BALANCE OF PAYMENTS

E
Conomic policies of particularly the trade policy, foreign in
country,
a
exchange rate and curreney convertibility policies, foreign exchange allocation/avai
ocation/ianvaivestlamten y
eIc. and even monetary and fiscal be influenced by the
balance na
and
policies may of p
foreign positions of the nation. policies affect the hu
These
economy.
change reserves
business a
MEANING
In simple terms, the balance of international payments, usually referred to as theb
payments, is a systematic and summary record of a country's economic and financial tao
with the rest of the
world,
transac
over a period of timne.
The IMF publication Balance of Payments Manual describes the concept as follows

The Balance of Payments is a statistical statement for a given period showing:

1. Transactions in goods and services and income between an economy and therest

world;
2. Changes of ownership and other changes in that country's monetary gold, Special Da
Rights (SDRs) and claims on and liabilities to the rest of the world; and
3. Unrequited transfers and counterpart entries that are needed to balance, in the acou
sense, any entries for the foregoing transactions and changes which are not mui

offsetting."

BALANCE OF TRADE AND BALANCE OF PAYMENTS

is a much
Balance of trade takes into account only arising
those transactions out of the exper
concept than invisible items such
T is a part of items, it does not consider the exchange of
imports of the visible and dividen
BoP insurance and banking; payment of interest,
services rendered by shipping, of both vao
tourists. Balance of payments takes into account the exchange fore
expenditure by items (such as
current account items) and the capital account
invisible items (the debt service, NRI depos
assistance, external lending and borrowing, count;:1R
external
investments,
includes only the visible items (merchandise trade)
of the current acc at
The balance trade
current
of the
includes the goods trade plus the invisible
transactions
balance of payments a better
Hence, balance of payments represents balance

account transactions. the

and the capital financial transactions world than
with the rest of the
and
country's economic
trade.
ACCOUNTING
NATURE OF
BALANCE OF PAYMENTS n d a r dd o u l e - e n

cOuntry willresult
are recorded in st
that fall under Balance of Payments r e c o r d e di nd o u e

The
transactions
international transaction undertaken by
the count
which each
under internationa
size. As international transactions are
reco
entry of
of equal
bookkeeping,

and debit
a
credit entry
 Payments 257
Trade and
ational
nterna.

tkeeping. the balance of payments must always balance, i.e., the total amount of debits
lthe total amount of eredits. Sometimes, the balancing item errors and omissions must
m U s te q u a l

to balance' the balance of payments.

* added t o

MPONENTS OF BALANCE OF PAYMENTSs

COMPON

fomat of the balance of payments given below shows the important types of transactions The most importat
The transactions entering
ntet the balance of payments. The various debit and credit entries are generally grouped the BoP are grouped
ente

heads: under current account

urkerthe following and capital account
1. Current Account

2. Capital Account

Account
. Unilateral Payments
4, Official
Reserves Assets Account

Carrent Account

The current account includes all transactions which give rise to or use up national income.

The Current Account consists of two major items, namely, (a) merchandise exports and
ports; and (b) invisible exports and imports.
Merchandise exports, i.e., sale of goods abroad, are credit entries because all transactions Curet account
gving rise to monetary claims on foreigners represent credits. On the other hand, merchandise shows a nation's
goods and invis+bles
mports, i.e., purchase of goods from abroad, are debit entries because all transactions giving rise
transactions with the
n foreign money claims on the home country represent debits. rest of the world.
Merchandise imports and exports form the most important international transaction of most
of the countries.

Invisible exports, i.e., sale of services, are credit entries and invisible imports, i.e., purchase
f services, are debit entries.

Important invisible exports include sale abroad of services like transport and insurance, foreign
ouSt expenditure in the home country and income received on loans and investments abroad
mtierests or dividends).

Purchase of foreign services like transport and insurance, tourist expenditure abroad and
E paid on loans and investments (by foreigners) in the home country form the important
Ssible entries on the debit side.
OTWare exports have emerged as a very important invisible item of India's current
un
apital Account
The capital account consists of short-term and long-term capital transactions.
dutflow represents debit and capital inflow represents credit. For instance, if an
Balirm invests 100 million in India, this transaction will be represented as a debit in the
Balance and a credit in the Balance of Payments of India.
of Payments
te. they ?n of interest on loans and dividend payments are recorded in the curre account, Capital accounts
are really payments for the services of capital. As has already been mentioned above, shows the capital
1est paid
debite n loans given by foreigners or dividend on foreign investments in the home country
inflows and
outilows.
ividne home country, while, on the other hand, interest received on loans given abroad
d s on
investments abroad are credits.
 Internaional
258-
Busine Eov
ITEMS

TABLE 5.11 BALANCE OF PAYMENTS OF

INDIA:
MAJOR

Sr
Item
No.

Current Account
1.
Exports
Imports
3. Trade Balance
4. Invisibles (net)
A. Non-factor Service
B. Income
C. Transfer

Goods and Services Balance

. Current Account Balance
L Capital Account
Capital Account Balance
) External Assistance (net)
External Commercial

Borrowing (net)
ii) Short-term debt
(iv) Banking Capital (n
of which:
Non-Resident Deposits (net)
(v) Foreign Investment (net)
of Which
A FDI (net)
B Portfolio (net)
(vi) Other Flows (net
IIL Errors and omissions

IV Overall Balance'

V Reserves
increase (H decrease (+)|

a includes among others delayea export receipts and rupee debt.

mchudes total current account
b balance, capital account
Source: Tables 5.11 to 5.15, 5.16 to >.20 and 5.23 to 5.25 are
from
balance and errors and om
Government of India,
Economic Survey
i 2010-
tnternationa/Trade
nal
and Payments

259
nsfers Account
y a i l o t o r a lT r a n s t

transfers is another term for

gifis, and
Unilatera
includes private remittances,
reparations
and disaster relief government
Aranis,

Uhilater
navments received from abroad are
credits and those made abroad are debits.
eial Reserves Account
DHcia.

reserves represent the holdings by the

off at are
are generally accepted for the
government or official agencies of the means
payment
that
settlement of international claims.
of
BALANG OF PAYMENTS DISEQUILIBRIUM
The balance ofpayments of a country is said to be in equilibrium en the demand for
change is exactly equivalent to the supply of it. The balance of payments is regarded as A BOP disequilibrium
ma be caused by
toreign e x c h

4isequilibrium when it shows either a surplus or a deficit. There will be a deficit in the economic, political or
Aeing

nayments when the demand for foreign exchange exceeds its supply, and there will be social factors
halance

when the
when
the supp
supply of foreign exchange exceeds the demand.
Surplus
are Are a number of factors that may cause disequilibrium in the balance of payments.
hese various c a u s e s may be broadly categorised into: (1) economic factors, (2) olitical factors,
sociological factors.
nd (3)
Economic Factors

There are a number of economic factors which may cause disequilibrium in the balance of
payments.

Development Disequilibrium: Large-scale development expenditures usually increase the

purchasing power, aggregate demand and prices, resulting in substantially large imports.
because the above
Development disequilibrium is common in the case of developing countries,
factors and the large-scale import of capital goods needed for carrying out the various development
give rise to a deficit in their balance of payments.
programmes
fluctuations of business activity is one of
Cyclical Disequilibrium: Cyclical general
the prominent reasons for balance of payments disequilibrium. As Lawrence W. Towle points out,
stimulates it.
depression always brings about a drastic shrinkage in world trade, while prosperity
Acountry enjoying a boom all by itself will ordinarily experience a more rapid growth in its
countries. But production in
umports than in its exports, while the opposite will be true of other
lIe other countries will be activated as a result of the increased exports to the former.

for
Secular Sometimes, the balance of payments disequilibrium persists
Disequilibrium:
For instance, in a developed country,
periods due to certain secular trends in the economy. so is the
therefore, aggregate demand. At the
posable income is generally very high and, due to the wages. This naturally results
, t h e production costs are also very high demand higher and higher domestic prices may
a r prices, These two factors high aggregate
the imports being much higher than the exporis.
n
str also cause a balance of
u a l Disequilibrium: Structural changes in the economy mayof alternative sources of
ayments disequili
librium. Such structural changes include development
resources or changes in
Velopment of better substitutes, exhaustion of productive
ansport routes and
costs.
 Political Factors balance ofpayments iisequilibrium.
dis.
For instan
a capital outflo
di.and inadeq
produce large
could also
Certain political facto
experience

isequiroutes,libriumCOu
cause a
instability may Sometimes,

a country plagued with political These

factors may,
in the world trad ib
production. changes
of domestic i n v e s t m e n t and factors like w a r or
Further,
the balance ofip a y m e n t s .
also produce similar difficulties.

Social Factors For instance, chanoes

es in the
ofpayments.and
the balance
balance
social factors also
influence thereby affect the
Certain and exports
affect imports
Preterences and fashions, may

payments.

cORRECTION OF DISEaUILIBRIUM of payments but eve

in the balance
A country may not be bothered about a surplus
defiCit.
COuntr
reduce a balance
of payments
S t r i v e s to r e m o v e o r at least

available for correcting

the balance of pav
There a r e a number of measures
m e a s u r e s and deliberate mea

disequilibrium. They fall into two broad groups,

namely, automatic

Automatic Correction
Today sin e there is no country on gold standar
dar.
This worked well under the gold standard.
it is irrelevant to discuss the mechanism here.
The balance of payment disequilibrium may, however, be automatically corrected ung
the paper currency standard also.The theory of automatic correction is that if the marie
forces of demand and supply are allowed to have free play, in course of time, equilibrium
Under fixed will be automatically restored. For example, assume that there is a deficit in the balace
exchange rate of payments. When there is a deficit, the demand for foreign exchange exceeds its supply and this
system, BoP
disequilibrium may results in an increase in the exchange rate and a fall in the external value of the domestic currenc
be corrected by This makes the exports of the country cheaper and imports dearer than before. Consequently, the
adjustmemts in price,
interest rate, income increase in exports and fall in imports restore the balance of payments equilibrium.
and capital flows. However, because of the various problems associated with the policy of automatic correcton
deliberate measures are widely employed today.

Deliberate Measures
As the name indicates, deliberate measures refer to correction of disequilibrium by means
measures taken deliberately with this end in view.

The various deliberate measures may be broadly grouped

asures

b) trade measures and (c) miscellaneous.

into: (a) monetary mca
(a) Monetary Measures

Theimportant monetary measures are outlined below:

price level and
1. Monetary Contraction: The level of
aggregate domestic demand, domestic pric
the demand for imports and exports may be influenced
money

supply so that a balance of payments

by contraction or expansion sume a

disequilibrium may be corrected. For examp

alance of payments deficit to correct which a
situation of bala requie
contraction of money suppagreg
Contraction of money supply Is likely to reduce the
purchasing power and thereby, tn
age

demand. It is also likely to reduce domestic prices. The fall in the domestic
demand and domestic prices reduces the demand for ces.
imports. The fall in domestic pr
 Payments
m i e r n n t o a lT Trade
and 261
aal

rts. Thus, the fall in

imports and rise in exports would the
y ncrease e x p

help correct
iseyuniltbrium.
.dion: Devaluation means the reduction of the official rate at which the currency
evaluar

. Der another currency. A country with fundamental disequilibrium in the balance of

enchanged devalue its currency in order to stimulate its exports and discourage imports to
Vmenis may

sauilibrium. Devaluation makes export goods cheaper and imports dearer. For details,
rectthe disequilib,

on
Devaluation.
Der
chapter
e
r
3. noe Com
Exchangge Control: Exchange control is a popular method employed to influence the
ments positions of a country. Under exchange control, the government or central
ance O complete control over the foreign exchange reserves and earnings of the country.
Aankassunmes

fs of foreign exchange, like exporters, are required to surrender foreign exchange to

The r e c i p i e n t s

overnment/central
bank in exchange for domestic currency. By virtue of its control over the
of foreign e x c h a r ange, the government can control imports. For details, refer to the chapter on

oaign Exchange

b) Trade Measures

Current account
include export promotion measures and measures to reduce imports.
Trade measures balance may be
duties, improved by trade
Export Exports may be encouraged by reducing or abolishing export
Promotion: measures.
by giving monetary,
encouraging export production and export marketing
widing export subsidy,
and i n s t i t u t i o n a l incentives and
facilities.
iscal, physical
be controlled by imposing orenhancing import duties,
Import Control: Imports may
2 of
quotas, licensing and even prohibiting altogether the import
Estricting imports through import
certain inessential items.

DISEQUILIBRIUM FIGURE 5.3

METHODS OF CORRECTION OF BOP

Correction of BoP Disequilibrium

Deliberate Measures
Automatic Correction

Miscellaneous Measures
Monetary Measures
1. Foreign loans
1. Monetary contraction/expansion investment/remittances
2. Incentives for foreign
2. Devaluation/Revaluation
3. Tourism development
|3. Exchange control

Trade Measures

Import Control
Export Promotion
1. Import duties
Abolition/Reduction of export duties 2. Import quotas
2 Export subsidies 3. Import prohibition
3. Export incentives
 262
International Business Envi
(c) Miscellancous Measures EnvironmeN
Apart from the measures mentioned above, there are a number of other measures
help make th
the balance of payments position more favourable, like obtaining foreiat
couraging foreign investment in the home country, development of tourism to att ign
attract
tourists
and providing incentives to enhance inward remittances. forevng
FINANCING OF BOP DEFICIT
When a nation has a Balance of Payments deficit, i.e., when the total
external pav
obligations
to find out
exceed the total receipts, an external
payments problem arises. The nation has, theres ayment
means for
meeting the payments obligation. The common methods of
BoP deficit are the financino h
following:
Using Forex Reserves
A natios which does If the nation has
comfortable foreign exchange reserves, the deficit can be
aet heve forex
drawing down the reserves. For example, at the middle of 2003 India financed h
s e e s tot ha a forex
than S80 billion. If reserve of more
BoP deficit m by any chance India runs into a BoP deficit, the reserves can
to finance the be made use of
exte deficit. The problem, however, is that
that there. only when the BoP has a continuous
surpls
normally,
will be a comfortable forex reserves. If a
deficits the reserves would
dry up and it will have to resort to some other
country experiences persisten
the deficit. method(s) to finance

During the First Five Year

Plan, the BoP deficit did not
had a stock of forex pose much problem for India ast
which could relied
reserves
to finance the deficit. But the
soon changed and upon situation
by the Third Plan it became so serious
drastic step of a steep deval uation of the that the nation had to resort to te
currency in bid to
encourage exports and discours
imports. In most of the years until the mid-1990s, India
forex reserves the nation had was had a BoP
problem and in July 1991 u
sufficient to meet just 15
the generally accepted bare minimum days of import requirements, aga
requirement
therefore, had to borrow from the IMF and it of three months' import requirement. India
even had to
reserves with the Bank of England to
borrow.
pledge some of its monetar gold
External Assistance
Jfa nation does not have enough forex deficit, i
reserves to draw
may have to take recourse to external
assistance.
upon to finance the BOr

A very
important source
in 3,
of assistance
for countries
with BoP problem is the IMF.
Chapter one of the
purposes of the IMF is to AS
to tide over BoP
problems. provide financial assistance to
India has made use of IMF hei
A nation may also resort assistance on several occasio
other external owing
for financing the deficit.
In the 1950s sources, including commercial
comm borr o fI n d i a

was financed by concessional

through the 1970s, almost it
the entire
however, commercial
assistance and this
rowings and NRI deposits kept the debt service burden low. dehe1980
" external S o u r c e sa n d

ntially increased India's debt burden. became the dominant

this has substanti the consequen

s e in the FDI and the FIl The economic

liberalisation and ia and
the

nows have
exter debt service burden has also contributed to favourable BoP for
substantially come down.