Balance of Payments

Balance of Payments
Balance of Payments
• Balance of Payments is the statistical
record of a country’s international
transactions over a period of time
presented in double-entry bookkeeping.
• The BOP of a country is a systematic
record of all economic transactions
between the residents of a country and
rest of the world
Balance of Payments
• Transactions can be between governments, companies,
individuals
• 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.
• Includes export, imports, bank accounts, bonds, stocks,
real estate, investments, receipts and payment for
services, interest, dividends, grants and aids.
Balance of Payments
• In India’s balance of payments (BoP),
transactions are recorded in accordance with the
guidelines given in the fifth edition of IMF’s
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.
Balance of Payments
• 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.
• Simple rule of BoP accounting is that any
transaction that gives rise to payment by a
country is a deficit item in that country’s BoP and
vice versa.
Balance of Payments
The basic structure of the Balance of Payments (BOP)
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: omitted and missed
transactions
(iv) International reserves and IMF transactions.
Current Account
• An important long run and comprehensive measure of
country’s transaction with the rest of the world
• Comprises trade in goods and services and income
from assets abroad and payment on foreign owned
assets in the country
• Trade in goods results in Merchandise trade balance:
net balance of exports minus imports on merchandise
(goods)
• Trade surplus = exports>imports (Inflow of cash>outflow
of cash)
• Trade deficit = exports<imports (Inflow of cash<outflow
of cash)
Current Account
• Trade in services includes freight, passenger
fares, royalties, fees, tourism
• Factor income: includes net investment
income, interest, profits
• Unilateral transfers include relief funds, grants,
income earned by guest workers.
– Have only one directional flows hence only net flow
recorded
– Also believed that the country donating funds earns
goodwill.
Capital Account
• Capital Account shows transactions in real
or financial assets between countries
– Purchase of real estate
– FDI, FII
– Purchase and sale of securities
– Changes in official reserves of gold, silver,
SDRs, and foreign exchange
• Transaction of private sector
Statistical discrepancy
• Represents omitted and missed
transactions
• Transactions made at different points of
time using different modes hence
possibility of omissions
• Balancing debit or credit as Statistical
discrepancy.
Official Reserve Account
• Official reserves transaction (by central
bank)
– foreign currency assets of the central bank
– gold holdings of central bank and
– special drawing rights (SDR)
– Reserve positions with IMF
• In case of deficit BoP official reserves
used to fill the gap
External account must balance
• Payments to abroad=receipts from abroad
• Current account deficit has to be compensated with
capital account surplus
• Current account deficit is financed by
– Private sector by selling off assets or borrowing abroad
– Govt. runs down its official reserves
• In case of surplus,
– private sector can buy assets abroad or pay off past debt or
– Central bank can buy foreign exchange earned by private sector
and increase reserves
External account must balance
• Increase in official reserves is called balance
of payments surplus
• Balance of payments surplus = Increase in
official reserves = current account surplus+ net
private capital inflow
• Balance of payments deficit is a bad news
– Means both current and capital accounts are in deficit
– Central bank is losing reserves
• Current account deficit is just equal to capital
account surplus, BoP is neither surplus nor
deficit
Measures To Reduce BOP Deficit
• Crises management
– Devaluation of rupee,
– Action to compress imports
– Seek foreign exchange
– Use gold
• Reform the economy
Importance
• Balance of payments data influence the
exchange rates and government policy
– Shows demand and supply of the currency
• Shows the international competitiveness of the
country
• Corporates monitor Balance of Payments to
watch for factors that could lead to currency
instability or government actions to correct an
imbalance
– Large current account deficit is a bad signal: unstable
currency exchange rates

Balance of Payments

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