transaction with outside world in a given year.
All transaction = govt. + private
It’s a double entry book keeping.
1.CURRENT ACCOUNT Single time & one way transaction
1.1 EXPORT 1.2 IMPORT 1.3 Trade Balance/ Balance of
=Receipts against export of merchandise GOODS to other countries. =Payments for import of merchandise GOODS from other Trade
*Export Receipts of Services are NOT included. countries. = Export receipts – Import
*Import Receipts of Services are NOT included. payments.

1.4 INVISIBLES (NET)

It contains receipts & payments regarding services exports & imports AND other current A/C payments VIZ.,
1.4A. NON-FACTOR SERVICES=export & impoer of services 1.4B. INCOME 1.4C private TRANSFERS
alone. income from investment in the form of Dividend, Profit & Interest grants, gift etc. which do not have quid
all invisible payments or receipts non-attributable to from loans, rent from house property and income generated pro quo.
conventional factors of productions i.e. Labour (remittances through employment. Without any quid pro quo.= need not
from overseas migrants). Factor income services:- to be compensated. Once it is received it
I. LabourRemittances need not be repaid.
It includes:- II. Capital Dividend, Profit & Interest
Group of services={travel, transportation, insurance, govt.
not included elsewhere (GNIE)} & CURRENT A/C BALANCE= Trade Balance + INVISIBLES (NET)
Misc.= communication .S, construction.S, finL.S, If (+)  surplusfavorable current account balance.
software.S{IT & ITES}, news agency.S, royalties, If (-)  deficitunfavorable current account balance.
management.S & biz.S etc.
2.CAPITAL ACCOUNT :Two way & multiple transaction
2.1 EXTERNAL ASSISTANCE (NET)
transaction of govt. bilateral & multilateral loans End Use Restriction @ ECB:- ECB can be raised only for specific purposes such as
bilateral loans = loan transaction B/W 2 countries. import of capital goods, implementation of new projects etc.
multilateral loans = loan transaction B/W a country & multilateral bodies like IMF, WB & ECB also covers :-
ADB etc. Foreign Currency Convertible Bonds (FCCB).
2.2 EXTERNAL COMMERCIAL BORROWINGS (NET) Foreign Currency Exchangeable Bonds (FCEB).
loan transaction by commercial enterprises. (FCCB) (FCEB)
ECB means loan in the form of issued by an Indian Co. expressed in foreign issued by an issuing Co. expressed
 bank loans, currency. in foreign currency.
 buyers’ credits{relates to loan for repayment of imports into India arranged by the P&i are paid in foreign currency P&i are paid in foreign currency
importer from a bank/finLinstituN O/S India}, Issued to persons who are
*both of them are for the purpose of import & loan availed by the importer. residents outside India.
** buyers’ credits+ suppliers’ credits = Trade Credits. These are exchangeable into
 suppliers’ credits{relates to credit for import into India extended by the overses equity share of another Co.
supplier}, called the offered Co.
scrutinised instruments{debt secY like bonds & preferences shares} availed of from non-
residents lenders with min. avg. maturity of 3 yrs.
2.3 SHORT TERM DEBT
These are trade credits for a maturity of less than 3 yrs.
2.4A foreign assets of commercial banks=
foreign currency holdings
rupee overdraft to Non-Resident Banks.
2.4B foreign liabilities of commercial banks=
 Non-Resident deposits.
 Liabilities other than Non-Resident deposits.ie.
Rupees & foreign currency liabilities to Non-
Resident Banks & official and semi-official
institutions like IBRD,IDA, ADB. IFC etc maintained
with DAD{deposits account dept.} of RBI as well as
transactions held abroad by embassies of Indian in
London & Tokyo
2.5 FOREIGN INVESTMENT
2.5A FDI
= investment through the mode other than stockex is called
FDI in India.
It includes{purchase where, there is direct contact b/w
buyer & seller}:-
 Shares acquired by the way of IPO
 Shares acquired by the way of preferential allotment
 Shares acquired by the way of OFS through private
arrangement
 Transfer of shares by the way of OFS through private
arrangement
*Arvind Mayaram Committee on FDI & FII suggested that
any investment in a Co. >10% to be treated as FDI.
2.4 BANKING CAPITAL=
2.4A foreign assets of commercial banks
2.4B foreign liabilities of commercial banks
2.4C Others.
2.4B(i) Non-Resident deposits.[3 NRI deposits schemes in India]
 Foreign currency non-residents (banks)=>held in US$, Pound sterling, euro, Japanese Yen, Auz $ & Canadian
$. Only term deposits 1-3yrs maturity allowed. i rate are pegged to LIBOR/SWAP.
 Non-resident external rupee a/c [NReRA]=>held in Indian rupee. term deposits 1-3yrs maturity allowed as
well as saving deposit. i rate are pegged to LIBOR/SWAP.
 Non-resident ordinary rupee a/c [NRO]=>held by Indian living ordinarily abroad.* an Indian who was
indian residentbut migrated abroad CANNOT shit to this a/c.held in rupee. Saving & current a/c, FD & RD.
2.5B Portfolio/Rentier investment
=Investment trough stock EX that is through 20 markets.
= Investment in various finL instruments like shares, debentures of Co. through 2 0 market.,
its 3 types:-
2.5A(i)Foreign Institutional Investment=portfolio investment of foreign institutions like MF,PF, Insurance Co. etc
in shares & debentures.
2.5A(ii)Depository Receipts=>Co. of a country can go abroad to sell their shares in foreign capital market.
When foreign investor buy shares of those domestic co. in forein market ,then he is issued a receipt by a custodian
bank.These represent underlying hsares of the domestic co. & are called DR.
DR raised by Indian Co. in American market are called ADRs & those raised in any other country are clled GDRs.
DR raised by foreign CO. in India are called IDRs.
2.5A(iii)Offshore funds:-maney raised from offshore destination(low tax/no tax countries) by MFs & other
investment funds.eg.Cayman Island, Isle of man, Mauritius & british virgin islands etc.

2.6 OTHER FLOWS

 Delayed exports receipts
 Leads & lags in export receipts{=diff. b/w custom data & banking channel date} it arises because banking channel data relies on foreign exchange release/receipts return
which are actual cash outgo & cover all flows; & custom datas are based on bill of enteries{import data files with customs} which might remain somewhat incomplete for a
no. of reaons in short run.
*defense imports are NOT reflected @ custom data.
 Funds held in abroad
 Other capital transactions not included elsewhere like flows arising from cross-border finL derivatives & commodity hedging transactions
 Sale of intangible assets likes patents, copyrights, trademarks etc.
Capital A/C BALANCE (net)= EXTERNAL ASSISTANCE (NET)+ EXTERNAL COMMERCIAL BORROWINGS (NET) + SHORT TERM DEBT+ BANKING CAPITAL + FOREIGN
INVESTMENT+ OTHER FLOWS
III.ERRORS & OMMISSIONS:-diff. b/w vredit & debit entries of all transactions. It arised because both entries are compiled from various sources & mismatch happens.
IV.OVERALL BALANCE{Balance Of Payment}=current a/c balance + capital a/c balance.
If there is (+) balance increases reserves(surplus is added to ForeignEX reserves) & vice-versa.
V.RESERVES= Foreign Exchange Reserves.=
5.1 Foreign currency assets
5.2 Gold stocks of RBI
5.3 SDR[special drawing rights] holdings of the govt.
5.4 Reserve tranche
5.1 Foreign currency assets
currencies of various countries are held in FOREX reserves
it is expressed in terms of US$ or INR
it also includes foreign currency deposits held by RBI with foreign central banks, BIS & non-residents deposit taking institution as well as deposit agreement with IMF trust a/c
that are readily available to meet a BoP financing need.
It also includes secY issued by non-residents & finL derviatives having underlying Foreign Currency assets.

5.2 Gold stocks of RBI

as a back up to issue currency & tackle BoP crises.
it is expressed in terms of US$ or INR
5.3 SDR[special drawing rights] holdings of the govt.
it is a reserve created by IMF to help countries to tackle Bop crises.
Member countries contribute to it, in a proportion of their IMF quota (membership fee).
It is held with RBI’s FOREX reserve in India.
Two dimensions of SDR:-
5.3AIt is an exchange rate system.:-
SDR is an avgd Ex-rate derived from a basket of 4 currencies{US$, Sterling Pound, Euro & Japanese Yen}.These currencies are assigned different weights as per their imp. @
world economy.Ex-rate of a country is expressed against SDR.
5.3B It is a loan arrangement.:-
members countries are entitles to get lain from IMF special drawing account
loan amt=200% of their quota.Also caleed paper gold.
Its an indirect lending=>strong nations lend to nations with BoP crises.

5.4 Reserve Tranche

Tranche= portion/slice.
Reserve Tranche= portion of fund. It is equal to 25% of its quota in SDR/foreign currency acceptable to IMF(i.e. hard currencies)
It is consisted of India’s quota (membership subscription fee) to IMF & lending to IMF’s general resource a/c{=pool of member’s quota payment}
*money lent in foreign currency/SDR over & above the quota to IMF’s general resource a/c=>part of Reserve Tranche
 FOREIGN EXCHANGE
EXCHANGE RATE
Rate @ home currency is exchanged with foreign currency.
It varies depending upon demand for & supply of currencies.
DEPRECIATION APPRECIATION
Increase in Ex-rate / fall in the external value of domestic currency d.t. more demand of fall in Ex-rate / increase in the external value of domestic currency d.t. more demand
foreign currency {or less supply of foreign currency} OR more supply of of domestic currency {or less supply of domestic currency} OR more supply of
Domestic currency{or less demand of domestic currency} foreign currency {or less demand of foreign currency}
DEVALUATION REVALUATION
REDUCTION in the external value of domestic currency. It is aimed at increasing exports of Increase in the external value of domestic currency. It is aimed at decreasing
the country. It is usually resorted to correct the deficit in BoP. exports of the country. It is usually resorted to correct the surplus in BoP.
surplus in BoP means deficit in BoP in some other country.
*Both DEPRECIATION & DEVALUATION helps to increase export.
**DEVALUATION also increases the profit of the EXPORTER.
***DEPRECIATION & APPRECIATION takes place automatically whereas DEVALUATION & REVALUATION is done voluntarily by govt. or monetary authority.
PURCHASING POWER PARITY
Proposed by Gustav Cassel & it’s a method of determining Ex-rate. Conversion of prevailing (BOP based) Ex-ratePPP:-
It means equality of buying capacity. PPP Ex-rate =
𝒅𝒐𝒎𝒆𝒔𝒕𝒊𝒄 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙
𝑿 𝒑𝒓𝒆𝒗𝒂𝒊𝒍𝒊𝒏𝒈 𝒎𝒂𝒓𝒌𝒆𝒕 𝑬𝒙 − 𝒓𝒂𝒕𝒆
𝒇𝒐𝒓𝒆𝒊𝒈𝒏 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙
Ex-rate is determined o.t.b.o buying capacity of respective currencies in their home country.

NEED FOR PPP BASED EX-RATE

Trade based Ex-rate failed to reflect the purchasing power of money to buy non-traded goods.
As trade is not a free flowing one, it is subject to many manipulations & obstructions & so is the Ex-rate.
To overcome this, PPP based Ex-rate is used to convert the income of diffT currencies into a common currency US PPP$.

In developing & less developed nations, less money is enough to buy more goods than that in developed nations. Means, high std of living in less money. This nature is not
reflected in Trade based Ex-rate.
SO, PPP based Ex-rate is used to compare std of living of people & stages of development.

CONVERTIBILTY
=Facility of exchanging domestic currency for foreign currency at market determined Ex-rate without any restrictions either on rate/quantum of money exchanged.

CONVERTIBILTY in India
CONVERTIBILTY in current a/c was introduced 1st then was introduced to capital a/c.

CURRENT A/C CONVERTIBILTY:-

Freedom of converting home currency into foreign currency w.r.t transaction @ current a/c.
Budget 1992-93:Introduced LERMS system{liberalized ex-rate management system}:- 60% of foreign Ex-earnings are convertible @ open market rate & 40% remaining @ RBI
fixed rate.
1993-93:full convertibility @ trade a/c.
Budget 1994-95: full convertibility @ current a/c was introduced. But was not satisfactory to IMF. So govt. introduced further relaxations. India got affiliation to Art VII of IMF.
CAPITAL A/C CONVERTIBILTY:-
Freedom of converting home currency into foreign currency w.r.t transaction @ capital a/c.

Committee on fuller capital a/c convertibility:-

Working definition of CAC=> freedom of convert local finL assets into foreign finL assets & vice-versa.
fuller capital a/c convertibility doesn’t mean 100% freedom. There should be some restrictions.

Capital A/C Convertibilty committee I :- Fuller CAC –II

Chairman-S.S.Tarapore Chairman-S.S.Tarapore
Gave green single to CAC(in a phased manner throughout the period from 1997-2000) but Same approach.
d.t east Asian crises it was not implemented. CAC in a 3 phased manner throughout the period from 2006-2011.

=policy instrument which obstructs trade.
TARIFF BARRIERS
NON-TARRIF BARRIERS
QUOTA
Limit fixed @ AMT of
trade(export & import)
PTA
 Partners reduce the tariffs level.
 To increase the trade flows.
 The parties to the agreement
maintain their own tariff level
with 3rd parties.
BARRIERS TO TRADE
Tariff obstructing free flow of trade is called tariff barriers.
Common purpose on tariff on import & export is to generate resource for govt.
Tariff on import? Tariff on export?
To make price of imported goods equal to that of domestic product & thus To discourage export & thus make goods available in the domestic
discourage import. market. Otherwise which may be exported.
Instruments & executive action obstructing free flow of trade other than tariffs are called non-tariff barriers.
Administrative action by domestic govt. to discriminate against foreign goods in favour of domestic goods.
PRODUCTION SUBSIDIES EXPORT SUBSIDIES HEALTH, SANITARY & SAFETY PACKAGING
REGULATIONS REQUIREMENTS
Given by govt. to producers of Given in the post production stage. Import restrictions o.t.g.o. health High restrictions imposed
exportable goods for the productions Subsidies in the form of & safety. @ trade.
of goods & services.  Transport subsidies Restrictions in the form of Standards push up the
Subsidies in the form of  Low cost shipment credits  Residues of pesticides in food costsimports comes
 raw material at low cost products. down
 Credits @low i rates.  Level of germs etc
 Tax concessions etc
ECONOMIC INTEGRATION
FTA CUSTOMS UNION COMMON MARKET ECONOMIC &
 Tariff abolished on most of goods  Member countries abolish trade Provisions of custom union + free MONETARY UNION
& services. & services barrier. flow of labour & capital. Provisions of common
 Keep tariffs on some  As a whole maintain common market +
item{sensitive goods} @ Min. tariff among 3rd parties. Harmonized monetary &
level fiscal policies among
 The parties to the agreement partner nations.
follow their own independent
trade relation with 3rd parties.
 RELATED TERMS
COMPARITIVE ADVANTAGE
As per this theory: a country has to produce & export the goods in which it has comparative advantages.
RULE OF ORIGIN
Aimed at preventing 3rd parties from routing their products through member countries to take advantages of low tariffs & allowing only goods that are originated from parties to the
agreement.
Two criteria:
1. Value addition/local content requirement.:-goods which are not fully originated in the partner countries, should have a value addition in terms of raw material, labour costs
etc. as garred by the member countries. It is usually 30%
2. Change of tariff heading @ 4 digit level.:- code assigned to various products under Harmonized Commodity Description & Coding System Of World Custom Union called as
Harmonized Coding System.
1st 4 digits of the code are called heading & subsequent digits are called sub heading.
Change of tariff heading means when product is not originated in the partner countries then it should be codified in diffT heading {converted to another product} when exported.
DEBT SERVICE RATIO
𝒅𝒆𝒃𝒕 𝒔𝒆𝒓𝒗𝒊𝒄𝒆
Debt Service =Repayment of P & i. Debt Service Ratio=
𝒕𝒐𝒕𝒂𝒍 𝒆𝒙𝒑𝒐𝒓𝒕 𝒆𝒂𝒓𝒏𝒊𝒏𝒈𝒔

NEER & REER

𝒅𝒐𝒎𝒆𝒔𝒕𝒊𝒄 𝒄𝒖𝒓𝒓𝒆𝒏𝒄𝒚 𝑬𝒙−𝑹𝒂𝒕𝒆 𝒊.𝒕.𝒐 𝑺𝑫𝑹
NEER= nominal effective Ex-Rate. NEER=
𝒇𝒐𝒓𝒆𝒊𝒈𝒏 𝒄𝒖𝒓𝒓𝒆𝒏𝒄𝒚 𝑬𝒙−𝒓𝒂𝒕𝒆 𝒊.𝒕.𝒐 𝑺𝑫𝑹

𝒅𝒐𝒎𝒆𝒔𝒕𝒊𝒄 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙

REER= Real effective Ex-Rate REER = 𝑿 𝑵𝑬𝑬𝑹
𝒇𝒐𝒓𝒆𝒊𝒈𝒏 𝒑𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙

*EER is fixed against a currencies’ basket. For NEER & REER=> currencies’ basket= SDR currencies.
**Price index in the above equation is CPI (combined)