Balance of Payment

BOP The International Monetary Fund (IMF) defines the BOP as a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. BOP data measures economic transactions include exports and imports of goods and services, income flows, capital flows, and gifts and similar ―one-sided transfer payments. The net of all these transactions is matched by a change in the country‘s international monetary reserves.

BOP Credits are transactions that increase the amount of money to domestic residents from foreigners, and debits are transactions that increase the money paid to foreigners. For instance, if someone in England buys a INDIAN goods, the purchase is a debit to the British account and a credit to the India account. If a Indian company sends an interest payment on a loan to a bank in the United States, the transaction represents a debit to the Indian BOP account and a credit to the United States BOP account.

BOP The current account deals with international trade in goods and services and with earnings on investments. The capital account consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets. The official reserves account, is the foreign currency held by central banks, and is used to pay balance-of-payment deficits

Balance of Payments of India Current Account Rupees in Crores Credits Debits Net I. Merchandise (i) Private (ii) Government II. Non-monetary Gold Movements III. Invisibles (i) Travel (ii) Transportation (iii) Insurance (iv) Investment Income (v) Govt. not included elsewhere (vi) Miscellaneous (vii) Transfer Payments (a) Official (b) Private Total Current Account (I+II+III)

The Current Account When a trade deficit or surplus is reported, this is usually the account that is being referred to. It is an indication of the desirability of a country's products and services by the rest of the world, and therefore, its competitiveness in the world marketplace.

The Current Account Merchandise trade consists of all raw materials and manufactured goods bought, sold, or given away. Services include tourism, transportation, engineering, and business services, such as law, management consulting, and accounting. Fees from patents and copyrights on new technology, software, books, and movies also are recorded in the service category. Most outsourcing of labor is a debit to the services account.

The Current Account Income receipts include income derived from ownership of assets, such as dividends on holdings of stock and interest on securities. Unilateral transfers represent one-way transfers of assets, such as worker remittances from abroad and direct foreign aid.

Balance of Payments of India Current Account Rupees in Crores Credits Debits Net I. Private (i) Long Term (ii) Short Term II. Banking III. Official (i) Loans (ii) Amortisation (iii) Miscellaneous Total Capital Account (I+II+III) Balance of Payments of India

Explanation  The capital account reflects the real monetary position of a country in the international capital market. Changes in the balance of payments produce deep repercussions on the functioning of the economy.  A ‘surplus’ in the balance of payment generally means an inflow of income into the country, more economic activity and more employment for the people.  Deficit in the balance of payments, on the contrary, implies and outflow of income abroad, less of economic activity and less of employment at home.

Balance of Payments Deficit and Surplus The current account should balance with the capital account, because every transaction is recorded as both a credit and a debit (double-entry accounting), and since credits must equal debits and the balance of payments is equal to credits minus debits, the sum of the balance of payments statements should be zero. BOP = Current Account + Capital Account = Credits - Debits ≈ 0 For practical reasons, however, it deviates slightly from zero.

For Example When the INDIA buys more goods and services than it sells—a current account deficit—it must finance the difference by borrowing, or by selling more capital assets than it buys—a capital account surplus. A country with a persistent current account deficit is, therefore, effectively exchanging capital assets for goods and services. Large trade deficits mean that the country is borrowing from abroad or selling assets to foreigners.

For Example In the balance of payments, this appears as an inflow of foreign capital. In reality, the accounts do not exactly offset each other, statistical discrepancies, accounting conventions, and exchange rate movements that change the recorded value of transactions.

The Official Reserve Account The official reserve account, a subdivision of the capital account, is the foreign currency and securities held by the government, usually by its central bank, and is used to balance the payments from year to year. The official reserves increases when there is a trade surplus and decreases when there is a deficit.

The Official Reserve Account If a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency.

In Economic Terms A balance of payments surplus means a nation has more funds from trade and investments coming in than it pays out to other countries, resulting in an Appreciation in the value of its national currency versus currencies of other nations. A deficit in the balance of payments has the opposite effect: an excess of imports over exports, a dependence on foreign investors, and an overvalued currency. (China- Exception) Countries experiencing a payments deficit must make up the difference by exporting gold or Hard Currency reserves, such as the U.S. Dollar, that are accepted currencies for settlement of international debts.

SDR An international type of monetary reserve currency, created by the International Monetary Fund (IMF) in 1969, which operates as a supplement to the existing reserves of member countries Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs are designed to augment international liquidity by supplementing the standard reserve currencies. An artificial currency used by the IMF and defined as a "basket of national currencies". The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the member countries' governments.

Exchange Rate Impacts: The relationship between the BOP and exchange rates can be illustrated by use of a simplified equation that summarizes BOP data: BOP = (X-M) + (CI-CO) + FXB Where: X is exports of goods and services, M is imports of goods and services, (X-M) is known as Current Account Balance CI is capital outflows, CO is capital outflows, (CI-CO) is known as Capital Account Balance FXB is official monetary reserves such as foreign exchange and gold

Exchange Rate Impacts The effect of an imbalance in the BOP of a country works somewhat differently depending on whether that country has fixed exchange rates, floating exchange rates, or a managed exchange rate system.

Fixed Exchange Rate Countries. Under a fixed exchange rate system, the government bears the responsibility to ensure a BOP near zero. If the sum of the current and capital accounts does not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves.

Fixed Exchange Rate Countries. If the sum of the first two accounts is greater than zero, a surplus demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and sell domestic currency for foreign currencies or gold so as to bring the BOP back near zero.

Fixed Exchange Rate Countries. If the sum of the current and capital accounts is negative, an exchange supply of the domestic currency exists in world markets. Then the government must intervene by buying the domestic currency with its reserves of foreign currencies and gold. It is obviously important for a government to maintain significant foreign exchange reserve balances to allow it to intervene effectively. If the country runs out of foreign exchange reserves, it will be unable to buy back its domestic currency and will be forced to devalue.

Fixed Exchange Rate Countries. For fixed exchange rate countries, business managers use balance-of-payments statistics to help forecast devaluation or revaluation of the official exchange rate. Normally a change in fixed exchange rates is technically called ―devaluation or ―revaluation, while a change in floating exchange rates is called either ―depreciation or ―appreciation.

Floating Exchange Rate Countries. Under a floating exchange rate system, the government of a county has no responsibility to peg the foreign exchange rate. The fact that the current and capital account balances do not sum to zero will automatically (in theory) alter the exchange rate in the direction necessary to obtain a BOP near zero. For example, a country running a sizable current account deficit with the capital account balance of zero will have a net BOP deficit. An excess supply of the domestic currency will appear on world markets.

Floating Exchange Rate Countries As is the case with all goods in excess supply, the market will rid itself of the imbalance by lowering the price. Thus, the domestic currency will fall in value, and the BOP will move back toward zero. Exchange rate markets do not always follow this theory, particularly in the short-to-intermediate term.

Managed Floats Although still relying on market conditions for day-to-day exchange rate determination, countries operating with managed floats often find it necessary to take actions to maintain their desired exchange rate values. They therefore seek to alter the market‘s valuation of a specific exchange rate by influencing the motivations of market activity, rather than through direct intervention in the foreign exchange markets. The primary action taken by such governments is to change relative interest rates, thus influencing the economic fundamentals of exchange rate determination.

Managed Floats A change in domestic interest rates is an attempt to alter capital account balance, especially the short-term portfolio component of these capital flows, in order to restore an imbalance caused by the deficit in current account. The power of interest rate changes on international capital and exchange rate movements can be substantial.

Managed Floats A country with a managed float that wishes to defend its currency may choose to raise domestic interest rates to attract additional capital from abroad. This will alter market forces and create additional market demand for domestic currency. In this process, the government signals exchange market participants that it intends to take measures to preserve the currency‘s value within certain ranges.

Managed Floats The process also raises the cost of local borrowing for businesses, however, and so the policy is seldom without domestic critics. For managed-float countries, business managers use BOP trends to help forecast changes in the government policies on domestic interest rates.

Balance of Payments The balance of payments of a country is 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. It is an important index, which reflects the true economic position of a country, whether the country is a creditor country or a debtor country, and whether its currency is rising or falling in its external value.