BALANCE OF PAYMENT

Balance of Payments

• The balance of payments (BoP) record the transactions in

goods, services, and assets between residents of a country
with the rest of the world for a specified time period typically
a year.
• It represents a summation of country’s current demand and
supply of the claims.
• The aim of this record is to present an account of all receipts
and payments on account of goods exported, services
rendered, and capital received by the residents of a country,
and goods imported, services received, and capital
transferred by residents of the country.
• The main purpose of keeping these records is to know the
international economic position of a country which helps the
Government in making decisions on monetary and fiscal policies
on the one hand, and trade and payments policies on the other.

• There are two main accounts in the BoP –

✓ Current Account: The current account records exports and
imports in goods, trade in services and transfer payments.
✓ Capital Account: The capital account records all international
purchases and sales of assets such as money, stocks, bonds,
etc. It includes foreign investments and loans.
CURRENT ACCOUNT

The current account is a record of all trade

between one nation and other nations.
✓ It includes payments for imports and
exports of both goods and services.
✓ It also includes monetary gifts or transfer
payments to and from other nations.
1. TRADE in GOODS – EXPORT & IMPORT of Goods

Exports of goods is sale of domestically produced goods to a

foreign country.
In general, domestic producers (and their workers) want to sell
their goods to foreign countries - leading to more buyers, a higher
price, and more profit.

Imports of goods refer to goods produced by the foreign sector and purchased
by the domestic economy. Imports are goods purchased from other countries.
• Buying foreign goods is expenditure from our country and it becomes the
income of that foreign country.
✓ Hence, the purchase of foreign goods or imports decreases the domestic
demand for goods and services produced in our country.
TRADE in GOODS – EXPORT & IMPORT of Goods

Imports & exports, are the essence of foreign trade--goods and services
that are traded among the citizens of different nations. Imports and
exports are frequently combined into a single term, net exports (exports
minus imports).
2. TRADE in SERVICES

Trade in services includes factor income and non-factor income

transactions.

Net Factor Income from Abroad (NFIA) –

• It captures the net flow of income payments (or factor payments)

between the domestic economy and the foreign sector.
• It is the difference between foreign factor payments to domestic
citizens and domestic factor payments to foreign citizens.
• NFIA is usually quite small. However, the two components of net foreign
factor income:
✓ foreign payments to domestic citizens
✓ domestic payments to foreign citizens are more substantial.
• Net foreign factor income is small because the two larger components
almost cancel out.
2. TRADE in SERVICES

Net Non - Factor Income from Abroad (NFIA) –

• Non-factor services comprise shipment, passenger and other

transport services, and travel, as well as current account
transactions not separately reported (e.g., not classified as
merchandise, nonfactor services, or transfers).
• Software exports are classified within invisibles under the sub-
head `miscellaneous non-factor services.
• Non-factor services refer to all invisible receipts or payments not
attributable to any of the conventional `factors of production',
i.e., labour (remittances from overseas migrants) and capital
(income from investments, interest payments, dividend
repatriation).
3. TRANSFER PAYMENTS

• Transfers represent one-sided transactions, such as

grants, gifts, and migrants’ transfers by way of
remittances for family maintenance, repatriation of
savings and transfer of financial and real resources
linked to change in resident status of migrants.
• Official transfer receipts include grants, donations and
other assistance received by the Government from
bilateral and multilateral institutions.
• Similar transfers by Indian Government to other countries
are recorded under official transfer payments.
 BALANCE on CURRENT ACCOUNT

BALANCE on TRADE

BALANCE on INVISIBLE BALANCE on TRANSFER

BALANCE on CURRENT ACCOUNT
• Current Account is in balance when receipts on current
account are equal to the payments on the current account.
• Current account surpluses refer to positive current account
balances, meaning that a country has more exports than
imports of goods and services.
• Current account deficit refers to negative current account
balances and indicates that a country is importing more than
it is exporting.

Balance on Current Account has three components -

1. Balance of Trade or Trade Balance
2. Balance of Invisibles
3. Balance of Transfers
1. BALANCE OF TRADE

• Balance of Trade (BOT) is the difference between the value of

exports and value of imports of goods of a country in a given
period of time.
• Export of goods is entered as a credit item in BOT, whereas import of
goods is entered as a debit item in BOT. It is also known as Trade
Balance.
✓ BOT is said to be in balance when exports of goods are equal to
the imports of goods.
✓ Surplus BOT or Trade surplus will arise if country exports more
goods than what it imports.
✓ Deficit BOT or Trade deficit will arise if a country imports more
goods than what it exports.
2. BALANCE OF INVISIBLES

• Net Invisibles is the difference between the value of exports and

value of imports of invisibles of a country in a given period of time.
• Invisibles include services, transfers, and flows of income that take
place between different countries.
• Services trade includes both factor and non-factor income.
✓ Factor income includes net international earnings on factors of
production (like labour, land, and capital).
✓ Non-factor income is net sale of service products like shipping,
banking, tourism, software services, etc.
3. BALANCE OF TRANSFER

• This is the difference between gifts or transfers received

from other nations and transfers sent to other nations.
• In includes gifts or transfers between individuals, and
perhaps more important, it includes transfers between
governments.
The balance of payments is composed of a capital account
and a current account.
The capital account measures the changes in national
ownership of assets, whereas the current account measures
the country's net income.

In accounting, the capital account shows the net worth of a

business at a specific point in time. It is also known as owner's
equity for a sole proprietorship or shareholders' equity for a
corporation, and it is reported in the bottom section of the
balance sheet.
CAPITAL ACCOUNT

It includes those transactions, which cause a change in the assets or

liabilities of a country’s residents or its government.
Components of Capital Account includes –

1. Borrowings and Lendings to and from abroad – Includes all the

transactions related to borrowings from abroad by the government,
private sector, etc.
2. Investments to and from abroad – Includes all the investments by
the rest of the world in shares of Indian companies, real estate, etc.
3. Change in Foreign Exchange Reserves - The financial assets of the
government held in the central bank are Foreign Exchange
Reserves.
DIRECT INVESTMENT

The investments to and from abroad are:

• Foreign Direct Investment - FDI consists of the

purchase of an asset, which gives direct control to the
buyer over the asset. For example, purchase of land,
building, etc.
• Portfolio Investment – It is the cross-border
transactions and positions involving equity or debt
securities, other than direct investment or reserve
assets. Ex - FII (Foreign Institutional Investment).
EXTERNAL BORROWINGS

• External debt is the portion of a country's debt that was

borrowed from foreign lenders, including commercial
banks, governments, or international financial
institutions.
• These loans, including interest, must usually be paid in
the currency in which the loan was made.
• To earn the needed currency, the borrowing country may
sell and export goods to the lender's country.
• External Commercial borrowings cover all medium/long
term loans.
EXTERNAL ASSISTANCE

• External assistance by India denotes aid extended by

India to other foreign Governments under various
agreements and repayment of such loans.
• External Assistance to India denotes multilateral and
bilateral loans received under the agreements between
Government of India and other
Governments/International institutions and repayments
of such loans by India.
BALANCE on Capital Account

• Capital account is in balance when capital inflows (like

receipt of loans from abroad, sale of assets or shares in
foreign companies) are equal to capital outflows (like
repayment of loans, purchase of assets or shares in
foreign countries).
• Surplus in capital account arises when capital inflows are
greater than capital outflows, whereas deficit in capital
account arises when capital inflows are lesser than
capital outflows.
Significance of Capital Account

• A country's capital account shows whether it is

importing or exporting capital.
• Large fluctuations in the capital account can reveal a
country's attractiveness to international investors.
• An analysis of a current account can have a significant
impact on currency rates.
Balance of Payment Surplus & Deficit

1. Balance of Payment Surplus

A balance of payments surplus would occur if the balance is greater
than zero. This means that the country has a net inflow of
payments. More payments are coming into the country for exports,
transfers, or investments than are going out.

2. Balance of Payment Deficit

A balance of payments deficit would occur if the balance is less than
zero. This means that the country has a net outflow of payments.
More payments are going out of the country for imports, transfers,
or investments than are coming in.
3. Balance of Payment - Achieving a Balance

The essence of international payments is that just like an

individual who spends more than her income must finance the
difference by selling assets or by borrowing, a country that has a
deficit in its current account (spending more than it receives
from sales to the rest of the world) must finance it by selling
assets or by borrowing abroad.

Thus, any current account deficit must be financed by a capital

account surplus, that is, a net capital inflow.
Current account + Capital account = 0
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Q1 . What does the Balance of Payments (BoP) represent?

A. The financial transactions between a country and its central
bank
B. The difference between a country's total exports and total
imports
C. The record of a country's economic transactions with the rest
of the world during a specific period
D. The financial statements of a country's government and public
sector
E. The difference between a the revenue and expenditure of a
country
C.
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Q2. A deficit in the Balance of Payments means that -

A. The country's economy is performing well and
attracting foreign investment
B. The country is exporting more than importing
C. The country's external liabilities exceed its external
assets
D. Both A & C
E. None of the above

C. The country's external liabilities exceed its external

assets
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Q3. Which of the following correctly explains the relationship

between the Current Account and the Capital and Financial Account
in BoP?
A. They are not directly related to each other
B. A surplus in the Current Account is offset by a surplus in the
Capital Account
C. A deficit in the Current Account is offset by a deficit in the Capital
Account
D. A surplus in the Current Account is offset by a deficit in the Capital
Account.
E. None of the above
D. A surplus in the Current Account is offset by a deficit in the Capital
Account.
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Q4. Which components are included in the Current Account

of the Balance of Payments?
A. Imports and exports of goods and services, income
receipts, and unilateral transfers
B. Foreign direct investment, portfolio investment, and
other investment flows
C. External debt and foreign exchange reserves
D. Both A & B
E. Both B & C
A. Imports and exports of goods and services, income
receipts, and unilateral transfers
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Q5. Which of the following is NOT considered a part of the

Official Reserves Account in the Balance of Payments?
A. Gold and foreign currency reserves
B. Special Drawing Rights (SDRs)
C. Foreign loans and credits
D. Reserve position in the International Monetary Fund
(IMF)
E. All of the above
C. Foreign loans and credits
 DESCRIPTIVE WRITING

Q1. What is balance of payment? What difficulties are

faced by India in this context?

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 Practice Questions

The balance of payments (BoP) records the transactions in

goods, services, and assets between residents of a country with
the rest of the world for a specified time period typically a year.
It represents a summation of country’s current demand and
supply of the claims on foreign currencies and of foreign claims
on its currency.

Various difficulties faced by India in this context -

 Practice Questions
Balance of Trade Deficits:

The first and the foremost cause of balance of payments

deficit in India has been the trade deficits that India has
had to encounter right since the beginning of the growth
process. The import needs of the economy went on
increasing without a corresponding increase in exports,
resulting in mounting trade deficits.
 Practice Questions

Declining Surplus on Account of Invisibles

• A marked feature of India’s BOP has been that it has been earning
a net surplus on account of trade in invisibles.
• Large earnings on account of invisibles have been due to
remittances form Indians working abroad and surplus earnings on
travel services.
• There exists a strong possibility that in the long run the negative
forces of investment income would outweigh the positive impact
of the rest of the items, leading to a deficit in invisible trade
thereby creating further complications in the BOP.
 Practice Questions
Mounting Burden of External Debt Servicing:
Another factor behind the increasing pressure on the BOP
has been steadily mounting burden of external debt
servicing.

Dim Prospects of Getting Concessional Aid:

The prospects for getting concessional aid on an increasing scale
appear to be bleak under the given economic circumstances, mainly
because of the factors, explained here -
 Practice Questions
1. the generally worsening climate for official development
Assistance (ODA)- most developed nations have been
unwilling to increase and, in some cases, even maintain the
size of their contribution,
2. the view that the Indian economy is now well equipped to
tap commercial sources of foreign exchange finance;
3. the entry of new claimants on the pool, such as China and
other nations of East Europe, and emergence of new
independent nations, like Estonia, Lithuania, Latvia, Ukraine
etc.
 Practice Questions
India is presently known as one of the most important
players in the global economic landscape. Its trade policies,
government reforms and inherent economic strengths has
attributed to its standing as one of the most sought-after
destination for foreign investments in the world. The need
of the hour is product and geographical diversification in
order to further consolidate the BOP. The government
along with financial regulators have taken proactive
measures to captivate the opportunities. of the