BOP Components: Current Account, Capital Account and Reserve Account; Disequilibrium of BOP; Factors Affecting BOP and Methods of Correcting BOP Disequilibrium

1. IGNOU M.Com
IBO-01 (UNIT-3)
BALANCE OF PAYMENT
BY: SIMRAN SETH
(UGC NET QUALIFIED IN COMMERCE)

2. INTRODUCTION
• Balance 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.
• According to Kindle Berger, “ The balance of payments of a
country is a systematic record of all economic transactions
between the residents of the reporting country and residents
of foreign countries during a given period of time”.

3. • A country has to deal with other countries in respect
of 4 items:-
• Visible items which includes all types of physical
goods exported and imported.
• Invisible items which include all those services whose
export and import are not visible. E.g. transport
services, medical services etc.
• Capital transfers which are concerned with capital
receipts and capital payment.
• Unilateral transfers is a one-way transfer of money,
goods, or services from one country to another.

4. 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.

5. DIFFERENCE B/W BOT AND BOP

6. ASPECTS OF B.O.P. ACCOUNTING

7. THE GENERAL RULE IN BALANCE OF
PAYMENT ACCOUNTING
• If a transaction earns foreign currency for the nation, it is a
credit and is recorded as a plus item.
• If a transaction involves spending of foreign currency it is a
debit and is recorded as a negative item.
• Buying goods and services creates debit entries and selling
things produces credit entries.

8. COMPONENTS OF BALANCE OF
PAYMENTS
•Current Account
•Capital Account
•Reserve Account

9. CURRENT ACCOUNT
• BOP on current account is a statement of actual receipts and
payments in short period.
• It includes the value of export and imports of both visible and
invisible goods. There can be either surplus or deficit in current
account.
• The current account includes: export & import of services, interests,
profits, dividends and unilateral receipts/payments from/to abroad.
• BOP on current account refers to the inclusion of three balances of
namely – Merchandise balance, Services balance and Unilateral
Transfer balance.

10. CURRENT ACCOUNT

11. MAIN COMPONENTS OF CURRENT ACCOUNT
 Export and Imports of Goods (Merchandise Transactions or Visible
Trade) :
• A major part of transactions in foreign trade is in the form of export
and imports of goods (visible items). Payment for import of goods is
written on the negative side (debit items) and receipts 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)
 Export and Import of Services ( Invisible Trade) :
• 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.

12. • 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.
 Unilateral Transfer to and from abroad (One sided Transactions) :
Unilateral transfers include gifts, donations, personal remittances and other ‘one-way’
transactions. These refers 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.
 Income Receipts & Payments to and from abroad :
It includes investment income in form of interest, rent and profit.

13. CREDIT ITEMS DEBIT ITEMS NET CREDIT (Credit – Debit)
1. Visible Trade Exports of
goods:
Imports of goods Net Exports of goods (Balance of
Trade)
2. Invisible Trade Exports
of services:
Imports of services Net Exports of services
3. Unilateral Transfers
Transfer Receipts:
Transfer Payments Net Transfer Receipts
4. Income Receipts &
Payments Income Receipts:
Income Payments Net Income Receipts
Current Receipts
(1+2+3+4)
Current Payments Current Account Balance

14. BOT V/S CURRENT ACCOUNT
Basis Balance of Trade
(BOT)
Current Account
Components: Balance of trade includes only
visible items.
Current Account records both
visible and invisible items.
Scope: It is a narrow concept as it is
only a part of current account
It is a wider concept and it includes
BOT.

15. CAPITAL ACCOUNT
• The capital account of a country consists of its transactions in
financial assets in the form of short-term and long-term lending’s
and borrowings, and private and official investments. In other
words, the capital account shows international flow of loans and
investments, and represents a change in the country’s foreign
assets and liabilities.
• 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.

16. • There can be surplus or deficit in capital account.
• The credit side records:
 The official and private borrowing from abroad net of
repayments.
 Direct and portfolio investment.
 Short term investments into the country.
• The debit side records:
 Disinvestment of capital.
 Country’s investment abroad.
 Loans given to the foreign government or a foreign party.

17. CAPITAL ACCOUNT

18. BALANCE OF CAPITAL ACCOUNT
The transactions, which lead to inflow of foreign exchange ( like receipt
of loans 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.
 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.

19. Credit Items Debit Items Net Credit (Credit – Debit)
1. Borrowings and lending’s to
and from abroad Borrowings
from abroad:
Lending to abroad Net Borrowings from abroad
2. Investments from abroad
Investments from abroad:
Investments to abroad Net Investments from abroad
3. Change in Foreign Exchange
Reserves.
Decreases in foreign exchange
reserves:
Increases in foreign exchange
reserves
Net change in foreign exchange
reserves
Capital Receipts
(1+2+3):
Capital Payments Capital Account Balance

20. CURRENT ACCOUNT V/S CAPITAL
ACCOUNT

21. RESERVE ACCOUNT/ OTHER ACCOUNT
 This account is to adjust deficit/surplus in BOP.
 Represents purchase and sale by RBI.
 Govt. owned assets.
 SDRs.
 Foreign Exchange Reserve.
 Gold.

22. RESERVE ACCOUNT

23. DISEQUILIBRIUM OF BOP
• Though the credit and debit are written balance in the balance of payment
account, it may not remain balanced always. Very often, debit exceeds
credit or the credit exceeds debit causing an imbalance in the balance of
payment account. Such an imbalance is called the disequilibrium.
• DEFICIT : Disequilibrium of Deficit arises when our receipts from the
foreigners fall below our payment to foreigners. It arises when the effective
demand for foreign exchange of the country exceeds its supply at a given
rate of exchange. This is called an ‘unfavourable balance’.
• SURPLUS : Disequilibrium of Surplus arises when the receipts of the
country exceed its payments. Such a situation arises when the effective
demand for foreign exchange is less than its supply. Such a surplus
disequilibrium is termed as ‘favourable balance’.

24. FACTORS AFFECTING BALANCE OF
PAYMENTS
• The balance of payments can be affected two accounts:
• Current Account
• Capital Account
1. Factors Affecting the Current Account:
• A country’s current account balance can significantly change its national economy.
Therefore, it is important to identify the factors that influence current account.
The most important factors affecting current account are:
• Inflation
• National Income
• Government Restructures
• Exchange Rates.

25. • Inflation: If a country’s inflation rate increases relative to the other countries with which
it trades, its current account would be expected to decline. Due to higher prices at home,
consumers and corporations within the country are most likely to purchase more goods
and services overseas (due to high local inflation), while the country’s exports to other
countries will fall.
• National Income: If the national income of a country rises by a higher percentage than
those of other nations, its current account is expected to decline, other things being
same. As the real income level (adjusted for inflation) rises, so does consumption of
goods. A percentage of that increase in consumption of goods will most likely reflect an
increase in demand for the foreign nation goods.
• Government Restrictions: If a country’s government imposes a particular type of
tax (often referred to as a tariff tax) on imported goods from foreign countries, the prices
of foreign goods to consumers effectively increases. An increase in prices of imported
goods relative to goods produced at domestic country will discourage imports and is
expected to increase its current account balance. In addition to tariffs, a government may
reduce its imports by enforcing a quota, or a maximum limit on imports.
• Exchange Rates: The value of a country’s currency regarding other currencies is called
the exchange rate. Changes in a currency’s exchange rate brought about by market forces
or actions by national government or government of other countries will influence a
country’s current account balance. An appreciation in a country’s exchange rate vis-a-vis
another country’s currency, other things being equal, is likely to lead to a decline in the
country’s exports and increase in imports.

26. FACTORS AFFECTING CAPITAL ACCOUNT
As with the current flows, government policies will also change the
capital account. A country’s government could, for example, impose a
special tax on income account by local investors who invested in foreign
markets. A tax would discourage people from investing abroad and
could, therefore, increase the country’s capital account. Capital flows
are also influenced by capital controls of various types. Interest rates
also affect the capital flows. A hike in interest rates relative to other
countries may affect capital inflows from overseas countries.
Conversely, a reduction in domestic interest rates may induce people to
invest overseas.

27. METHODS OF CORRECTING BOP
DISEQUILIBRIUM
• Use of past reserves: A country may make use of past reserves to
finance the BOP deficit provided such reserves are available. Such
reserves consists of gold, foreign currencies and fund related assets
i.e. reserve position with the IMF and holding of special drawing
rights.
• Borrowing from IMF: Countries with disequilibrium in BOP can make
use of IMF facilities. These are :
 Stand by loans.
 Extended Fund Facilities (EFF).
 Structure Adjustment Facilities (SAF).
 Enlarged Structural Adjustment Facilities (ESAF).

28.  Compensatory and Contingency Financing Facilities (CCFF).
 Systematic Transformation Facilities (STF).
• Monetary and Fiscal Policy Measures: 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.
Fiscal Policy is government’s policy on income and expenditure. It gets
income through taxation and non-tax sources. Depending on the
situation the governments expenditure may be increased or decreased.
• Exchange Rate Adjustments: By reducing the value of the domestic
currency, government can correct the disequilibrium in BOP. Exchange
rate depreciation reduces the value of the home currency in relation
to foreign currency. As a result exports will be encouraged and
imports will be discouraged and equilibrium is restored.

29. • Export Promotion: To control export promotions the country may
adopt measures to stimulate exports like:
Export duties may be reduced to boost exports.
Subsidies can be given to exporters to increase exports.
Goods meant for exports can be exempted from taxes.
• Import Substitution: It is a strategy under trade policy that abolishes
the import of foreign products and encourages for the production in
domestic market. The purpose of this policy is to change the
economic structure of the country by replacing foreign goods with
domestic goods.
The government may fix and permit quantity through quotas.
Tariffs are duties or taxes imposed on imports.

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