BALANCE OF PAYMENTS

BOP or Balance of International

Payments is the systematic and
summary record of a country’s
economic and financial transactions
with the rest of the world over a
period of time.

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As per IMF:
BOP is a statistical statement for a given period
showing: (a) transactions in goods & services and
income between an economy and the rest of the world;
(b) changes of ownership and other changes in that
country’s monetary gold, SDRs, and claims on and
liabilities to the rest of the world; and (c) 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. – IMF, Balance of Payments
Manual.

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 Difference between BOP and BOT
Balance of Trade:
only exports and imports of merchandise
or goods , i.e. only visibles.
• Hence does not show the services
(shipping, insurance, payment of interest,
royalties, tourist spendings, etc.)
BOP:
both visibles and invisibles.

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 Nature of BOP accounting

• Follows double entry book

keeping system.
• Each transaction has a debit and
credit
• Has to balance (if not : errors &
omissions entry)

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 Components of BOP
Various entries grouped under 4 categories
or accounts (parts)

• A) Current Account
• B) Capital Account
• C) Unilateral Payments Account
• D) Official Settlements Account.

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 Components of BOP

Balance of payment (BoP)

comprises:
• current account,
• capital account,
• errors and omissions and
• changes in foreign exchange reserves.

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 Current Account
• Is a summary record of a nation’s goods and invisibles
transactions with the rest of the world.
• All transactions which give rise to or use up National
Income.
• Includes 2 major items:
Merchandise exports & imports
Invisible exports & imports
• Exports = credit entry ( i.e. claims
on foreigners)
• Imports = debit entry (i.e.claims on
home country)
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 Invisibles
• Invisibles include:
a. non factor services:
–travel, transportation, insurance, Government not included
elsewhere (GNIE) and miscellaneous, (which includes
communication, construction, financial, software, news agency,
royalties, management and business services)

b.income
c. private transfers ( NRI remittances, gifts ) and
official transfers (Grants) ( for which no quid
pro quo)
• Non Factor Services include:
1. export of software services
2. travel and transportation (tourist
spending,
shipping etc,)
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 Current account balance
• Current account balance is synonymous with net
foreign investment.
• A current account surplus means that:
– The country has positive net foreign investment (i.e.,
the country is acting as a net lender to or investor in
the rest of the world).
– The country is producing more ( and has more
income from this production) than it is spending on
goods and services.
– such a country is saving more than it is
investing domestically
• A deficit = the nation is a net borrower or
domestic savings are less than domestic investment.

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 Capital Account
• Shows the capital inflows and outflows.
• =Claims and liabilities which go to finance the
deficit on current a/c or absorb its surplus.
• Short Term
• Long Term
• Capital Outflow = Debit ( eg. Indian inv in a foreign
country, inv in foreign securities, govt.loans to foreign
countries)
• Capital Inflow = Credit ( FDI by a foreign co. in
India, loans to Govt. from foreign countries, NRI
deposits).
• Also ST investments from abroad (incl FIIs).
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• The interest on loans and
dividends/profits received are current
account;

• while the loan and FDI are capital

account transactions.

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 Capital Account components
• Capital inflows can be classified by instrument (debt
or equity) and maturity (short or long term).
• The main components of capital account include
foreign investment, loans and banking capital.
• Foreign investment comprising foreign direct
investment (FDI) and portfolio investment represents
non-debt liabilities, while loans (external assistance,
external commercial borrowings and trade credit) and
banking capital including non-resident Indian (NRI)
deposits are debt liabilities.

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 Unilateral Transfer Account
• = Gifts. No quid pro quo.
• One-sided transactions
• Include private remittances, govt
grants, pension payments, disaster
relief, etc.
• If received = credit; if paid = debit
• Now included in Other Receipts.

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 Official Settlement Account
• =Monetary Movement
• 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.

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 Causes of BOP disequilibrium
• Disequilibrium = there is surplus or
deficit in BOP
• Deficit = demand for forex exceeds
the supply
• Reasons:
– Economic factors
– Political factors
– Sociological factors

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 Economic factors
1. Development Disequilibrium:
Large scale development expenditure =
increase in purchasing power + increase
in demand & prices.
--Leads to huge imports (also of
Capital Goods)
--Hence adverse BOT adverse BOP.

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 2. Capital Disequilibrium
• Due to cyclical fluctuations in general business
activity.
• If domestic economy experiences a boom, while
the rest of the world not so
--then more purchasing power & demand and higher
prices
--hence more imports
• But exports difficult because of slackness in world
economy.
• Hence……

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 3. Secular Disequilibrium
• If long term BOP problem, then it is due
to some secular trends in the economy.
• If domestically: persistent high demand
and high domestic prices (eg.USA) then
imports will always be more than exports.
• ( if high production costs locally: but high
disposable incomes and hence very high aggregate
demand and high prices….)

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 4.Structural Disequilibrium
Affects exports & imports
• Because of development of
alternative sources of supply,
• discovery of better substitutes,
• exhaustion of productive resources,
• changes in transport routes and costs
etc.

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 II. Political factors
• Continuous political instability, wars, etc.,
will lead to capital outflows and
inadequacy of domestic investment and
production

• Hence BOP problems.

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 III. Social factors

• Changes in tastes, preferences, fashions

etc., will affect the exports and imports.

• Hence BOP…

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 Correction of Disequilibrium
• Automatic Correction & Deliberate Measures
• Automatic: If adverse BOP fall in the
external value of the domestic currency
--So, exports will become cheaper and
imports will become costlier
--this will restore …

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 Deliberate Measures
1. Monetary Measures:
a)Contraction in money supply —will
reduce purchasing powerreduce
demand
-- so less imports

b)fall in prices cheaper—so more

exports
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 Devaluation
• Exports cheaper and imports
costlier

• E.g.: 1966 June: 4.76 to 7.50

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 Exchange control

• To conserve forex
• Only through ADs
• Central Bank

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 Trade Measures

• Export incentives
• High import duties and restrictions
• Canalisation

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 Other Measures
• Getting foreign loans
• Foreign assistance, Aid…
• Development of tourism
• Export of services, BPOs, ITES, etc.

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 BOP: INDIA
• Because of the trade deficit, India has
had BOP deficits in most of the years
• Though its effect has been mitigated to
a great extent by invisible surplus.
• But this problem has increased the
country’s dependence on external capital
markets and increased its vulnerability to
external shocks.

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• During the I FYP: no BOP problem because of
the huge sterling balances India had at the time of
independence.
• In 1950-51: our forex reserves were equal to
158% of our merchandise imports.
• But by 1957-58 the reserves came down to about
1/3 of the level in 50-51 and resulted in
shortage.
• So, we got aid from Aid India Consortium and
drawals from IMF.—also stringent import
controls started.
• 1966 Re was devalued : to improve exports
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• In 1972-73: we had a trade surplus of Rs.104 cr.
• But then came the I Oil Shock: 4 fold increase in
international crude prices between Sept1973
and April, 74.
• But we managed somehow this and during 1976-
77 to 1979-80: an improvement in BOP.
• In 1976-77, there was even a small trade
surplus
of Rs.72 cr.
• But the main reason for the improvement in BOP
was the sharp increase in inflow of remittances
from our emigrant workers,esp from Gulf.
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• But then came the II Oil Shock in 1979-80: trade
deficit shot up from Rs 2200cr in 78-79 to Rs 6,200 cr
in 1980-81.
• Also a gradual decline in net receipts from invisibles,
while the trade deficit widened.
• An important reason for the BOP problem in 1980s
and since then is the change in source of financing
the large current a/c deficit.
--Until the beginning of the 80’s; almost the entire
deficit was financed thru inflows of concessional
assistance (hence, debt-service burden low)
--this was drastically replaced by commercial debt—to
pvt creditors, incl com banks and NRIs
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• Invisible surpluses have traditionally financed
a large part of India’s trade deficits
--but there was a steep fall in this since 80’s.
• In 1980-81: net invisibles financed nearly 73%
of trade deficit.
• During 6th Plan(1980-85): it was on an average >
60%.
• But by 1990-91: it dropped to about 13% only.
• Hence, was forced to go for external
(commercial) sources to meet our payments
obligations—crisis….pledging gold….
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• Made worse by the falling trend in net
invisibles
• Why:
Rise in invisibles payments: due to rising
interest and service payments on foreign
loans & credits.
-- In 1990-91, the Debt service ratio
was 35.3%.

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 Liberalisation and after
With the ec liberalisation: improvement
• Marked improvement in the coverage ratio i.e. ratio of
export bill to import bill
• And inflow of invisibles
• In 1990-91 it was only 2.5 months (bare minimum norm =3
months of import). In July 1991 only 15 days !
• now (‘04-05) more than 14.3 months. (in ‘03-04, it was
16.9)
• As a result, there was surplus in the Capital a/c of BOP
(esp.
during 1996-97 to 1998-99)
• So, comfortable BOP
• The debt creating flows as % of total capital flows which
averaged 97% during the 7thPlan(85-90) declined to less than
18% by 94-95. 34
 Capital Account
• The substantial increase in the foreign
investment, as a result of the liberalization has
been generating significant capital account
surplus.
• Capital account surplus increased from less
than $ 4 billion during the 1980s to US $ 8.6
billion during 1992-2002, resulting in a huge a
accumulation of foreign exchange reserves.
• As a proportion of GDP, capital flows
increased from 1.6 per cent during 1980s to
2.3 per cent during 1992-2002 and now it is
around 2%.

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• The trends in the capital flows over
the 1990s reflects a shift in
importance from debt to non-debt
flows with the declining importance of
external assistance and external
commercial borrowings (ECBs) and the
increased share of foreign
investment - both direct and
portfolio.
• FDI inflows (net) was $4.7 bn in 05-06
and of this 75.2% was in equity.
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• The increase in capital inflows coupled
with the improvement in the current
account position resulted in a surplus in
the overall BOP of India from 1993-94
onwards, excepting 1995-96.
• The surplus amounted to $ 26.2 billion
in 2004-05 as against a deficit of US $
0.6 billion in 1992-93.
• As a result India is one of the largest
reserve-holding economies of the world.

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 Causes of BOP problem in India
• 1. Large trade deficit
• 2. Fall in invisible surplus, caused by
a) increase in invisibles payments (debt service)
b) slackening of emigrants’ remittances and travel
income.
• 3. Sensitive behaviour of foreign creditors and
NRIs
• 4. Declining role of concessional external
finance.

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 Major determinants of BoP transactions
such as external demand, international oil
and commodity prices, pattern of capital
flows and the exchange rate changes
significantly during the course of the year.

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Invisibles
 The invisibles account of BoP reflects the
combined effect of transactions relating to
international trade in services, income
associated with non-resident assets and
liabilities, labour, property and cross-border
transfers, mainly workers’ remittances.
 Two components namely software services
and workers’ remittances, continued to remain
relatively resilient in 2019-20, as was the case in
2018-19, despite the global economic meltdown
and were mainly responsible for the net
invisible surplus.

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