Balance of Payments

Macro Economics
Reasons to Study International
Trade
1. Due to globalization – we are moving
towards a single global economy which
have powerful economic influences on
other economics through Trade
Relations .
2. If U.S Economy grows or goes into
recession affects the other economies.
3. If the industrial countries shift to fiscal
stimulus or stringency makes a
differences to U.S economy.
Balance of Payments
Balance of Payments:
BOP is a systematic record of economic
transactions of the residents of a
country with rest of the world during
a given period of time.
Thus, the aim is to present an account
of all receipts and payments on
account of goods exported & goods
imported by the residents of a
country.
Balance of Trade
Balance of Trade: refers to the difference in
value of imports & exports of commodities
only.
◘ If imports & exports are exactly equal we
have balanced trade.
◘ If value of exports exceeds value of imports
we have favourable balance of trade.
◘ If value of imports exceeds value of
exports, the country is said to have deficit
or adverse balance of trade.
Balance of Payments
Accounts

 A country’s balance of payments

accounts keep track of both its
payments to and its receipts from
foreigners.
 Every international transaction
automatically enters the balance of
payments twice: once as a credit
(+) and once as a debit (-).
Balance of Payments Accounts
 Three types of international
transactions are recorded in the
balance of payments:
 Exports or imports of goods or services
in the current account
 Purchases or sales of financial assets in
the financial account
 Transfers of wealth between countries in
the capital account.
Balance of Payments Accounts
 The Current Account:
The current account records trade in goods and services,
as well as transfer payments. It is divided into :
 Merchandise trade
 Exports or imports of goods
 Services
 Payments for legal assistance, tourists’
expenditures, and shipping fees, royalty payments
and interest payments.
 Income
 International interest and dividend payments and
the earnings of domestically owned firms
operating abroad
 Net Transfer Payments
Remittances, gifts and grants
Balance of Payments Accounts
 The Capital Account
Trade balance simply records trade in goods,
adding trade in services and net transfer to the
trade balance, we arrive at the current account
balance
 The Financial Account
 It measures the difference between sales of
assets to foreigners and purchases of assets
located abroad.
 Financial inflow (capital inflow)
 A loan from the foreigners with a promise that they
will be repaid
 Financial outflow (capital outflow)
 A transaction involving the purchase of an asset
from foreigners
Balance of Payments Accounts
 The simple rule for BOP accounting is that
any transaction that gives to a payment by a
country’s resident is a deficit item in that
country’s BOP eg gifts to foreign, a purchase
of land in Spain, or a deposits in foreign
banks.
 Eg of surplus items would be sales of goods
abroad, payments from foreign, pensions
from abroad received by Indian residents,
foreign purchases of Indian assets .
Capital Account
 The capital and financial account is that
balance of payments account in which all
cross-border transactions involving
financial assets are listed. This includes
transactions between foreign and domestic
residents, and foreign and domestic
governments.
 All purchases or sales of assets, including:
 Direct investment
 Securities (debt)
 Bank claims and liabilities
 Official reserves transactions
 When Indian citizens buy foreign securities or
when foreigners buy Indian securities, they are
listed here as outflows and inflows,
Account Overview (Level 2)
Capital Account
Current Account Changes in US assets abroad, net
Merchandise trade other US govt assets
exports US private assets
imports All changes, net
Trade Balance
Changes in foreign assets in the US,
Services
military trans. (net) net foreign private assets
other services, net All changes, net
Service Balance
Balance on goods & services
Investment income, net Changes in holdings of official
Unilateral transfers international reserves, net
US government grants
US govt pensions, and
other transfers Statistical discrepancy
Private remittances and
other transfers
All transfers, net Balance on capital account
Balance on current account
 Current Account Surplus and
Deficit

 A current account surplus means

exports of goods and services,
investment income and transfers
exceed imports and outflows.
 A current account deficit means
imports of goods and services,
and outflows are greater than
exports and inflows; must be
financed by borrowing (capital
account inflows).
Current Account Surplus and
Deficit
 Deficit in current account is financed
by selling assets or borrowings
abroad. This implies that the country
should have a capital account surplus.
 In short a current account deficit
should be financed by an offsetting
capital inflow.
BOP Surplus and Deficit (Continued)

 In terms of the supply and demand of a

nation’s currency, there is:
 A balance of payments surplus if quantity
demanded for a currency exceeds quantity
supplied, putting upward pressure on the
value of the nation’s currency.
 A balance of payments deficit if quantity
supplied of a currency exceeds quantity
demanded, putting downward pressure on
the value of the nation’s currency.
Exchange Rates
 Exchange Rate is the price of a
foreign currency in terms of a
Domestic currency .
 The market in which currencies are
exchanged traded or converted is
called “Foreign Exchange Market “
Floating or Flexible Exchange
Rate
 Since exchange rate is a price, its
determination can be explained
through demand for and supply of
currencies. The system of exchange
in which the value of a currency is
allowed to adjust freely or to float as
determined by demand for and supply
of foreign exchange is called a flexible
exchange system.
Fixed or Pegged Exchange Rate
 If the exchange rate instead of being
determined by demand for and supply
of foreign exchange is fixed by the
government, it is called the fixed
exchange rate system, which
prevailed under the Bretton Wood
System , where exchange rates were
pegged at a certain rate .
Appreciation of Currency
 Appreciation of a currency is the
increase in its value in terms of
another foreign currency. For eg if
the value of rupee interns of Us dollar
increases from Rs 45.50to Rs 44 to a
dollar, Indian rupee is said to
appreciate. This indicates
strengthening of the rupee.
Depreciation of Currency
 If the value of Indian rupee interms
of US dollars falls, say from Rs45.5 to
Rs 46 to a dollar, the Indian rupee is
said to depreciate which shows
weakening of Indian rupee.
Devaluation and Revaluation of
a Currency
 Devaluation is a reduction in the value of a
currency with respect to other monetary units.
In common modern usage, it specifically
implies an official lowering of the value of a
country's currency within a fixed exchange rate
system, by which the monetary authority
formally sets a new fixed rate with respect to a
foreign reference currency. In contrast,
(currency) depreciation is used for the
unofficial decrease in the exchange rate in a
floating exchange rate system. The opposite of
devaluation is called revaluation
Devaluation and Revaluation of
a Currency
 Revaluation This term is specially
used as revaluation of a currency,
where it means a rise of currency to
the relation with a foreign currency in
a fixed exchange rate. In floating
exchange rate correct term would be
appreciation.
Currency Convertibility
 By convertibility of a currency we mean
currency of a country can be freely converted
into foreign exchange at market determined
rate of exchange, that is, exchange rate as
determined by demand for and supply of a
currency. For eg, convertibility of rupee means
that those who have foreign exchange ( eg US
dollars, Pound Sterling etc ) can get them
converted in rupee and vice-versa at the
market determined exchange rate
Current Account and Capital
Account Convertibility
 A current may be convertible on
current account (i.e exports, imports
of visible and invisible items )
 By Capital Account convertibility we
mean that in respect t of capital
flows, i.e flows of portfolio capital,
direct investment flows, flows of
borrowed funds and dividends and
interest payable on them.
Current Account and Capital
Account Convertibility
 By convertibility of rupee on capital
account means those who bring in
foreign exchange for purchasing
stocks, bonds in the Indian stock
market, or for direct investment in
power projects, highways, steel plant
etc. can get them freely converted
into rupees converted into us dollar.
 The End

 Thank You ….