Structure of Balance of payment and elements

1. BALANCE OF PAYMET

2. Balance Of Payment : Definition RBI
•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 non-residents or foreigners.

3. Features
•It is a systematic record of all economic transactions
between one country and the rest of the world.
•It includes all transactions, visible as well as invisible.
•It relates to a period of time. Generally, it is an annual
statement.
•It adopts a double-entry book-keeping system. It has two
sides: credit side and debit side.
•Receipts are recorded on the credit side and payments on
the debit side.

4. Structure/Components of a BOP statement
•B.O.P. on Current account
• B.O.P. on Capital account
•Unilateral Payment accounts
• Official Settlement accounts

5. Current Account
Main Components
1.Export and Import of Goods (MerchandiseTransactions orVisible
Trade)
A major part of transactions in foreign trade is in the form of export and import of
goods (visible items).
Payment for import of goods is written on the negative side (debit items) and receipt
from exports is shown on the positive side (credit items). Balance of these visible
exports and imports is known as balance of trade (or trade balance).
2. Export and Import of Services (InvisibleTrade)
It includes a large variety of non- factor services (known as invisible items) sold and
purchased by the residents of a country, to and from the rest of the world. Payments
are either received or made to the other countries for use of these services.

6. Services are generally of three kinds:
• (a) Shipping,
• (b) Banking, and
• (c) Insurance.
Payments for these services are recorded on the negative side and receipts on the
positive side.
3. Unilateral or UnrequitedTransfers to and from abroad (One sided
Transactions)
Unilateral transfers include gifts, donations, personal remittances and other
‘one-way’ transactions.These refer to those receipts and payments, which take
place without any service in return. Receipt of unilateral transfers from rest of the
world is shown on the credit side and unilateral transfers to rest of the world on the
debit side.

7. 4.Income receipts and payments to and from abroad
It includes investment income in the form of interest, rent and
profits.
Current Account shows the Net Income.
Current Account records all the actual transactions of goods and
services which affect the income, output and employment of a
country. So, it shows the net income generated in the foreign sector.
• BOP on current account is a statement of actual receipts and
payments in short period.

8. Balance on Current Account
• In the current account, receipts from export of goods, services and
unilateral receipts are entered as credit or positive items and
payments for import of goods, services and unilateral payments are
entered as debit or negative items.
The net value of credit and debit balances is the balance on current
account.
• Surplus in current account arises when credit items are more than
debit items. It indicates net inflow of foreign exchange.
• Deficit in current account arises when debit items are more than
credit items. It indicates net outflow of foreign exchange

9. Capital Account
• Capital account of BOP records all those transactions, between the
residents of a country and the rest of the world, which cause a
change in the assets or liabilities of the residents of the country or
its government. It is related to claims and liabilities of financial
nature.
Capital Account is used to:
• (i) Finance deficit in current account; or
• (ii) Absorb surplus of current account.
• Capital account is concerned with financial transfers. So, it does not
have direct effect on income, output and employment of the
country.

10. Components of Capital Account
1. Borrowings and landings to and from abroad: It includes
• All transactions relating to borrowings from abroad by private sector,
government, etc. Receipts of such loans and repayment of loans by
foreigners are recorded on the positive (credit) side.
• All transactions of lending to abroad by private sector and
government. Lending abroad and repayment of loans to abroad is
recorded as negative or debit item.
2. Investments to and from abroad: It includes
Investments by rest of the world in shares of Indian companies, real
estate in India, etc. Such investments from abroad are recorded on the
positive (credit) side as they bring in foreign exchange.

11. • Investments by Indian residents in shares of foreign companies,
real estate abroad, etc. Such investments to abroad be recorded on
the negative (debit) side as they lead to outflow of foreign
exchange.
• 3. Change in Foreign Exchange Reserves
• The foreign exchange reserves are the financial assets of the
government held in the central bank.
• A change in reserves serves as the financing item in India’s BOP. So,
any withdrawal from the reserves is recorded on the positive
(credit) side and any addition to these reserves is recorded on the
negative (debit) side. change in reserves’ is recorded in the BOP
• It must be noted that ‘account and not ‘reserves’.

12. Balance on Capital Account
• The transactions, which lead to inflow of foreign exchange (like
receipt of loan from abroad, sale of assets or shares in foreign
countries, etc.), are recorded on the credit or positive side of
capital account.
• Similarly, transactions, which lead to outflow of foreign exchange
(like repayment of loans, purchase of assets or shares in foreign
countries, etc.), are recorded on the debit or negative side.
• The net value of credit and debit balances is the balance on capital
account.

13. • Surplus in capital account arises when credit items are more than
debit items. It indicates net inflow of capital.
• Deficit in capital account arises when debit items are more than
credit items. It indicates net outflow of capital.
UnilateralTransfers 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.

14. 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.

15. In addition to the above , there are two more elements in BOP,
‘Errors and Omissions’.
• The entries under this head relate mainly to leads and lags in reporting of
transactionsIt is the balancing item, which reflects the inability to record all
international transactions accurately.
The Reserve Account
• Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called
asThe Reserve Account.
• The IMF account contains purchases (credits) and repurchase (debits) from
International Monetary Fund.
• 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.

16. Structure Of BOP
• Balance of payments is a complete record ofTotal Receipts and
Total Payments of a country in relation to other countries over a
given time period.
• Total Receipts are called CREDIT andTotal Payments are termed as
DEBIT.
• Credit side comprises of all those values received from foreign
countries. On the other hand, Debit side comprises of all the
payments made to other countries.
• It is maintained in a double entry book keeping system.

17. Structure Of BOP
CREDITS DEBITS
ITEMS OF CURRENTACCOUNT
• Export of Goods • Import of Goods
• Exports of Services • Import of Services
• UnilateralTransfer Receipts (gifts,
• indemnities from foreigners).
• UnilateralTransfer Payments (gifts,
• indemnities from foreigners).
• Income receipts. • Income payments.
ITEMS OF CAPITAL ACCOUNT
• Capital Receipts ( borrowings from capital
repayments by or sale of assets to
foreigners).
• Capital Payments ( lending to, capital
repayments to or purchase of assets from
foreigners).

18. Importance of Balance Of Payments
• BOP records all the transactions that create demand for and supply of a
currency.
• Judge economic and financial status of a country in the short-term
• 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.
• 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.

19. Balance ofTrade
• The difference between a country's imports and its exports.
Balance of trade is the largest component of a country's balance
of payments.
• Debit items include imports, foreign aid, domestic spending
abroad and domestic investments abroad.
• Credit items include exports, foreign spending in the domestic
economy and foreign investments in the domestic economy.
• When exports are greater than imports the BOT is favourable
and if imports are greater than exports then it is unfavourable

20. • Economists use BOT as a statistical tool to help them understand
the relative strength of a country's economy versus other
countries' economies and the flow of trade between nations.
• The balance of trade is also referred to as the trade balance or the
international trade balance.
• A trade surplus or deficit, taken on its own, is not necessarily a
viable indicator of an economy's health.

21. • Many people believe that trade deficit is unfavourable , bad.
• The numbers must be taken in context relative to the business
cycle and other economic indicators.
• In a recession, countries like to export more, creating jobs and
demand in the economy.
• In a strong expansion, countries prefer to import more,
providing price competition, which limits inflation without
increasing prices
• Trade deficit is not a good thing during a recession but may help
during expansion

22. Examples of Balance ofTrade
• There are countries where it is almost certain that a trade deficit will
occur. For example, the United States has had a trade deficit since
1976, in large part due to its imports of oil and consumer products.
• Conversely, China, a country that produces and exports many of
the world's consumable goods, has recorded a trade surplus since
1995.
• In 2015, the European Union, Germany, China and Japan all had very
large trade surpluses, while the United States, the United
Kingdom, Brazil, Australia and Canada had the largest trade
deficits.

23. Factors affecting BOT
A country's balance of trade is defined by its net exports (exports minus
imports) and is thus influenced by all of the factors that affect
international trade.
• These include factor endowments (labor, land and capital) and
productivity, barriers to trade, investment activity and fiscal policy.
Demand also affects the balance of trade.
• The cost of production (land, labor, capital, taxes, incentives, etc.) in
the exporting economy vis-à-vis those in the importing economy;
• The cost and availability of raw materials, intermediate goods and
other inputs;

24. • Exchange rate movements;
• Multilateral, bilateral and unilateral taxes or restrictions on trade;
• Non-tariff barriers such as environmental, health or safety
standards;
• The availability of adequate foreign exchange with which to pay
for imports; and
• Prices of goods manufactured at home (influenced by the
responsiveness of supply)
• Population Growth-To meet their needs, imports become
essential and the quantity of imports may increase as population
increases.

25. • Demonstration Effect - people in the less developed countries imitate
the consumption pattern of the developed countries, import will
increase, export remain constant.
• Poor Marketing Strategies- The superior marketing of the developed
countries have increased their surplus.The poor marketing facilities of
the developing countries have pushed them into huge deficits.
• Natural Factors - calamities such as the failure of rains or the coming
floods may easily cause disequilibrium in the balance of payments by
adversely affecting agriculture and industrial production in the
country.The exports may decline while the imports may go up causing
a discrepancy in the country's balance of payments.

26. Balance ofTradeVs Balance of Payments
Basis for Comparison Balance ofTrade Balance of Payment
Meaning Balance ofTrade is a statement that
captures the country's export and import of
goods with the remaining world.
Balance of Payment is a statement that
keeps track of all economic transactions
done by the country with the remaining
world.
Records Transactions related to goods only. Transactions related to both goods and
services are recorded.
Capital transfers Are not included in the Balance ofTrade. Are included in Balance of Payment.
Which is better? It gives a partial view of the country's
economic status
It gives a clear view of the economic
position of the country
Result It can be Favorable, Unfavorable or
balanced
Both the receipts and payment sides tallies
Component It is a component of Current Account of
Balance of Payment.
Current Account and Capital Account.

27. MeasuresTo Correct Disequilibrium in the BOP
1. Monetary Measures :-
a) Monetary Policy
The monetary policy is concerned with money supply and credit in the
economy.The Central Bank may expand or contract the money supply in the
economy through appropriate measures which will affect the prices.
b) Fiscal Policy
Fiscal policy is government's policy on income and expenditure. Government
incurs development and non - development expenditure,. It gets income
through taxation and non - tax sources. Depending upon the situation
governments expenditure may be increased or decreased.

28. c) Exchange Rate Depreciation
By reducing the value of the domestic currency, government can
correct the disequilibrium in the BOP in the economy. Exchange rate
depreciation reduces the value of home currency in relation to
foreign currency. As a result, import becomes costlier and export
become cheaper. It also leads to inflationary trends in the country,
d) Devaluation
Devaluation is lowering the exchange value of the official currency.
When a country devalues its currency, exports becomes cheaper and
imports become expensive which causes a reduction in the BOP
deficit.

29. e) Deflation
Deflation is the reduction in the quantity of money to reduce prices
and incomes. In the domestic market, when the currency is deflated,
there is a decrease in the income of the people.This puts curb on
consumption and government can increase exports and earn more
foreign exchange.
f) Exchange Control
All exporters are directed by the monetary authority to surrender their
foreign exchange earnings, and the total available foreign exchange is
rationed among the licensed importers.The license-holder can import
any good but amount if fixed by monetary authority.

30. II. Non- Monetary measures :-
a) Export Promotion
To control export promotions the country may adopt measures to stimulate
exports like:
• Export duties may be reduced to boost exports
• Cash assistance, subsidies can be given to exporters to increase exports
• Goods meant for exports can be exempted from all types of taxes.
b) Import Substitutes
• Steps may be taken to encourage the production of import substitutes.This will
save foreign exchange in the short run by replacing the use of imports by these
import substitutes.

31. c) Import Control
Import may be kept in check through the adoption of a wide variety of measures
like quotas and tariffs. Under the quota system, the government fixes the
maximum quantity of goods and services that can be imported during a particular
time period.
1. Quotas – Under the quota system, the government may fix and permit the
maximum quantity or value of a commodity to be imported during a given period
By restricting imports through the quota system, the deficit is reduced and the
balance of payments position is improved.
2.Tariffs – Tariffs are duties (taxes) imposed on imports.When tariffs are imposed,
the prices of imports would increase to the extent of tariff.The increased prices
will reduced the demand for imported goods and at the same time induce
domestic producers to produce more of import substitutes