BALANCE OF

PAYMENTS

International Financial
Management
LEARNING OUTCOMES

 Analyze and evaluate the Balance of

Payments position of a country

Appraise with the principles and various

components of balance of payments
THE BALANCE OF PAYMENTS (BOP)
The Balance of Payments (BOP) is an accounting system that records the economic
transactions between the residents and government of a particular country and the
residents and governments of the rest of the world during a certain period of time,
usually a year.

Economic transactions include exports and imports of goods and services, capital
inflows and outflows, gifts and other transfer payments and changes in a country’s
international reserves.
THE BALANCE OF PAYMENTS (BOP) ACCOUNTING
Like other accounting statements, the BOP conforms to the principle of double entry
bookkeeping.
This means that every international transaction should produce debit and credit
entries of equal magnitude.
It is important to mention here that BOP is neither an income statement nor a balance
sheet.
It is a sources and uses of funds statement that reflects changes in assets, liabilities
and net worth during a specified period of time.
KEY TAKEAWAYS (BOP)
The balance of payments include both the current account and capital account.

The current account includes a nation's net trade in goods and services, its net
earnings on cross-border investments, and its net transfer payments.

The capital account consists of a nation's transactions in financial instruments and

central bank reserves.

The sum of all transactions recorded in the balance of payments should be zero;
however, exchange rate fluctuations and differences in accounting practices may
hinder this in practice.
HTTPS://ENERGY.ECONOMICTIMES.INDIATIMES.
COM/NEWS/RENEWABLE/INDIA-LOOKS-
FORWARD-TO-GREATER-PARTICIPATION-FROM-
JAPAN-IN-PLI-SCHEME-DPIIT-SECY/81477701
  India looks forward to greater participation from Japan in PLI scheme
HTTPS://ENERGY.ECONOMICTIMES.INDIATIMES.COM/
NEWS/RENEWABLE/INDIA-LOOKS-

FORWARD-TO-
NEWS ANALYSIS
 Secretary in the Department for Promotion of Industry and Internal Trade

GRECIPATION-FROM- (DPIIT) Guruprasad Mohapatra said the government has undertaken several
policy reforms, including PLI scheme, to boost manufacturing and exports.
JAPAN-IN-PLI-SCHEME-DPIIT-SECY/81477701
 India and Japan are collaborating in the form of India-Japan industrial
competitiveness partnership.

 As a part of this partnership, it is proposed that governments of India and

Japan will jointly work towards enhancing India's industrial competitiveness,
and the discussions have started, joint working groups have been formed and
we are making very steady progress.

 Japanese Ambassador to India Satoshi Suzuki said it is important for India to

have a more stable business environment to further strengthen bilateral
economic ties.
 Every credit in the account is balanced by a matching debit
and vice versa.

Credit transactions are those that earn foreign exchange

and are recorded in the balance of payments with a plus
(+) sign.

THE BALANCE Selling either real or financial assets or services to

nonresidents is a credit transaction.

OF PAYMENTS The BOP’s accounting principles regarding debits and credits

can be summarized as follows.
DEBITS AND
CREDITS 1.
a.
Credit Transactions (+)
Exports of goods or services
b. Unilateral transfers (gifts) received from foreigners
c. Capital inflows
2. Debit Transactions (-)
a. Import of goods and services
b. Unilateral transfers (or gifts) made to foreigners
c. Capital outflows
BALANCE OF PAYMENTS STATEMENT
The Current Account

The balance of merchandise trade refers to the balance between exports and
imports of tangible goods such as automobiles, computers, machinery and so on.
Services represent the second category of the current account. Services include
interest payments, shipping and insurance fees, tourism, dividends and military
expenditures.
Unilateral transfers are gifts and grants by both private parties and governments.
Private gifts and grants include personal gifts of all kinds and also relief organisation
shipments.
 The Capital Account

Direct investment occurs when the investor acquires equity such as

purchases of stocks, the acquisition of entire firms, or the
establishment of new subsidiaries.
Portfolio investments represent sales and purchases of foreign
BALANCE OF financial assets such as stocks and bonds that do not involve a
transfer of management control.

PAYMENTS Capital flows represent the third category of capital account and
represent claims with a maturity of less than one year.

STATEMENT
The Official Reserve Account

Official reserves are government owned assets. The official

reserve account represents only purchases and sales by the central
bank of the country
THE BALANCE OF PAYMENTS (BOP)
DEBIT AND CREDIT ENTRIES

The Balance of Payment of a country is classified into Debit Credit

(Outflow) (Inflow)
three well-defined categories – the Current Account, the
Capital Account and the Official Reserves Account. Goods Buy Sell

Services Buy Sell

The Current account measures the net balance resulting
Investment Pay Receive
from merchandise trade, service trade, investment Income
income and unilateral transfers and reflects the country’s
current competitiveness in international markets. The rules Unilateral Give Receive
transfers
for recording a transaction as debit and credit in the
current account are:
THE BALANCE OF PAYMENTS (BOP)
The Capital account in the BOP records the capital transactions – purchases and sales
of assets between residents of one country and those of other countries.

Short-term portfolio investments are financial instruments with maturities of one year
or less e.g.,
 Long-term portfolio investments are stocks, bonds and other financial instruments issued by
private and public organisations that have maturities greater than one year and are held for
purposes other than control. The rules for doubly entry recording here are as follow:
THE BALANCE OF PAYMENTS (BOP)
Debit (Outflow)
Portfolio Receiving a payment from a foreigner
(short-term) Buying a short-term asset
Buying back a short-term domestic asset
from its foreign owner
Portfolio Buying a long-term foreign asset (not for
(long-term) purpose of control)
Buying back a long-term domestic asset
from its foreign owner (not for purpose of
control)
Foreign direct investment Buying a foreign asset for purpose of
control
Buying back from its foreign owner a
domestic asset previously acquired for
purposes of control
Credit (Inflow)
Making a payment to a foreigner
Selling a domestic short-term asset to a
foreigner
Selling a short-term foreign asset
acquired previously
Selling a domestic long-term asset to a
foreigner (not for purpose of control)
Selling a long-term foreign asset
acquired previously (not for purposes of
control)
Selling a long-term foreign asset
acquired previously (not for purposes of
control)
Selling a foreign asset previously
acquired for purposes of control
https://economictimes.indiatimes.com/news/economy/indicators/double-whammy-indias-industry-output-
contracts-to-1-6-jan-retail-inflation-rises-to-5-03-in-feb/articleshow/81467922.cms?from=mdr

IIP/CPI SHOCK AND

BALANCE OF PAYMENTS
QUIZ
Which of the following should not be included in the balance of payments account?

a) imports of automobile parts

b) Interest payment on loan to the IMF
c) dividend payment to home-country investors from a foreign subsidiary
d) bonus shares to equity shareholders
QUIZ
Aid provided by a country to another country will come in which of the following
accounts of the second country?

a) errors and omissions

b) official reserves account
c) capital account
d) current account
QUIZ
Capital flows that take place to help bring equilibrium in the balance of payments
are called —

a) FDI
b) official reserves
c) autonomous flows
d) accommodating flows
QUIZ
External commercial borrowing comes under the category of —

a) current account
b) Exports
c) official reserves account
d) capital account
MEXICO’S BALANCE OF PAYMENTS PROBLEM
Mexico experienced large-scale trade deficits, depletion of foreign reserve holdings
and a major currency devaluation in December 1994, followed by the decision to
freely float the peso. These events also brought about a severe recession and higher
unemployment in Mexico. Since the devaluation, however, the trade balance has
improved.
investigate the causes of Mexico’s balance of payments difficulties prior to the peso
devaluation
What policy actions might have prevented or mitigated the balance of payments
problem and the subsequent collapse of the peso; and
Derive lessons from the Mexican experience that may be useful for other developing
countries
BRAINSTORM
Classify whether the following transactions will be recorded in current account or capital
account.

Purchase of shares of Tata by Microsoft.

Imports of computer spare parts from America.
Borrowings from World Bank.
Repayment of loan by Indian Government taken from Japan.
Gifts received from a relative in Australia.
Purchase of Land in China.
Import of machinery.
ANSWER
Current Account
Imports of computer spare parts from America.
Gifts received from a relative in Australia.
Import of machinery.

Capital Account
Purchase of shares of Tata by Microsoft.
Borrowings from World Bank.
Repayment of loan by Indian Government taken from Japan.
Purchase of Land in China.
NEWS CASE ANALYSIS
The Reserve Bank of India (RBI), cut Repo Rate to 4.4%, the lowest in at least 15
years. Also, it reduced the Cash Reserve Ratio (CRR) maintained by the banks for the
first time in over seven years. CRR for all banks was cut by 100 basis points to
release ₹ 1.37 lakh crores across the banking system. RBI governor Dr. Shaktikanta
Das predicted a big global recession and said India will not be immune. It all
depends how India responds to the situation. Aggregate demand may weaken and
ease core inflation.

The Economic Times; March 27th, 2020

QUESTIONS
1 Cut in Repo rate by RBI is likely to……(increase/decrease) the demand for goods and services in the economy.

2 Decrease in Cash Reserve Ratio will lead to…....

a. fall in aggregate demand

b. rise in aggregate demand

c. no change in aggregate demand

d. fall in general price level

3 The difference by which actual Aggregate Demand exceeds the Aggregate Demand, required to establish full

employment equilibrium is known as……….………(inflationary gap/deflationary gap)

QUESTION
4 The impact of „Excess Demand‟ under Keynesian theory of income and employment, in an
economy are: (choose the correct alternative)

a. decrease in income, output, employment and general price level

b. decrease in nominal income, but no change in real output

c. increase in income, output, employment and general price level

d. no change in output/employment but increase in general price level.