08

Balance of Payments

MGUg of Balance of Payments (BOP)

It is a systematic record of all economic 3. Unilateral Transactions These transactions
transactions between the residents of a country are one-sided and include gifts, donations
and the rest of the world in a given period of time, etc. These are also referred to as unrequited
usually one year. transactions as they do not involve
repaymnent.
It is prepared on thebasis of double-entry
system of accounting and isa flow concept. 4. Capital Transfer Transactions These
transactions involve capital receipts and
Economic Transactions Recorded in BoP capital payments. They also involve purchase
and sale of assets.
Economic transactions i.e. transactions leading
totransfer of title, ownership, goods, money and
assets that are recorded in BoP incude Balance of Payments Structure
1. Transactions involving Visible Items Al1 Balance of payments account is prepared on
a double entry basis i.e., there are two sides
types of physical goods i.e. goods that can
be seen or touched are known as visible of transaction namely debit side and credit
side.
items. The exports and imports of such
items are recorded in BoP and can be Debit side of BoP records all such transactions
verified by custom officials. that results in the outflow of foreign currency
while credit side of BoP records all such
2. Transactions involving Invisible Items All
theservices are known as invisible items. transactions that leads to inflow of foreign
These include services like insurance, exchange.
banking, shipping, consultancy,investment If the balance of credit side exceeds the balance
income (like interests, profits, dividend and of debit side, it refers to surplus in BoP, whle u
royalties) etc. Transactions involving such debit side balance exceeds credit side balance, 1t
services are also recorded in BoP. refers to deficit in BoP.
Components of Balance of Payments (BoP) "Compensation paid to employees.
The following are the two main components of " Investment income involving payment
BoP received on account of rent, interest
-Current Account Capital Account and profit.
(ii) Transactions involving Non-factor
I.Current Account Services These transactions involve all
Current account records the actual receipts and services other than factor services that
payments relating to export and import of goods involve the payments to factors of
and services and unilateraltransfers during a production. Examples of such services
given period of time, usually a financial year. are banking, insurance, etc.
It shows the status of income and employment These are recorded in the following
manner
in thecountry. Also, these transactions do not
Debit Side Credit Side
impact the assets and liabilities of the country. (Negative Side) (Positive Side)
Components of Current Account Payment made on
account of factor and
Receipts on account
of factor and
The main components of current account are
non-factor services. non-factor services.
Components of Current Account
3. Unilateral Transfers /Current Transfers
These are transfers made by residents or
Export and Import Export and Unilateral non-residents settled abroad in the form of
of Visible Items/ Import of Invisible Transfers/Current gifts, donations, grants, remittances, etc. In
Goods Items/Services Transfers
the BoP account, unilateral transfers are a
part of invisibles'.
Transactions Transactions These are recorded in the following manner
involving involving
factor services non-factor services Debit Side Credit Side
(Negative Side) (Positive Side)
1. Export and Import of Visible Items/ Goods Unilateral transfers Unilateral transfers
Current account includes export and import made by residents to received by residents
of visible items or goods like wheat, rice, the rest of the world. from the rest of the
machine, etc. world.
These are recorded in the following manner
Debit Side Credit Side Balance of Trade (Bol)
(Negative Side) (Positive Side) The term Balance of trade' means the difference
Payment for import of Receipt from export of between value of exports and imports of visible
g0ods. goods. goods in a given period of time. It is also known as
Balance of visible trade' or Trade balance'.
2. Export and Import of Invisible Items/ BoT V, Vm
Services Current account also includes
export and import of invisible items or Where, V, =Value of goods exported
services which are further categorised as V, Value of goods imported
factor services and non-factor services Deficit in the balance of trade occurs when value
of exports of goods are less than value of imports
(i) Transactions involving Factor Services of goods,
These transactions involve payments Surplus in the balance of trade occurs when value
made to factors of production and of exports of goods are more than value of imports
involve the following of goods.
Balance on Current Account 1. Foreign Investment It includes
The difference between the credit and debit items investment made by the residents of a
shows the balance on current account. country in rest of the world or by the
It can show residents of rest of the world in the
domestic country.
1. Current Account Surplus It arises when the
sum of credit items exceed the sum of debit Foreign investment can be of the followine
items. It shows net inflow of foreign exchange. It types
signifies that the nation is a lender to the rest of (i) Foreign Direct Investment (FDI) It is
the world. related to change in the ownership
2. Current Account Deficit It arises when the sum statusand allows direct controlof the
purchaser over the asset. e.g.
of debit items exceed the sum of credit items. It
Dominos opens its restaurants in
shows net outflow of foreign exchange. It India or Haldiram opens its
signifies that the nation is a borrower from rest restaurants in America.
of the world. (ii) Foreign Portfolio Investment (FPI) It
Balances Related to Current Account refers to the purchase of securities
and other financial assets such as
" Trade Balance It is the difference between export
and import of goods. bonds, mutual funds, GDRs, etc. by
" Goods and Services Balance It is computed in the investors from another country. It is
same as Foreign Institutional
following manner
Trade Balance + Balance of Non-factor Services Investors (FIIs).
" Invisibles Balance is computed in the following Foreign investment is recorded in the
manner following manner
Balance on Non-factor Services + Balance on Factor
Services/ Income + Balance on Current Transfers Debit Side Credit Side
(Negative Side) (Positive Side)
. Current Account Balance It is the sum of trade
balance and invisibles' balance. Physical assets Physical assets
purchased by the purchased by the
residents of
Il. Capital Account domestic country in
residents of rest of
the world in the
It records capital transactions between the residents rest of the world. domestic country.
of country and the rest of the world.
Financial assets Financial assets
These transactions cause a change in the assets or purchased by the purchased by the
liabilities of the residents of the country or its residents of residents of rest of
government during a financial year. It is used to domestic country in the world in the
rest of the world. domestic country.
finance deficit in current account and absorb
surplus of current account. 2. Borrowings Borrowings to and from
abroad also affect the assets and liabilities
Components of Capital Account status of the country and are therefore
The main componentsof capital account are recorded in capital account.
Components of Capital Account Borrowings can be further categorised as
follows
Borrowings Other (i) External Commercial Borrowing It is
Component: available at market rate of interest n
’ Foreign direct " External NRI deposits the international money market.
investment Commercial
Banking (ii) External Assistance It is available at
Foreign portfolio borrowing capital concessional rate of interest in the
investment " External Short-term
assistance trade credit international money market.
 Borrowings are recorded in the following 2. Capital Account Deficit It arises when the
manner sum of debit items exceed the sum of credit
Debit Side Credit Side items. It shows net outflow of foreign
(Negative Side) (Positive Side)
Borrowings to
exchange.
Borrowings from
abroad by private abroad by private
sector and
government.
sector and government. Errors and Omissions in BoP
It is difficult to record all international
Repayment of Repayment of loans transactions accurately. Thus, in addition to
loans taken from given to the rest of the
abroad by private world by private sector current account and capital account, there is
sector and and government. one more element of BoP, called as errors and
government.
omissions.
3. Other Components The other components of When all actual balance of payments entries are
capital account include the following added,the resulting balance will almost inevitably
show a net credit or a net debit. That balance is
(i) NRIDeposits It refers to deposits held by
Non-resident Indians (NRIs) in India. the result of errors and omissions in compilation
It should be remnembered that only of statements. Some of the errors and omissions
deposits held by NRIs in the domestic may be related to recommendations for practical
economny to be considered as a approximation to principles.
component of capital account.
In balance of payments, the standard practice is
(i) Banking Capital It refers to foreign toshow separately an item for net errors and
assets held by the commercial banks.
omissions. Labelled by some compilers as a
(ii) Short-term Trade Credit It refers to balancing item or statistical discrepancy, that
purchases made in the international item is intended as an offset to the overstatement
market without paying for them or understatement of the recorded components.
immediately.
Ofiial Reserves Account CHECK POINT 01
This account shows the reserves of foreign 1, Which account of BoP records the items that do not
exchange (FOREX) with the RBI. This account can impacts the assets or liabilities of the country?
be shown as a part of the capital account of BoP or 2. Import of machinery will be recorded in which
as a separate account account of BoP and why?
" As a part of Capital Account In such a case, the 3. What is invisible trade?
BoP always balances. 4. What is external commercial borrowing?
"As a Separate Account In such a case, BoP may 5. Define errors and omissions.
or may not balance.
The reserves in this account could be used by a
country to balance any deficit in its BoP. The RBI AutonomoUs and
sells foreign exchange when there is a deficit.
On the other hand, net inflows or surplus in BoP Accommodatiny Items of BoP
The items shown in BoP can also be classified as
helps in accumulating the official reserves that
helps to cover the deficit, if arises. under

Balance on Capital AccOunt 1.Autonomous Items of BoP

The difference between the credit and debit items Autonomous items of Balance of Payments refer to
Shows the balance on capital account. It can show the international economic transactions which are
1. Capital Account Surplus It arises when the made wvith a view to earn profit.
sum of credit items exceed the sum of debit These transactions are independent of the state
items. It shows net inflow of foreign of BoP. Autonomous items are called
above the
line items in BoP.
exchange.
e.g. if an MNC is making Foreign Direct S.No. Item
Investment in our country, with a view to earn 6. Capital Account Balance MilHon Ush
profit, then this transaction will not be affected (6a + 6b+ 6c + 6d+ 6e + 6f]
a. External Assistance (net)
41.15
by thestate of BoP. It will not be dependent on
the fact that whether the BoP is in surplus or in b. External Commercial Borrowings 0.15
deficit. (net)
2
C. Short-term Debt
The main autonomous items are as follows 10
d. Banking Capital (net) of which
" Exports and importsof goods.
Non-resident Deposits (net)
Exports and imports of services. 9
" Unilateral transactions. e. Foreign Investments (net) of which 19
[6eA + 6eB]
" Capital transactions. A. FDI (net) 13
These items can either be recorded in current and B. Portifolio (net) 6
capital account depending on their nature. f. Other Flows (net) -5
7. Errors and Omissions
2. Accommodating Items of BoP 8. Overall Balance (5 + 6+ 7
3.15

Accommodating items refer to those transactions 9. Reserves Change

which are taken up by the government in order to
keep the Balance of Payments (BoP) balanced.
These transactions are based on the state of BoP Equilibrium and Disequilibrium in BoP
and not carried out with a view to earn proft. The BoP of a country may reflect the following
Accommodating items are called below the line two situations
items in BoP. 1. Equilibrium in BoP When the sum of the
All the items related to the monetary transfers balances of the current and capital accounts
that correct the disequilibrium in balance of equals to zero, the BoP is said to be in
payments are accommodating items. equilibrium. In such a situation there is no
movement in the official reserves of the
The main accommodating items are as follows
" Borrowings from IMF or other international country.
financial institutions. 2. Disequilibrium in BoP Disequilibrium inBoP
Changes in foreign exchange reserve. can be reflected in the following manner
(i) Surplus in BoP When the sum of the
These transactions are only recorded in capital balance of the current account and
account. capital account is positive, then BoP
Balance of Payments for India (in million USD) account is said to be in surplus. In such
S.No. Item Million USD a situation, there is inflow of foreign
exchange leading to an increase in the
1. Exports (of goods only) 150
official reserves account.
2. Imports (of goods only) 240
(ii) Deficit in BoP When the sum of the
3. Trade Balance |2 - 1] -90
balance of the current account and
4. (Net) Invisibles (4 a + 4b + 4 c] 52 capital account is negative, then Bo
a. Non-factor Services 30 account is said to be in deficit. In such
b. Income -10 asituation, there is outflow of foreign
C. Transfers 32
exchange leading to decrease in offica
5 Current Account Balance [3 + 4] -38 reserves acCOunt.
Causes of Surplus in BoP Soial Factors
1. Demonstration Effect When the people
Surplusin the BoP can arise due the following
reasons
of underdeveloped countries follow the
consumption pattern of the people of
1 Economic Growth In case the country is developed countries, this leads to an increase
experiencing high economic growth, leading in the level of imports. This increase results
to increase in GDP, this situation leads to in a deficit in the BoP account.
increase in inflow of foreign exchange,
resulting in surplus. 2. Change in Tastes, Preferences, Fashion and
Trends An unfavourable change in tastes and
). Low Levelof Inflation When the inflation preferencesof consumers towards domestic
in the domestic economy is low, this leads goods leads to a deficit in the BoP account.
to increase indemand for domestically
produced goods in theinternational market Political Factors
leading to increase in exports from the 1. Political Instability Political instability of a
domesticeconomy and thus surplus in BoP. country has an adverse effect on balance of
3. Political Stability Stable government policies paymentsof a country. In other words, when
develop a faith in the minds of foreign the government is instable in the domestic
investors leading to increase in foreign economy, foreign investors lose trust while
domestic investors prefers to invest abroad.
investment. This further leads to surplus in
BoP.
This results in huge outflow of foreign
exchange.
Couses of Deficit in BoP 2. Political Disturbances Frequentchanges in
Adeficit in BoP is the major cause of concern
the government, inadequate support to the
government in Parliament also discourage
and its causes are as follows
inflows of capital. This leads to a deficit due
to higher outflows than inflows.
Economic Foctors
Note Disequilibrium in balance of payments can be
1. Inflation Increase in price of agood due to corrected by various methods like promoting exports,
higher wages, higher prices of raw material, reducing imports, depreciation of currency and
etc. makes export costlier and imports exercising foreign exchange control.
cheaper. This results in deficit in balance of
Effects of Deflekt in Bo?
payments.
Some of the effects of a deficit in BoP account are
2. Expenditure on Developing Relations " It reduces the foreign exchange reserves of a
Developing countries, in order to develop country.
relations with other countries, have to spend " It slows the pace of economic development of the
huge amount of money on ambassadors, COuntry.
missions, etc. This has adverse effect on " Acountry's economic crelibility is hampere.
balance of payments. "A country's foreign dependence may take the
form of political dependence.
3. Fall in Demand When the demandof the
goods of a country falls in the foreign market, CHECK POINT 02
export reduces and affect the balance of
payments. e.g. owing to the outbreak of 1. Whena BoP is said to be in equilibrium?
Covid, the demand for Chinese goods has 2. What is BoP surplus and how it is different from the
BoP deficit?
fallen in the international market.
3. Mention the causes of BoP surplus.
4. Import Services Underdevelopedcountries 4. In which account of BoP does autonomous
import capital and other services from transactions recorded?
developed countries. This results in deficit in 5. Mention the economic causes of BoP deficit.
BoP.