Balance of Payment Account

Balance of Payment Account

 Balance of Payment (BOP) is a way to measure the
performance of an economy.

 It is the recording of total transactions of an economy with

other economies.

 Balance of Payment is a statement that shows an economy’s

transactions with the remaining world in a particular time
period.

 It takes the net inflows and outflows of money into

account and then differentiates them into different sections.
Components of BOP Account

Balance of
Payment

Current Capital Official Error and

Account Account Reserves Omission
Account

I. Merchandise
I. Short Term
II. Services Capital Flows
III. Transfers II. Long Term
IV. Income Capital Flows
Current Account Components
Current Account

Merchandise Services Unilateral Net Income from

Transfers Investments

I. Travel and Tourism

Movable goods II. Transportation I. Official
and Shipping II. Private I. Investment
Income
III. Insurance and
Banking II. Compensation
to employees
IV. Computer and
Information
Technology
Merchandise Transactions
 Also termed as Balance of Trade
 Merchandise Transaction is the largest component of
the Current Account.
 It consists of:
 Exports:When Indian producers sell their products
abroad, buyers (foreigners) supply their own currencies.
 Itis recorded as a credit transaction (+)
 When Indian residents buy products from abroad, they
supply INR.
 Imports: It is recorded as a debit transaction (-)
Service Transactions
Export and Import of Services:
 Travel & tourism

 Transportation & shipping

 Financial

 Insurance & banking

 Computer & Information

 Construction

 Communication

In addition, there are royalties, payments for capital

services besides interest, such as dividends, payments for
foreign labor, etc.
Other Current Account Components
 Net Investment Income: -
 Income (interest, dividend, etc.) received from
investment abroad minus income paid to foreigners
investing in India.

 Unilateral Transfers: -
 Net of gift received from and given to foreign
countries. –
 Remittances, donations, other one way transactions
Example: Current Account
 Trade balance
 Debit: Infosys buys LEDs from China
 Credit: Chinese citizen buys a Maruti car

 Trade in services
 Debit: Indian citizen rents an apartment in US.
 Credit: Siemens - Germany places an ad in the TOI/ HT

 Income payments
 Credit: RBS pays salary to an employee in the Delhi office

 Unilateral Current Transactions

 Credit: African company pays for the tuition of its employees at IIM
Current Account Balance
 Current Account Surplus:
 The country has positive net foreign investment (i.e., the
country is acting as a net lender to or investor in the
rest of the world).
 The country is producing more (and has more income
from this production) than it is spending on goods and
services.
 The country is saving more than it is investing
domestically.
 Current Account Deficit:
 The nation is a net borrower or domestic savings are
less than domestic investment.
Capital Account
 Capital Accounts records the transaction that cause a
changes in assets and liabilities of the residents or Govt. of
the country.

 Capital A/c includes all purchases and sales of assets such

as stocks, bonds, real estate and businesses.

 Capital A/C is concerned with Financial transfers. So it does

not have direct effect on income, output and employment of
the country.

 Capital A/C is used to –

 Finance deficit of Current A/C
 Absorb surplus of Current A/C
Capital Account
 Capital Outflow = Debit (eg. Indian investment in
a foreign country, investment in foreign securities,
Govt. loans to foreign countries)
 Capital Inflow = Credit (FDI by a foreign co. in
India, loans to Govt. from foreign countries, NRI
deposits).

The interest on loans and dividends/profits received are

current account; while the loan and FDI are capital
account transactions
 Capital Account Components

Capital Account

Foreign Investment Loan Banking Capital

I. External I. Commercial
I. Direct Assistance Banks
II. Portfolio II. Commercial II. Any other
Borrowings
III. Short Term Loan
Example: Capital Account
 Direct Investment
 Debit: Bajaj builds factory in Egypt
 Credit: Bajaj sells its factory in some foreign country

 Portfolio Investment
 Debit: Indian investor buys BASF stock @ Frankfurt Stock
Exchange
 Credit: Indonesian Govt. buys Indian T-bills to hold as forex
reserves

 Other investment
 Debit: Infosys deposits $100m in a bank account in London
 Credit: Infosys generates accounts receivable in China.
Balance of Payments Accounting System:

 Double-entry accounting system

 If a transaction creates supply of the nation's currency

in the foreign exchange market it is recorded as a
Debits (e.g. Imports)
 Debits are used to increase assets and decrease liabilities.

 If a transaction creates demand for the nation's

currency in the foreign exchange market it is recorded
as a Credit ( e.g. Exports)
 Credits are used to increase liabilities and decrease assets.
Valuation and Timing of Recording
Transactions in BOP:
 IMF recommends Market price
 Choice between F.O.B and C.I.F valuation
 F.O.B = Free on Board and C.I.F = Cost Insurance
Freight
 IMF recommends F.O.B as C.I.F includes the Value of
Transportation and insurance in addition to the value of
goods.
 In India, exports are valued at F.O.B and imports are
valued at C.I.F
 Exports are recorded when cleared by customs and
Imports are recorded when payment is made.