Balance of Payments

Nations continually carry out economic, commercial and

financial transactions between residents of one nation and
rest of world in the form of :
-- exchange of goods for goods
-- goods for services
-- services for services
-- goods and services for money etc.
Summary of these transactions for a period carries great
economic significance for the nation.
The systematic record of all economic transactions between
residents of a country and rest of world in a given period is
called the Balance of Payment.
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Presentation by Prof. H.Ganguly.

BOP statistics are published monthly by RBI in India.

These are analysed by bankers, businessmen, economists
foreign exchange traders etc. to know international
economic performance of the country.

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BOP is a double entry system statement of followings :

-- all receipts for goods exported
-- all services rendered
-- capital received by residents* of the nation
-- and payments made by residents* for goods imported and
services received in addition to capital transferred to
non-residents and foreigners.
* Residents mean individuals , businesses and govt.
agencies.
-- Military personnel, diplomats, tourists and workers who
emigrate temporarily
are considered residents of the 2
Presentation by Prof. H.Ganguly.
country of their citizenship.

On the other hand, Balance of Trade considers the value

of exports and imports of visible items i.e. merchandise only.
-- It does not take into account trade of invisible items.
-- Thus Balance of Trade is a sub-set of Balance of
Payment.
Components of Balance of Payment
* B.O.P. on Current account
* B.O.P. on Capital account
* Unilateral Payment accounts
* Official Settlement accounts

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Presentation by Prof. H.Ganguly.

* Balance Of Payment on Current Account

-- It includes value of exports and imports of visible items

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and receipts and payments on invisibles i.e. services like

banking, insurance, travel, tourism, transportation etc.
-- Balance of Payment on current account is added to
determine nations Gross Domestic Product (GDP).
* Balance of Payment on Capital Account
-- It comprises of
i) Private capital (both long and short-term) :
Long- term with maturity period of more than one year
and short-term with maturity of one year or less.
-- Long-term private capital includes Foreign
Investments ( both Direct and Portfolio), long term
loans, foreign currency deposits and unclassified
capital account receipts of foreign currency, SDRs etc.
Presentation by Prof. H.Ganguly.

ii) Banking capital covers the external financial assets and

liabilities of commercial and co-operative banks who
deal in foreign exchange.
iii) Official capital are RBIs holding of foreign currency,
SDRs etc. on behalf of Govt. of India in the form of loan,
miscellaneous receipts, payments etc.
-- Capital outflow from home country to foreign
countries is treated as debit and inflow of capital from
foreign countries to home country is treated as credit.

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93-94
97-98
02-03
05-06

Inflow on
cap. account
$ 9.882 b.
7.867
10.640
24.238

Curr. a/c bal.

Import cover of
as %age of GDP For. Exch.(months)
(-) 0.4 %
8.6 months
(-) 1.4 %
6.9
n.a.
n.a.
(-) 1.1%
11.6

Presentation by Prof. H.Ganguly.

* Unilateral Transfers Account

It comprises of uni-directional transactions like giving of
gifts. Disaster relief, foreign aids, govt. grants, pension
paid to and received by Indian citizens for services
rendered abroad.
* Official Settlements Account
It represents official sales of foreign currencies and other
reserves to foreign countries or official purchase of foreign
currencies or other reserves from foreign countries.
-- Credits here are money received from official sale of
foreign currencies and reserves. Similarly, debits comprise
of official purchases of foreign currencies and other assets.

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Balance on Current Account consist of exports and

imports of goods and services plus net unilateral transfers.
Presentation by Prof. H.Ganguly.

Equilibrium in Balance of Payment of Nations

-- When demand for and supply of foreign currency in a
nation in a given period are equal it is viewed as
equilibrium position in BOP.
-- But in case of most of nations, it is not so i.e. they either
enjoy a surplus BOP or deficit. It represents disequilibrium
in Balance of Nations.
Disequilibrium in BOP are caused by :
* Economic factors
* Political factors and
* Sociological factors.
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Presentation by Prof. H.Ganguly.

* Economic Factors may cause

1) Development Disequilibrium
2) Cyclical Disequilibrium
3) Secular disequilibrium and
4) Structural Disequilibrium
1. Development Disequilibrium

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-- Developing countries mostly take up activities like

establishment of industries, infrastructure etc. which
require greater imports of capital goods, machinery etc.
In addition it also shoots up imports of consumer goods on
account of increase in per capita income and aggregate
demands.
-- Thus increased developmental activities result in
greater outflow of foreign currency leading to deficit in
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BOP.

2. Cyclical Disequilibrium
Due to fluctuations in business cycle in a country , value
of imports of consumer goods and then consumer goods
go up or down periodically, both of which lead to
disequilibrium in BOP.
3. Secular Disequilibrium
It mostly happens in developed countries where disposable
income of people are very high. It raises in turn the cost of
production and price of goods and services.
-- Consequently, developed countries prefer to outsource
goods and services from other countries where quality of
goods is high and cost of production is low.
-- It may lead to secular disequilibrium in BOP of nation.
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Presentation by Prof. H.Ganguly.

4. Structural Disequilibrium
-- Sometimes notable shift comes in nature of economy of
countries e.g. from agricultural to manufacturing or
services.
-- These may call for structural changes in developing
alternative items, sources of supply, changes in transport
channels and also costs.
-- These structural changes may enhance imports of capital
goods and consumer goods resulting in deficits in BOP.
Indias BOP Disequilibrium due to Structural Changes
Between 1999-2000 & 2000-2001, structural changes in
Indias economy increased POL imports from $ 5.64 b. to
$ 9.77 b. ; electronic goods from $ 1.47 b. to $ 2.05 b. etc.
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Presentation by Prof. H.Ganguly.

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* Political Factors
-- Political uncertainties, instability, internal
disturbances,
external wars etc. create threatening situation for local
industry and investments. In such cases domestic
production declines leading to increase in imports and
outflow of capital
-- It results in deficit in BOP as it happened in Sri Lanka,
Pakistan etc.
* Social Factors
-- Changes in culture, taste, preference, fashion etc. bring
about changes in nature of import of consumer items first,
followed by capital goods leading to deficit in BOP.
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Presentation by Prof. H.Ganguly.

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Correction of BOP Disequilibrium

When BOP becomes surplus, nations enjoy the same as it
offers a number of desirable situation like increased
purchasing power and influence in global market.
-- In cases of disequilibrium due to deficit, countries adopt
measures to eliminate the same completely, if not possible
at least reduce it.

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1. Automatic Correction of BOP Disequilibrium

-- Deficit in BOP indicates that demand for foreign
exchange is higher than its supply in the nation.
-- It leads to devaluation of local currency in relation to the
foreign currency. Thereby imports become costlier and
exports cheaper. So imports get reduced and exports are
increased. Thereby outflow of FE is reduced and income is
increased leading to automatic restoration of equilibrium.
Presentation by Prof. H.Ganguly.

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2. Deliberate Measures
Govt. also adopts certain measures to control deficit BOP
Deliberate
Measures as indicated.
A.called
Monetary
Measures
* Reduction in Money Supply :
-- RBI takes to control credit so that money supply in
the country is reduced which leads to decline in income,
purchasing power, aggregate demand and consumption.
-- Thus imports decline and hence outflow of foreign
currency. In turn exports grow and inflow of foreign
currency to set right BOP disequilibrium.

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* Interest Rate Adjustment :

Inflow of FE in deficit BOP nation falls, so liquidity
falls. So on short term basis Interest rate is raised
leading to investments and loans coming from foreign
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nations improving
BOP scenario.

* Devaluation
In case of deficit BOP, purchasing power of local currency
reduces, the Govt. delebarately devalues currency. Thus
imports become costlier and exports cheaper. Hence
increased exports and reduced imports balance the
disequilibrium of BOP.
* Exchange Control
Exporters are to surrender the foreign exchange earned to
RBI through authorised dealers and importers are to draw
foreign exchange from authorised dealers.
-- Through suitable policies from time to time, Govt. of
India and RBI control imports to reduce deficit of BOP.

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B. Trade Measures
These measures try to restore equilibrium through
Presentation
by Prof. H.Ganguly.
increasing exports
and/or
reducing imports.

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* Export Promotion Measures

Govt. of India endeavour to boost exports by reducing
export duties, providing incentives, encouraging EOUs,
forming EPZs, FTZs etc.
* Import Control Measures
Import control measures include ways and means of
restricting imports through duties, quotas, licences etc.

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C. Miscellaneous Measures
Govt. of India tries to remove BOP disequilibrium by
assortment of means like
a) Attracting Foreign Investments both FDI and FPI
b) Attracting NRI deposits
c) Promoting tourism
d) Negotiating
Foreign currency loans etc.
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Structure of Indias BOP Statement

Credit Debit Net
A. Current Account
I. Merchandise
i) Private
ii) Govt.
II. Invisibles
1. Non-monetary gold
2. Travel
3. Transportation
4. Insurance
5. Investment Income
6. Govt. not included anywhere
7. Miscellaneous
8. Transfers Receipts / Payments
i) Official
ii) Private
Presentation by Prof. H.Ganguly.
Total Current Account ( I + II )

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Indias BOP Account

(contd.)

Credit Debit Net

B. Capital Account
1. Private
i) Long-term
ii) Short-term
2. Banking
3. Official
i) Loans
ii) Amortisation
iii) Miscellaneous
Total Capital account (1 + 2 + 3 )
C. I.M.F.
D. S.D.R. Allocation
E. Capital Account, I.M.F. & S.D.R. Allocation
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Presentation by Prof. H.Ganguly.

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Indias BOP Account (Contd.)

Credit Debit Net
F. Total Current Account,
Capital Account,I.M.F.
& S.D.R. Allocation
G. Errors & Omissions
H. Reserves and Monetary Gold

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Presentation by Prof. H.Ganguly.

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