BALANCE OF PAYMENTS

•It is s a macro level statement showing inflow and outflow of

foreign exchange

•The system of recording is based on the concept of double

entry book keeping- where the credit side shows the receipt of
foreign exchange from abroad and debit side shows the
payments in foreign exchange to foreign residents.
 Balance of payments (BOP) accounts are an accounting
record of all monetary transactions between a country and the
rest of the world. These transactions include payments for the
country's exports and imports of goods & services, financial
capital, and financial transfers.

 A country has to deal with other countries in respect of 3 items:-

 Visible items which include all types of physical goods
exported and imported.
 Invisible items which include all those services whose export
and import are not visible. e.g. transport services, medical
services etc.
 Capital transfers which are concerned with capital receipts
and capital payment.
Definition-

 According to Kindle Berger, "The balance of payments of

a country is a systematic record of all economic
transactions between the residents of the reporting
country and residents of foreign countries during a given
period of time".
 Definition
“The Balance Of Payments of a country is a systematic
record of all economic transactions between the
‘residents’ of a country and the rest of the world. It
presents a classified record of all receipts on account of
goods exported, services rendered and capital received
by ‘residents’ and payments made by them on account
of goods imported and services received from the
capital transferred to ‘non-residents’ or ‘foreigners’.” –
Reserve Bank of India (RBI)
Features
 It is a systematic record of all economic transactions
between one country and the rest of the world.
 It includes all transactions, visible as well as invisible.
 It relates to a period of time. Generally, it is an annual
statement.
 It adopts a double-entry book-keeping system. It has two
sides: credit side and debit side. Receipts are recorded on
the credit side and payments on the debit side.
•Receipts and payments are compartmentalized into 2 heads
•Current account
•Capital account

•Basic distinction between the two is that former represents

transfer of real income and latter accounts only for transfer
of funds without effecting a shift in real income.
Current Account
 It includes visible exports and imports, and invisible
items like receipts and payments for various services.
 It contains credit and debit items.
 Credit includes merchandise exports and invisible
exports.
 Debit includes merchandise imports and invisible
imports.
 CURRENT ACCOUNT

•It is the part of BOP showing the flow of real income or

foreign exchange transactions on account of trade of goods
and invisibles.

•The current account records the receipts and payments of

foreign exchange in the following ways.
Current account receipts
1. Export of goods
2. Invisibles
a) Services
b) Unilateral transfers
c) Investment income
3. Non-monetary movement of gold

Current account payments

1. Import of goods
2. Invisibles
a) Services
b) Unilateral transfers
c) Investment income
3. Non-monetary movement of gold
•Export of goods effects the Inflow of foreign exchange into
the country, while import of goods causes outflow of foreign
exchange from the country.

•The difference between the two is known as the Balance Of

Trade.

If export exceeds import ,balance of trade is surplus.

If import exceeds export ,balance of trade is deficit.

•Trade in services, the unilateral transfers and the investment

income form the ‘invisibles’.
•Trade in services includes receipts and payments on account
of travel and tourism, financial charges concerning banking,
insurance, transportation and so on.

•Unilateral transfers
 include pension, remittances, gifts and other transfer for
which no specific services are rendered.
They are called unilateral transfers because they represent
the flow of funds only in one direction.
They are unlike export and import, where goods flow in
one direction and the payment flows in the other.

•Investment income include interest, dividend and other such

payments and receipts.
Non monetary movement of gold

There are 2 types of sale and purchase of gold.

1. One is termed as monetary sale and purchase that influence the
international monetary reserves.
2. The other is non monetary sale and purchase of gold
this is for industrial purposes and is shown in the current
account, either separately from or along with trade in
merchandise.

The debit and credit sides of two accounts- trade in merchandise

and invisibles – are balanced.
oIf credit side>debit side current account surplus
oIf debit side> credit side current account deficit
 CAPITAL ACCOUNT

•It is the part of bop statement showing flow of foreign

loans/investments and banking funds

•Capital account transactions takes place in the following ways:

Capital account receipts

1. Long term inflow of funds
2. Short term inflow of funds

Capital account payments

1. Long term outflow of funds
2. Short term outflow of funds
•The flow of capital account is long term as well as short term.
•Long term flows involves maturity over one year
•Short term flows are effected for one year or less.

•The credit side records

The official and private borrowing from abroad net of
repayments
Direct and portfolio investment
Short term investments into the country
The bank balances of non residents held in the country.

•The debit side includes

disinvestment of capital
country’s investment abroad
loans given to the foreign government or a foreign party
 the bank balances held abroad.
•The difference between credit side of the current account along
with the credit side of long term capital account transactions is
compared with the transactions on the debit side of current account
and the long term account is known as the basic balance, which
may be negative or positive.

•As per the practice adopted by the RBI, basic balance is not
shown in the BOP statement.

•The capital account balancing is not complete with the basic

balance

•The debit side and credit side of short term capital transactions are
added to respective sides and then the capital amount is balanced.

•Difference between these sides is known as Capital Account

Balance
•Errors and omissions is an important item on the BOP
statement and taken into account for arriving at the overall
balance.

•Also known as statistical discrepancy

•Statistical Discrepancy refers to estimate of foreign exchange

flow on account of either variations in the collection of related
figures or unrecorded illegal transaction of foreign exchange.
•It arises on different accounts

 It arises because of the difficulties involved in collecting

BOP Data. There are different sources of data, which
sometimes differ in their approach.

For example: In India, trade figures compiled by RBI and the

DGCIS(Director General Of Commercial Intelligence and
Statistics) differ.

The movement of funds may lead or lag the transactions

that they are supposed to be finance.
For example: goods are shipped in March but payments are
received in April.
 Certain figures are derived on estimates
For example: figures of earning on travel and tourism are
estimated on basis of sample Cases. If sample is defective,
errors are sure.

Unrecorded illegal transactions either on debit side or

credit side or both
•After the statistical discrepancy is located,the overall balance is
arrived at.

•Overall balance represents the balancing between the credit

items and the debit items appearing on the current account,
capital account, and the statistical discrepancy.

•If the overall balance of payments is in surplus, the surplus

amount is used for repaying the borrowings from the IMF and
then the rest is transferred to the official reserves account.

•On the contrary, when the overall balance is found deficit, the
monetary authorities arrange for capital flows to cover up the
deficit.
•Such inflows may take the form of drawing down of foreign
exchange reserves or official borrowings or purchases from
the IMF.

•From this point of view, capital flows are bifurcated into

autonomous and accommodating ones.

•Accommodating or compensatory capital flow is the

inflow of foreign exchange to meet the balance of payments
deficit, normally from the IMF . On other words, it aim at
putting the balance of payments in equilibrium.

•Autonomous capital flow refers to flow of loans/investment

in normal course of a business.
 OFFICIAL RESERVES ACCOUNT

•Official reserves are held by the monetary authorities of a

country.

•They comprise monetary gold, SDR allocations by the IMF,

and foreign currency assets.

•Foreign currency assets are normally held in form of balances

with foreign central banks and investment in foreign
government securities.
•If the overall BOP is in surplus, it adds to the official
reserves account.

•If overall BOP is in deficit, and if accommodating capital

is not available, the official reserves account is debited by
the amount of deficit.
 BALANCE OF PAYMENTS

•Balance of Trade= Export of Goods – Import of Goods

•Balance of Current Account= Balance Of Trade + Net

Earnings on Invisibles

•Balance of Capital Account = Foreign Exchange Inflow –

Foreign Exchange outflow, on account of foreign investment,
foreign loans, banking transactions, and other capital flows

•Overall Balance of Payments = Balance of Current Account +

Balance of Capital Account + Statistical Discrepancy
Causes and Measures of
Disequilibrium!
 Overall account of BOP is always in equilibrium. This
balance or equilibrium is only in accounting sense
because deficit or surplus is restored with the help of
capital account.
 In fact, when we talk of disequilibrium, it refers to
current account of balance of payment. If autonomous
receipts are less than autonomous payments, the
balance of payment is in deficit reflecting
disequilibrium in balance of payment.
(i) Economic Factors:

 (a) Imbalance between exports and imports. (It is the

main cause of disequilibrium in BOR), (b) Large scale
development expenditure which causes large imports,
(c) High domestic prices which lead to imports, (d)
Cyclical fluctuations (like recession or depression) in
general business activity, (e) New sources of supply
and new substitutes.
(ii) Political Factors:
 Experience shows that political instability and
disturbances cause large capital outflows and hinder
Inflows of foreign capital.

(iii) Social Factors:

 (a) Changes in fashions, tastes and preferences of the
people bring disequilibrium in BOP by influencing
imports and exports; (b) High population growth in
poor countries adversely affects their BOP because it
increases the needs of the countries for imports and
decreases their capacity to export.
Measures to correct
disequilibrium in BOP:
 Sustained or prolonged deficit has to be settled by
short term loans or depletion of capital reserve of
foreign exchange and gold.
 Following remedial measures are recommended:
 (i) Export promotion:
 Exports should be encouraged by granting various
bounties to manufacturers and exporters. At the same
time, imports should be discouraged by undertaking
import substitution and imposing reasonable tariffs.
(ii) Import:
 Restrictions and Import Substitution are other measures
of correcting disequilibrium.
(iii) Reducing inflation:
 Inflation (continuous rise in prices) discourages exports
and encourages imports. Therefore, government should
check inflation and lower the prices in the country.
(iv) Exchange control:
 Government should control foreign exchange by
ordering all exporters to surrender their foreign
exchange to the central bank and then ration out among
licensed importers.
(v) Devaluation of domestic currency:
 It means fall in the external (exchange) value of domestic
currency in terms of a unit of foreign exchange which
makes domestic goods cheaper for the foreigners.
Devaluation is done by a government order when a country
has adopted a fixed exchange rate system. Care should be
taken that devaluation should not cause rise in internal
price level.
(vi) Depreciation:
 Like devaluation, depreciation leads to fall in external
purchasing power of home currency. Depreciation occurs
in a free market system wherein demand for foreign
exchange far exceeds the supply of foreign exchange in
foreign exchange market of a country (Mind, devaluation is
done in fixed exchange rate system.)
•India’s external sector witnessed further improvement with
the recovery seen in the global economy as reflected in the
turnaround in exports, buoyancy in capital inflows and
further accretion to the country’s foreign exchange reserves.

• Exports recovered from 12 months of consecutive decline

and posted an average growth of 20.5 per cent during
November 2009-February 2010.

•Imports also turned around and exhibited an average

growth of about 43.0 per cent during December 2009-
February 2010, mirroring the impact of strong recovery in
growth.
•India’s balance of payments position during April-
December 2009 remained comfortable with a modest
increase in current account deficit, despite a lower
trade deficit, on account of decline in invisibles surplus.

•There has been a turnaround in capital inflows, mainly led

by portfolio inflows, reflecting the buoyant growth
prospects of the Indian economy.

•India’s foreign exchange reserves during 2009-10

increased by US$ 27.1 billion to reach US$ 279.1 billion as
at end-March 2010.

•As on April 9, 2010, foreign exchange reserves stood at

US$ 280.0 billion.
The impact of global economic recovery was visible in different accounts of
India’s balance of payments.
The current account position during the third quarter of 2009-10 witnessed a
turnaround in both exports and imports.
India’s merchandise
exports (on BoP basis) registered a robust
growth in the third quarter of 2009-10 as
compared with decline in the corresponding
period of 2008-09.
Imports (on BoP basis)
increased moderately during the quarter as
compared with a higher growth in the
corresponding quarter of the previous year.
Trade deficit was lower during the third
quarter of 2009-10 as compared with the
preceding quarter and the corresponding
quarter a year ago.
During April-December
2009 also, trade deficit remained lower (US
$ 89.5 billion) as compared with the
corresponding period of the preceding year
(US$ 98.4 billion) led by decline in both
oil and non-oil imports (Table III.5).
Invisibles
The robust growth observed in
invisibles receipts and payments in the past few years was
reversed during 2009-10, reflecting the lagged impact of the
recession in advanced economies.
The decline was
seen in both factor and non-factor
components.
Although software exports
witnessed a turnaround, the decline in nonsoftware
Exports
Despite lower trade deficit, the fall in
invisibles surplus led to marginally higher
current account deficit during the third
quarter of 2009-10
The current
account deficit during April-December 2009
stood at US$ 30.3 billion, higher than US$
27.5 billion during April-December 2008.
During 2008-09, current account deficit as
a per cent of GDP stood higher at 2.4 per
cent as compared to 1.3 per cent a year ago.
Capital Account
Capital flows continued to remain
buoyant during the third quarter of 2009-10, mainly led by
large inflows under foreign direct investments, portfolio
investments and short-term trade credits

The latest available information

on certain indicators of the capital account
indicates that the revival in capital inflows,
which started at the beginning of 2009-10
and gathered momentum in the second and
third quarters, has remained buoyant even
in the last quarter
Stronger
recovery in 2009-10 ahead of the global economy coupled
with positive sentiments
of global investors about India’s growth
prospects are the factors that underlie the
momentum of sustained capital inflows
during the year.
During 2009-10, India’s foreign
exchange reserves increased by US$ 27.1
billion to reach US$ 279.1 billion as at end-
March 2010
Foreign currency assets (FCAs) increased
by US$ 13.3 billion during the year.
the Reserve Bank purchased
200 metric tonnes of gold from the IMF
on November 3, 2009 as part of the Reserve
Bank’s foreign exchange reserve
management operations.
The foreign
exchange reserves, however, remained
unaffected by this transaction as it merely
reflected substitution of foreign currency
assets by gold.
The IMF made additional
allocations of SDRs to India in two
tranches, viz., general allocation of SDR
3,082 million (equivalent to US$ 4.82
Both long-term and shortterm
debt increased at end-December
2009 from their levels at end-March
2009. Of the total increase in India’s
external debt at end-December 2009, the
valuation effect on account of
depreciation of US dollar against major
international currencies accounted for
36.9 per cent.
India’s external sector, thus,
improved alongside the recovery in global
economy and further stabilisation in global financial conditions.
This was
reflected in the turnaround in exports and
continued buoyancy in capital inflows.

Despite higher net capital inflows during

2009-10, reflecting improved absorptive
capacity of the economy, capital inflows
mostly financed the higher current account
deficit.
Reflecting easy global liquidity
conditions and both interest rate and growth
differentials in favour of India, capital inflows are expected to be strong,
which may
put pressure on asset prices and exchange
rate.
Global commodity price trends,
particularly possible firming up of oil prices
could exert pressures on the balance of
payments through higher imports. For
dealing with the external shocks
transmitting through various accounts of the
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