Subject : International Finance

Class : Finance Group 2

Date : 28/11/2022

Submitted By : Group 4

Abhiraj Mendhe (PF2123-B120)

Shubh Dedhia (PF2123-B109)

Devam Parikh (PF2123-B093)

Sumeet Khaitan (PF2123-B237)

Sanket Patil (PF2123-B069)

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 TABLE OF CONTENTS

TOPIC Pg No
Introduction 3-5
Literature Review 6-7
BOP & Economic Parameters 8-13
Conclusion 14-15
References 16

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 INTRODUCTION

What is Balance of Payments?

The balance of payments (BOP), also known as the balance of international payments, is a summary of all
transactions that occurred between entities in one country and the rest of the world over a certain time period,
such as a quarter or a year. It outlines all interactions between individuals, businesses, and governments within a
country and individuals, businesses, and governments outside the country.
BOP transactions include imports and exports of goods, services, and capital, as well as transfer payments such
as foreign aid and remittances. The international accounts of a country are comprised of its balance of payments
and net international investment position.
The balance of payments divides transactions into two accounts: the current account and the capital account.
Sometimes the capital account is called the financial account, with a separate, usually very small, capital
account listed separately. The current account includes transactions in goods, services, investment income, and
current transfers.
The capital account, generally defined, encompasses financial instrument transactions as well as central bank
reserves. Only financial instrument transactions are included under a narrow definition. The current account is
included in national production calculations, while the capital account is not.
When a country exports an item (a current account transaction), it effectively imports foreign capital (a capital
account transaction). If a country cannot pay its imports through capital exports, it must do so by depleting its
reserves. This is referred to as a balance of payments deficit when the capital account is defined narrowly to
exclude central bank reserves. In actuality, the widely defined balance of payments must, by definition, equal
zero.

History of Balance of Payments :

Before the 19th century, international transactions were priced in gold, giving countries with trade deficits little
choice. Because growth was slow, creating a trade surplus was the major way to boost a country's financial
situation. However, because national economies were not highly connected, large trade deficits seldom caused
crises. The industrial revolution accelerated worldwide economic integration, and balance-of-payment crises
became increasingly common.
Countries abandoned the gold standard and engaged in competitive devaluation of their currencies during the
Great Depression, but the Bretton Woods system, which prevailed from the end of World War II until the
1970s, introduced a gold-convertible dollar with fixed exchange rates to other currencies.
However, when the United States' money supply expanded and its trade imbalance widened, the government
was unable to properly redeem foreign central banks' dollar holdings for gold, and the system was abandoned.
Since the Nixon shock, or the termination of the dollar's convertibility to gold, currencies have floated freely,
which means that a country with a trade deficit may artificially weaken its currency—for example, by hoarding
foreign reserves—making its products more appealing and increasing exports. Balance-of-payments crises can
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emerge as a result of greater capital mobility across borders, resulting in dramatic currency devaluations such as
those experienced by Southeast Asian nations in 1998.
Several nations engaged in competitive depreciation of their currencies during the Great Recession in order to
promote exports. All of the world's major central banks implemented radically expansionary monetary policy in
response to the financial crisis at the time. As a result, other countries' currencies, particularly those in
developing markets, appreciated against the US dollar and other major currencies.
Many of these countries responded by easing monetary policy even further in order to bolster their exports,
particularly those whose exports were under pressure due to stagnating global demand during the Great
Recession.

Formula for Balance of Payments:

The formula for calculating the balance of payments is current account + capital account + financial account +
balancing amount = 0

Why is the Balance of Payments Important for country?

The BOP of a country is critical for the following reasons:
 A country's BOP indicates its financial and economic situation.
 A BOP statement can be used to evaluate if the value of a country's currency is increasing or decreasing.
 The BOP statement assists the government in making budgetary and trade policy decisions.
 It gives critical information for analyzing and comprehending economic transactions with foreign
countries.
 By thoroughly reviewing its BOP statement and its components, one may spot patterns that may be
advantageous or destructive to the county's economy and, as a result, take suitable adjustments.

Elements of Balance of Payment:

There are three components of the balance of payment viz current account, capital account, and financial
account. The total of the current account must balance with the total of capital and financial accounts in ideal
situations.

Current Account:
The current account monitors the inflow and outflow of goods and services between countries. This account
covers all the receipts and payments made with respect to raw materials and manufactured goods.
It also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from
patents and copyrights. When all the goods and services are combined, they make up a country’s Balance Of
Trade (BOT).
There are various categories of trade and transfers which happen across countries. It could be visible or invisible
trading, unilateral transfers or other payments/receipts. Trading in goods between countries is referred to as
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visible items, and import/export of services (banking, information technology etc.) are referred to as invisible
items.
Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This can also be
personal transfers like – money sent by relatives to their family located in another country.

Capital Account:
All capital transactions between the countries are monitored through the capital account. Capital transactions
include purchasing and selling assets (non-financial) like land and properties.
The capital account also includes the flow of taxes, purchase and sale of fixed assets etc., by migrants moving
out/into a different country. The deficit or surplus in the current account is managed through the finance from
the capital account and vice versa. There are three major elements of a capital account:
Loans and borrowings – It include all types of loans from the private and public sectors located in foreign
countries.
Investments – These are funds invested in corporate stocks by non-residents.
Foreign exchange reserves – Foreign exchange reserves held by the country’s central bank to monitor and
control the exchange rate do impact the capital account.

Financial Account:
The flow of funds from and to foreign countries through various investments in real estate, business ventures,
foreign direct investments etc., is monitored through the financial account. This account measures the changes
in the foreign ownership of domestic assets and domestic ownership of foreign assets. Analyzing these changes
can be understood if the country is selling or acquiring more assets (like gold, stocks, equity, etc.).

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 LITERATURE REVIEW

Within the international economic literature, there have been three principal approaches to analyzing the
balance of payments problems. These are the elasticity approach, absorption approach, and monetary approach.
The first two approaches analyze devaluation and its effects on the balance of payments. However, devaluation
can temporarily improve the balance of payments but cannot, on its own sustain, the improvement unless
complemented by an appropriate domestic monetary policy.
There are many theoretical approaches to analyze the balance of payments. In order to discern such analysis, it
would be useful to distinguish such theoretical approaches on the two components of BOP, namely the current
and capital account. In the current account, the first common theoretical approach to mention is based on the
competitive nature of the economy thus termed the competitiveness approach, based on the elasticity or
sensitivity of trade. This approach is viewed from an explicit premise of an economy in equilibrium in terms of
trade.
In order to find the determinants of balance of payments, a host of studies have already been done. Some of the
studies are related to Pakistan while others to rest of the world. Various economists have worked on the
determinants of balance of payments and they have used different approaches like absorption approach,
elasticity approach and monetary approach in order to observe the effect of the determinants of balance of
payments in case of Pakistan.
(Reference 1, Chaudhary and Shabbir 2005); found that price level and real income were positively related
whereas interest rate, inflation rate, money multiplier and domestic credit were negatively related to foreign
exchange reserves and significant. They found that fiscal deficit financing through domestic credit creation was
harmful and would cause the reduction in foreign reserves. They concluded that monetary approach to the
balance of payments was not a good approach.
(Reference 2, Khan 2008); found that income and real exchange rate were positively whereas interest rate and
domestic credit were negatively related to foreign reserves and significant in short run
Reference [3] Investigated the balance of payment concern of a country’s constricted on the most crucial of
double-entry book-keeping. Such payment is entered on the debit and credit score ranking aspect of the balance
part, but balance of payments accounting differs from business accounting in one respect. In business
accounting debits are display on the left surface and credit score ranking on the right aspect of the balance
piece. But in balance cope accounting to the practice is to demonstrate credits on the left aspect and debits on
the right aspect of the balance piece. When a transaction is received from overseas it is a credit score
transaction. The major items display on the money ranking aspect are exporters of products or services,
unrequited (or transfer receipt in the form of gift etc. from individuals from other countries borrowing from
abroad, investment strategies by individuals from other countries in the country, and official sale of source
resources including gold to worldwide countries and worldwide agencies). The major item on the charge aspect
include imports of products or services, transfer transaction to individuals from other countries lending to
worldwide countries, investment strategies by resident to foreign countries and global institutions. These debit
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and credit score ranking items are shown vertically in the balance of transaction concern of a country according
to the most crucial of charge access bookkeeping. Horizontally they are divided into three categories: the
current concern, the capital concern and the official settlement concern or the official source resources account.
Reference [4] Empirically investigates result is the BOP shortfall or excess. On account of floating exchange
rate direction, a modification occurs through sequence in exchange rate and not through the accumulate stream
or BOP. At long last, under the supervision of managed floating, slithering peg or creeping band, modifying
occurs both through the foreign reserve (BOP) and exchange rate changes. Under this circumstance, the powers
mediate time to time in the foreign exchange souk to control the discrepancy in the exchange rates and to keep
the rate in the steadiness level. Additionally they have to prefer the proportionate measure of exchange rate
burden, instigate through disequilibrium in the money market, ought to be assuaged through the exchange rate
expansion and through the reserve streams. Thus, both the variables will change and help the restoration of
economic equilibrium.

Objective:
To study the Impact of Balance of Payment on Determinants of Economic of Country (India, Bangladesh,
Pakistan, Nepal & Sri Lanka)

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 BALANCE OF PAYMENT OF 5 COUNTRIES FOR 5 YEARS COMPARING WITH
INFLATION AND UNEMPLOYMENT RATE

UNEMPLOYMENT RATE
The unemployment rate of a country represents the share of people without a job in the country’s labor force,
i.e. unemployed persons among those who are able and/or willing to work. Among other factors, it takes
population growth into account, and thus increases in the labor force, as well as the age of the population. A
high unemployment rate usually indicates economic troubles, with a popular example being Greece, where the
unemployment rate skyrocketed from 7.76 percent in 2008 to 27.5 percent as a result of the Great Recession.

Year India
2018 5.36 %
2019 5.33 %
2020 5.27 %

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 2021 8%
2022 6%

India possesses one of the fastest-growing economies in the world and as a result, India is recognized as one of
the G-20 major economies as well as a member of the BRIC countries, an association that is made up of rapidly
growing economies. As well as India, three other countries, namely Brazil, Russia and China, are BRIC
members. India’s manufacturing industry plays a large part in the development of its economy; however, its
services industry is the most significant economical factor. The majority of the population of India works in this
sector. India’s notable economic boost can be attributed to significant gains over the past decade in regards to
the efficiency of the production of goods as well as maintaining relatively low debt, particularly when compared
to the total amount earned from goods and services produced throughout the years. Since India is hub of
manufacturing, most of the units are importing machines from foreign countries it is bound that there will be
unemployment in the country. Over the years the unemployment percent in India is moving around 5.50%.
2020, saw highest unemployment rate at 8% which was due to covid pandemic and huge layoffs by corporates.
Our Balance of Payment is in deficit where importing heavy machinery will lead to outflow of funds and can in
turn lead to rise in unemployment. Hence India as a country needs to focus on making in house tools and
machinery which will lead to development of country and lowering the outflow of the funds.
When considering individual development as a country, India progressed significantly over the years. However,
in comparison to the other emerging countries in the BRIC group, India’s progress was rather minimal. While
China experienced the most apparent growth, India’s efficiency and productivity remained somewhat stagnant
over the course of 3 or 4 years. India also reported a rather large trade deficit over the past decade, implying that
its total imports exceeded its total amount of exports, essentially forcing the country to borrow money in order
to finance the nation. Most economists consider trade deficits a negative factor, especially in the long run and
for developing or emerging countries.

Year Pakistan
2018 3.95 %
2019 4.08 %
2020 3.54 %
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 2021 4.3 %
2022 4.8 %

Pakistan which is the neighboring country to India having around 21 crore of population where about 80 Lakhs
or 4.3% of people are unemployed. While Pakistan’s unemployment slumped below the one percent mark in
2010, it is now on the rise again and currently standing at just over four percent. Traditionally, most Pakistanis
work in agriculture however, the lion’s share of the country’s GDP is generated by services, like tourism,
banking, and IT. While agriculture is still important for Pakistan’s economy, the services sector is gaining
ground in the country, and more and more people are moving to urban areas from the countryside to find jobs in
the cities. Balance of Payment for Pakistan is in deficit while rising unemployment might impact the Balance of
Payment .

Year Sri Lanka

2018 4.05 %
2019 4.32 %
2020 4.35 %
2021 5.88 %
2022 6.30 %

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Unemployment Rate in Sri Lanka increased to 4.60 percent in the second quarter of 2022 from 4.30 percent in
the first quarter of 2022. The employment rate went down to 95.4 percent from 95.7 percent and the labor force
participation rate also went down to 50.1 percent from 51.2 percent. Sri Lankan economy is in deep trouble due
to the over burdening of Debt from major countries specially China . It was a tourist destination and was
exporting good number of commodities, they are currently in deficit and looking at the current condition it
seems that this is going to stay for a long time due to political issues. Because of all this the creditibility of Sri
Lanka as a nation has dropped down significantly and this will lead to lesser job creation and widen their
Balance of Payments. There will be more government spending on the capital goods , creating job opportunities
but this process will take time to move on .

Year Bangladesh
2018 4.37 %
2019 4.41 %
2020 4.5 %
2021 5.41 %
2022 5.23 %

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In 2021, the unemployment rate in Bangladesh was at approximately 5.23 percent. After a decrease from 2010
through 2011, Bangladesh’s unemployment has been steady at around 4.3 percent. Among all the neighboring
nations surrounding India , Bangladesh has one of the lowest unemployment rates and it has been quite steady
at 4.5% over 5 years. Bangladesh has emerged as one of the best nations for manufacturing, textiles and jute
production. There is cheap labour in Bangladesh hence the percentage of unemployment is less as compared to
other neighboring countries. Hence comparing the Balance of Payment and unemployment of Bangladesh it has
been in a stable condition. Though the BOP is in deficit but unemployment is significantly less majorly due to
the high labour workforce and production .

Year Nepal
2018 3.32 %
2019 3.19 %
2020 3%
2021 4.72 %
2022 5%

The unemployment rate in Nepal increased by 0.3 percentage points in 2021 in comparison to the previous year.
With 5.05 percent, the unemployment rate thereby reached its highest value in the observed period. Nepal's
Balance of Payment is in slight deficit because the country is in maintaining good import export ratio . Covid
pandemic has affected the unemployment percent and gave a sudden rise upto 5% . But previously Nepal was in
a good state when it comes to unemployment rate . Balance of Payment and unemployment here goes hand in
hand as the BOP deficit reduces unemployment also reduces. Most of the revenue generated by Nepal comes
from agriculture and service sector and these sectors works well when the economy is in progressive state.
Since the population of Nepal is lowest amongst all the neighboring countries the 5% rise is very significant .

Inflation
In South-East Asian countries, Inflation has always been a significant problem, one of the reasons being
negative Balance of Payment.
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As these countries import a lot of goods from Chinese and US markets.
Main products imported are generally technology and oil imports which amounts to a significant number while
these countries usually export more of agricultural goods such as grains, tea, Coffee etc.
India: India has been trying to fight inflation for a very long time and it has been successful to some extent.
India has been able to control its inflation within 6% since 2014. But since the beginning of covid, inflation has
shot up and reached a high of 8%. Also, other global factors played an important role such as Supply Chain
Crisis (2021), Russia-Ukraine War (2022) etc. Thus, these things resulted in Economic Slowdown in many
countries while India somehow managed it. Inflation in India in last five years has been between 2% to 8% with
the recent highs of 7.80%.
Srilanka: SriLankan has been in serious financial troubles since covid’19 pandemic. SriLankan economy is
mainly based on tourism sector and somewhat agriculture being its main contributors, but due to lockdowns
around the world tourism sector has been one of the worst hit sectors which caused serious troubles for
Srilanka. Thus, reducing their inflows of foreign currency and more rapidly declining of their foreign exchange.
Inflation in Srilanka was around 5%-6% until the pandemic hit the country. Its effect started seeing mainly after
the beginning of Russia-Ukraine war which shot up the oil prices and thus country was not able to matchup and
eventually defaulted on their payments. Inflation shot up to 68% within this current year.
Pakistan: Pakistan has been in political and financial turmoil since a long time. But situation started worsening
after the Russia-Ukraine war broke out. Since then, the country’s inflation shot up to more than 25% within the
span of 10-11 months. Since covid-19, Inflation in Pakistan used to stay between 5% to 15% but after country’s
declining foreign reserve, Pakistan is almost on the verge of defaulting as it is not able to cope up with rising
crude prices resulting in food inflation at its peak. Thus, GDP growth has also turned negative for the country
with rising inflation.
Bangladesh: Inflation in Bangladesh is mainly under control. It used to be within 7% even during covid-19
period. But due to war, rising crude has been a problem and thus inflation started rising and it currently peaked
out at 9.5% in 2022. Bangladesh is comparatively at better place with low chance of defaulting but quite high
food inflation.
Nepal: Inflation in Nepal has been below 8% for last five years. But now due to rising crude and food prices in
global markets, inflation has started rising. From 6% in the beginning of 2022 to 8.64% within 10 months.
Inflation is being rising quite rapidly in the country. Nepal’s negative Balance of Payment is also increasing
which is going to impact its economy bigtime in near future.

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 CONCLUSION

India
The Indian economy is much more open and globalized now than ever before. Under trade facilitation, India has
improved its ranking from 143 in 2016 to 68 in 2019 under the indicator, “Trading across Borders”
India has gained further stability in the first half of 2019-20, with an improvement in Balance of Payments
position, anchored by capital flows through FDI, FPI and ECBs
However, there is a need to bring the CAD to sustainable levels in the short run and over the medium-term to
accelerate efforts towards structural reforms that help boosting our competitiveness, raise growth potential and
bring in more stable flows into the economy.
The unemployment rate is expected to decrease due to globalization. The government is tightening the monetary
policy in order to control inflation.
Decreased unemployment will boost the economic growth but at the same time inflation needs to be controlled.

Pakistan
Attention needs to focus on supply-side improvements that will raise the growth of exports. In other words,
Pakistan needs to move out of its traditional export areas and shift the structure of its trade toward the export of
manufactured goods with higher sophistication. It is unlikely that trade liberalization and the free market will
result in the optimal strategy for Pakistan. The country requires a carefully thought industrial policy that
emphasizes the new niches (exports) in which Pakistan can succeed.
Inflation in Pakistan is expected to reach 20 percent in FY 23, the International Monetary Fund stated in its
latest report. The higher inflation rate would directly affect the unemployment rates in Pakistan as they will also
increase. This will lead to decrease in economic growth.

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Bangladesh
Bangladesh should relax restrictions on imports more slowly than barriers to export. Export growth has
increased less than import growth, leading to an increase in the trade deficit.
Foreign direct investment (FDI) may increase if there is political stability and continuation of policies. If the
IMF, World Bank and Asian Development Bank release their loans for Bangladesh as promised, then our
balance of payment may show some improvement.
Friends of Bangladesh have promised significant monetary support, which will certainly have a positive effect.
Imports are expected to decrease. If this happens, it will have a positive effect on balance of payment, since this
is relying on foreign elements and support. If this is accomplished, then the balance of payment deficit will
decrease.
Policymakers in Bangladesh are facing extraordinary challenges to tame inflation. There are two reasons for the
same. First: the drivers of ongoing inflation- the pandemic, the war, supply chain disruption, sanctions,
geopolitical factors, etc.- are to large extent beyond the control of the country. Second: There are adverse
developments in key macro variables, notably large “twin deficits” in the past few months. The external sector
of the country is also facing significant challenges owing to big gaps in export earnings and import payments
and the slowdown in inward remittances.
The unemployment rate is around 5%

Nepal
On account of the lack of employment opportunities in Nepal thousands of Nepali workers have going abroad
for employment and they sending remittance home in foreign currencies which is taken for granted as
supportive to Nepa’s BOP on the hand and the remittance has improved the socio-economic status of the
workers families on the other. Most of the Nepali workers are unskilled and professionally untrained because of
which they do not reasonable wages on the one side and they have to do highly risky jobs abroad on the other
side.
Foreign employment, in fact, is not a long-run solution to the unemployment problem. It is, therefore, necessary
to create an immense opportunities of employment within the country.
Price rises in September 2022 more than doubled to 8.64 percent from 3.49 percent in the same month last year,
according to Nepal Rastra Bank.

Sri Lanka
The Sri Lankan economy has been facing a crisis owing to a serious Balance of Payments (BoP) problem.
Its foreign exchange reserves are depleting rapidly and it is becoming increasingly difficult for the country to
import essential consumption goods
The Easter bomb blasts of April 2019 in churches in Colombo resulting in 253 casualties,
consequently, dropped the number of tourists sharply leading to a decline in foreign exchange reserves.
The Covid-19 pandemic in 2020 made the bad situation worse

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 In 2021, all fertiliser imports were completely banned and it was declared that Sri Lanka would become a
100% organic farming nation overnight.
This overnight shift to organic fertilisers heavily impacted food production.
Consequently, the Sri Lankan President declared an economic emergency to contain rising food prices, a
depreciating currency, and rapidly depleting forex reserves.
Lanka is planning to increase direct taxes to reduce the deficit in its upcoming budget for 2023 and put the
economy on a more stable footing.

REFERENCES

1) Choudhary, A.M., Shabbir, G (2005). Macroeconomic Impact of Monetary Variables on Pakistan’s Foreign
Sector. The Lahore Journal of Economics Vol. 9, NO. 1, 63-84.
2) Khan, M. Arshad (2008). Long- Run and Short-Run Dynamics of Foreign Reserves and Domestic Credit in
Pakistan. International Journal of Applied Economics and Quantitative Studies, Vol. 5, No. 1, 61-84.
[3] Anyanwu (1993) Monetary Economics theory, Policy and Institutions. 247-274.
[4] Humphrey, Keleher (1982) The Monetary Approach to the Balance of Payment, Exchange Rates and World
Inflation.

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