EXTERNAL SECTOR

MODULE 1
BALANCE OF PAYMENT
External sector deals with export and import of goods and services, and
financial capital between nations. The countries export goods and services
over which it has advantage over other countries and import goods and
services in which it lacks advantage over others.
BALANCE OF PAYMENT
RECEIPTS PAYMENTS
Trade Account Export Import
CURRENT
ACCOUNT

1. Non-factor services
Invisibles
2. Investment Income
Account
3. Transfers
1. Foreign Investment
2. External Assistance
ACCOUNT
CAPITAL

3. External Commercia
Borrowings (ECBs)
4. NRI deposits
5. Other flows

Current Account Balance = Trade Balance + Invisibles Balance

Goods & Services Balance = Trade Balance + Non-Factor Services Balance
BoP Balance = Current Account Balance + Capital Account Balance

BALANCE OF PAYMENT
The balance of payment of a country is a systematic record of all its
economic transactions with the outside world in a given year. The term
‘all transaction’ means transaction of government as well as private. It is a
double entry book keeping. It means the incoming receipts are credited and
outgoing transactions are debited.
1. EXPORT
Export means the receipts against export of merchandise goods to other
countries. The export receipts of services are not included here.

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2. IMPORT
Import means the payment for import of merchandise goods from other
countries. The payments for import of services are not included here.
3. TRADE BALANCE
The balance of trade is difference between export receipts and import
payments.

Trade balance = Export – Import

4. INVISIBLES (NET)
The head of invisibles record the receipts and payments regarding services
exports and imports and other current account payments viz.,
(a) Non-factor services
(b) Income
(c) Private Transfers

(a) NON-FACTOR SERVICES

Non-factor services refer to all invisible receipts or payments not
attributable to conventional factor of production, i.e., labour (remittance
from overseas migrants). Thus Non-factor services mean the export and
import of services alone. The non-factor services includes Group of
Services viz., Travel, Transportation, Insurance and Miscellaneous
Services, which encompass communication services, construction
services, financial services, software services, news agency services,
royalties, management services and business services etc. The
software services comprise information technology (IT) and IT-enabled
services (ITeS).

(b) INCOME
Income includes transactions regarding income from investments in the
form of dividends, profit and interest from loans.

(c) PRIVATE TRANSFERS

Private transfers include grants, gifts, remittances, etc., which do not
have any quid pro quo. Among the private transfers, the remittances is the
major source.

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Remittance is directly earned by labour which is a factor of production and
incomes like dividend, profit and interest are earned by capital which is also
a factor of production. So the income from both these heads is called factor
income services.
5. GOODS AND SERVICES BALANCE
It is the sum of trade balance and non-factor services
Goods and services balance = Trade balance + Non-factor
services.

6. CURRENT ACCOUNT BALANCE

Current account balance is the sum of trade balance and net invisibles.
Current account balance = Trade balance + Net
invisibles.

If the current account balance is positive, it is said to be surplus which

means favourable current account balance. If the current account
balance is negative, it is said to be deficit which means unfavorable
current account balance.

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7. EXTERNAL ASSISTANCE (NET)
External assistance means the transaction of official (government)
bilateral and multilateral loans. The bilateral loans are loan transactions
between two countries. Multilateral loans are official loan transactions
between a country and multilateral bodies like World Bank, IMF and Asian
Development Bank etc.
8. COMMERCIAL BORROWINGS (NET)
Commercial borrowings mean loan transaction by commercial enterprises.
It is also called as External Commercial Borrowing (ECB).
9. NON-RESIDENT DEPOSITS
The deposit received from non-resident Indians come under this head.
10. FOREIGN INVESTMENTS
There are two types of foreign investments. One is foreign direct
investment and another is portfolio investment. Portfolio investment is
also called as rentier investment.
(a) FOREIGN DIRECT INVESTMENT (FDI)
Foreign Direct Investment refers to direct bulk investment in a domestic
company by a foreign individual or company. The foreign direct investors
have control over company’s management and day to day affairs of
company which is possible by enough voting rights in his hand due to bulk
investment.
(b) PORTFOLIO (OR) RENTIER INVESTMENT
Portfolio investment refers to investment minimally in various financial
instruments like shares, debentures of a company. The portfolio investor
cannot have any control over company management.
11. OTHER FLOWS
Other flows include, delayed export receipts, leads and lags in export
receipts (the difference between the customs data and the banking channel
data), funds held abroad, and other capital transactions not included
elsewhere such as flows arising from cross-border financial derivative
and commodity hedging transactions, and sale of intangible assets such
as patents, copyrights, trademarks etc., and errors and omissions.

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The difference between the customs data and the banking channel data
arises because banking channels data relies on foreign exchange release/
receipt returns which are actual cash outgo and cover all flow and customs
data are based on bills of entries (import document field with the customs),
which might remain somewhat incomplete for a number of reasons in the
short run.
12. CAPITAL ACCOUNT TOTAL
Capital Account total (net) = External Assistance (net) + Commercial
Borrowings (net) + Non-resident deposits (net) + Foreign investments (net)
+ Other flows (net).
If the capital account balance is positive, it is said to be surplus. Surplus
capital account balance means favorable capital account balance. If the
capital account balance is negative, its said to be deficit. Deficit capital
account balance means unfavorable capital account balance.

13. RESERVES
Reserve means foreign exchange reserve. The sum of current and capital
account balance is the balance of payment.
Balance of payment = current account balance + capital account balance

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The balance is added to foreign exchange reserve if the balance of
payment is in surplus. The balance is deducted if the balance of payment
is in deficit. It means payment is made out of old balance (foreign
exchange reserve.)

IMPORT COVER
Import cover of reserves is a traditional trade-based indicator of
reserve adequacy. It is defined in terms of the number of months of
import equivalent to reserves.
After declining from seven months of imports as of March-end 2013 to
6.6 months of imports as of September-end 2013, the import cover of the
country’s reserves steadily climbed in each of the half-year periods
since then. The import cover of India’s foreign exchange reserves has
increased to 12 months as on September-end 2016 from 10.9 months
as on March-end 2016.

PREVIOUS YEARS’ QUESTIONS (PRELIMS)

1. Which one of the following best describes the term ‘import cover’,
sometimes seen in the news? (2016)
(a) It is the ratio of value of imports to the Gross Domestic Product of a
country
(b) It is the total value of imports of a country in a year.
(c) It is the ratio between the value of exports and that of imports
between two countries.
(d) It is the number of months of imports that could be paid for by a
country’s international reserves.
2. With reference to Balance of payments, which of the following
constitutes / constitute the Current Account? (2014)
1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights
Select the correct answer using the code given below.
(a) 1 only (b) 2 and 3 (c) 1 and 3 (d) 1, 2 and 4

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3. Which of the following constitute Capital Account? (2013)
1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment
Select the correct answer using the codes given below:
(a) 1, 2 and 3 only (b) 1, 2 and 4 only
(c) 2, 3 and 4 only (d) 1, 3 and 4
4. The balance of payments of a country is a systematic records of (2013)
(a) all import and export transactions of a country during a given period
of time, normally a year
(b) goods exported from a country during a year
(c) economic transaction between the government of one country to
another
(d) capital movements from one country to another
5. In terms of economy, the visit by foreign nationals to witness the XIX
Common Wealth Games in India amounted to (2011)
(a) Export (b) Import (c) Production (d) Consumption
6. Assertion (A): ‘Balance of Payments’ represents a better picture of a
country’s economic transactions with the rest of the world than the
‘Balance of Trade’.
Reason (R): ‘Balance of Payments’ takes into account the exchange of
both visible and invisible items whereas ‘Balance of Trade’ does not.
(2006)

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