BALANCE OF PAYMENT Chapter 3

BOP It is the systematic summary of the economic transactions of the residents of a country with the outsiders. An economic transaction arises when values are exchanged or moved between nations.

Features

Economic transaction- Export and import rendering of services, gift & grants from one country to another, Investments made or received Increase or decrease in international reserves

Resident with non residents Residents may mean individuals, institutions, corporate bodies, government departments, branches or units of MNCs

A flow statement It is compilation of flow of economic transaction of the country during the period and not a statement of the position as on date.

Periodicity It is prepared of one year.

Components of BOP

I) Current account It covers all transactions between residents & non residents, other than financial items.

1) Merchandise trade It represents exports and imports of commodities from / into India. The credit in the item represents exports and debit represents imports. The net balance, being the difference between exports and imports is known as balance of trade.

When the aggregate exports of goods from the country during the period exceed its aggregate import, the balance of trade is said to be favorable or surplus or positive and vice a versa.

2) Invisibles A) Services B) Transfers C) Investment income Travel Transportation Insurance Miscellaneous B) Transfers Official Private C) Investment income

II) Capital account It represents transfer of money and other capital items and changes in the country’s foreign assets and liabilities resulting from the transactions recorded in current account.

1. Foreign investment 2. Loans 3. Banking capital In India Direct Portfolio Abroad 2. Loans External assistance By India To India Commercial borrowings Short term to India 3. Banking capital Commercial banks Assets Liabilities Non residents deposits Others 4. Rupee debts service 5. Other capital

III) Official reserve account Official reserves are government owned assets. The official reserve account represents only purchases and sales by the central bank of the country.

Example.. If a country has a BOP deficit, the central bank will have to either run down its official reserve assts such as gold, foreign exchange and SDR or borrow fresh from foreign central banks. Or if a country has a BOP surplus, its central bank will either acquire additional reserve assts from foreigners or retire some of its debt.

BOP accounting principles..

Credit transactions (+) Are receipts of payment from foreigners. Like- Exports of goods or services Unilateral transfers (gifts) received from foreigners Capital inflows

Capital inflows It can take either of the two forms- An increase in foreign assts of the nation. A reduction in the nation’s assets abroad.

Example.. A US resident purchases an Indian stock. This is a capital inflow to India because it involves the receipt of a payment from a foreigner and thus foreign assets in India go up. When an Indian resident sells a foreign stock. This is a capital inflow to India because it involves receipt of a payment from a foreigner, thus Indian assts abroad decreases.

Debit transactions (-) Are the payment of foreign exchange. Like- Imports of goods and services Unilateral transfers (gifts) made to foreigners Capital outflows

Capital outflow It can take either of the two forms- An increases in the nations assets abroad. A reduction in foreign assets abroad.

Example Purchase of a UK t –bill by an Indian resident. This results in an increase in the Indian assets abroad & is a debit transaction since it involves a payment to foreigners. Sale by a US firm of an Indian subsidiary. This results in reduction in foreign assets in India and is entered as a debit transactions.

BOP disequilibrium BOP is said to be in equilibrium when the demand for foreign exchange is exactly equivalent to the supply of it. It is at disequilibrium when it shows either a surplus or deficit. There will be deficit in BOP when the demand for foreign exchange exceeds its supply, and there will be a surplus when supply for foreign exchange exceeds the demand

Factors.. 1) Economic 2) Political 3) Social Development disequilibrium Cyclical disequilibrium Secular disequilibrium Structural disequilibrium 2) Political 3) Social

Correction of disequilibrium

contraction/ expansion Monetary contraction/ expansion 2. Devaluation/ Revaluation 3. Exchange control Foreign loans 2. Incentives for foreign investments 3. Tourism development 4. Incentives for foreign remittances 5.Import substitution Export promotion Abolition / reduction of export duties 2. Export subsidies 3. Export incentives Import control Import duties Import quotas Import prohibition