Balance of Payment

2021
Balance
of
Payment
Classroom Deliberations
CA Dr. Prithvi Ranjan Parhi
1
CA DR Prithvi Ranjan Parhi

703- INTERNATIONAL TRADE AND BUSINESS
MODULE- I
International Trade: Concept, Importance, Benefits of International Trade, international
Marking vs. Domestic Marking (differences).
Theory of International Trade: theory of comparative Cost, factor proportion Theory.
MODULE-II
Multinational corporations (MNCs): Definition, Role of MNCs in International marking.
International Trade barriers: Meaning, tariff and non-Tariff Barriers, Impact of Non-tariff
barriers.
MODULE-III
Organizational and Agreements: WTO (Functions, Principle, agreements), IMF
(Purposes, Facilities Provided by IMF), World Bank (Purpose, Principle, Policies).
MODULE-IV
Foreign Trade of India: Organizational Setup (Autonomous Bodies, Attached and
subordinate offices), Major Export and Imports, Concept of Export House, EXIM Policy
(2002-2007) of India (Features and Objectives of the Policy).
MODULE-V
Foreign Exchange market: Concept, Functions, Methods of international Payment,
concept of Balance of Payment, Concept of Fixed and Flexible Exchange Rate and
Convertibility of Rupee.
CA DR Prithvi Ranjan Parhi 2

India’s BoP Position
CA DR Prithvi Ranjan Parhi 3

4
Balance of Payment
• Is the summary of flow of economic transactions between the
residents of a country & the rest of the world, during a given time
period, usually a year.
• Same as a Source & Application of funds to a Company.
• Measures the flow of international payments & receipts.
• BOP is the statistical record of a country’s international transaction
over a certain period of time presented in the form of double entry
book keeping.
• BOP is a statement listing receipts and payments in international
transactions of a country.
© CA. Prithvi R Parhi, M Com, FCA,DISA(ICAI)
© CA Dr Prithvi R Parhi
5:57 PM

5
Economic Txns
• Includes all activities whereby 2 countries
exchange something of economic value.
• 2 parties involved
• In reality or implication (NRs fund transfer to
migrating country)
• Exception:
• Transactions with only 1 sided eco value is
also recorded (Aids, grants, gifts etc.)
5:57 PM

6
BoP Vs. BoT
• BoT
• Refers to
merchandise exports/
imports
(visibles)
• BoP
• Refers all eco txns
including invisibles
like banking,
insurance, services
etc.
• Wider
5:57 PM

Importance of BOP
• BOP provides detailed information concerning the demand and
supply of foreign currency.
• (If Export>Import, Domestic currency will appreciate where as
if Import>Export domestic currency will depreciate)
• A country’s BOP data may signal its potential as a business
partner for the rest of the world.
• BOP deficit country more likely to impose control on FOREX.
• BOP surplus country more likely to encourage imports.
• BOP data can be used to evaluate the performance of the
country in international economic competition.

BOP Accounting
• BOP is presented in a system of double entry book
keeping.(Every credit in the account is balanced by a
matching debit and vice versa)
• Any transaction that results in a receipt from foreigners
will be recorded as credit.
• Any transaction that give rise to payment to foreigner
will be recorded as debit.
• Credit entries give rise to supply of foreign
currency(demand for domestic currency),where as
debit entries give rise to demand for foreign
currency(supply of domestic currency)

Balance of Payment
• All types of international transactions can be
grouped in to Four heads:
1.Current Account
2.Capital Account
3.Other Account(Error & Omission)
4.Official Reserve Account

Current Account
• Current account records the following four categories of
transactions:
• Merchandise Trade: Represents exports and imports of
tangible goods/visibles (Trade balance/Trade
deficit/Balance of trade)
• Services/Invisibles: It includes payment and receipt for
following services:(Transport, Travel, construction,
Insurance and pension, financial, telecommunication,
computer & IT, personal, cultural & recreational services,
other services, charges for use of intellectual property
right)

Current Account
• Factor Income: It consists largely of payments and
receipts of interest, dividend and other income
on foreign investments that were previously
made.
• Unilateral Transfers: it involves unreciprocated
payments and receipts. These are only one
directional flow.(Foreign Aid, official and Private
Grant,Gifts,Remittances etc)
• Current Account may show balance or deficit.

Current A/C Balance & Exchange Rate
A Balance in Current A/C
– More supply of Foreign Currency
– More Demand for Home Currency
– Appreciation of Domestic Currency
– Affect Positively Imports and Negatively Exports.
A Deficit in Current A/C
• More Demand for Foreign Currency
• Depreciation of Domestic Currency
• Positively affects exports and negatively Imports.

Capital Account
• Foreign Direct Investment (Inward/Outward)
• Foreign Portfolio Investment (Inward/ Outward)
• Loans: (External Assistance, Commercial
Borrowing (LT/MT,Short term loans)
• Banking Capital (Assets & Liabilities)
• Rupee Debt Service
• Other Capital

Capital Account
• Hence current account deals with trade in goods
and services, but capital account deals with
trade in financial assets and liabilities.
– Increase in foreign financial Assets = Debit items
– Decrease in foreign financial Assets = Credit items
– Increase in Foreign Financial liabilities =Credit items
– Decrease in Foreign Financial liabilities = Debit items.

Error & Omission
Error and omission are put in BOP due to:
– Difficulties involved in collecting BOP data
– Different sources of BOP data
– Movement of capital may precede or follow the
transaction that they are supposed to finance before
or after 31st March.
– Some figures are based on estimates only
– Unrecorded illegal transactions

Deficit Adjustment
• If the overall balance is found to be in deficit,
Central Bank(RBI)arranges capital flows to cover
deficit by official borrowing and/or drawing from
the IMF.
• This short of capital flow is accommodating or
compensatory capital flow. This also put in capital
account.
• Hence capital inflows is of two types:
1.Autonomous Capital flow
2.Accommodating/Compensatory Capital Flow

Deficit Adjustment
• If overall BOP is negative/deficit and
accommodating capital is not sufficient, the
official reserve account is debited by the
amount of deficit.(It means there will be
decrease in official reserve)
• If overall BOP is surplus, the surplus amount
adds to the official reserve account.(It means
there will be increase in official Reserve)

Official Reserve Account
• It is held by the central bank of the country.
(RBI)
• It consists of the following
– Gold
– Foreign Currency Assets
– Special Drawing Rights(SDR)
• This account is used for balancing the BOP.
• If a country do not have sufficient Official
Reserve it leads to BOP crisis and the country
goes for policy reforms.

BOP always Balances?
• Since the balance of payment is based upon
system of double-entry book-keeping, the total
debits must equal to total credits.
• This is because two aspects of each transaction
recorded are equal in amount but appear on
opposite sides of the balance of payments
account.
• In this accounting sense, balances of payments for
a country must always balance.
• But in economic sense/real sense there may be
disequilibrium in BOP.

20
A/cn’ Principles
• Double entry system
• When no compensation involved ~ treated as
goodwill to satisfy the principle of double entry.
• Outflow ~ Purchase of goodwill
• Inflow ~ Sale of goodwill
5:57 PM

21
Debit- Credit
• Txn which creates demand for domestic currency in
forex mkt ~ Credit (Export)
• Txn increasing supply of domestic currency in forex mkt
~ Debit (Import)
• Sources of Forex ( Export ) ~ Credit
• Application of Forex (Import) ~ Debit
• Credits r recorded with + sign & Debits - sign
5:57 PM

22
Current Account
• Records txns in merchandise &
invisible with rest of the world.
• Exports~ f.o.b. basis
• Imports ~ c.i.f. basis
• However IMF manual provides both expt &
impt should b on f.o.b
• Gnie ~ Govt not included elsewhere~ credit~ fund received from foreign Govts.
5:57 PM

23
Capital Account
• Increase in Countries Foreign Financial Asset ~ Debit
• Decrease in Countries Foreign Financial Asset ~ Credit
• Increase in Countries Foreign Financial Liability ~ Credit
• Decrease in Countries Foreign Financial Liability ~ Debit
• Rupee Debt Service is defined as the cost of meeting interest payments of principal
loan + admn charges
• Monetary movements ~ India’s txn with IMF & India’s forex reserve.
5:57 PM

24
Trade Balance
• Difference between merchandise export &
merchandise import.
• Changes in TB indicates efficiency of the
country in producing & exporting goods.
5:57 PM

25
Terms of Trade
• Ratio of countries export prices to import
prices.
• Constructed by taking an index of prices
for exports & imports
=Index of Export / Index of Import
• Improvement in ToT indicates faster rise of
export prices than imports.
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26
ToT
Year 2009 2010
Index of Export 100 150
Index of Import 100 125
Terms of Trade Index 100 120
5:57 PM

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Current Account Balance
• Represents the difference between domestic
saving & domestic investment.
• Deficit ~ Domestic saving insufficient to fund
domestic investment.
• Surplus ~ Comfortable.
5:57 PM

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Current A/c Study
• Growth in export accompanied with high rate
of Investment indicates is a +ve sign.
• High deficit accompanied with high growth
rate in imports is a –ve sign.
5:57 PM

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Capital Account Balances
• Shows how the balances in the current A/c has been financed.
• If balance in current a/c & Capital A/c taken together is -ve ,
~ BoP deficit.
• This has 2b managed by matching surplus on official reserve
account (i.e. reduction of foreign exchange & gold reserve)
• Txn in current A/c & Capital A/c are autonomous txns,
responding to economic situation, while official reserve txns
are compensating in nature.
5:57 PM

30
The Balance
• How BoP always balances ?
• Same as Household exp =
Income + Withdrawals from SB a/c +
borrowings
5:57 PM

31
The equation
• Balance in Current A/c +Balance in
Capital A/c + Change in monetary
movements = Zero
• Change in Monetary Movements
reflects the overall BoP position.
5:57 PM

32
Monetary Movements
• Increase in Forex Reserve or net repurchase from
IMF ~ Surplus.
• Decrease in Forex Reserve or net purchase from IMF
~ Deficit.
5:57 PM

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If no monetary movement :
• Surplus/ Deficit in Current A/c = Deficit/ Surplus in
Capital A/c
• Country neither borrows nor lends.
• In reality BoP seldom balances ‘coz – Imperfect
nature of data, different data sources, different
exchange rates applied to receipts & payments
• E & O inserted.
5:57 PM

Disequilibrium in BOP & Its
Correction

Disequilibrium in BOP-------
• Though the credit and debit are written balanced 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.
Disequilibrium may take place either in the form of
deficit or in the form of surplus.
• If autonomous receipts are less than autonomous
payments, the balance of payment is in deficit
reflecting disequilibrium in balance of payment.

-------Disequilibrium in BOP
• 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 ‘Unfavorable balance'.
• 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 ‘Favorable balance'.

Causes of Disequilibrium in BOP---
1. Population Growth
Most countries experience an increase in the population and
in some like India and China the population is not only large
but increases at a faster rate. To meet their needs, imports
become essential and the quantity of imports may increase as
population increases.
2. Development Programmes
Developing countries which have embarked upon planned
development programmes require to import capital goods,
some raw materials which are not available at home and
highly skilled and specialized manpower. Since development is
a continuous process, imports of these items continue for the
long time landing these countries in a balance of payment
deficit.

----Causes of Disequilibrium in BOP
3. Demonstration Effect
When the people in the less developed countries imitate
the consumption pattern of the people in the developed
countries, their import will increase. Their export may
remain constant or decline causing disequilibrium in the
balance of payments.
4. Natural Factors
Natural 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.

5. Cyclical Fluctuations
Business fluctuations introduced by the operations of the
trade cycles may also cause disequilibrium in the country's
balance of payments. For example, if there occurs a
business recession in foreign countries, it may easily cause
a fall in the exports and exchange earning of the country
concerned, resulting in a disequilibrium in the balance of
payments.
6. Inflation
An increase in income and price level owing to rapid
economic development in developing countries, will
increase imports and reduce exports causing a deficit in
balance of payments.

7. 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.
8. Flight Of Capital
Due to speculative reasons, countries may lose foreign
exchange or gold stocks People in developing countries
may also shift their capital to developed countries to
safeguard against political uncertainties. These capital
movements adversely affect the balance of payments
position.

9. Political Factors: Political uncertainties,
instability, internal disturbances and external
war create threatening situation for industry and
investment. Hence, these factors contribute to
the outflow of capital, decline in domestic
production and import of goods.
10. Social Factors: The addition to and drop-outs
from the existing culture, changes in tastes,
fashions and preferences of the people
contribute to the increase in imports and deficit
in balance of payments.

Methods of Correction of
Disequilibrium-------
• If balance of payment disequilibrium is due to
surplus balance, the country enjoys the
position as it would be most desirable.
• But the countries worry when their balance of
payment shows deficit. In case of
disequilibrium due to deficit, the countries
take measures to eliminate deficit completely,
if possible otherwise to reduce the deficit.

-----------Methods of Correction of
Disequilibrium
• These measures are broadly categorized in to the
following:
1.Automatic Correction
2.Deliberate Measures
a. Monetary Measures(i)Reduction in money
supply(ii)Devaluation(iii)Exchange Control
b. Trade Measures:(i)Export Promotion
Measures(ii)Import Control Measures
c. Miscellaneous Measures

Automatic Corrections
• The deficit BOP indicates that the imports are
more than exports.
• It means demand for foreign currency is higher
than the supply of the same.
• This results in depreciation of domestic currency
in term of foreign currency.
• The increased exchange rate makes the imports
costlier and exports cheaper.
• Therefore the country reduces imports and
increase export, which in turn restores
equilibrium position.

Deliberate Measures(Monetary
measures)-----------
• Reduction in money Supply: With the help of
credit control techniques(Bank rate, open
market operations and variable reserve
requirement(SLR,CRR) the central bank reduce
the supply of money. Reduction in money
supply===Decline in Income=== Decline in
Purchasing Power===Decline in domestic
demand & consumption===Decline in imports
& Increase in exports.

------Deliberate Measures(Monetary
measures)
• Devaluation: Under this measure the country
deliberately devalues its currency. Once the
currency is devalued the importer has to pay
more domestic currency for the same quantity
of imports. Hence, import becomes costly and
reduces. Further, the foreign businessman
feels that importing from this country is cheap
as they can get more number of products for
the same amount of their currency. Hence, it
increases exports.

------Deliberate Measures(Monetary
measures)
• Exchange Control Measures: The exporters
after earning foreign exchange have to
surrender it to central bank. Similarly
importers get the permission from the central
bank for imports and to use the foreign
exchange. Hence, the central bank in this
process may control imports and reduces the
deficit in BOP.

------Deliberate Measures(Trade
Measures)
Export Promotional Measures:
• Abolishing/Reducing Export duty
• Export Subsidies
• Encouragement to EOUs(Export oriented Units)
• Creation of EPZs(Export Promotion Zones)
• Creation of FTZs(Free Trade Zones)
• Liberal loans for EOUs
• Fiscal, marketing incentives to EOUs
• Incentives and facilities for EOUs

------Deliberate Measures(Trade
Measures)
Import Control Measures
• Increase import duties
• Imposition of import quotas
• Imposition of import licenses
• Prohibiting import of certain items
• Increase in custom duty on imports

Miscellaneous Measures
• The following measures helps in reducing
imports and enhancing exports, thus
contributes for the reduction of deficit in BOP
– Attracting Foreign investments
– Attracting NRI deposits
– Developments of tourism etc.

Thank You
51
CA DR Prithvi Ranjan Parhi

Balance of Payment

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