Definition - Balance of Payment A Balance of Payment account is a statement of double entry system of record of all economic transactions (involving foreign payments) between residents of a country and the rest of the world carried out in specific period of time.
Purpose Of BOP
Provides data for economic analysis
Reveals changes in the composition & magnitude of foreign trade
Provides indications of future repercussions of country’s past trade performances
Reveals the weak and strong points of a country’s foreign trade relations
Favorable Balance Of Payments – Value of total receipts more than total payments
Adverse Balance Of Payments – Value of total receipts less than total payments
Balanced Balance Of Payments – Value of total receipts equals total payments
Unrequited receipts – Receipts for which nothing has to be paid in return.
Unrequited payments – Payments for which nothing is received in return.
Balance of Trade Definition: Difference between value of exports and imports of visible items only BOT BOP
Records only merchandise transactions
Does not record transactions of capital nature
A part of current account of BOP
Records transactions relating to both goods and services
Records transaction of capital nature
Includes BOT , Balance of services , Balance Of Unrequited Transfers and Balance Of Capital Transactions.
BALANCE OF PAYMENT ACCOUNTS
All transactions relating to goods, services and unrequited transfers constitute current account
Flow of items pertaining to specific period of time
Visible items include
Invisible items include
Structure of current account Transactions Credit Debit Net Balance
Capital receipts (Borrowings from abroad , capital repayments by , or sale of assets to foreigners, increase in stock of gold and reserves of foreign currency etc.)
Imports of goods(Visible items)
Imports of services(Invisibles)
Unrequited payments( gifts, remittance, indemnities etc. to foreigners)
Capital payments (lending to , capital repayments to , or purchase of assets from foreigners, reduction in stock of gold and reserves of foreign currency etc.)
Let us consider the following hypothetical situation:
Export of goods Rs. 550 Crore
Import of goods Rs. 650 Crore
Export of services Rs. 150 Crore
Import of services Rs. 70 Crore
Unrequited receipts Rs. 100 Crore
Unrequited payments Rs. 80 Crore
Capital receipts Rs. 200 Crore
Capital payments Rs. 200 Crore.
Balance Of Payment Account Credits
Export of goods 550
Export of services 150
Unrequited receipts 100
Capital receipts 200
Total receipts 1000
Import of goods 650
Import of services 70
Unrequited payments 80
Capital payments 200
Total payments 1000
EQUILIBRIUM IN BOP ACCOUNTS
Total receipts equals total payments arising out of transfer of
Goods and services
These transactions are classified as:-
Induced transactions or Accommodating capital flows
In the current account autonomous transactions are the export and import of goods and services
When export is not equal to import, short run capital movements such as international borrowing and lending take place, which are called induced or accommodating transactions
In the capital account the export and import of long term capital are autonomous transactions
The short term capital movements viz. gold movements and accommodating capital movements on account of autonomous transactions are induced transactions.
Example of Autonomous and Accommodating transactions
Export of goods 550
Export of services 150
Import of goods 800
Import of services 50
Total receipts and total payments inequality shows disequilibrium of balance of payments account
Total receipt and payment arising from autonomous transactions determine the deficit or surplus in the balance of payments
If payments>receipts, BOP shows Deficit
If payments<receipts, BOP shows Surplus
CAUSES OF DISEQUILIBRIUM
Increase in imports
Slow progress in exports
Burden of interest payments
Deficit in capital account
Supply of credit
Special treatment to NRIs
Announcement of trade policies
Improvements in production efficiency
Variations in India’s deficit position
1991-1995 :- Equal growth of exports & imports
1995-1999 :- Growth of imports & stagnation of exports(widening of trade deficits)
1999-2000 :- Exports recovered while imports surged(continued rise in trade deficits)
2000-2001 :- Rise in exports & stagnation of imports(normal level of trade deficit)
2001 Onwards – Exports rising, but still deficit
India’s current BOP position
Remained comfortable during 2007-08
Increase in net inflows by FIIs
Increase in FDI inflows
Increase in net surplus
Capital Account Convertibility
In India, Foreign exchange transactions in foreign currencies are broadly classified into two accounts :-
Current Account Transactions Capital Account Transactions Components
Transactions which gives rise or spends national income.
Merchandise /Invisible export & Imports .
Short Term Capital transactions
Long Term Capital transactions
Import of refrigerator
Export Of Software
Export of steel
Sending money to a child studying in United States .
Capital Inflows :
Indian company taking loan from US bank .
Foreign investment in India (FDI)
Indian Companies buying assets abroad. Ex- Tata for Corus Steel
CAC is desirable due to following reasons :-
Reduction in Cost of Capital.
Diversify Portfolios Internationally.
Induces Competition against Indian Finance
Reduce size of black economy
Convertibility Aspect of Current Account India has “Current Account convertibility” which means that we are free to buy foreign exchange for importing goods, in other words rupee is fully convertible on current account . Convertibility Aspect of Capital Account Today the rupee is not fully convertible on capital account as there exists restriction on the money that comes in India or that goes out to buy assets abroad .