Balance of Payments The balance of payments of a country is a systematic record of all economic transactions between the residents of the

reporting country and the residents of foreign countries during a given period of time. It is an important index, which reflects the true economic position of a country, whether the country is a creditor country or a debtor country, and whether its currency is rising or falling in its external value. There are various types of monetary transactions that take place between two countries: The export and import of a goods and services The international lending and borrowing Servicing of foreign debts and their final repayments. Components of Balance of Payments Balance of Payments is generally grouped under the following heads i) Current Account ii) Capital Account iii) Unilateral Payments Account iv) Official Settlement Account. Current 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: i) Merchandise exports and imports, and ii) Invisible exports and imports. Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. On the other hand, merchandise imports , i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Merchandise imports and exports form the most important international transaction of most of the countries .Invisible exports, i.e., sales of services, are credit entries and invisible imports, i.e. purchases of services, are debit entries. Important invisible exports include the sale abroad of such services as transport, insurance, etc., foreign tourist expenditure abroad and income paid on loans and investments (by foreigners)in the home country form the important invisible entries on the debit side. Capital Account The Capital Account consists of short- terms and long-term capital transactions A capital outflow represents a debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a debit in the US balance of payments and a credit in the balance of payments of India. The payment of interest on loans and dividend payments are recorded in the Current Account, since they are really payment s for the services of capital. As has already been mentioned above, the interest paid on loans given by foreigners of dividend on foreign investments in the home country are debits for the home country, while, on the other hand, the interest received on loans given abroad and dividends on investments abroad are credits. Unilateral Transfers Account Unilateral transfers is one part of the current account of the balance of payments. It tracks the "one-way" transfer of funds from one country to another that are made without any counter flow or exchange or goods and services. These payments are merely gifts from one country to another. The gift might come

Official Settlements Accounts Official reserves represent the holdings by the government or official agencies of the means of payment that are generally accepted for the settlement of international claims Balance of trade: The balance of trade (or net exports. bilateral and unilateral taxes or restrictions on trade. a negative balance is referred to as a trade deficit or. Equally. informally.       The cost and availability of raw materials. Unilateral payments received from abroad are credits and those made abroad are debits. which includes other transactions such as income from the international investment position as well as international aid.from a person. labor.disaster relief. Non-tariff barriers such as environmental. or (frequently) government. intermediate goods and other inputs. The balance of trade is sometimes divided into a goods and a services balance. BOT include as current item in balance of payment and described as: . health or safety standards. incentives. Factors that can affect the balance of trade include:  The cost of production (land.. sometimes symbolized as NX) is the difference between the monetary value of exports and imports of output in an economy over a certain period. etc. business. If the current account is in surplus. A positive balance is known as a trade surplus if it consists of exporting more than is imported. These terms are different but related to each other as Balance of trade is a component of Balance of Payment. It is the relationship between a nation's imports and export. The availability of adequate foreign exchange with which to pay for imports. etc. a deficit decreases the net international asset position. Multilateral. and Prices of goods manufactured at home (influenced by the responsiveness of supply) Difference between BOT and BOP Balance of trade and balance of payment are two commonly used terms in international economics. taxes. Exchange rate movements. the country's net international asset position increases correspondingly.) in the exporting economy vis-àvis those in the importing economy. These unilateral transfers include private remittances. capital. a trade gap. The balance of trade forms part of the current account. government grants . Foreign aid payments from one government to another are an important part of unilateral transfers.

form its reserves or even by borrowing form other countries. it will pay by incomes earned from investments overseas. the gross private investment. The balance of these receipts and payments must be equal. services and capital employment. services (intangible goods) and foreign investments of the residents of the country in their transactions with residents of other countries. together with its net income received from other countries (notably interest and dividends). the government consumption expenditures. It is a broader term includes trade of physical goods. its gross domestic product). It’s called the current account as it covers transactions in the "here and now" – those that do not give rise to future claims” Balance of trade can be in deficit or surplus as per the tangible business transactions of one country to another. factor income (earnings on foreign investments – payments made to foreign investors) and cash transfers. BOP of a country must be equal to zero even if the payment and receipts are not equal. Adding all receipts and subtracting payment the outcome deficit or surplus figure is called Balance of Payment. Gross national income Gross national income (GNI) comprises the value of all products and services generated within a country in one year (i. Any apparent inequality simply leaves one country acquiring assets of the others. and if country has more exports than its imports the balance of trade will be considered positive or surplus. The Equation of Balance of Payment by IMF is as under: BOP = Current Account—Financial Account – Capital Account +Balancing Item The BOP account records the payments and receipt in terms of current account (Tangible goods).e. after deducting two components: the gross imports of goods and services. The GNI is similar to the gross national product (GNP). .[1] The GNI consists of: the personal consumption expenditures. The deficit or surplus balance of trade cannot represent or guarantee the economic growth of a country. When the economy is in expansion phase there may be positive economic indicators with deficit or negative balance of trade.. the net income from assets abroad (net income receipts). except that in measuring the GNP one does not deduct the indirect business taxes. If imports of a country increase to its exports the balance of payment will be negative or deficit. For example if the imports are excessive to exports and country has to pay the balance amount. International trade’s imbalances can be problematic of not as per economic condition and trade cycle of the country. and the gross exports of goods and services. Balance of trade has a current account affect in Balance of Payment. and the indirect business taxes. Normally these statistics represent one year economic activities of a country.“It is the sum of the balance of trade (net earnings on exports – payments for imports).

But this ideal equilibrium rate is difficult to achieve because demand and supply are affected by several factors. Higher demand for foreign currency means high value of foreign currency and low value of the domestic currency. . 2. India will require US dollars to pay for those imports. The equilibrium rate of exchange is attained at the point where demand for foreign currency is exactly equal to it’s supply. Whereas. the demand for foreign currency in this country will be high. India will buy dollars. investments and other international transactions. Sometimes the exchange rate may change over a period of some months or years and sometimes fluctuations occur within a span of some hours and days. For example. International trade. the rate of exchange is determined by the demand for and supply of foreign currency. The demand and supply of foreign currency arise from international trade. in a free market. Outflow of capital would mean a depreciation of domestic currency. The value or strength or weakness of a countries currency in terms of other currencies depends on its trade with those countries.International investments in the form of Foreign direct investment (FDI) and Foreign institutional investments (FII) have become the most important factors affecting the exchange rate in today’s open world economy. There are several factors which affect and decide the exchange rate of currencies. which cause frequent fluctuations and adjustments in the exchange rate. that demand and supply keep adjusting till they become equal and the equilibrium rate is achieved. This is demand for dollars and supply of Rupees in exchange.If India imports some goods from the US. is the price of one currency in terms of another currency. market. Capital movements. it is the rate at which two currencies can be exchanged. Factors affecting forex: Exchange rate. Theoretically. Gross national expenditure differs from Gross Domestic Product in that expenditures on exports are not included. in the foreign exchange. The current account balance (deficit or surplus) thus reflects the strength and weakness of the domestic currency. This is a typical case for underdeveloped countries which rely on imports for development needs. fixing it at a rate which may not be the equilibrium rate. if India exports some goods or services to the US. This is basic economics. Countries which attract large capital inflows through foreign investments. Factors influencing the rate of exchange1.Trade of goods and services between countries is the major reason for the demand and supply of foreign currencies. In other words. against Rupees to pay for its imports. causing frequent fluctuations in the rate. will witness an appreciation in its domestic currency as its demand rises.Gross national expenditure Combined amount of all expenditures to include those which are public and private. If a country’s imports are higher. there will be a demand for Indian Rupees by the US to pay for its imports from India.

welcoming foreign investments and avoiding an appreciation of the domestic currency. Political factors. international current account balance. 5. the demand for rupee will fall. In 1998. .Political scenario of the country ultimately decides the strength of the country. Speculations. If the speculators expect a fall in the value of a currency.In countries where there is fixed or managed float.Stock exchange operations in foreign securities. confidence and a good image in the international market. in the near future. The bank rate also influences the exchange rate by influencing investments and thereby the demand and supply of the domestic currency. creating investor . all at the same time. with various predictions.If the economic fundamentals of a country are strong. 4. Change in prices. An economy with a strong. positive image will obviously have a strong domestic currency. 6. Speculators study the various ups and downs of a country and its resilience to international happenings and forecast the possible future exchange rate based on a particular countries economic strengths and weaknesses. GDP. making Indian goods costlier. stable currency.3. in various countries. the exchange rate of its domestic currency remains stable and strong. influence the demand and supply of related currencies. Strength of the economy. with policies taking care of conflicting demands like inflation and export promotion. debenture. When exports go down. Fiscal balance. Speculators predict about the future exchange rate based on various happenings in the world. For example. of the future government and its policies. causing depreciation in its exchange value. Value of a currency is thus not a simple result of its demand and supply. Government policies. if prices in India go up. inflation rate all are indicators of a country’s economic strength. It’s a tight rope walk for any country to maintain a strong. resilience to international trade fluctuations. The selling of the former currency will thus increase its supply in the foreign exchange market and bring down its value.Domestic inflation. they will sell that currency and start buying the other currency that they expect to appreciate. The bank influences the value of the currency by its market operations like buying and selling of bills and currencies. or deflation affects the exchange rate by affecting the demand and supply of domestic currency in the foreign exchange market. The other currency appreciates as its demand increases. the central bank becomes an important player in the foreign exchange market.Uncertainties are always there in the financial market. stocks and shares. This is the reason why speculations rise considerably during the parliament elections. Stable efficient government at the centre will encourage positive development in the country. but a complex mix of multiple factors influencing the demand and supply. Stock exchange operations. 8. thus influencing their exchange rate. 7. the demand for Indian goods will do down. . s. foreign exchange reserves. international liabilities. the Indian rupee depreciated against the dollar due to the American sanctions after India conducted the Pokharan nuclear test.

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