International Financial Management

P G Apte
 What is the Balance of Payments?
• The Balance of Payments of a country is a systematic, double-entry
accounting record of all economic transactions during a given
period of time between the residents of the country and foreign
residents
• Some Simple Rules of Thumb
– All transactions which lead to an immediate or prospective
payment from the Rest of the World (ROW) to the country should
be recorded as credit entries. The payments themselves, actual or
prospective, should be recorded as the offsetting debit entries.
– All transactions which lead to an immediate or prospective
payment to the ROW from the country should be recorded as
debit entries. The payments themselves, actual or prospective,
should be recorded as the offsetting credit entries.
–A transaction which results in an increase in demand
for or reduction in supply of foreign exchange is a debit
entry while a transaction which results in an increase in
the supply of or reduction in demand for foreign
exchange is a credit entry.

Thus : Exports are credit entries; payments for exports

increase our forex balance – a use of forex – balancing
debit entries. Conversely, an import transaction is a
debit entry while payment for imports is a credit entry.
 Components of the BOP
• Three Main Categories
– The Current Account: Includes imports and
exports of goods and services and unilateral
transfers.
– The Capital Account: All transactions leading to
changes in foreign assets and liabilities of the
country.
– The Reserve Account: In this category only
"reserve assets" are included.
Further sub-categories within each main category.
 The Current Account
• Merchandise Trade
– Merchandise trade should cover all
transactions relating to tangible goods.
Exports (+), Imports(-), Net Balance:
Merchandise Trade Balance.
– The valuation should be on f.o.b. basis so that
international freight and insurance are treated
as distinct services and not merged with the
value of the goods themselves.
– Contra-entries in capital account unless barter
trade.
 The Current Account
• Invisibles
The invisibles account includes services such as
transportation and insurance, bpo services, consultancy
services, income payments and receipts for factor services
- labour and capital - and unilateral transfers.
– Services rendered to ROW (+); Services bought from
ROW (-); Transfers received (+), transfers given (-).
– Net Balance: Balance on Invisibles Account
– Contra-entries in Capital Account
Merchandise Trade Balance + Invisibles Balance
= Current Account Balance
 The Capital Account
• Banking, Government, Other
Records changes in foreign assets and liabilities.
Capital inflows are credits, outflows are debits.
Hence increase in foreign assets or reduction in liabilities are
debits; reduction in foreign assets or increase in liabilities are
credits.
Loans raised, portfolio investments by foreigners, direct inward
investment – credits
Loans repaid, investments by residents abroad, disinvestment
by foreigners – debits.

Net Balance : Capital Account Balance

 The Reserve Account
• Other Accounts and Forex Reserves

• The IMF account contains purchases (borrowings) and repurchases

(repayments) from the IMF. Former are credits, latter debits.

• The Foreign Exchange Reserves account records increases (debits)

and decreases (credits) in reserve assets (RBI's holdings of gold and
foreign exchange, SDRs)

* (Current+Capital) Account Balance (+) implies reserves increase,

reserve account (-)
* (Current+Capital) Account Balance (-) implies reserves decrease,
reserve account (+)
 Meaning of “Deficit” and “Surplus”in the
Balance of Payments
• In a double-entry accounting statement total credit
entries must equal total debit entries.
• The terms “Deficit" or “Surplus" cannot then refer to
the entire BOP but must indicate imbalance on a
subset of accounts included in the BOP
• In popular parlance, BOP deficit or surplus refers to
deficit or surplus on current account.
• An economically meaningful distinction is between
“autonomous” and “compensating” transactions.
Balance on autonomous transactions- “above the
line”; on compensating transactions- “below the line”
 Meaning of “Deficit” and
“Surplus”in the BOP
• Several concepts of "balance" have
evolved
– Trade Balance: This is the balance on the
merchandise trade account.
– Balance on Goods and Services: This is
the balance between exports and imports
of goods and services.
– Current Account Balance: This is the net
balance on the entire current account.
 Meaning of “Deficit” and
“Surplus”in the BOP
– Balance on Current Account and Long
Term Capital: This is sometimes called
Basic Balance. This is supposed to
indicate long term trends in the BOP, the
idea being that while short term capital
flows are highly volatile, long term capital
flows are of a more permanent nature and
indicative of the underlying strengths or
weaknesses of the economy.
 No. 41: Foreign Trade (Annual and Monthly)
Year / Month Rupees Crore US Dollar Million SDR Million
Export Import Balance Export Import Balance Export Import Balance
1 2 3 4 5 6 7 8 9 10
2002-03 2,55,137 2,97,206 -42,069 52,719 61,412 -8,693 39,785 46,345 -6,560
2003-04 2,93,367 3,59,108 -65,741 63,843 78,149 -14,307 44,663 54,672 -10,009
2004-05 3,75,340 5,01,065 -1,25,725 83,536 1,11,517 -27,981 56,081 74,866 -18,785
2005-06 4,56,418 6,60,409 -2,03,991 1,03,091 1,49,166 -46,075 70,774 1,02,405 -31,632
2006-07 5,71,779 8,40,506 -2,68,727 1,26,361 1,85,749 -59,388 85,018 1,24,975 39,957
2007-08 6,40,172 9,64,850 -3,24,678 1,59,007 2,39,651 -80,644 1,02,181 1,54,005 -51,824
2006-07
April 38,612 56,342 -17,729 8,590 12,535 -3,944 5,915 8,630 -2,716
May 45,588 64,963 -19,375 10,040 14,307 -4,267 6,741 9,606 -2,865
June 47,920 64,683 -16,764 10,405 14,044 -3,640 7,040 9,502 -2,463
July 48,934 67,558 -18,624 10,533 14,542 -4,009 7,128 9,841 -2,713
August 49,649 68,658 -19,009 10,669 14,753 -4,085 7,173 9,920 -2,746
September 49,486 77,611 -28,125 10,730 16,829 -6,098 7,242 11,358 -4,116
October 44,589 76,047 -31,458 9,807 16,725 -6,919 6,655 11,350 -4,695
November 43,943 68,812 -24,868 9,798 15,342 -5,545 6,580 10,304 -3,724
December 47,368 66,848 -19,479 10,612 14,977 -4,364 7,038 9,932 -2,894
January 48,357 60,992 -12,636 10,908 13,758 -2,850 7,294 9,200 -1,906
February 46,484 62,470 -15,986 10,527 14,147 -3,620 7,030 9,448 -2,418
March 56,628 75,445 -18,817 12,862 17,137 -4,274 8,534 11,370 -2,836
2007-08 R
April 46,164 74,895 -28,731 10,953 17,769 -6,817 7,196 11,675 -4,479
May 49,794 78,760 -28,966 12,210 19,313 -7,103 8,046 12,726 -4,680
June 48,400 79,200 -30,800 11,870 19,424 -7,554 7,855 12,853 -4,999
July 50,331 74,091 -23,759 12,454 18,333 -5,879 8,144 11,989 -3,844
August 51,491 80,460 -28,969 12,614 19,710 -7,096 8,245 12,884 -4,639
September 50,243 68,616 -18,373 12,455 17,010 -4,555 8,069 11,019 -2,951
October 57,641 83,472 -25,832 14,588 21,126 -6,538 9,360 13,554 -4,195
November 50,353 80,171 -29,819 12,768 20,329 -7,561 8,048 12,814 -4,766
December 50,580 73,395 -22,815 12,825 18,609 -5,785 8,131 11,799 -3,668
January 58,267 88,786 -30,519 14,798 22,550 -7,751 9,343 14,237 -4,894
February 58,861 82,477 -23,616 14,814 20,758 -5,944 9,344 13,093 -3,749
March 61,542 94,016 -32,474 15,250 23,297 -8,047 9,336 14,263 -4,927
2008-09 P
April 57,633 97,151 -39,518 14,400 24,274 -9,874 8,801 14,836 -6,035
May 58,057 1,03,409 -45,352 13,782 24,548 -10,766 8,487 15,117 -6,630
Capital Flows
Capital flows during 2006-07 were substantially higher than a
year ago, led by foreign direct investment (FDI) flows, on the
back of strong growth prospects and buoyant investment
demand. FDI inflows at US $ 16.4 billion during April-January
2006-07 were substantially higher than the inflows in the
corresponding period of the previous year. FDI was channeled
mainly into financial services, manufacturing, banking services,
information technology services and construction. Mauritius, the
US and United Kingdom remain the dominant sources of FDI to
India. Outward direct investment from India also exhibited a
significant rise to US $ 8.7 billion during April-December 2006
from US $ 1.9 billion a year ago due to some large overseas
acquisitions by Indian corporates.
Capital Flows 2008-09

During 2008-09 so far capital flows have remained volatile. Net capital

flows during 2008-09 so far were lower than those in the corresponding

period of 2007-08, mainly on account of outflows by foreign

institutional investors (US $ 7.3 billion) during 2008-09 (up to October

10, 2008) in contrast to net FII inflows (US $ 18.9 billion) during the

corresponding period of 2007-08.

On the other hand, net FDI flows into India were placed higher at US $
The funds raised through issuances of ADRs/GDRs abroad were at

US $ 1.1 billion during April-August 2008 (US $ 2.8 billion in April-

August 2007).

NRI deposits recorded a net inflow of US $ 273 million during April-

August 2008 mainly due to inflows under the rupee deposit accounts

as against a net outflow (US $ 168 million) during April-August 2007.

With net capital flows being higher than the current account deficit,
 Capital Flows (US $ billion)

Components 2008-09 2009-10

(April-March) (January-June)
Foreign Direct Investment
FDI into India 35.0 10.0
FDI Abroad 17.5 7.4
FIIs (net) -15.0 5.6
ADRs/GDRs 1.2 0.06
External Aid (Net) 2.6 0.88
ECB (Net) 8.2 1.50
Short-term
Trade Credits (Net) -5.8 -8.6
NRI Deposits (Net) -7.7 -10.6

Source: RBI
INDIA’S FOREIGN EXCHANGE RESERVES
Why BOP Statistics Are Important
• BOP statement contains useful information for
financial decision makers.
• In the short run, BOP deficits or surpluses may
have an immediate impact on the exchange rate
• When exchange rates are market determined,
BOP figures indicate excess demand or supply
for the currency and the possible impact on the
exchange rate
• May signal a policy shift on the part of the
monetary authorities of the country, unilaterally
or in concert with its trading partners
 BOP and the Macroeconomy
• Persistent imbalance- exchange rate changes and/or
policy responses.
• Reserve loss, not sterilized, leads to monetary
contraction, higher interest rates, economic slowdown
• Reserve gain leads to monetary expansion, lower
interest rates, economic upturn
• No intervention leads to exchange rate depreciation
or appreciation – quantity impacts on exports, imports
thereby other sectors
• Excessive imbalance (-), may lead to crises/panics.