Balance of payments (BOP)

*BOP is a standard double entry accounting record to capture all the transactions of an economy with
rest of the world. BOP is a record of payments and receipts of the country. Hence in strict sense, it is
a calculation of BOP and receipts.

Components of BOP-:
*BOP is a collection of accounts of all such eligible transactions which shall have bearing on the
forex position of the economy. This BOP the collection of accounts is grouped into three main
accounts with subdivisions in each. The three major accounts in the BOP are
a. The Current Account
b. The Capital Account
C. The Reserve Account

a) The Current Account-:

It consists of all the transactions in goods and services. Exports are recorded as credits while
imports as debits.

Components of Balance of Payments -:

____________________________________________

Item Credit Debit Net

(A) Current Account

(1) Merchandise
(A) Private
(B) Govt
(2) Non-Monetary Gold Movement
(3) Invisibles
(A) Travel
(B) Transportation
(C) Insurance
(d) Investment Income
(E) Govt Not Elsewhere Classified
(F) Miscellaneous
(G) Transfer Pymts----Official

Total Current Account

(B) Capital Account

(1) Private
(A) Long Term
(B) Short Term
(2) Banking
(3) Official
(A) Loans
(B) Amortization
(C) Miscellaneous
Total Capital Account = 1+ 2 + 3
(C) IMF (International Monetary Fund)
(D) SDR (Special Drawing Rights) Allocation
(E) B +C + D
(F) (A +E)
(G) Errors and Omissions
(H) Reserves and Monetary Gold

C D and H collectively refer to reserve account

(SOURCE ---BOP COMPILATION MANUAL---RBI)

1. Merchandise -:
All the transactions relating to movable goods baring some exceptions are covered under this
account. It is export and import of tangible goods. Typically only the value of goods is taken into
consideration for this account. International freight and insurance charges are excluded as these are
not tangible goods. Hence valuation is on fob basis. Private transactions and govt. transactions
are recorded separately. The difference between credit (exports) and debit (imports) appears in the
net column. This is the balance on merchandise trade account. If credit is higher than debit, then it is
surplus otherwise deficit.

(2) Non-Monetary Gold Movements -:

Gold is the only tangible asset that has stood the test of time for past 6000 yrs of human history.
Traditionally gold is treated as both a commodity and a financial asset. The quantum of gold that is
held by monetary authority as a part of international reserves is classified as financial asset. All the
other gold that is with residents is commodity
The commodity gold traded by residents and non-residents is recorded in the account which is part
of the current account. It is simply import /export transaction of gold by any one other than monetary
authority. In India, monetary authority is RBI.

Monetization and De-Monetization of Gold -:

Gold is more than just another commodity. It is the currency that evolved in the marketplace over
centuries. It may be observed that part ‘H’ of the BOP accounts for monetary gold. Monetary
authority might sometimes acquire gold from residents or non-residents to increase gold that forms
part of international reserves. In this process, commodity category gold gets transferred to financial
asset category. Hence, it is debit to reserve account “H” and credit to A-II Non-monetary gold
movement current account. This process is called as Monetization of Gold.
If it is reverse process i.e. monetary authority sells gold debiting “A-II and crediting “H” is called as
“De-Monetization of Gold)

(3) Invisibles-:
This includes trade in services i.e. trade of non-tangible items. Services such as consultancy,
insurance, transportation, receipts of tour operators, from foreign tourists, tuition fees of colleges etc
are included in this a/c. Revenue contributions of Govt. of India to international institutions such as
United Nations shall also be debited under this account. In transfer payments official foreign aid is
also recd, in this a/c.
Cash sent to the family members by NRI for routine expenses (which is known as factor income)
shall also be under transfer payments.

Private-: it also includes pension paid to former residents living abroad, gifts, donations and
subsidies recd by non-govt bodies in the country.
Foreign Govts pay Govt of India for maintenance of their embassy and vice-versa. This is recorded
in Govt .not classified elsewhere--.

The net difference between all credits and debits is the balance on invisibles account. the net balance
between the debit and credit entries under merchandise, non—monetary gold movements and
invisibles taken together is current account balance. If credit exceeds debits, it is current account
surplus “and if debits exceed credits, it is “current account deficit.

The Capital Account -:

The capital account consists of financial transactions that lead to changes in foreign assets and
liabilities of the economy. Increase in assets (decrease in liabilities) is debit. Decrease in assets
(increase in liabilities) is credit. It means capital inflow is credit and capital outflow is debit.

The transactions are grouped by the institutional sector (banking, Govt, and Pvt) and by term to
maturity of the original claim.

(1) Private Sector Capital Flows -:

This consists of loans received by pvt entities (other than banks) in india from NRI’s, investment by
foreigners in shares of Indian companies, repayment of loans to residents by non residents,
repatriation of Indian investments abroad i.e. capital inflows on credit side.

The capital outflows are recorded on the debit side such as investments by residents in shares abroad,
investment by residents in foreign properties and assets, repatriation of foreign investments in india,
disbursement of loans to non – residents. Short-Term Capital flows pertain to claims with maturities
up to a year, rest are long term capital flows.

(2) Banking Capital-:

This covers changes in assets and liabilities of commercial banks. This includes Govt. banks, Pvt.
banks as well as Co-op. banks that are authorized to deal in foreign exchange. Assets are the
balances held by foreign branches of indian banks and liabilities are deposit balances held by foreign
banks in india. Increase in assets is debit and increase in liabilities is credit. Decrease in assets is
credit and decrease in liabilities is debit.

(3) Official Capital Flows-:

These include transactions of Govt. Of india and RBI that affect foreign financial assets and
liabilities of Govt. of india. In case of RBI, official reserve assets are excluded as they are to be
covered under “H” transactions of Govt. of india with International Monetary Fund (IMF) are
excluded here and covered under “C”

The net balance between the debit and credit entries under private sector capital flows, capital and
official capital flows taken together is “Capital Account Balance”

If credits exceed debits it is “Capital Accounts Surplus” and if debits exceed credits it is Capital
Account Deficit”

The Reserves Account-:

Three accounts IMF, SDR and Reserves and Monetary Gold are collectively called as The Reserve
Account.
The IMF account contains purchases (credits) and repurchases (debits) from International Monetary
Fund.
SDR’S (SPECIAL DRAWING RIGHTS) are a reserve asset created by IMF and allocated from time
to time to member countries. SDR’S can be used to settle international pymts between monetary
authorities of two different countries. An allocation is a credit while retirement is debit.

(H) RESERVE ASSETS are RBI’S holdings of gold and foreign exchange. These are in the form
of balances with foreign central banks and investments in foreign govt. Securities.

Errors and Emissions-: Section G

The changes in “H” that contain changes in reserve assets is accurately measured as these contain
transactions from RBI accounts only.

But changes in other items may be inaccurate because of data inadequacy, discrepancies of valuation
and timing, erroneous reporting, etc, these are reconciled by this fictitious head of account called as
“Errors and Omissions”

Official settlement balance, official reserve transactions and basic balance are some of the
terminology related to the BOP

Official settlement balance is the net change in a country’s stock of foreign exchange reserves and
official Govt. borrowing

Official settlements account includes-:-

(1) Changes in Official Reserves-:

*Official Gold Reserves
*Official Foreign Exchange Holdings
*Reserve Position in the IMF And
*Special Drawing Rights (SDR’S)

(2) Changes in liabilities to foreign authorities official settlements balance:

*Equal to changes in the country’s official reserves (thus equal to the negative of the sum of
all other accounts)
*Represents the extent of official central bank intervention in the foreign exchange market
over the time period covered.

Official Reserve Transactions (ORT) -:

Central banks transactions in international reserve assets, gold SDR’s.

Official international reserves foreign assets held by central banks.

Deficit and Surplus in the BOP-:

*the net balance between the debit and credit entries under all the heads of balance of payments
taken together is “Balance on BOP”. If credits exceed debits it is BOP Surplus, if debits exceed
credits it is BOP deficit.

The BOP always balances in technical and accounting sense------

*The balance in the BOP implies that a net credit

In any one of the items must have a counterpart net debit in another and vice-versa. This is because
there cannot be imbalance left without accommodating it. When the total credits and total debits of
all accounts balance, we say that the bop balances. A clear picture of deficit or surplus is revealed
when we examine the bop statement splitting it vertically into current account, capital account, and
the reserves account.

Any account in isolation will be mostly imbalance. A current account deficit would be matched with
by capital account surplus and vice-versa.

*Whatever imbalance remains after current and capital account together is balanced through reserves
account [Link] effective changes in forex-reserves with the monetary authority (RBI)

Basic Balance-:
1. Basic balance is the sum of the current account and capital account.

2. When credits in current and capital account together are equal to debits in current and capital
accounts the basic balance is achieved. In this situation, reserves position of the country is unaltered.
Surplus in basic balance adds to reserves and deficit reduces reserves.

3. Surplus is generally considered as favorable situation. Sometimes short-term capital account is

excluded while calculating basic balance in this case basic balance is sum of current account balance
and long-term capital account balance.

If surplus or balance in basic allowance is achieved through long term capital borrowings/inflows, it
may not be a good situation in long term as in subsequent yrs, there would be outflow of
Interest/dividend. If deficit in basic balance is because of reasonable capital investments abroad, it
may still be a good situation as the entry would envisage inflows in future in the form of
interest/dividend

Overall Balance-:
It is the sum of the current account, capital account and errors -omissions. Hence it is basic balance
plus errors, omissions.

Though interpretation of overall balance is almost similar to the basic balance. It also serves the
purpose of “total exclusion of all reserve account transactions. Only errors and omissions is not in
real sense a reserve account ”transaction”, it is in fact an accommodating entry for current and
capital account errors.

The terms like basic balance and overall balance are used interchangeably in forex literature. It
essentially refers to everything excluding changes in official forex reserves.

Autonomous Capital Flows-:

Autonomous flows take place in ordinary course of foreign trade.
*These flows take place on their own as part of trade. They are not decided depending upon
other accounts balance position. These are also called as “Transactions above the Line”
Accommodating Capital Flows-:
*These flows take place to equalize the BOP these flows are a result of deliberate act to balance the
BOP overall.

*They depend upon the balance position of other accounts. These are also called as “Transactions
below the Line”

Importance of the BOP -:

(1) BOP records all the transactions that create demand for and supply of a currency. This indicates
demand-supply equation of the currency. This can drive changes in exchange rate of the currency
with other currencies.
(2) BOP may confirm trend in economy’s international trade and exchange rate of the currency. This
may also indicate change or reversal in the trend.
(3) This may indicate policy shift of the monetary authority (RBI) of the country.
(4) This may indicate movement of the interest rates in the economy.
(5) all the above shall have substantial effect on the decisions of the finance mgr’s of co’s as they
take decisions related to foreign trade and investments.