Introduction

Balance of Payments

The balance of payments, also known as balance of international payments and

abbreviated BoP, of a country is the record of all economic transactions between
the residents of the country and the rest of the world in a particular period (over a
quarter of a year or more commonly over a year). These transactions are made by
individuals, firms and government bodies. Thus the balance of payments includes
all external visible and non-visible transactions of a country. It represents a
summation of country's current demand and supply of the claims on foreign
currencies and of foreign claims on its currency [1] .[2] These transactions include
payments for the country's exports and imports of goods, services, financial capital,
and financial transfers. It is prepared in a single currency, typically the domestic
currency for the country concerned. Sources of funds for a nation, such as exports
or the receipts of loans and investments, are recorded as positive or surplus items.
Uses of funds, such as for imports or to invest in foreign countries, are recorded as
negative or deficit items.

When all components of the BOP accounts are included they must sum to zero
with no overall surplus or deficit. For example, if a country is importing more than
it exports, its trade balance will be in deficit, but the shortfall will have to be
counterbalanced in other ways such as by funds earned from its foreign
investments, by running down currency reserves or by receiving loans from other
countries.

While the overall BOP accounts will always balance when all types of payments
are included, imbalances are possible on individual elements of the BOP, such as
the current account, the capital account excluding the central bank's reserve
account, or the sum of the two. Imbalances in the latter sum can result in surplus
countries accumulating wealth, while deficit nations become increasingly indebted.
The term balance of payments often refers to this sum: a country's balance of
payments is said to be in surplus (equivalently, the balance of payments is positive)
by a specific amount if sources of funds (such as export goods sold and bonds sold)
exceed uses of funds (such as paying for imported goods and paying for foreign
bonds purchased) by that amount. There is said to be a balance of payments deficit
(the balance of payments is said to be negative) if the former are less than the
latter. A BOP surplus (or deficit) is accompanied by an accumulation (or
decumulation) of foreign exchange reserves by the central bank.

Under a fixed exchange rate system, the central bank accommodates those flows
by buying up any net inflow of funds into the country or by providing foreign
currency funds to the foreign exchange market to match any international outflow
of funds, thus preventing the funds flows from affecting the exchange rate between
the country's currency and other currencies. Then the net change per year in the
central bank's foreign exchange reserves is sometimes called the balance of
payments surplus or deficit. Alternatives to a fixed exchange rate system include a
managed float where some changes of exchange rates are allowed, or at the other
extreme a purely floating exchange rate (also known as a purely flexible exchange
rate). With a pure float the central bank does not intervene at all to protect or
devalue its currency, allowing the rate to be set by the market, and the central
bank's foreign exchange reserves do not change, and the balance of payments is
always zero.
 Research Methodology

The research in this project has been done based on information on the
internet, articles , magazines and newspapers .

Further, some respondents who have been participants of the investment

environment had also helped the project to reach meaningful conclusions.

The university syllabus coupled with articles and other data from the public
libraries were vital for the research preparation and completion of the
project.

The information shared in the following pages are indicative but not
exhaustive.

I have tried to encapsulate the overview and basics of this project through
data analysis and classification.

The research in this project has been largely conducted through secondary
data while primary data had methods like preparing a questionnaire and data
sampling.
 Meaning and Definitions

The IMF definition of Balance of Payment:

The International Monetary Fund (IMF) use a particular set of definitions for the
BOP accounts, which is also used by the Organisation for Economic Co-operation
and Development (OECD), and the United Nations System of National Accounts
(SNA).]

The main difference in the IMF's terminology is that it uses the term "financial
account" to capture transactions that would under alternative definitions be
recorded in the capital account. The IMF uses the term capital account to
designate a subset of transactions that, according to other usage, previously formed
a small part of the overall current account. [7] The IMF separates these transactions
out to form an additional top level division of the BOP accounts. Expressed with
the IMF definition, the BOP identity can be written:

The IMF uses the term current account with the same meaning as that used by
other organizations, although it has its own names for its three leading sub-
divisions, which are:

The goods and services account (the overall trade balance)

 The primary income account (factor income such as from loans and
investments)

The secondary income account (transfer payments)

balance of payments are also known as "balance of international trade"

The balance of payments is compiledaccording to the rules recommended by

theInternational Monetary Fund (IMF) (Balance ofPayments Manual, 5th Ed.
International Monetary Fund,Washington D.C., USA, 1993) and is defined as
asystematic record of all economictransactions carried out in a given
periodbetween the domestic economy and the restof the world.Since the 1999
Statistical Abstract, thebalance of payments is shown in a newformat. This format,
adopted by internationalstatistics agencies and by most countries,allows convenient
international comparisonsof balance of payment flows. Additionally, thedefinitions
and classifications in the newformat of the balance of payments have
beenharmonized with those customary in theNational Accounts, thereby
obtainingconsistency between the international flowsand transactions and those in
the NationalAccounts.Data since 1967 include estimates ofeconomic transactions
between residents ofIsrael and non-Israeli residents of Judea,Samaria and the Gaza
Area (and Sinai until1982).The Balance of Payments consists of threemain
sections:
a. The current account: includes trade ingoods and services, income
andexpenditure from production factors -capital and labour and current transfers;

b. Capital account: includes capitaltransfers (mainly by immigrants),

c. Financial account: includes directinvestments, tradable portfolioinvestments,

other investments and netreserve assets.

BALANCE OF PAYMENTS by RBI:

In Indias balance of payments (BoP), transactions are recorded in accordance with

the guidelines given in the fifth edition of IMFs Balance of Payments Manual
(1993), with minor modifications to adapt to the specifics of the Indian situation.
The Manual defines BoP as a statistical statement that systematically summarises,
for a specific time period, the economic transactions of an economy with the rest of
the world. Transactions between residents and non-residents consist of those
involving goods, services, and income; involving financial claims on and liabilities
to the rest of the world; and those classified as transfers, involving offsetting
entries to balance one-sided transactions. The data are received from the banking
system as part of the Foreign Exchange Management Act (FEMA), 1999. The data
are received by the Reserve Bank of India mainly from the banking system
(authorized dealers) as part of the Foreign Exchange Management Act (FEMA),
1999. The basic structure of the Balance of Payments (BOP) of India consists of:

(i) Current account: exports and imports of goods, services, income (both
investment income and compensation of employees) and current transfers;

(ii) Capital account: assets and liabilities covering direct investment, portfolio
investment, loans, banking capital and other capital;

(iii) Statistical discrepancy;

(iv) International reserves and IMF transactions.

Features of Balance of Payments:

Balance of Payments has the following features:

(i) It is a systematic record of all economic transactions between one country and
the rest of the world.
(ii) It includes all transactions, visible as well as invisible.
(iii) It relates to a period of time. Generally, it is an annual statement.
(iv) 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.
(v) When receipts are equal to payments, the balance of payments is in
equilibrium; when receipts are greater than payments, there is surplus in the
balance of payments; when payments are greater than receipts, there is deficit in
the balance of payments.
(vi) In the accounting sense, total credits and debits in the balance of payments
statement always balance each other.
Payments and receipts on international account are of three lands:
(a) the visible balance of trade;
(b) the invisible items; and
(c) capital transfers.
Kindleberger defines balance of payments as "a systematic record of all economic
transactions between the residents of the reporting country and the residents of
foreign countries during a given period of time."
In the words of Benham, "Balance of payments of a country is a record of the
monetary transactions over a period with the rest of the world."

Components of Balance of Payments

(1) Current Account:

Current account refers to an account which records all the transactions relating to
export and import of goods and services and unilateral transfers during a given
period of time.

Current account contains the receipts and payments relating to all the transactions
of visible items, invisible items and unilateral transfers.

Components of Current Account:

The main components of Current Account are:

1. Export and Import of Goods(Merchandise Transactions or Visible 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 (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.

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 Unrequited Transfers 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.

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.

Difference between Balance of Trade and Current Account:

Basis Balance of Trade (BOT) Current Account

Components: Balance of trade includes only visible Current Account records both
items. visible and invisible items.

Scope: It is a narrow concept as it is only a It is a wider concept and it

part of current account includes BOT.

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.
 1. Surplus in current account arises when credit items are more than debit items. It
indicates net inflow of foreign exchange.

2. Deficit in current account arises when debit items are more than credit items. It
indicates net outflow of foreign exchange.

Components of Current Account:

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

(2) 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.

Components of Capital Account:

The current account shows the net amount a country is earning if it is in surplus, or
spending if it is in deficit. It is the sum of the balance of trade (net earnings on
exports minus payments for imports), factor income (earnings on foreign
investments minus payments made to foreign investors) and cash transfers. It is
called the current account as it covers transactions in the "here and now" those
that don't give rise to future claims.[3]

The capital account records the net change in ownership of foreign assets. It
includes the reserve account (the foreign exchange market operations of a nation's
central bank), along with loans and investments between the country and the rest of
world (but not the future interest payments and dividends that the loans and
investments yield; those are earnings and will be recorded in the current account).
If a country purchases more foreign assets for cash than the assets it sells for cash
to other countries, the capital account is said to be negative or in deficit.

The term "capital account" is also used in the narrower sense that excludes central
bank foreign exchange market operations: Sometimes the reserve account is
classified as "below the line" and so not reported as part of the capital account.[4]

Expressed with the broader meaning for the capital account, the BOP identity
states that any current account surplus will be balanced by a capital account deficit
of equal size or alternatively a current account deficit will be balanced by a
corresponding capital account surplus:

The balancing item, which may be positive or negative, is simply an amount that
accounts for any statistical errors and assures that the current and capital accounts
sum to zero. By the principles of double entry accounting, an entry in the current
account gives rise to an entry in the capital account, and in aggregate the two
accounts automatically balance. A balance isn't always reflected in reported figures
for the current and capital accounts, which might, for example, report a surplus for
both accounts, but when this happens it always means something has been missed
most commonly, the operations of the country's central bank and what has been
missed is recorded in the statistical discrepancy term (the balancing item).[4]

An actual balance sheet will typically have numerous sub headings under the
principal divisions. For example, entries under Current account might include:

Trade buying and selling of goods and services

o Exports a credit entry

o Imports a debit entry

Trade balance the sum of Exports and Imports

Factor income repayments and dividends from loans and investments

o Factor earnings a credit entry

o Factor payments a debit entry

Factor income balance the sum of earnings and payments.

Especially in older balance sheets, a common division was between visible and
invisible entries. Visible trade recorded imports and exports of physical goods
(entries for trade in physical goods excluding services is now often called the
merchandise balance). Invisible trade would record international buying and
selling of services, and sometimes would be grouped with transfer and factor
income as invisible earnings.[2]

The term "balance of payments surplus" (or deficit a deficit is simply a negative
surplus) refers to the sum of the surpluses in the current account and the narrowly
defined capital account (excluding changes in central bank reserves).

The main components of capital account are:

1. Borrowings and landings to and from abroad:It includes:

A. 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.

B. 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:

A. 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.

B. 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 Indias 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. It must be
noted that change in reserves is recorded in the BOP account and not reserves.

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.

A. Surplus in capital account arises when credit items are more than debit items. It
indicates net inflow of capital.

B. Deficit in capital account arises when debit items are more than credit items. It
indicates net outflow of capital.

In addition to current account and capital account, there is one more element in
BOP, known as Errors and Omissions. It is the balancing item, which reflects the
inability to record all international transactions accurately.