WHAT IS BOP ?

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The balance of payments accounts are those that record all transactions

between the residents of a country and residents of all foreign nations.

The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers.

It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits).

Balance of payments is one of the major indicators of a country's status in international trade
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CURRENT ACCOUNT
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Includes all imports and exports of goods and services.

Includes unilateral transfers of foreign aid.

If the debits exceed the credits, then a country is

running a trade deficit.

If the credits exceed the debits, then a country is running a trade surplus.
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CAPITAL ACCOUNT
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1.

2.
3. 4.

Foreign Investment(FDI, FII) Banking Capital (NRI Deposits) Short term credit External Commercial Borrowings(ECB)

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OFFICIAL INTERNATIONAL RESERVES

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The official international reserve account records the change in stock of official international reserve assets (also known as foreign exchange reserves) at the country's monetary authority .

Official reserves assets include gold reserves, foreign currencies, SDRs, reserve positions in the IMF.
{Special Drawing Rights (SDRs) are potential claims on the freely usable currencies of IMF members.}
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NET ERRORS AND OMISSIONS

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This is the last component of the balance of payments and principally exists to correct any possible errors made in accounting for the three other accounts. They are often referred to as "balancing items".

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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.

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 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 countrys 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. 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 OF BOP DISEQUILIBRIUM

Disequilibrium = there is surplus or deficit in BOP Deficit = demand for forex exceeds the supply Reasons:

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Economic factors Political factors Sociological factors

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.

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if high production costs locally: but high disposable incomes and hence very high aggregate demand and high prices.)

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

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Changes in tastes, preferences, fashions etc., will affect the exports and imports. Hence BOP

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 powerreduce demand -- so less imports
b) fall in prices cheaperso more exports
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DEVALUATION

Exports cheaper and imports costlier

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E.g.: 1966 June: 4.76 to 7.50

EXCHANGE CONTROL

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To

conserve forex Central Bank

TRADE MEASURES

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Export

incentives High import duties and restrictions Canalisation

OTHER MEASURES
Getting

foreign loans Foreign assistance, Aid Development of tourism Export of services, BPOs, ITES, etc.

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Indias 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 countrys 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 2009February 2010, mirroring the impact of strong recovery in growth.

Indias balance of payments position during AprilDecember 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. Indias 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 Indias balance of payments. The current account position during the third quarter of 2009-10 witnessed a turnaround in both exports and imports. Indias 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 Indias growth prospects are the factors that underlie the momentum of sustained capital inflows during the year.

During 2009-10, Indias foreign exchange reserves increased by US$ 27.1 billion to reach US$ 279.1 billion as at endMarch 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 Banks 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 Indias 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.

Indias 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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