Open Economy

Framework:
Balance of Payments
- Dr Vighneswara Swamy

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Coverage
1.Balance of Payments
2.Current Account
3.Capital Account
4.Financial account
5.The effects of Crude oil /Gold price on Current account.

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Balance of Payments
Balance of Payments (BOP)—is an accounting
record of all the economic transactions
between the residents of one country and the
rest of the world.
The nations keep the record of BoP on an
annual basis. Some nations like U.S. keep the
record of BoP on quarterly basis.
The BoP is the statistical record of a country’s
international transactions over a certain period
of time presented in the form of double-entry
bookkeeping.
VIGHNESWARA SWAMY
BoP – RBI Definition
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 them on account of
goods imported and services received from the capital
transferred to ‘non-residents’ or ‘foreigners’.” – Reserve
Bank of India (RBI)
VIGHNESWARA SWAMY
Visible and Invisible Items
1. Visible Items: 2. Invisible Items:
1.These include all types of physical
goods which are exported and 1.Invisible items of trade refer to all
imported. types of services like shipping,
2.These are called ‘visible items’ as they banking, insurance etc., which are
are made of some matter or material given and received.
and can be seen, touched and 2.These are called invisible items as
measured.
they cannot be seen, felt, touched
3.The movement of such items is open
and can be verified by the customs
or measured.
officials.

VIGHNESWARA SWAMY
Unilateral Transfers and Capital
Transfers
Unilateral Transfers: Capital Transfers:
Unilateral transfers include gifts, Capital transfers relate to
personal remittances and other capital receipts (through
‘one-way transactions’. borrowings or sale of assets)
Since these transactions do not and capital payments (through
involve any claim for repayment, capital repayments or purchase
they are also known as of assets).
unrequited transfers.

VIGHNESWARA SWAMY
Features of the BOP
❖BOP follows the accounting procedure of double-entry bookkeeping (debits &
credits).
❖A credit entry records an item or transaction that brings foreign exchange into
the country.
❖A debit entry represents a loss of foreign exchange.
❖BOP will always balance.
❖A BOP deficit (surplus) means that the debit entries exceed (are less than) the
credits. This imbalance applies only to a particular account or component of
the BOP.
❖BOP is a flow statement, not a stock statement.

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Why is it useful to examine BOP?
The BOP provides detailed information about
the supply and demand of the country’s
currency.
◦ The trade statistics in the Current Account, show
the composition of trade – what a country imports
and what it exports?
◦ The Capital Account shows inflows and outflows of
capital in various categories.
Viewed over time, BOP data can shed light on
important developments in a country’s
comparative advantage and international
competitiveness.
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Significance of BoP
The BoP is an important indicator of pressure on a country’s foreign
exchange rate .

The BOP helps to forecast a country’s market potential, especially in

the short run.

Changes in a country’s BOP may signal the imposition or removal of

controls over payment of dividends and interest, license fees, royalty
fees, or other cash disbursements to foreign firms or investors.
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BoP Accounting
Current Account
The current account of the
balance of payments refers
to the monetary value of
international flows
associated with transactions
in goods, services, income
flows, and unilateral
transfers.
Capital Account
Capital Account includes
transactions that are purely
claims on financial assets
(i.e. purchases or sales of
financial assets).
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 Balance of Payment
Current Account Capital Account
1.Merchandize Trade balance: 1. Foreign Investment:
- Exports - FDI, FPI, ADRs, GDRs,
- Imports
2. Invisibles: 2. Loans:
- Services Balance: - External assistance
Transportation, - Commercial Borrowing
Military transactions, - Short Term Funds
Royalties, Software
3. Unilateral Transfers: 3. Banking Capital
- Government Grants - Foreign assets of banks
- Private Transfers or remittances - Foreign liabilities of ADs
- Others
4. Other Capital
5. Reserve Account
6. Statistical discrepancy 11
Reserve Account
Reserve Account Statistical Discrepancy
Reserve Account constitutes the Statistical Discrepancy account
changes in the reserves indicated includes the errors and
separately. omissions.

These are the assets that are

acceptable across the world for
settlements of international
transactions.

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Different Accounts …. In short
Current Account a record of all international transactions for goods and services.
The current account combines the transactions of the trade
account and the services account.
Merchandise a record of all international transactions for goods only. Goods
Trade Account include physical items like autos, steel, food, clothes,
appliances, furniture, et. al.
Services Account a record of all international transactions for services only.
Services include transportation, insurance, hotel, restaurant,
legal services, consulting, et. al.
Financial a record of all international transactions for assets. Assets
Account include bonds, treasury bills, bank deposits, stocks, currency,
real estate, et. al.
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Standard Presentation of India's Balance of Payments
(US$ Million)
Apr-Jun 2018 PR Jul-Sep 2018 P Apr-Sep 2018 P
Credit Debit Net Credit Debit Net Credit Debit Net

1 Current Account (1.A+1.B+1.C) 155692171613 -15921 160007 179098 -19091 315699 350711 -35012
1.A Goods and Services (1.A.a+1.A.b) 131563 158619 -27057 133493 163277 -29784 265055 321896 -56840
1.B Primary Income (1.B.1to1.B.3) 5327 11244 -5917 5623 14282 -8659 10950 25526 -14576
1.C Secondary Income (1.C.1+1.C.2) 18803 1750 17053 20891 1539 19352 39694 3289 36405
2 Capital Account (2.1+2.2) 111 94 17 75 96 -21 186 190 -4
3 Financial Account (3.1 to 3.5) 142502125807 16695 131048 112851 18198 273551 238658 34893
3.1 Direct Investment (3.1A+3.1B) 17313 7453 9860 14997 7126 7872 32310 14579 17732
3.1.B Direct Investment by India 276 3619 -3344 751 3071 -2320 1027 6690 -5663
3.5 Reserve assets 11338 0 11338 1868 0 1868 13206 0 13206
3 Total assets/liabilities 142502 125807 16695 131048 112851 18198 273551 238658 34893
4 Net errors and omissions 792 -792 914 914 123 123
P: Preliminary. PR: Partially Revised.

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 India's Current Account
(US$ Million)
Apr-Jun 2018 PR Jul-Sep 2018 P Apr-Sep 2018 P
Credit Debit Net Credit Debit Net Credit Debit Net
Current Account
1 (1.A+1.B+1.C) 155692171613 -15921 160007 179098 -19091 315699 350711 -35012
1.A Goods and Services (1.A.a+1.A.b) 131563 158619 -27057 133493 163277 -29784 265055 321896 -56840

1.A.a Goods (1.A.a.1 to 1.A.a.3) 83389 129141 -45752 83399 133432 -50034 166788 262574 -95786

1.A.b Services (1.A.b.1 to 1.A.b.13) 48174 29478 18696 50094 29844 20250 98268 59322 38946

1.B Primary Income (1.B.1to1.B.3) 5327 11244 -5917 5623 14282 -8659 10950 25526 -14576

1.C Secondary Income (1.C.1+1.C.2) 18803 1750 17053 20891 1539 19352 39694 3289 36405
P: Preliminary. PR: Partially Revised.

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India Current
Account - Services
What services bring current account surplus to
India?
The detailed analysis of service component of
current account deficit shows that the largest
component of India’s services surplus comes
from IT industries.
Similarly, India is a net exporter of travel
meaning foreigners visiting India spend more
money than Indians visiting foreign countries.
India has to send abroad a significant amount
of money for use of intellectual property.
India is a net importer of recreational services
that include services in film, music industry and
so on. 16
What Factors cause a current account deficit?
1.A current account deficit occurs when the value of imports (of goods,
services and investment incomes) is greater than the value of exports.
2.Running a Current Account Deficit means that an economy is not
paying its way in the global economy.
3.There is a net outflow of demand and income from the circular flow of
income and spending.
4.Spending on imported goods and services exceeds the income from
exports.
5.Decreasing a current account deficit is not in the hands of home
country alone.
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What factors cause a current account deficit?
1. Exchange Rate
2. Economic Growth
3. Decline in Competitiveness
4. Higher inflation
5. Poor productivity
6. Low levels of investment in real capital
7. Low levels of investment in human capital
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 India's Capital Account (US$ Million)
Apr-Jun 2018 PR Jul-Sep 2018 P Apr-Sep 2018 P
Credit Debit Net Credit Debit Net Credit Debit Net
2 Capital Account (2.1+2.2) 111 94 17 75 96 -21 186 190 -4
Gross acquisitions (DR.)/disposals (CR.) of non-
produced nonfinancial assets
2.1 66 16 51 2 4 -2 68 20 49
2.2 Capital transfers 45 78 -33 72 92 -19 118 170 -53
2.2.1 General government 1 22 -22 0 21 -21 1 43 -43
2.2.1.1 Debt forgiveness
2.2.1.2 Other capital transfers 1 22 -22 0 21 -21 1 43 -43
Financial corporations, nonfinancial
2.2.2 corporations, households, and NPISHs 44 56 -12 72 71 2 117 127 -10
2.2.2.1 Debt forgiveness
Other capital transfers including migrants
2.2.2.2 transfers 44 56 -12 72 71 2 117 127 -10
P: Preliminary. PR: Partially Revised.

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Capital Flows and BoP
In addition to Currency Depreciation and Protectionism,
another way of monitoring and arresting the adverse
Balance of Payments (BoP) is controlling the capital flows
on account of transactions of financial assets.

VIGHNESWARA SWAMY
 India's Financial Account
(US$ Million)
Apr-Jun 2018 PR Jul-Sep 2018 P Apr-Sep 2018 P
Credit Debit Net Credit Debit Net Credit Debit Net

3 Financial Account (3.1 to 3.5) 142502 125807 16695 131048 112851 18198 273551 238658 34893

3.1 Direct Investment (3.1A+3.1B) 17313 7453 9860 14997 7126 7872 32310 14579 17732

3.2 Portfolio Investment 60453 68598 -8145 60388 62006 -1618 120841 130604 -9763
Financial derivatives (other than
3.3 reserves) and employee stock options 3631 5113 -1482 5623 4344 1278 9254 9458 -204

3.4 Other investment 49767 44643 5124 48172 39374 8798 97939 84017 13922

3.5 Reserve assets 11338 0 11338 1868 0 1868 13206 0 13206

P: Preliminary. PR: Partially Revised.

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Twin Deficit Identity
The Relationship between a Country’s Government Budget
Deficit and Its Current Account Deficit.

To understand this identity it will be helpful to take a much

more careful look at the national income identity.

VIGHNESWARA SWAMY
Tit-Bits
Difference between Current Account Deficit and Fiscal Deficit

Fiscal Deficit Current Account Deficit

Fiscal Deficit is a percentage of
the nation's GDP and can be
considered as an economic
event in which the government
expenditure exceeds its revenue
Current Account Deficit occurs
when the country's imports are
greater than the country's
exports of goods, services and
transfers.

VIGHNESWARA SWAMY
Tit-Bits
Difference between Current Account Balance and Trade Balance

Current Account Balance Trade Balance

Total Exports – Total Imports Merchandize Exports –
= > 0 means surplus BoP Merchandize Imports
= < 0 means deficit BoP = > 0 means surplus BoT
= < 0 means deficit BoT

Indicates the competitiveness on

the manufacturing sector

VIGHNESWARA SWAMY
Tit-Bits
Difference between Current Account Balance and Trade Balance

Current Account Balance Trade Balance

Total Exports – Total Imports Merchandize Exports –
= > 0 means surplus BoP Merchandize Imports
= < 0 means deficit BoP = > 0 means surplus BoT
= < 0 means deficit BoT

Indicates the competitiveness on

the manufacturing sector

VIGHNESWARA SWAMY
Tit-Bits
Difference between BoT and BoP
BoT
The difference between
exports and imports of goods
BoP
A system of accounts that
measures transactions of goods,
services, income and financial
assets between domestic
households, businesses, and
governments and residents of the
rest of the world during a specific
time period
VIGHNESWARA SWAMY
Globalization
Globalization
1. Globalization is a process of greater interdependence among countries and their
citizens.
2. OECD defines Globalization as a process of deeper economic integration
between countries and regions of the world.
3. For a common man, globalization means, residents of one country are more
likely to consume the products of other country, to invest in other country.
4. Globalization has two facets: (1) Globalization of Markets and (2) Globalization
of Production.
5. Globalization is also termed as the shrinkage of economic space.

VIGHNESWARA SWAMY
Globalization: Major Drivers
1. Emergence of global financial markets.
2. Emergence of the Euro as a global currency (beginning of 1999).
3. Trade liberalization (GATT and WTO) and economic integration
(EU, SAFTA)
4. Surge in privatization, public private participation (PPP)
5. Emergence of Multinational Corporations (MNCs) like GE,
Vodaphone, Toyota, Siemens, TATA, and others

VIGHNESWARA SWAMY
Waves of Globalization
1. First Wave of Globalization: 1870-1914
- Largely driven by European and American businesses
2. Second Wave of Globalization: 1945-1980
-Decline in trade barriers, specialization in manufacturing

3. Latest Wave of Globalization: 1980 onwards

- Outsourcing of technologies and labor

VIGHNESWARA SWAMY
Globalization of Finance
1. Rise in international financial instruments
2. International funds (mutual funds)
3. Emerging country funds
4. Hot money flows

VIGHNESWARA SWAMY
Tit-Bits
Difference Globalization of Markets and Globalization of Production

Globalization of Markets Globalization of Production

Globalization of markets refers to the fact
that in many industries historically distinct
and separate national markets are merging
into one huge global marketplace.
The globalization of production refers to
the tendency among many firms to source
goods and services from different locations
around the globe in an attempt to take
advantage of national differences in the
cost and quality of factors of production.
(labor, energy, land and capital)

VIGHNESWARA SWAMY
Key learnings
1. The merchandise trade balance measures exports minus imports of goods.
2. Net exports includes trade in services as well.
3. The current account includes net international factor income, taxes, and
transfers.
4. The current account is mirrored by an equal and opposite capital and financial
account measuring net asset transactions.
5. The net international investment position measures our current net claims on
the rest of the world.
6. The flow identity tells us that the current account reflects some combination of
personal saving, investment in plant and equipment, and the government deficit.

VIGHNESWARA SWAMY
Key words
Balance of Payments
Current Account
Capital Account
Financial Account
Current Account Deficit
Globalization
Financial integration

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