Balance of Payments by AbhinavAg1


									         Balance of Payments
      The balance of payments is defined as a
 systematic record of all economic transactions
between the residents of a country and residents
   of foreign countries during a certain period of
    time. Systematic record means the system
generally adopted is double entry book-keeping
  system. Economic transaction include all such
  transactions that involve the transfer of title or
    ownership. While some transaction involve
 physical transfer of goods, services, assets and
        money along with the transfer of title
• First – the balance of payments accounts
  provide extremely useful data for the economic
  analysis of the country’s weakness and strength
  as a partner in international trade.
• Second – balance of payments also reveals the
  changes in the composition and magnitude of
  foreign trade. The changes that are deterrent to
  the economic well being of the country call for
  necessary action by the government. For
  example a regular outflow of capital or export of
  essential goods causing scarcity; in the
  domestic market needs to be curbed through
  policy measures of direct action.
• Third – balance of payment also provides
  indications of future repercussions of country’s
  past trade performances. If balance of
  payments shows continuous and large trade
  deficits over time, it shows the growing
  international indebtedness of the country, which
  may ultimately lead to financial bankruptcy.
• Finally – detailed balance of payments
  accounts reveal also the weak and strong
  points in the country’s foreign trade relations
  and thereby invites government attention to the
  need for corrective measures against the weak
  spots and unhealthy developments.               3
    Balance of Payments Account
• The economic transactions between a country
  and the rest of the world may be grouped under
  two broad categories.
• Current transactions – pertain to export and
  impost of goods and services that change the
  current level of consumption in the country or
  bring a change in the current level of national
  (money) income.
• Capital transactions – are those which increase
  or decrease a country’s total stock of capital,
  instead of affecting the current level of       4
  consumption or national income.
             Current Account
• The item which are entered in the current account of
  the balance of payments are listed in table in the order
  of their importance as suggested by the IMF and
  currently followed in India. In the credit column are
  entered the values receivable and in debt column the
  values payable. The net balance shows the excess of
  credit over the debit for each item : it may be negative
  (-) or positive (+). The items listed in the current
  account cab be further grouped as :
• Visible items – merchandise trade, i.e., export and
  import of goods, fall under the visible items.
• Invisible items – all other items in the current account
  payment and receipt for the services, such as banking,
  insurance and shipping etc.                           5
  Transactions     Credit     Debit      Net balance
1 Merchandise      Export     Import        -
2 Foreign travel   Earning    Payments      -
  Transportation   Earning    Payments      -
  Insurance        Receipts   Payments      -
  Investment       Dividend   Dividend      -
  Govt sales and   Receipt    Payment       -
  purchase of
  goods and
                   Receipt    Payment        -

 Current account       -         -       Surplus (+)
              Capital Account
• Broad categories of capital account items are
• Short-term capital movements include (1) purchase of
  short-term securities such as treasury bills,
  commercial bills and acceptance bills, etc.;(2)
  speculative purchase of foreign currency and (3) cash
  balances held by foreigners for such reasons as fear
  of war, political instability, etc.
• Long-term capital movements include: (1) direct
  investments in shares, bonds and in real estate and
  physical assets such as plants, buildings, equipments,
  etc. (2) portfolio investments in stocks and bonds such
  as governments securities, securities of firms not
  entitling the holder with a controlling power and (3)
  repurchase and resale of securities earlier sold to or
  purchased from the foreigners.
   Balance of payments accounts are
           always in balance
• The balance of payments accounting is based on the
  double-entry book keeping system in which both sides
  of a transaction – receipts and payments are
  recorded. For example export involve outflow of goods
  and inflow of foreign currency. Similarly, imports
  involve inflow of goods and outflow of foreign
  currency. Both inflow and outflow are recorded in this
  system. However, donations, gift, aids, assistance,
  etc., are unilateral transfers and do not involve transfer
  of an equivalent value. In regard to these items, there
  is only give, no take or there is only credit, no debit
  since it is non-refundable. Since in this system of BOP
  accounting international transactions are entered on
  both debit and credit side, BOP accounts are always     8
  in balance.
    Disequilibrium in balance of payment
• The BOP is always in balance also because, in the
  accounting procedure, a deficit in the current account
  is offset by a surplus on capital account. Balance of
  payments remains always in balance. Such as it is
  there should be no question of imbalance or
  disequilibrium in the balance of payments. But
  disequilibrium in the balance of payments does arise
  because total receipts during the reference period
  need not always necessarily be equal to the total
  payment obligations of that period. When total receipts
  do not match with total payment obligations of the
  accounting period this is a positions of disequilibrium
  in the balance of payments.
            Assessing the BOP
  For the purpose of assessing the overall balance of
 payment position of the country, the total receipts and
   total payments arising out of transfer of goods and
services and long terms capital movements and all other
   transactions are regrouped under the following two
  categories: (a) autonomous transactions (b) induced
 Autonomous transactions are those that take place on
their own due to people’s desire to consume more or to
make a large profit. For example exports and imports of
goods i.e., items of current account are undertaken with
    a view to making profit or consuming more goods.  10
  On the other hand, the short-term
      capital movements, gold
  movements and accommodating
  capital movements on account of
  the autonomous transactions are
    induced transactions. These
transactions lead to reduction in the
 gold and foreign exchange reserve
           of the country.
            Causes and kinds of BOP
• That disequilibrium of deficit nature arise when total imports
  exceed total exports. But imports and exports are determined
  themselves. The volume and value of imports and exports are
  determined by a host of other factors. And, these factors
  become the ultimate cause of BOP disequilibrium.
• As regards the determinants of imports, the total import of a
  country depends on three factors. (1) internal demand for
  foreign goods, which depends largely on the total purchasing
  power of the residents of the importing country,(2) the relative
  prices of imports and their domestic substitutes,(3) people’s
  preference for foreign goods (4) price-elasticity of demand for
  imports and (5) income-elasticity of imports. Similarly, total
  export of a country depends on (1) foreign demand for its
  goods, (2) competitiveness of its price and quality and (3) its
  exportable surplus
     Price changes and Fundamental
• The change in the price level may be inflationary or
  deflationary. Deflation normally causes a surplus in
  the balance of payments, the balance of payment
  surplus does not cause a serious concern form the
  surplus country’s point of view. On the other hand,
  inflationary changes in prices cause deficit in the
  balance of payments. The BOP deficit results in
  increase indebtedness, depletion of gold reserves,
  loss of employment, distortions in the domestic
  economy and cause other economy problem in the
  deficit countries. We will therefore, discuss here only
  the impact of inflationary price changes on the balance
  of payment position.                                 13
        Business cycle and cyclical
• Business cycle are characterized by economics
  ups and downs. The economics ups and downs
  are often associated with inflationary rise or
  deflationary decline in the general price level,

    Structural changes and structural
• Structural changes in an economy are caused
  by such factors as (1) depletion of the cheap
  natural resources, (2) change in technology
  with which a country is not in a position to keep
  pace i.e., technology lag and (3) change in
  consumers’ taste and preference. Such
  changes cause inefficiency and high cost in the
  exporting country and they found it difficult to
  face the competition in the international market,
  due to either high cost of production or lack of
  foreign demands.                                15

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