2. Introduction
oBalance of payments (BOP)accounts are an accounting record of all
monetary transactions between a country and the rest of the world. These
transactions include payments for the country's exports and imports of
goods & services, financial capital, and financial transfers.
A country has to deal with other countries in respect of 3 items:
oVisible items which include all types of physical goods exported and
imported.
oInvisible items which include all those services whose export and import
are not visible. e.g. transport services, medical services etc.
oCapital transfers which are concerned with capital receipts and capital
payment.
3. Balance of Payment (Definition)
oThe balance of payment of a country is a systematic
accounting record of all economic transactions
during a given period of time between the residents
of the country and residents of foreign countries.
4. Components of BOP
oCurrent Account:
It includes imports and exports of goods and services
and unilateral transfer of goods and services.
oCapital Account:
Under this are grouped transactions leading to changes
in foreign assets and liabilities of the country.
5. Accounting Treatment of Items
(Debit and Credit Items)
oAny item which gives rise to a sale of foreign
exchange (an inflow) is recorded as a credit item (+)
in the accounts e.g. export of goods and services
oAny item which gives rise to the purchase of foreign
exchange (an outflow) is recorded as a debit item (-)
in the accounts e.g. imports of goods and services.
6. BOP Disequilibrium
oBOP is a double entry accounting record, then apart
from errors and omissions, it must always balance.
oThe BOP deficit or surplus indicate imbalance in the
BOP.
oThis imbalance is interpreted as BOP Disequilibrium.
oA country’s balance of payments is said to be in
disequilibrium when its autonomous receipts (credits)
are not equal to its autonomous payments (debits).
7. BOP Deficit
oA deficit or an unfavorable balance exists when the
value of autonomous debit items exceeds the value
of autonomous credit items.
8. BOP Surplus
oA surplus or a favorable balance exists when the
value of autonomous credit items exceeds the value
of autonomous debit items.
9. Types of Disequilibrium
oCyclical Disequilibrium
oDisequilibrium caused by trade cycles
oTerms of trade and growth of trade undergo a change as a
result of trade cycles. It affects BOP.
oIt can be corrected by import-export adjustment
oSecular Disequilibrium
oWhen an economy undergoes intensive changes, it causes
secular or long term disequilibrium in the BOP
10. Cont…
oStructural Disequilibrium
oWhen structural changes take place in some sectors of the
economy, they effect import-export trade of the country
resulting in structural disequilibrium
oFundamental Disequilibrium
oWhen a country suffers chronic disequilibrium in its BOP, then
according to IMF it will be called fundamental disequilibrium.
oTemporary Disequilibrium
oShort term factors account for temporary disequilibrium in
BOP.
11. Causes of Disequilibrium
Economic factors
oStructural changes in the economy
oChanges in exchange rates (overvaluation / undervaluation)
oChanges in the level of foreign exchange reserves
oCyclical fluctuations
oInflation / deflation Developmental expenditure undertaken by
developing countries, etc.
Natural factors
oFloods, Earthquake etc.
12. Cont…
Social factors
oThe social factors may include changes in tastes &
preferences due to demonstration affect, population
growth rate, rate of urbanization, etc.
Political factors
oThe political factors may include – political stability /
instability in a country, war, change in diplomatic
policy, etc.
13. Measures to correct disequilibrium
in BOP
oSustained or prolonged deficit has to be settled by
short term loans or depletion of capital reserve of
foreign exchange and gold.
14. Recommended Remedial measures
Export Promotion:
oExport should be encouraged by granting various
bounties to manufacturers and exporters. At the same
time , imports should be discouraged by undertaking
import substitution and imposing reasonable tariffs.
15. Cont…
Import:
oRestrictions and Import Substitution are other
measures of correcting disequilibrium.
Reducing Inflation:
oInflation (continuous rice in prices) discourages exports
and encourages imports. Therefore, government
should check inflation and lower the prices in the
country.
16. Cont…
Exchange Control:
oGovernment should control foreign exchange by
ordering all exporters to surrender their foreign
exchange to the central bank and then ration out
among licensed importers.
17. Cont…
Devaluation of Domestic Currency:
oIt means fall in the external (exchange) value of domestic
currency in terms of a unit of foreign exchange with
makes domestic goods cheaper for the foreigners.
Devaluation is done by a government order when a
country has adopted a fixed exchange rate system. Care
should be taken that devaluation should not cause rise in
internal price level.
18. Devaluation of Domestic Currency
Explain
oWhen devaluation is effected, the value of home currency
goes down against foreign currency.
oLet us suppose the exchange rate remains $1 = Rs. 10 before
devaluation. Let us suppose, devaluation takes place which
reduces the value of home currency and now the exchange
rate becomes $1 =Rs.20.
oAfter such a change our goods becomes cheap in foreign
market.This is because, after devaluation, dollar is exchanged
for more domestic currencies
19. Cont…
Depreciation:
oLike devaluation, depreciation leads to fall in external
purchasing power of home currency. Depreciation occurs
in a free market system wherein demand for foreign
exchange far exceeds the supply of foreign exchange
market of a country (Mind, Devaluation is done in fixed
exchange rate system).
