Balance of Payments
all transactions between countries
difference between imports and exports
The balance of payments of a country is a
systematic record of all economic transactions
between the residents of a country and the rest
of the world. It presents a classified record of
all receipts on account of goods
exported, services rendered and capital
received by residents and payments made by
them on account of goods imported and
services received from the capital transferred to
Tata buy jaguar and land rover.
Ford India pays dividends to parent.
An American tourist purchases a necklace in India.
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
(X – M) + (CI – CO) + (FI – FO) + FXB = BOP
X = exports of goods and services
M = imports of goods and services
CI = capital inflows
CO = capital outflows
FI = financial inflows
FO = financial outflows
FXB = official monetary reserves
BOP on current account refers to the inclusion of
three balances of namely – Merchandise
balance, Services balance and Unilateral
Transfer balance. In other words it reflects the
net flow of goods, services and unilateral
transfers (gifts). The net value of the balances of
visible trade and of invisible trade and of
unilateral transfers defines the balance on
Goods Trade or Balance of Trade (BOT) – export/import of
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
What can foreigners buy?
FDI in Retail ……
How shall profit be distributed?
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.
Three accounts: IMF, SDR, & Reserve and
Monetary Gold are collectively called as The
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
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)
BOP & Macroeconomic Variables
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
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.
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