HI Balance of Payments: MEANING, DISEQUILIBRIUM AND ADJUSTMENT 50.2 The Balance of Payments 30.2.1 The balance of payment is defined’ as “a systematic record 6 Definition 1) The term ‘balance of payments? has been used in a ©. cit, Ch 2 We give here only the most Introduction Just as every business firm prepares its annual (or periodic) final « balance sheet of its transactions with the rest of the society with a its profit or loss, and assets and liabilities, every nation transactions with foreign countries prepares its Balance of Payment Periodically with a view to taking stock of ts assets and liabilities ar and payment obligations to the rest of the world. In this chay ‘meaning and structure of BOP and causes and cures of BOP diset transactions between the residents of a country and residents of. during a certain period of time. Although the above definition of b {s quite revealing, certain terms used in the definition may requi ‘The term “systematic record” does not refer to any partic the system generally adopted is double entry book-keeping transactions’ include all such transactions that involve the ownership. While some transactions involve physical transfer assets and money along with the transfer of title, some t example, India and making profit. This company may pay all its profit Shareholders abroad, or it may, alternatively, reinvest its profit paying dividends to its parent company abroad, While in the transferred (physically) abroad, in the latter case, profits both kinds of these transactions are recorded i What is important is the transfer of title and transacted, numer of diferent senses See, widely used definition,BALANCE OF PAYMENTS; Miasivo, Drsrounnarom xo Anrusrvenr 60S The term ‘residents’ refer to the nationals of the reporting country: Tors diplomats, military personnel, temporary and migratory workers and the branches of foreign companies Operating in the reporing country do fot fall in, the category Of resident, The time pero for balance of payments is not specially defined: may be any period. The getera reference period i, however, ne Yeat=-inaieal oF salen ‘The balance of payments serves a very useful purpose in $0 information for the formulation of future policy in r and foreign trade policies. The major uses of BOP First, the balance of payments accounts provide economic analysis of the country’s weakness and stter trade. By comparing the entries of transactions co for several successive years, one can find out position of the country is improving or deterio necessary corrective measures are warranted. ‘Second, balance of payments also reveals the ch magnitude of foreign trade, The changes that are a being of the country call for necessary action by th regular outflow of capital or export of essential domestic market? needs to be curbed through polic) Third, balance of payments also provides ‘country's past trade performances. If Bi large trade deficits over time, it shows country, which may ultimately lead to exchange crisis of 1990 that had p bankruptcy so far as her extemal pa was concemed. On the other hand, of payments, particularly when its m the country, indicates impending 4 Finally, detailed balance of points in the country’s foreign t to the need for corrective m 30.3 Balance of Payments Accot — Note 2. For example, heavy export of ‘onion price had shot up then put a ban on onion606 Part Vif; INTERNATIONAL ECONOMIC LINKAGES i i onal income, In ital, i affecting the current level of consumption or national ee ‘he two kinds of transactions, balance of payments accountng is divided into two major accounts: (?) current accounts and (i) capital accounts 30.3.1 The items which are entered in the current account of the bi Current jisted in Table 30.1, in the order of their importance, as suege Account currently followed in India. In the “credit” column are enter ‘and in ‘debt’ column, the values payable. The net balance ‘over the debit for each item: it may be negative (-) or posi Table 30.1 Balance of Payments: Current Account Transactions Creda | Deb Net Balance 1.| Merchandise Export | Import = 2'| Foreign travel Earnings | Payments | — 3.| Transportation Eamings | Payments | — 4.) Insurance (Premium) Receipts | Payments| 51] Investment Income Dividend | Dividend | — Receipts | Payments Goverment (purchase and sales of goods and services)| Receipt | Payment | — Miscellaneous" Receipt_| Payment | __— ‘Garrent Account Balance | — = Suplus @) Deficit @) “includes motion pleture royalties, telephone and telegraph services, consultaney fees, ete the items items are different from other invisible item ‘The net balance on the visible items, ix over the merchandise imports (M,) is call of trade is said to be fovourable and i 30.3.2 Capital Account as treasury bills, commercial bills of foreign currency and (iif) c@ in real estate and physical ass investors hold a controllingBALANCE OF PAYMENTS: Meawmo, Diseoumusnicm ax Anvustwent 607 | ae. government securities, securities of firms not entitling the holder with a lling power and (iif) amortization of capital, i., repurchase and resale of Securities earlier sold to or purchased from the foreigners. Direct export or imports capital goods fall under the category of direct investment and are treate It is important to note here that export of capital is a debit item 8 of capital is a credit item whereas export of merchandise is a credit item ‘merchandise is a debit item. The reason for this contrasting treatment import of capital and that of merchandise is their contrasting effect on Export of goods results in inflow of foreign currency which is an circular flow of money income, whereas export of capital results in outflow exchange which amounts to withdrawal from the foreign exchange re Gold and foreign exchange reserves make the third major category of i capital account. Gold and foreign exchange reserves are maintained to exchange rate of the home currency and to make payments to the there exist payment deficits on all other accounts. Balance of The balance of payments accounting is based on the double-entry: ‘aceeiiments system in which both sides of a transaction ~ receipts and payments ~ are ‘Always In For example, exports involve outflow of goods and inflow of foreign Balance Similarly, imports involve inflow of goods and outflow of foreign curren inflow and outflow are recorded in this system. International bor give rise to credit to the lender and debit to the borrower. balance of payments. However, donations, gifts, aids, assist transfers and do not involve quid pro quo or transfer of an eqi to these items, there is only give, no take or, in other debit since it is non-refundable. Yet, the receiving record of non-refundable amounts and donor is ere Such entries have information value for non: transactions reduce the deficit, if any, in the Curr Since in this system of BOP accounting int debit and cre¢ les, BOP accounts 30.4 Disequilibrium in Balance of Pay We have noted above accounting point of accounting proceducon Port Yi; TERNATIONAL ECONOMIC EIKACES a sah tal payment obligations 0 rotal receipts do nat match with total ig tee postion of seq in te balance of Pom vrments positon is obtained in the mani ‘below. ee of a the BOP the total receipts and total payments arising ‘out of tran Disceuieiam 1 term capital movements, and all other ti following two categories: (a) autonomous Transa ‘accommodating capital flows. ‘stonomoss Autonomous transactions are those that take place © Dect arin cestre so, consume TET OF to make a large profit. For ¢ commodsting. of goods, i-e., items of current account—are Un ‘or consuming more goods. Exports and imports transactions included in the balance of payments | autonomous transactions. If exports (X,) equal i no other transactions. But, if X, + M, it leads to sho international borrowing or lending. Such international ‘undertaken for their own sake, but for making of trade. Hence, these are called induced oF involve accommodating capital flows. (On the capital account, the export and. transactions. Also, the short-term capital m abroad for higher return fall in the exports and imports of goods and servic motivated by the desire to earn higher etc, are the autonomous trans movements, viz, gold movements and. the accounting period, ‘The final balance of In the assessment of bal are taken into account. The total transactions determine the deficit receipts and payments are unequal the total payments exceed the to On the contrary, if receipts from autonomous transactions, the b equal, there is neither deficit equilibrium.* 7 From the policy point of reserves is generally taken as an which is a matter of concem fo — Note 3, See also, “Towards © General Theory of the B (of International Trade and Commercial Policy Publishing House, Bombay), 1973.30.5 Causes 4 See also PT. Ellsworth, op. cit, pu Severnment has adopted a deliberate policy to run it down, then the deficit in Of payments is not an unhealthy sign for the economy. Besides, the dise surplus nature (except that it might cause inflation) is not as serious a as the disequilibrium of deficit nature. We will, therefore, be, concer with the deficit kind of disequilibrium in the balance of payments. and Kinds of BOP Disequilibrium AAs already mentioned, a deficit kind of disequilibrium in the b arises when a country’s autonomous payments exceed its auton\ autonomous payments arise due to import of goods and services and ex Similarly, autonomous receipts result from the merchandise export capital. It may, therefore, be said that disequilibrium of deficit nature ar imports exceed total exports. But imports and exports do not determi The volume and value of imports and exports are determined by factors. And, these factors become the ultimate cause of BOP AAs regards the determinants of imports, the total import of a co three factors’: (i) internal demand for foreign goods, which total purchasing power of the residents of the importing prices of imports and their domestic substitutes; (iti) people’ goods; (iv) price-elasticity of demand for imports and ( imports. Similarly, the total export of a country depends its goods, (ii) competitiveness of its price and quality and Under static conditions, these factors remain constant. the balance of payments, once achieved, conditions, factors which determine imports and gradually and smoothly, but often violently and their duration and intensity from country to changes which occur as a result of unhealthy « abroad create coiiditions for disequilibriur kinds of disequilibria are associated here briefly the causes of d 1. Price Changes and Ft change in the price level m surplus in the balance 6 cause a serious cor lead to wasteful inflationary changes in deficits result in i employment, distort problems in the de inflationary price ef610 — Note 5. Ellsworth, PT, op. cit, p. 235, Part Vil: INTERNATIONAL ECONOMIC LINKAGES ,__ Inflation causes a change in the relative prices of imports and exports. It makes imports cheaper and exports costlier. Therefore, exchange rate remaining the same, inflation causes an increase in imports because domestic prices b come hhigher than the import prices. On the other hand, inflation lead exports because of decrease in foreign demand due to increase The increase in imports depends also on the price-elastcity of de in the home market and decrease in exports depends on the price demand for home-products. In case price-elastcities of imports equal to zero, imports are bound to exceed the exports. AS a deficit in the balance of payments, If inflationary conditions in-built fundamental imbalances in the economy, it disequilibrium. If the size of deficit is large and disequilibrium fundamental disequilibrium. 2. Business Cycles and Cyclical Disequilibrium. Business by economic ups and downs. The economic ups and downs af inflationary rise or deflationary decline in the general p effect of continuous inflationary or deflationary changes discussed, Let us see what happens when inflation an regular phenomena, The price changes or fluctuations may be countries or they may be global as it happened in th take the form of a business cycle, most countries affected in varying degrees. Deficits and surpl from moderate to large. The countries with accumulate larger deficits during inflationary deficit, or even a surplus, during the period known as eyclical disequilibria. This is, ho little is known about the marginal propensiti unwise’ 3. Structural Changes and Structural Di economy are caused by such factors as (i) (ii) change in technology with which a co production or lack of foreign demand. cit.) the gradual exhaustion of better coal cost of coal production despite improve