Balance of Payments | Current Account | Debits And Credits

Balance of payments

What is BOP?

It is the summary of flow of economic transactions between the residents of a country and the rest of the world during a given time period. It is similar to sources and uses of funds statement for a company. It measures the flow of international payments and receipts. It records only changes in the levels (not the absolute level) of international assets and liabilities.

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What is BOP?

BOP is described by the IMF in its BOP Manual as a statistical statement for a given period showing:

Transactions in goods, services and income between an economy and the rest of the world; Changes of ownership and other changes in the economy’s monetary gold, SDRs, and claims and liabilities to the rest of the world; and unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting.

BOP manual prescribes the principles and concepts to be followed by the member countries while preparing BOP data.
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Components of Balance of Payments Balance of payments account is based on the ‘standard double entry system’ of book keeping. Thus, every entry is entered twice, once as a credit item and once as a debit item. A transaction which increases the external purchasing power of a country is recorded as a credit entry. It represents a source of foreign exchange. A transaction which reduces the external purchasing power of the country is recorded as a debit entry. It shows the use of foreign exchange reserves.
  

Current Account Capital Account Monetary Movements
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Current Account
The current account records all the merchandise and invisible transaction around the world. It effectively captures the trading pattern across the countries. Current account has two components, merchandise transactions and invisible transactions.

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India’s Overall Balance of Payments
Credit A. CURRENT ACCOUNT 1. MERCHANDISE a. Exports (on f.o.b. basis) b. Imports (on c.i.f. basis) 2. INVISIBLES (a + b + c) a. Services i. Travel ii. Transportation iii. Insurance iv. G.n.i.e. v. Miscellaneous b. Transfers vi. Official vii. Private c. Investment Income Debit Net

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Capital Account
Capital account depicts the movements of foreign capital in and out of the country. Capital account has the

following components.

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Credit B. CAPITAL ACCOUNT 1. FOREIGN INVESTMENT (a + b) a. In India i. Direct ii. Portfolio b. Abroad 2. LOANS a. External Assistance b. Commercial Borrowings (MT and LT) c. Short Term 3. BANKING CAPITAL (a + b) a. Commercial Banks b. Others 4. RUPEE DEBT SERVICE 5. OTHER CAPITAL Total Capital Account (1 + 2 + 3 + 4 + 5)
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Debit

Net

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Credit A. CURRENT ACCOUNT B. CAPITAL ACCOUNT C. ERRORS AND OMISSIONS D. OVERALL BALANCE (A + B + C) E. MONETARY MOVEMENTS (i + ii) i. ii. I.M.F. Foreign Exchange Reserves (Increase -/ Decrease +)

Debit

Net

Balance in Current Account + Balance in Capital Account + Change in Monetary Movements = Zero

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Factors influencing BOP

Exports

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Current exchange rate of home currency - a lower value results in domestic price getting translated into a lower international price and vice versa. Inflation rate-higher the inflation, lower competitiveness and lower the demand for domestic goods and vice versa. World prices of a commodity-an increase in the world price of a commodity, the value of exports for that commodity will increase and vice versa. Income of foreigners Trade barriers

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Factors influencing BOP

Imports
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Value of domestic currency- opposite effect as for exports Level of domestic income-an increase in income levels increases demand for both domestic and imported goods International prices-a higher international price gets translated into higher domestic price and vice versa. Demand for imports depends on the elasticity of demand. Inflation rate Trade barriers.

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Importance of BOP statistics

Forecasting exchange rates can be made if the factors affecting demand & supply of a currency are known. A careful study of the factors influencing different components of BOP and of the economic factors the world over can prove quite handy for predicting the direction if not the magnitude. A movement in the reserve position of a country can also provide some indications as to the likely movement of exchange rates
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Importance of BOP statistics
 For

example, a continuous overall BOP deficit could mean downward pressure on the value of the home currency. If reserves are used defend the home currency, the reserves will deplete.  On the contrary, continuous BOP surplus may lead to build up of reserves. This could result in strengthening of home currency.
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