Trade Balancedifference between imports and exportsBalance of Paymentsall transactions between countries
The balance of payments of a country is asystematic record of all economic transactionsbetween the residents of a country and the restof the world. It presents a classified record ofall receipts on account of goods exported,services rendered and capital received byresidents and payments made by them onaccount of goods imported and servicesreceived from the capital transferred to
BOP transactions Tata buy jaguar and land rover. Ford India pays dividends to parent. An American tourist purchases a necklace in India. 5
BOP records all the transactions that create demand for and supply of a currency. This indicates demand-supply equation of the currency. This can drive changes in exchange rate of the currency with other currencies. BOP may confirm trend in economy’s international trade and exchange rate of the currency. This may also indicate change or reversal in the trend. This may indicate policy shift of the monetary authority (RBI) of the country.
a) If a transaction earns foreign currency for the nation, it is a credit and is recorded as a plus item. Credit Transactions (+ve): Provision of goods and services to non-residents Income receivable from non-residents A decrease in foreign financial assets An increase in foreign financial liabilities b) If a transaction involves spending of foreign currency it is a debit and is recorded as a negative item. Debit Transactions (-ve): Purchase of goods & services from non-residents Income payable to non-residents An increase in foreign financial assets A decrease in foreign financial liabilities
BOP (X – M) + (CI – CO) + (FI – FO) + FXB = BOPWhere: X = exports of goods and services Current M = imports of goods and services Account CI = capital inflows Balance Capital CO = capital outflows Account FI = financial inflows Balance Financial FO = financial outflows Account Balance FXB = official monetary reserves 9
BOP on current account refers to the inclusion ofthree balances of namely – Merchandisebalance, Services balance and UnilateralTransfer balance. In other words it reflects thenet flow of goods, services and unilateraltransfers (gifts). The net value of the balances ofvisible trade and of invisible trade and ofunilateral transfers defines the balance oncurrent account.
Goods Trade or Balance of Trade (BOT) – export/import of goods. Services Trade – export/import of services (financial, construction, and tourism). Income – predominately current income associated with investments made in previous periods, + wages & salaries paid to non-resident workers. Current Transfers – financial settlements due to change in ownership of real resources or financial items. Any transfer b/n countries which is one-way, a gift or a grant. Infosys buys LCDs from Hong Kong. Indian Airlines buys Boeing jet. Infosys places an ad in the US News Paper. Bank Austria pays salary to rep in India office. Toyota India pays dividend to Toyota Japan.
The capital account records all international transactions that involve a resident of the country concerned changing either his assets with or his liabilities to a resident of another country. Transactions in the capital account reflect a change in a stock – either assets or liabilities. A resident of India acquires an immovable property outside India or acquires shares of a foreign company. This way his/her overseas assets are increased; or (ii) a resident of India borrows from a non-resident through External commercial Borrowings (ECBs). This way he/she has created a liability outside India.
Financial account: three components; classified by degree of control, Direct Investment – Net balance of capital which is dispersed from and into India for the purpose of exerting control over assets. E.g. Indian company acquires foreign company stake (-) Foreign company acquires Indian company stake (+) foreign direct investment (FDI) How much shall the country control the direct investments? What can foreigners buy? FDI in Retail …… How shall profit be distributed? 13
Portfolio Investment – No voting or control rights over the asset. Purchase/sale of equity securities. Purchase/sale of debt securities. Far more volatile than FDI. Other Investment Assets/Liabilities –Short & long- term trade credits, cross-border loans, currency & bank deposits, & other accounts receivable and payable in cross-border trade. 14
Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Reserve Account. Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to time to member countries. It can be used to settle international payments between monetary authorities of two different countries. - Net Errors and Omissions – Account is used to account for statistical errors and/or untraceable monies within a country
A country, like India, which is on the path of development generally, experiences a deficit balance of payments situation. This is because such a country requires imported machines, technology and capital equipments in order to successfully launch and carry out the programme of industrialization
BOP & Macroeconomic Variables A nation’s balance of payments interacts with nearly all of its key macroeconomic variables. Interacts means that the BOP affects and is affected by such key macroeconomic factors as: Gross Domestic Product (GDP) Exchange rate Interest rates Inflation rates 17
Temporary causes National Income Inflation Economic Development Borrowing and Lending Change in exchange rate Political factors-like instable govt.
Temporary Causes- Temporary causes may arises due to variations in the trade, effect of weather on agriculture production etc. National Income - Another cause is the change in country’s national income. If the national income of a country increases, it will lead to an increase in imports thereby creating a deficit in balance of payments. Inflation- Inflation is another cause of disequilibrium in the balance of payment. If there is inflation in the country prices of exports increase, thus increase in export prices leading to decline in exports and rise in imports result in adverse.
Economic Development- A country’s balance of payments also depends on its stage of economic development. If a country is developing it will have a deficit in its balance of payments. Borrowing and lending- A country which gives loans and grants on a large scale to other countries has a deficit in its balance of payments on capital account. On the other hand, a developing country borrowing large funds from other countries may have a favourable balance of payments.
Change in exchange rate – This change arise due to change in exports and imports. If exports of the country are more then imports the demand for its currency increase so that the rate of exchange moves in favours. On the other hand if imports are more than exports the demand for the foreign currency increase and the rate of exchange will against the country.