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					              SEMINAR REPORT

                        On



          BALANCE OF PAYMENT


SUBMITTED TO:                SUBMITTED BY:

Lec. Azizinder Sekhon         Satinder Kaur

                              MBA-I (C)

                              ROLL NO-5855




       SCHOOL OF MANAGEMENT STUDIES

        PUNJABI UNIVERSITY, PATIALA
                               Acknowledgement




       With deep sense of gratitude, I would like to take opportunity to thank my

honorable seminar guide Lec. Azizinder Sekhon. I could not have asked for a more

cooperative guide. Her invaluable and in stinted support has given me the confidence to

do my work. Without her guidance, the seminar report would not have seen the light of

the day. I would also like to thank my friends who have helped me to find out the

suitable material for the report.




                                                                                     2
                         Index
Sr.No.          Content                       Page No.

1.       Introduction: BOP                     4-7
                  Definition
                  Features
                  Terminology

2.    Balance Of Trade & BOP                  8-9

3.    Components of BOP                       9 - 23
             Capital Account
             Current Account
             Financial Account
             Invisible Balance
             CAC

4.    Structure of BOP                        24 - 26

5.   BOP Components Information Sheet         27 - 30

6.   Methods to Measure BOP                   30 - 34
              Methods
              Meaning of Deficit & Surplus
              BOP always balances?

7. BOP Equilibrium & Disequilibrium           34 - 39
             Types of Disequilibrium
             Causes

8. Methods to Correct Disequilibrium          40 - 43
             Monetary
             Non Monetary

9.   Importance of BOP                        44 - 45

10. India‟s BOP 2009-10                       45 - 48

11. Conclusion                                49

12. Bibliography                              50




                                                         3
                                BALANCE OF PAYMENTS


       International trade plays a major role in the economic development of a country.
The world is becoming an integrated market place and trade equations are changing
rapidly. Realizing the importance of private capital inflow- outflow for the development
of a country, many countries are taking numerous measures to attract foreign investors
Balance of Payment is a term included in international trade.
       IMF definition: Balance of payments is a statistical statement that summarizes
transactions between residents & non residents during a period.
       “The balance of payments of a country is a systematic record of all economic
transactions between the residents of a country and the rest of the world. It presents a
classified record of all receipts on account of goods exported, services rendered and
capital received by residents and payments made by theme on account of goods imported
and services received from the capital transferred to non-residents or foreigners”. -
Reserve Bank of India


       The above definition can be summed up as following: - Balance of Payments is
the summary of all the transactions between the residents of one country and rest of the
world for a given period of time, usually one year. The definition given by RBI needs to
be clarified further for the following points:


A. Economic Transactions


       An economic transaction is an exchange of value, typically an act in which there
is transfer of title to an economic good the rendering of an economic service, or the
transfer of title to assets from one economic agent (individual, business, government, etc)
to another. An international economic transaction evidently involves such transfer of title
or rendering of service from residents of one country to another. Such a transfer may be a


                                                                                         4
requited transfer (the transferee gives something of an economic value to the transferor in
return) or an unrequited transfer (a unilateral gift). The following are the basic types of
economic transactions that can be easily identified:


1. Purchase or sale of goods or services with a financial quid pro quo – cash or a promise
to pay. [One real and one financial transfer].
2. Purchase or sale of goods or services in return for goods or services or a barter
transaction. [Two real transfers]
3. An exchange of financial items e.g. – purchase of foreign securities with payment in
cash or by a cheque drawn on a foreign deposit. [Two financial transfers]
4. A unilateral gift in kind [One real transfer].
5. A unilateral financial gift. [One financial transfer]



B. Resident

        The term resident is not identical with “citizen” though normally there is a
substantial overlap. As regards individuals, residents are those individuals whose general
centre of interest can be said to rest in the given economy. They consume goods and
services; participate in economic activity within the territory of the country on other than
temporary basis. This definition may turnout to be ambiguous in some cases. The
“Balance of Payments Manual” published by the “International Monetary Fund” provides
a set of rules to resolve such ambiguities. As regards non-individuals, a set of
conventions have been evolved. E.g. –government and non profit bodies serving resident
individuals are residents of respective countries, for enterprises, the rules are somewhat
complex, particularly to those concerning unincorporated branches of foreign
multinationals. According to IMF rules these are considered to be residents of countries
in which they operate, although they are not a separate legal entity from the parent
located abroad. International organisations like the UN, the World Bank, and the IMF are
not considered to be residents of any national economy although their offices are located
within the territories of any number of countries.
        To certain economists, the term BOP seems to be somewhat obscure. Yeager, for
example, draws attention to the word „payments‟ in the term BOP; this gives a false


                                                                                          5
impression that the set of BOP accounts records items that involve only payments. The
truth is that the BOP statements records both payments and receipts by a country. It is, as
Yeager says, more appropriate to regard the BOP as a “balance of international
transactions” by a country. Similarly the word „Balance‟ in the term BOP does not imply
that a situation of comfortable equilibrium; it means that it is a balance sheet of receipts
and payments having an accounting balance. Like other accounts, the BOP records each
transaction as either a plus or a minus.


The general rule in BOP accounting is the following:-


a) If a transaction earns foreign currency for the nation, it is a credit and is recorded as a
plus item.
b) If a transaction involves spending of foreign currency it is a debit and is recorded as a
negative item.
       The BOP is a double entry accounting statement based on rules of debit and credit
similar to those of business accounting & book-keeping, since it records both transactions
and the money flows associated with those transactions. Also in case of statistical
discrepancy the difference amount is adjusted with errors and omissions account and thus
in accounting sense the BOP statement always balances.




Features of Balance of Payments


   1. Systematic Record: It is a systematic record of receipts and payments of a
       country with other countries.
   2. Fixed period of time: It is a statement of a account pertaining to a given period
       of time, usually a year.
   3. Comprehensiveness: It includes all the three items, i.e., visible, invisible and
       capital transfers. The balance of payments is a comprehensive record of economic
       transactions of the residents of a country with the rest of the World during a given
       period of time. The aim is to present an account of all receipts and payments on



                                                                                            6
       account of goods exported services rendered and capital by resident of a country
       and goods imported, services received and capital transferred y residents of the
       country.
   4. Double entry system: Receipts and payments are recorded on the basis of double
       entry system. The basic convention applied in constructing a balance of payments
       statement is that every recorded transaction is represented by two entries with
       equal values. One of these entries is designated a credit with a positive arithmetic
       sign; the other is designated a debit with a negative sign. In principle, the sum of
       all credit entries is identical to the sum of all debit entries, and the net balance of
       all entries in the statement is zero.
   5. Self-balanced: From the point of view of accounting, double entry system keeps
       automatically debit and credit sides of the accounts in balance.
   6. Adjustment of Differences: Whenever there are differences in actual total
       receipts and payments, need is felt for necessary adjustment.
   7. All items-Government and Non-Government: Balance of Payments includes
       receipts and payments of all items government and non-government.




Terminology
• Favorable Balance Of Payment s – Value of total receipts more than total payments
• Adverse Balance Of Payments – Value of total receipts less than total payments
• Balanced Balance Of Payments – Value of total receipts equals total payments
• Unrequited receipts – Receipts for which nothing has to be paid in return.
• Unrequited payments – Payments for which nothing is received in return.




                                                                                            7
Balance of Trade and Balance of Payments- A Comparative Study


What is Balance of Trade?
       There are two main concepts relating to international transactions or receipts and
payment: Balance of Trade and Balance of Payments.
       Balance of Trade refers to the balance of difference between the value of total
imports and exports of visible material goods.
       In the words of Benham, “Balance of Trade of a country is the relation over a
period between the values of her exports and the values of her imports.”
       A proper record of all material goods exported and imported is kept at the ports,
so they are called visible items. Balance of Trade, as a matter of fact, is a part of balance
of payments. Balance of Trade may be of three kinds:


   1. Surplus or Favorable Balance of Trade: A country may have favorable or
       surplus Balance of Trade when the total value of the good exported by it is more
       than the total value of the goods imported by it. (Exports>Imports)
   2. Deficit or Unfavorable Balance of Trade: A country may have unfavorable or
       deficit Balance of Trade when the total value of the good imported by it is more
       than the total value of the goods exported by it. (Imports >Exports)
   3. Equilibrium in Balance of Trade: A country may have equilibrium Balance of
       Trade when the total value of the good imported by it is equal to the total value of
       the goods exported by it. (Exports=Imports)




Difference between Balance of Trade and Balance of Payments


   1. Balance of Payment is a broad term. It includes balance of trade. The latter is
       relatively a narrow concept. It is a part of balance of payments.




                                                                                           8
       2. Balance of trade includes imports and exports of goods alone i.e. visible items. On
           the contrary, the balance of payments includes all kind of items, that is import and
           export of goods, services and capital. In other words, it includes visible as well as
           invisible items. In brief, balance of trade is a part of balance of payments.
       3. Balance of trade of a country can be favorable or unfavorable but balance of
           payment always balances.
       4. Deficit of Balance of trade can be met by balance of payments but deficit of
           balance of payments cannot be met by balance of trade.
       5. From the point of view of economic analysis balance of payments is more
           significant than balance of trade. Every country takes into account items of
           balance of payments while formulating its foreign policy. If the liabilities of a
           country to other countries are large, it will have great impact on its national
           income, employment etc.
                   In short, the main difference between balance of payments and balance of
       trade is that the latter is a partial record of a country‟s international trade while the
       former is its complete record. Balance of trade is a part of Balance of payments.




   Components of Balance of Payment

The Balance of Payments for a country is the sum of the current account, the financial
account and the capital account, and the change in official reserves.


     Current Account
                  It is a record of all international transactions for goods and services. The
current account combines the transactions of the trade account and the services account. The
section covers the flow of goods, services and income in and out of a given country and also
financial aid from governments abroad:

* Trade in goods is also known as trade in visible or tangibles,

* Trade in services is also known as trade in invisibles or intangibles.




                                                                                              9
* Income refers not only to the money given back from investments made abroad
(investments are recorded in the financial account but income from investments is recorded
in the current account) but also to the money sent by individuals working abroad that send
money to their families back home (this is usual only in diasporas and developing countries).

           It is the sum of net sales from trade in goods and services, net factor income (such
as interest payments from abroad), and net unilateral transfers from abroad. Positive net sales
to abroad correspond to a current account surplus; negative net sales to abroad correspond to
a current account deficit. Because exports generate positive net sales, and because the trade
balance is typically the largest component of the current account, a current account surplus is
usually associated with positive net exports.

           The Income Account or Net Factor Income, a sub-account of the Current
Account, is usually presented under the headings "Income Payments", as outflows, and
"Income Receipts", as inflows. If the Income Account is negative, the country is paying more
than it is taking in interest, dividends, etc. For example, the United States' net income has
been declining exponentially since it allowed the Dollar's price relative to other currencies to
be determined by the market to a point where income payments and receipts are roughly
equal. The differences between Canada‟s Income Payments and Receipts have been declining
exponentially as well since its central bank in 1998 began its strict policy not to intervene in
the Canadian Dollar's foreign exchange. The various subcategories in the Income Account
are linked to specific respective subcategories in the financial account. From here,
economists and central banks determine implied rates of return on the different types of
capital exchanged in the Financial Account. The United States, for example, gleans a
substantially larger rate of return from foreign capital than foreigners from domestic capital.

                   When analyzing the current account theoretically, it is often written as a
function X of the real exchange rate, p, domestic GDP, Y, and foreign GDP, Y*. Thus the
current account can be written as X (p, Y, Y*). According to theory, the current account X
should increase if (1) the domestic currency depreciates (p increases), (2) domestic GDP
decreases, or (3) foreign GDP increases. Domestic currency depreciation makes domestic
goods relatively cheaper, boosting exports relative to imports. A decrease in domestic GDP
reduces domestic demand for foreign goods, lowering imports without affecting exports. An



                                                                                              10
increase in foreign GDP increases foreign demand for domestic goods, increasing exports
without affecting imports.

Current account =
Trade Balance

Net Exports (Exports - Imports) of Merchandise (tangible goods)

Net Exports (Exports - Imports) Services (such as legal and consulting services)

+ Net Factor Income from Abroad (such as interest and dividends)

+ Net Unilateral Transfers from Abroad (such as foreign aid, grants, gifts, etc.)




   Structure of current account


                                                                                    NET
    Transactions                                 CREDIT            DEBIT            BALANCE
                                                                                    -
    1.Merchanise                                 export            import           -
    2. Foreign Trade                             earning           payment          -
    3. Transportation                            earning           payment          -
    4. Insurance(Premium)                        receipt           payment          -
                                                 dividend          dividend          -
    5. Investment Income                         receipt           payment
    6. Government (purchase of goods &
    services)                                    receipt           payment          -

                                                                                    Surplus(+)
    CURRENT A/C balance                          -                 -                Deficit(-)




   Components of Current Account


    Following items are mainly included under capital account:




                                                                                           11
1. Export and Import of Visible goods: Import and Export of visible material
     goods and precious metals. In other words, all goods included in balance of trade
     are the main items of current account.
2. Invisible Items-Services: Import and Export of invisible goods, i.e., different
     kinds of services included in current account. Main Invisible services are:-


        (i)     Services Rendered by Commercial Undertakings: Commercial
                undertakings like shipping companies, insurance companies, banks,
                etc. belonging to a given country or different countries, exchange their
                services among different countries. Exchange their services among
                different countries. Exchanges of such services are included in current
                account.
        (ii)    Services of Experts: Every counter avails mostly the services of the
                foreign experts like doctors, engineers, soldiers, etc and also puts the
                services of its experts at the disposal of the other countries. The
                services received from abroad are like imports and the services
                rendered to foreign countries are like exports.


3. Traveling: one of the main invisible items of the balance of payments is travels.
     These traveling may be of any account for instance, these may be in connection
     with business, education, health, conventions or pleasure trip etc. the country
     visited to, for it these travels constitute exports and use of foreign transport by the
     natives amounts to be imports.


4. Transportation: Movement of goods from one country to the other. Use of
     domestic transport by the foreigner‟s amounts to exports and use of foreign
     transport by the natives mounts to imports.


5.   Investment Income: Interest, rent, dividend and profit also form an invisible
     item of balance of payments. When a country gets income from its investment
     abroad it is recorded under the head „receipts‟. On the other hand, when foreign



                                                                                         12
       investors earn income from the country where they make investment, then it is
       recorded under the head „payments‟


   6. Governmental Transactions: each government establishes its embassies, offices
       of high commissioners and other missions abroad and spends a lot on their
       maintenance. Such a expenditure is treated as „payments‟ Besides subscriptions
       etc. made to international institutions are also included in this category.


   7. Donations and gifts: Donations are gifts etc. received from abroad are included
       under „receipts‟ and donations and gifts etc. given to other countries are included
       under „payments‟


   8. Miscellaneous: These include such invisible items as commission, advertisement,
       rent, patent fees, royalties, membership fees etc. the amount received from abroad
       on this count constitutes credit item and amount paid to other countries I this
       respect constitutes debit item.




Capital Account


       The capital account records all international transactions that involve a resident of
the country concerned changing either his assets with or his liabilities to a resident of
another country. Transactions in the capital account reflect a change in a stock – either
assets or liabilities. It is often useful to make distinctions between various forms of
capital account transactions. The basic distinctions are between private and official
transactions, between portfolio and direct investment and by the term of the investment
(i.e. short or long term). The distinction between private and official transaction is fairly
transparent, and need not concern us too much, except for noting that the bulk of foreign
investment is private. Direct investment is the act of purchasing an asset and the same
time acquiring control of it (other than the ability to re-sell it). The acquisition of a firm



                                                                                           13
resident in one country by a firm resident in another is an example of such a transaction,
as is the transfer of funds from the „parent company in order that the „subsidiary‟
company may itself acquire assets in its own country. Such business transactions form the
major part of private direct investment in other countries, multinational corporations
being especially important. There are of course some examples of such transactions by
individuals, the most obvious being the purchase of the „second home‟ in another
country.
        Portfolio investment by contrast is the acquisition of an asset that does not give
the purchaser control. An obvious example is the purchase of shares in a foreign
company or of bonds issued by a foreign government. Loans made to foreign firms or
governments come into the same broad category. Such portfolio investment is often
distinguished by the period of the loan (short, medium or long are conventional
distinctions, although in many cases only the short and long categories are used). The
distinction between short term and long term investment is often confusing, but usually
relates to the specification of the asset rather than to the length of time of which it is held.
For example, a firm or individual that holds a bank account with another country and
increases its balance in that account will be engaging in short term investment, even if its
intention is to keep that money in that account for many years. On the other hand, an
individual buying a long term government bond in another country will be making a long
term investment, even if that bond has only one month to go before the maturity.
Portfolio investments may also be identified as either private or official, according to the
sector from which they originate.
        The purchase of an asset in another country, whether it is direct or portfolio
investment, would appear as a negative item in the capital account for the purchasing
firm‟s country, and as a positive item in the capital account for the other country. That
capital outflows appear as a negative item in a country‟s balance of payments, and capital
inflows as positive items, often causes confusions. One way of avoiding this is to
consider that direction in which the payment would go (if made directly). The purchase
of a foreign asset would then involve the transfer of money to the foreign country, as
would the purchase of an (imported) good, and so must appear as a negative item in the
balance of payments of the purchaser‟s country (and as a positive item in the accounts of



                                                                                             14
the seller‟s country). The net value of the balances of direct and portfolio investment
defines the balance on capital account.


Accommodating & Autonomous Capital Flows


       Economists have often found it useful to distinguish between autonomous and
accommodating capital flows in the BOP. Transactions are said to Autonomous if their
value is determined independently of the BOP. Accommodating capital flows on the
other hand are determined by the net consequences of the autonomous items. An
autonomous transaction is one undertaken for its own sake in response to the given
configuration of prices, exchange rates, interest rates etc, usually in order to realize a
profit or reduced costs. It does not take into account the situation elsewhere in the BOP.
An accommodating transaction on the other hand is undertaken with the motive of
settling the imbalance arising out of other transactions. An alternative nomenclature is
that capital flows are „above the line‟ (autonomous) or „below the line‟ (accommodating).
Obviously the sum of the accommodating and autonomous items must be zero, since all
entries in the BOP account must come under one of the two headings. Whether the BOP
is in surplus or deficit depends on the balance of the autonomous items.
The BOP is said to be in surplus if autonomous receipts are greater than the autonomous
payments and in deficit if vice – a – versa. Essentially the distinction between both the
capital flow lies in the motives underlying a transaction, which are almost impossible to
determine. We cannot attach the labels to particular groups of items in the BOP accounts
without giving the matter some thought. For example a short term capital movement
could be a reaction to difference in interest rates between two countries. If those interest
rates are largely determined by influences other than the BOP, then such a transaction
should be labelled as autonomous. Other short term capital movements may occur as a
part of the financing of a transaction that is itself autonomous (say, the export of some
good), and as such should be classified as accommodating. There is nevertheless a great
temptation to assign the labels „autonomous‟ and „accommodating‟ to groups of item in
the BOP. i.e. to assume, that the great majority of trade in goods and of long term capital
movements are autonomous, and that most short term capital movements are



                                                                                         15
accommodating, so that we shall not go far wrong by assigning those labels to the various
components of the BOP accounts. Whether that is a reasonable approximation to the truth
may depend in part on the policy regime that is in operation. For example what is an
autonomous item under a system of fixed exchange rates and limited capital mobility
may not be autonomous when the exchange rates are floating and capital may move
freely between countries.


Items of Capital Account
 Main items of capital account are as follows:


   1. Private Foreign loan flow: Foreign loans received by the private sector are
       counted as credit item and repayments o these loans is counted as debit item.
   2. Movement in Banking Capital: Beside central bank, inflow of banking capital is
       counted as credit item and out flow as debit item.
   3. Official Capital Transactions: Loans received by the public sector from abroad
       or International Monetary Fund constitutes credit items and loans repaid debit
       items.
   4. Reserves, Monetary Gold and SDR:                   Foreign currency assets of the
       government, gold reserves of the central bank, SDR of IMF and similar capital
       transactions, etc. are included under credit items and all kinds of payments under
       debit items
   5. Gold movement: when the central bank of a country buys gold from abroad, it
       makes payment to foreign sellers. It is reflected under debit items. On the
       contrary, when it sells gold it is reflected under credit items.
   6. Miscellaneous: Beside the above items, all other kinds of governmental capital
       receipts which also include receipts of the central bank are shown on credit side
       and all kinds of payments are shown on debit side.




                                                                                       16
   Financial Account

       The financial account (or Official reserve account) is the net change in foreign
ownership of domestic financial assets. If foreign ownership of domestic financial assets has
increased more quickly than domestic ownership of foreign assets in a given year, then the
domestic country has a financial account surplus. On the other hand, if domestic ownership
of foreign financial assets has increased more quickly than foreign ownership of domestic
assets, then the domestic country has a financial account deficit

       The accounting entries in the financial account record the purchase and sale of
domestic and foreign assets. These assets are divided into categories such as Foreign Direct
Investment (FDI), Portfolio Investment (which includes trade in stocks and bonds), and Other
Investment (which includes transactions in currency and bank deposits).

Financial account =

* Increase in foreign ownership of domestic assets - Increase of domestic ownership of
foreign assets




   Basic Balance


           The basic balance was regarded as the best indicator of the economy‟s position
   visa- vis other countries in the 1950‟s and the 1960‟s. It is defined as the sum of the BOP
   on current account and the net balance on long term capital, which were considered as the
   most stable elements in the balance of payments. A worsening of the basic balance [an
   increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit]
   was seen as an indication of deterioration in the [relative] state of the economy. The short
   term capital account balance is not included in the basic balance. This is perhaps for two
   main reasons:



                                                                                             17
       a) Short term capital movements unlike long term capital movements are
relatively volatile and unpredictable. They move in and out of the country in a period of
less than a year or even sooner than that. It would therefore be improper to treat short
term capital movements on the same footing as current account BOP transactions which
are extremely durable in nature. Long term capital flows are relatively more durable and
therefore they qualify to be treated along side the current account transactions to
constitute basic balance.


       b) In many cases, countries don‟t have a separate short term capital account as
they constitute a part of the “Errors and Omissions Account.” A deficit on the basic
balance could come about in various ways, which are not mutually equivalent. E.g.
suppose that the basic balance is in deficit because a current account deficit is
accompanied by a deficit on the long term capital account. The long term capital outflow
will, in the future, generate profits, dividends and interest payments which will improve
the current account and so, ceteris paribus, will reduce or perhaps reduce the deficit. On
the other hand, a basic balance surplus consisting of a deficit on current account that is
more than covered by long term borrowings from abroad may lead to problems in future,
when profits, dividends etc are paid to foreign investors.


The Official Settlement Concept


       An alternative approach for indicating, a deficit or surplus in the BOP is to
consider the net monetary transfer that has been made by the monetary authorities is
positive or negative, which is the so called – settlement concept. If the net transfer is
negative (i.e. there is an outflow) then the BOP is said to be in deficit, but if there is an
inflow then it is surplus. The basic premise is that the monetary authorities are the
ultimate financers of any deficit in the balance of payments (or the recipients of any
surplus). These official settlements are thus seemed as the accommodating item, all other
being autonomous.
       The monetary authorities may finance a deficit by depleting their reserves of
foreign currencies, by borrowing from the IMF or by borrowing from other foreign


                                                                                          18
monetary authorities. The later source is of particular importance when other monetary
authorities hold the domestic currency as a part of their own reserves. A country whose
currency is used as a reserve currency (such as the dollars of US) may be able to run a
deficit in its balance of payments without either depleting its own reserves or borrowing
from the IMF since the foreign authorities might be ready to purchase that currency and
add it to its own reserves. The settlements approach is more relevant under a system of
pegged exchange rates than when the exchange rates are floating.




        Balance of Invisible Trade


        Just as a country exports goods and imports goods a country also exports and
imports what are called as services (invisibles). The service account records all the
service exported and imported by a country in a year. Unlike goods which are tangible or
visible services are intangible. Accordingly services transactions are regarded as invisible
items in the BOP. They are invisible in the sense that service receipts and payments are
not recorded at the port of entry or exit as in the case with the merchandise imports and
exports receipts. Except for this there is no meaningful difference between goods and
services receipts and payments. Both constitute earning and spending of foreign
exchange. Goods and services accounts together constitute the largest and economically
the most significant components in the BOP of any country.


The service transactions take various forms. They basically include
        1) Transportation, banking, and insurance receipts and payments from and to the
foreign countries,
        2) Tourism, travel services and tourist purchases of goods and services received
from foreign visitors to home country and paid out in foreign countries by home country
citizens,
        3) Expenses of students studying abroad and receipts from foreign students
studying in the home country,




                                                                                         19
       4) Expenses of diplomatic and military personnel stationed overseas as well as the
receipts from similar personnel who are stationed in the home country and
       5) Interest, profits, dividends and royalties received from foreign countries and
paid out to foreign countries. These items are generally termed as investment income or
receipts and payments arising out of what are called as capital services. “Balance of
Invisible
       Trade” is a sum of all invisible service receipts and payments in which the sum
could be positive or negative or zero. A positive sum is regarded as favorable to a country
and a negative sum is considered as unfavorable. The terms are descriptive as well as
prescriptive.




       Balance of Visible Trade


       Balance of visible trade is also known as balance of merchandise trade, and it
covers all transactions related to movable goods where the ownership of goods changes
from residents to non-residents (exports) and from non-residents to residents (imports).
The valuation should be on F.O.B basis so that international freight and insurance are
treated as distinct services and not merged with the value of goods themselves. Exports
valued on F.O.B basis are the credit entries. Data for these items are obtained from the
various forms that the exporters have fill and submit to the designated authorities.
Imports valued at C.I.F are the debit entries. Valuation at C.I.F. though inappropriate, is a
forced choice due to data inadequacies. The difference between the total of debits and
credits appears in the “Net” column. This is the „Balance of Visible Trade.‟
       In visible trade if the receipts from exports of goods happen to be equal to the
payments for the imports of goods, we describe the situation as one of zero “goods
balance.‟ Otherwise there would be either a positive or negative goods balance,
depending on whether we have receipts exceeding payments (positive) or payments
exceeding receipts (negative).




                                                                                          20
Errors and Omissions


       Errors and omissions is a “statistical residue.” It is used to balance the statement
because in practice it is not possible to have complete and accurate data for reported
items and because these cannot, therefore, ordinarily have equal entries for debits and
credits. The entry for net errors and omissions often reflects unreported flows of private
capital, although the conclusions that can be drawn from them vary a great deal from
country to country, and even in the same country from time to time, depending on the
reliability of the reported information. Developing countries, in particular, usually
experience great difficulty in providing reliable information.
       Errors and omissions (or the balancing item) reflect the difficulties involved in
recording accurately, if at all, a wide variety of transactions that occur within a given
period of (usually 12 months). In some cases there is such large number of transactions
that a sample is taken rather than recording each transaction, with the inevitable errors
that occur when samples are used. In others problems may arise when one or other of the
parts of a transaction takes more than one year: for example wit a large export contract
covering several years some payment may be received by the exporter before any
deliveries are made, but the last payment will not made until the contract has been
completed. Dishonesty may also play a part, as when goods are smuggled, in which case
the merchandise side of the transaction is unreported although payment will be made
somehow and will be reflected somewhere in the accounts. Similarly the desire to avoid
taxes may lead to underreporting of some items in order to reduce tax liabilities. Finally,
there are changes in the reserves of the country whose balance of payments we are
considering, and changes in that part of the reserves of other countries that is held in the
country concerned. Reserves are held in three forms: in foreign currency, usually but
always the US dollar, as gold, and as Special Deposit Receipts (SDR) borrowed from the
IMF. Note that reserves do not have to be held within the country. Indeed most countries
hold a proportion of their reserves in accounts with foreign central banks. The changes in
the country‟s reserves must of course reflect the net value of all the other recorded items
in the balance of payments. These changes will of course be recorded accurately, and it is



                                                                                         21
the discrepancy between the changes in reserves and the net value of the other record
items that allows us to identify the errors and omissions.



Unilateral Transfers


       Unilateral transfers or „unrequited receipts‟, are receipts which the residents of a
country receive „for free‟, without having to make any present or future payments in
return. Receipts from abroad are entered as positive items, payments abroad as negative
items. Thus the unilateral transfer account includes all gifts, grants and reparation receipts
and payments to foreign countries. Unilateral transfer consist of two types of transfers:
(a) government transfers (b) private transfers. Foreign economic aid or assistance and
foreign military aid or assistance received by the home country‟s government (or given
by the home government to foreign governments) constitutes government to government
transfers. US foreign aid to India, for BOP 9but a debit item in the US BOP). These are
government to government donations or gifts. There no well worked out theory to explain
the behavior of this account because these flows depend upon political and institutional
factors. The government donations (or aid or assistance) given to government of other
countries is mixed bag given for either economic or political or humanitarian reasons.
Private transfers, on the other hand, are funds received from or remitted to foreign
countries on person –to –person basis. A Malaysian settled in the United States remitting
$100 a month to his aged parents in Malaysia is a unilateral transfer inflow item in the
Malaysian BOP. An American pensioner who is settled after retirement in say Italy and
who is receiving monthly pension from America is also a private unilateral transfer
causing a debit flow in the American BOP but a credit flow in the Italian BOP. Countries
that attract retired people from other nations may therefore expect to receive an influx of
foreign receipts in the form of pension payments. And countries which render foreign
economic assistance on a massive scale can expect huge deficits in their unilateral
transfer account.
       Unilateral transfer receipts and payments are also called unrequited transfers
because as the name itself suggests the flow is only in one direction with no automatic
reverse flow in the other direction. There is no repayment obligation attached to these


                                                                                           22
transfers because they are not borrowings and lending‟s but gifts and grants exchanged
between government and people in one country with the governments and peoples in the
rest of the world.


Capital Account Convertibility (CAC)


       While there is no formal definition of Capital Account Convertibility, the
committee under the chairmanship of S.S. Tarapore has recommended a pragmatic
working definition of CAC. Accordingly CAC refers to the freedom to convert local
financial assets into foreign financial assets and vice – a – versa at market determined
rates of exchange. It is associated with changes of ownership in foreign / domestic
financial assets and liabilities and embodies the creation and liquidation of claims on, or
by, the rest of the world. CAC is coexistent with restrictions other than on external
payments. It also does not preclude the imposition of monetary / fiscal measures relating
to foreign exchange transactions, which are of prudential nature.


Following are the prerequisites for CAC:
1. Maintenance of domestic economic stability.
2. Adequate foreign exchange reserves.
3. Restrictions on inessential imports as long as the foreign exchange position is not very
comfortable.
4. Comfortable current account position.
5. An appropriate industrial policy and a conducive investment climate.
6. An outward oriented development strategy and sufficient incentives for export growth.




                                                                                        23
Structure and Forms of Balance of payments


       Balance of payments is a complete record of the total receipts and payments of a
country in relation to the other countries over a given period of time. Total receipts are
called credit and total payments are called debit. Structure of balance of payments has
therefore, two aspects as under:
       (i)     Credit Side and (ii) Debit Side


Credit side includes those values received or likely to be received from abroad. Under
debit side, are included all the payments made to other countries.




                              BBalanceof Payments Statements


   Items         Receipts or Credits           Payments or Debits               Net (+) or (-)




                                                                                             24
Structure of Balance of Payments



 Credits                                       Debits

            Current A/ c:                               Current A/ c:

 •Imports of goods (Visible items)             •Imports of goods (Visible items)
  •Imports of services (Invisibles)             •Imports of services (Invisibles)
   •Unrequited payments ( gifts,                 •Unrequited payments ( gifts,
   remittance, indemnities etc. to               remittance, indemnities etc. to
            foreigners)                                   foreigners)

           Capital A/ c:                                 Capital A/ c:
  •Capital payments (lending to,                •Capital payments (lending to,
     capital repayments to, or                     capital repayments to , or
      purchase of assets from                       purchase of assets from
   foreigners, reduction in stock                foreigners, reduction in stock
  of gold and reserves of foreign               of gold and reserves of foreign
           currency etc.)                                currency etc.)



 Total Receipts                                Total Payments




An Example
Let us consider the following hypothetical situation:
• Export of goods Rs.550 Cr.
• Import of goods Rs.650 Cr.
• Export of services Rs.150 Cr.
• Import of services Rs.70 Cr.
• Unrequited receipts Rs.100 Cr.



                                                                                    25
• Unrequited payments Rs.80 Cr.
• Capital receipts Rs.200 Cr.
• Capital payments Rs.200 Cr.




     Credits                      Debits

           • Current A/c:               • Current A/c:
       1) Export of goods 550       1) Import of goods 650
      2) Export of services 150    2) Import of services 70
     3) Unrequited receipts 100   3) Unrequited payments 80

           • Capital A/c:               • Capital A/c:
       4) Capital receipts 200     4) Capital payments 200



            Total receipts            Total payments
                1000                       1000




                                                              26
Balance of payments components information sheet


Balance of payments components
Current Account
Goods – exports (credits)
Goods are tangibles. In this case, sold to overseas nations and produced in
Australia.
Goods – imports (debits)
Goods are tangibles. In this case, produced overseas and purchased by Australians.
___________________
= Net goods (X-M)
___________________
Service – exports (credits)
      Services include transport, travel, insurance charges, telephone calls, tourist
       accommodation, education, computer information services and the like.
      In this case, provided by Australians and sold to overseas nations.
Service – imports (debits)
As above, but provided by other nations and purchased by Australians
_________________
= Net services (X-M)
_________________
Balance on goods and services = net goods + net services
Income credits
Incomes paid to Australians from overseas sources:
      Earnings on investment i.e. income (rent, profits, dividends)
      Royalties
      Interest
Income debits
As above, but incomes paid by Australians to overseas sources.
________________________
Net income = credits – debits


                                                                                     27
________________________
Current transfer credits
Transfers of funds into Australia for things such as:
      payouts on insurance claims
      aid from overseas governments/nations (unless being used to build capital, thus
       creating capital accumulation)
      pensions received from foreign governments to Australian residents
      money sent from overseas relatives
      gifts from charities in other countries
      work remittances from people working overseas
Current transfer debits
As above, but transfers of funds out of Australia
_________________________________
Net current transfers = credits – debits
_________________________________
Balance on Current Account = Balance on goods and services +
Net income +
Net transfers


Capital and Financial Account
Capital Account
Capital transfers – credits
Money coming in to Australia for things like:
      People migrating and bringing money with them
      Aid from overseas where addition is made to the capital stock of the recipient
      Purchase and sale of intellectual property rights, including patents, copyrights,
       trademarks, franchises, works of art
      Selling embassy land
      Debt forgiveness (cancellation of debts owed by Australians)
      Movements of government savings offshore (into Australian reserves)




                                                                                           28
Capital transfers…debits
As for credits, but money going out of Australia
____________________________________
Total on capital account = credits – debits
____________________________________
Financial account
Direct Investment
(Buying assets abroad or lending to firms offshore which they control)
Includes:
      foreign transactions to fund new investment in Australia or overseas
      purchase of more than 10% of shares in an existing Australian company
      movement of equity savings
      reinvestment of profits
      loans to affiliated enterprises
      claims on affiliated enterprises


Portfolio Investment
(That is, commercial dealings involving savings movements across national boundaries
into assets which do not give the provider of the savings significant control of the user of
these savings) includes buying land, shares and marketable securities such as Treasury
Bonds, Treasury Notes, certificates of deposit, debentures, unsecured notes (corporate
bonds), other money market instruments, and financial derivatives such as interest rate or
exchange rate swaps which can be easily sold in existing companies.


Other Investment
(That is, commercial dealings involving savings but which are not based on securities or
which do not give significant control or involve affiliated companies) includes:
      trade credits (short term loans made on trade deals)
      loans made to intermediaries, including financial leases
      currency movements and deposits moving between national financial systems




                                                                                          29
Reserve Assets
(That is, money being moved by the RBA)
Includes:
          Monetary gold
          Special Drawing Rights (“paper gold” Created by the IMF to improve the foreign
           reserves of member nations)
          IMF transactions
_______________________________________
Total on financial account = total of the above
_______________________________________
Balance on Capital Account: add the above totals
(Also: net errors and omissions)




Methods to Measure Balance of Payments


Main methods to measure balance of payments are as follows:


   (i)        Basic Balance: basic balance comprises of current balance of payments and
              short period private illiquid capital balance.
   (ii)       Net liquidity Balance: In this account are included: basic balance and short
              period illiquid capital balance.
   (iii)      Official Settlement Balance: It includes gross liquid balance and short period
              private liquid capital balance.
           In terms of a formula it can be clarified as under:
    Balance of Trade= Import-Export                              =a
   (+) Transfer balance of payments                              =b
   (=) Current Balance of Payments                               = c = (a+b)



                                                                                         30
   + Long period capital balance                               =d
   = Basic Balance                                             = e = (c+d)
   (+) Short period illiquid capital balance                   =f
   (+) SDR‟s disbursement                                      =g
   (+) Errors and Omissions                                    =h
   (=) Net Liquid Balance                                      = i = (e+f+g+h)
   (+) Short period private liquid capital balance             =j
   (=) Official Settlement Balance                            = k = (i+j)




Meaning of “DEFICIT” & “SURPLUS” in BOP


       If the balance of payment is a double entry accounting record, then apart from
errors and omissions, it must always balance. Obviously, the terms “deficit” or “surplus”
cannot refer to the entire BOP but must indicate imbalance on a subset of accounts
included in the BOP. The “imbalance” must be interpreted in some sense as an economic
disequilibrium. Since the notion of disequilibrium is usually associated within a situation
that calls for policy intervention of some sort, it is important to decide what is the optimal
way of grouping the various accounts within the BOIP so that an imbalance in one set of
accounts will give the appropriate signals to the policy makers. In the language of an
accountant e divide the entire BOP into a set of accounts “above the line” and another set
“below the line.” If the net balance (credits-debits) is positive above the line we will say
that there is a “balance of payments surplus”; if it is negative e will say there is a
“balance of payments deficit.” The net balance below the line should be equal in
magnitude and opposite in sign to the net balance above the line. The items below the
line can be said to be a “compensatory” nature – they “finance” or “settle” the imbalance
above the line.
       The critical question is how to make this division so that BOP statistics, in
particular the deficit and surplus figures, will be economically meaningful. Suggestions


                                                                                           31
made by economist and incorporated into the IMF guidelines emphasis the purpose or
motive a transaction, as a criterion to decide whether a transaction should go above or
below the line. The principle distinction between “Autonomous” transaction and
“Accommodating” or compensatory transactions. Transactions are said to Autonomous if
their value is determined independently of the BOP. Accommodating capital flows on the
other hand are determined by the net consequences of the autonomous items. An
autonomous transaction is one undertaken for its own sake in response to the given
configuration of prices, exchange rates, interest rates etc, usually in order to realize a
profit or reduced costs. It does not take into account the situation elsewhere in the BOP.
An accommodating transaction on the other hand is undertaken with the motive of
settling the imbalance arising out of other transactions. An alternative nomenclature is
that capital flows are „above the line‟ (autonomous) or „below the line‟ (accommodating).
The terms “balance of payments deficit” and “balance of payments surplus” will then be
understood to mean deficit or surplus on all autonomous transactions taken together.
The other measures of identifying a deficit or surplus in the BOP statement are: Deficit or
Surplus in the Current Account and/or Trade Account. The Basic Balance which
shows the relative deficit or surplus in the BOP.


A deficit in BOP is desirable or not!
          The basic balance was regarded as the best indicator of the economy‟s position
via a- other countries in the 1950‟s and the 1960‟s. It is defined as the sum of the BOP on
current account and the net balance on long term capital, which were considered as the
most stable elements in the balance of payments. A worsening of the basic balance [an
increase in a deficit or a reduction in a surplus or even a move from the surplus to deficit]
is seen as an indication of deterioration in the [relative] state of the economy. Thus it is
very much evident that a deficit in the basic balance is a clear indicator of worsening of
the state of the country‟s BOP position, and thus can be said to be undesirable at the very
outset.
          However, on further thoughts, a deficit in the basic balance can also be
understood to be desirable. This can be explained as follows: A deficit on the basic
balance could come about in various ways, which are not mutually equivalent. E.g.



                                                                                          32
suppose that the basic balance is in deficit because a current account deficit is
accompanied by a deficit on the long term capital account. This deficit in long term
capital account could be clearly observed in a developing country‟s which might be
investing heavily on capital goods for advancement on the agricultural and industrial
fields. This long term capital outflow will, in the future, generate profits, dividends and
interest payments which will improve the current account and so, ceteris paribus, will
reduce or perhaps reduce the deficit.
       Thus a deficit in basic balance can be desirable as well as undesirable, as it clearly
depends upon what is leading to a deficit in the long term capital account.




In The Accounting sense BOP always balances


       The BOP is a double entry accounting statement based on rules of debit and credit
similar to those of business accounting & book-keeping, since it records both transactions
and the money flows associated with those transactions. For instance, exports (like sales
of a business) are credits, and imports (like the purchases of a business) are debits. As in
business accounting the BOP records increases in assets (direct investment abroad) and
decreases in liabilities (repayment of debt) as debits, and decreases in assets (sale of
foreign securities) and increases in liabilities (the utilisation of foreign goods) as credits.
An elementary rule that may assist in understanding these conventions is that in such
transactions it is the movement of a document, not of the money that is recorded. An
investment made abroad involves the import of a documentary acknowledgement of the
investment, it is therefore a debit. The BOP has one important category that has no
counter part or at least no significant counter part in business accounting, i.e.
international gifts and grants and other so called transfer payments. In general credits
may be conceived as receipts and debits as payments. However this is not always
possible. In particular the change in a country‟s international reserves in gold and foreign
exchange is treated as a debit if it is an increase and a credit if it is a decrease. The
procedure is to offset changes in reserves against changes in the other items in the table
so that the grand total is always zero, (except for errors and omissions).


                                                                                            33
           A transaction entering the BOP usually has two aspects and invariably gives rise
   to two entries, one a debit and the other a credit. Often the two aspects fall in different
   categories. For instance, an export against cash payment may result in an increase in the
   exporting country‟s official foreign exchange holdings. Such a transaction is entered in
   the BOP as a credit for exports and as a debit for the capital account. Both aspects of a
   transaction may sometimes be appropriate to the same account. For instance the purchase
   of a foreign security may have as its counter part reduction in official foreign exchange
   holdings. Thus it is clear that if we record all the entries in BOP in a proper way, debits
   and credits will always be equal. So that in accounting sense the BOP will be in balance.



Balance of Payments Equilibrium

       A Balance of Payments Equilibrium is defined as a condition where the sum of debits
and credits from the Current Account and the Financial Account equal to zero; in other
words, equilibrium is where

Current Account + Financial Account = 0

There is a condition where there are no changes in Official Reserves. When there is no
change in Official Reserves, the balance of payments may also be stated as follows:

Current Account = - Financial Account or


Current Account Deficit (Surplus) = Financial Account Surplus (Deficit)


Canada's Balance of Payments currently satisfies this criterion.




                                                                                           34
Disequilibrium in the Balance of Payments


B=R–P
Where, B stands for balance of payments,
R denotes receipts from foreigners,
P stands for payments made to foreigners
.A country whose balance of payments is positive is called as surplus country.
.A country whose balance of payments is negative is called as deficit country.


Types of disequilibrium


– Cyclical disequilibrium.
– Structural disequilibrium.
– Short run disequilibrium.
– Long – run or secular disequilibrium




 Cyclical disequilibrium:


       It occurs on account of trade cycles. Cyclical fluctuations in demand are caused
by changes in Income, employment, output & price.
– Trade cycles follow different paths and patterns in different countries. There are no
identical timings and periodicity of occurrence of cycles in different countries.
– No identical stabilization programmes and measures are adopted by different countries.
– Income driven demand for imports in different countries is not identical.
– Price driven demand for imports differ in different countries.




                                                                                      35
 Structural disequilibrium:


       It is caused because of fluctuation in the demand based on changes in tastes,
fashions, habits, income, economic progress etc.
– Structural changes are also produced by variations in the rate of international capital
movements.
– Other causes are due to crop failure in prime commodities, shortage of raw materials,
labor strikes etc. leads to reduction in Export.




 Short – run disequilibrium:


       When a country borrows or lends internationally, it will have short run
disequilibrium, as these are usually for short period.
– Short run disequilibrium may also emerge if a country‟s exceeds its exports in a given
year. It is a temporary one, because later on country will be in a position to correct it
easily by importing more.
– Still this disequilibrium can not be justified as it may lead to Long – term
disequilibrium. A persistent deficit will tend to reduce its foreign exchange reserves and
country may not be able to raise any more loans from foreigners.


 Long run disequilibrium:


       It occurs because of accumulation of deficits or surpluses over a long period.
– IMF uses the term „fundamental disequilibrium‟ to describe a persistent, long run
disequilibrium. It is mainly due to deficits which exist continuously for a long period of
time in a country‟s balance of payments.
– Unchecked series of short run disequilibria lead to the fundamental disequilibrium in
long run.
– It is caused by persistent deep rooted dynamic changes which slowly takes place in the
economy.



                                                                                        36
Causes of Disequilibrium


        The balance of payments of a country is said to be in equilibrium when the
demand for foreign exchange is exactly equivalent to the supply of it. The balance of
payments is in disequilibrium when there is either a surplus or a deficit in the balance of
payments. When there is a deficit in the balance of payments, the demand for foreign
exchange exceeds the demand for it. A number of factors may cause disequilibrium in the
balance of payments. These various causes may be broadly categorized into:


(i) Economic factors
(ii) Political factors; and
(iii) Sociological factors.


Economic Factors
A number of economic factors may cause disequilibrium in the balance of payments.
These are:



     Trade cycle:
  Cyclical fluctuations, their phases and amplitudes, differences in different countries,
  generally produce cyclical disequilibrium.


     Huge development & investment programmes:
– Due to huge development and investment programs , Import goes on increasing for
want of capital for rapid industrialization, while exports may not be boosted up to that
extent as these are the primary producing countries.
– Thus, there will be structural changes in the balance of payments and structural
equilibrium will result.




                                                                                        37
    Changing Export demand:
– A vast increase in the domestic production of foodstuffs, raw materials, substitute
goods, etc. in advanced countries has decreased their need for import from the
underdeveloped countries. Hence, export demand has considerably changed resulting in
structural disequilibrium.
– Similarly, developed countries will loose their market share in underdeveloped
 countries, owing to the tendency of underdeveloped nations to self reliance.


    Population growth:
High population growth in poor countries has adverse impact on their balance of
payments. Increase in the population increases the needs of these countries for imports
and decreases the capacity of export.




    Huge external borrowing:
A country will have adverse balance of payments when it borrows heavily from another
country, while the lending country will have a favorable balance and a deficit balance of
payments.


    Inflation:
Rapid economic development, increase in the income & price will adversely affect BOP
position of a developing country.
– With increase in income, import requirements will get increased. Also consumption of
the domestic production will be fast. This leads to increase in Import and decrease in
export.
– Also huge investment in heavy industries in the developing countries may have an
inflationary impact, as the output of these industries will not be forthcoming immediately,
whereas money income will have been already increased.




                                                                                        38
    Demonstration effect:
When people of underdeveloped nations come into contact with those of advance
countries through economic, political or social relations there will be a demonstration
effect on the consumption pattern. It will increase need for import whereas their export
quantum remains same.


    Reciprocal demands:
Need of reciprocal demand for products of different countries differs leading terms of
trade of a country may be set differently with differently with different countries under
multi trade transactions. This may also lead to disequilibrium.




Political Factors
       Certain political factors may also produce balance of payments disequilibrium.
For instance, a country plagued with political instability may experience large capital
outflows, inadequacy of domestic investment and production, etc. These factors may,
sometimes, cause disequilibrium in the balance of payments. Further, factors like war,
changes in world trade routes, etc., may also produce balance of payments difficulties.




Social Factors
       Certain social factors influence the balance of payments. For instance, changes in
tastes, preferences, fashions, etc. may affect imports and exports and thereby affect the
balance of payments.




                                                                                          39
Methods of correcting BOP disequilibrium


The various measures used for correcting an adverse balance of payments are of two
kinds: Monetary measures & Non monetary measures
Monetary measures
– Deflation
– Exchange depreciation.
– Devaluation.
– Exchange control.
Non-Monetary measures
– Tariff – import duties.
– Import quotas
– Export promotion policies and program.


Monetary Measures:


1. Deflation.
– Generally, deficit in the BOP occurs due to high imports and low exports.
– In this situation, country may adopt deflationary or dear money policy by raising
interest rates and restricting credit.
– Thus, prices of domestic goods fall which makes exports attractive and imports
relatively costlier.
– Deflation keeps exchange rates unaffected and tries to correct the deficit in the BOP
through domestic changes.
– In short, deflation being inexpedient, its side effects are dangerous to a poor country. It
creates more unemployment and poverty.


2. Exchange Depreciation.
– This is a correcting method in which “external value of the home currency” is
depreciated.




                                                                                          40
– Exchange depreciation of a country will tend to cheapen its domestic goods for the
foreigners so that its exports will be boosted, while its imports will be costlier.
– The success of this method hugely depends on the cooperation of the foreigners. If all
countries start depreciating their exchange rates then the technique may not prove useful.
– This method is not feasible under the present system of IMF of fixed exchange rate
system.


3. Devaluation.
– Devaluation is Official decrease in the external value of a currency or good.
– Exchange depreciation is based on the market mechanism whereas devaluation is
arbitrary.
– Devaluation is undertaken when the currency is found to be unduly overvalued.
– If a country has persistent deficit in its BOP, it may devalue its currency with the
permission of IMF.
– Once a country‟s currency is devalued its exports become cheaper to foreigners and
imports become relatively dearer.
Conditions for successful working of devaluation
– A fairly elastic demand.
– Structure of exports and imports.
– Domestic price stability.
– International cooperation.
– Coordination of other measures.


4. Exchange control.
– Restrictions on the use of foreign exchange by central banks are called “exchange
controls”.
– During exchange control, all the exporters have to surrender their foreign exchange
earnings to the central bank.
– Under exchange control, the central bank releases foreign exchanges only for essential
imports and conserves the rest of the balance.




                                                                                        41
       –       An exchange control offers no permanent solution to the problem of persistent
               disequilibrium.




     Non Monetary Measures


1.     Discouraging Imports: In order to correct adverse balance of payments, imports are
       reduced in the following ways:


       (i)        Import Duties- In order to discourage imports, their value is raised by
                  levying new import duties or raising the rate of existing import duties. On
                  account of these duties not only imports become dearer but their demand also
                  goes down. Fall in the volume of imports corrects adverse balance of
                  payments.
       (ii)       Import Quotas: Imports are curtailed by fixing import quotas. Under import
                  quota system, either the maximum volume of the value of the imported goods
                  is fixed by government. By restricting imports in this way balance of
                  payments is corrected.
       (iii)      Encouraging Import Substitutions: When substitutes of imported goods are
                  produced indigenously, it is called import substitution. It brings down the
                  demand for foreign goods and pressures on adverse balance of payment are
                  removed to a large extent.


2.     Export Promotion: The best method to correct an adverse BOP is to increase the
       volume of exports. All duties or restrictions on exports should be withdrawn and
       export industries be given special concessions and facilities. In order to increase the
       demand for domestic products in foreign countries, intensive publicity and
       advertisements should be undertaken. Indigenous products should be displayed in
       specially organized Exhibitions and Trade fairs abroad. Thus production and export
       capacity of the export industry will increase and balance of payments position to
       improve.


                                                                                           42
3.   Encouragement to Foreign Investment: investment of foreign capital in the country
     constitutes a credit item and so has a favorable effect on the balance of payment
     position. Foreign investment can be attracted by different kinds of incentives and
     concessions.




4.   Attraction to Foreign Tourists: In order to attract tourists, government has to
     develop recreation parks and entertainment programmes. Foreign tourists bring along
     with them large amount of foreign currency which serves the same purpose as the
     export earnings.


5.   Liberal Industrial Policy: Introducing an element of liberalization in the industrial
     policy goes a long way in encouraging exports and import substitution. Both have a
     favorable effect on the balance of payments. Since 1991-92 India has been following
     the policy of liberalization.




6.   State Trading: Balance of Payments is generally unfavorable in underdeveloped
     countries. Under the circumstances, the state can take over the import and export
     trade from private importers and exporters. In this way, it can effectively restrict the
     import of unnecessary goods and promote the exports. However, this method can be
     adopted by those countries only which are not under any pressure from any foreign
     country.




                                                                                          43
Importance of BOP Statements


       BOP statistics are regularly compiled, published and are continuously monitored
by companies, banks and government agencies. A set of BOP accounts is useful in the
same way as a motion picture camera. The accounts do not tell us what is good or bad,
nor do they tell us what is causing what. But they do let us see what is happening so that
we can reach our own conclusions. Below are 3 instances where the information provided
by BOP accounting is very necessary:
       1. Judging the stability of a floating exchange rate system is easier with BOP as
the record of exchanges that take place between nations help track the accumulation of
currencies in the hands of those individuals more willing to hold on to them.
       2. Judging the stability of a fixed exchange rate system is also easier with the
same record of international exchange. These exchanges again show the extent to which a
currency is accumulating in foreign hands, raising questions about the ease of defending
the fixed exchange rate in a future crisis.
       3. To spot whether it is becoming more difficult for debtor counties to repay
foreign creditors, one needs a set of accounts that shows the accumulation of debts, the
repayment of interest and principal and the countries ability to earn foreign exchange for
future repayment. A set of BOP accounts supplies this information.
       This point is further elaborated below.


       The BOP statement contains useful information for financial decision makers. In
the short run, BOP deficit or surpluses may have an immediate impact on the exchange
rate. Basically, BOP records all transactions that create demand for and supply of a
currency. When exchange rates are market determined, BOP figures indicate excess
demand or supply for the currency and the possible impact on the exchange rate. Taken in
conjunction with recent past data, they may conform or indicate a reversal of perceived
trends. They also signal a policy shift on the part of the monetary authorities of the
country unilaterally or in concert with its trading partners. For instance, a country facing
a current account deficit may raise interest to attract short term capital inflows to prevent
depreciation of its currency. Countries suffering from chronic deficits may find their


                                                                                          44
credit ratings being downgraded because the markets interpret the data as evidence that
the country may have difficulties its debt.
       BOP accounts are intimately with the overall saving investment balance in a
country‟s national accounts. Continuing deficits or surpluses may lead to fiscal and
monetary actions designed to correct the imbalance which in turn will affect exchange
rates and interest rates in the country. In nutshell corporate finance managers must
monitor the BOP data being put out by government agencies on a regular basis because
they have both short term and long term implications for a host of economic and financial
variables affecting the fortunes of the company.




India’s Balance of Payments


Major highlights of India’s during BOP 2009-2010



(i) Exports recorded a growth of 13.2 per cent during Q3 of 2009-10 over the
corresponding quarter of the previous year, after consecutive declines in the last four
quarters.

(ii) Imports registered a growth of 2.6 per cent in Q3 of 2009-10 after recording
consecutive declines in the last three quarters.

(iii) Private transfer receipts remained robust during Q3 of 2009-10.

(iv) Despite low trade deficit, the current account deficit was higher at US$ 12.0 billion
during Q3 of 2009-10 mainly due to lower invisibles surplus.

(v) The current account deficit during April-December 2009 was higher at US$ 30.3
billion as compared to US$ 27.5 billion during April-December 2008.




                                                                                       45
          (vi) Surplus in capital account increased sharply to US$ 43.2 billion during April-
          December 2009 (US$ 5.8 billion during April-December 2008) mainly on account of
          large inflows under FDI, Portfolio investment, NRI deposits and commercial loans.

          (vii) As the surplus in capital account exceeded the current account deficit, there was a
          net accretion to foreign exchange reserves of US$ 11.3 billion during April-December
          2009 (as against a drawdown of US$ 20.4 billion during April-December 2008).




          Balance of Payments for October-December of 2009-10: Sources RBI



Table 1: Major Items of India's Balance of Payments

(US$ million)

Item                                                April-June             July-September         October-December

                                                    2008-09      2009-10   2008-09      2009-10   2008-09    2009-10
                                                    (PR)         (PR)      (PR)         (PR)      (PR)       (P)
1                                                   2            3         4            5         6          7

1. Exports                                          57,454       37,910    53,630       41,915    39,436     44,648

2. Imports                                          82,731       64,804    92,752       73,810    73,484     75,374

3. Trade Balance (1-2)                              -25,277      -26,894   -39,121      -31,895   -34,049    -30,726

4. Invisibles, net                                  22,003       20,534    26,546       19,955    22,381     18,696

5. Current Account Balance(3+4)                     -3,274       -6,360    -12,575      -11,940   -11,668    -12,030

6. Capital Account Balance*                         5,509        6,475     7,841        21,358    -6,214     13,797

7. Change in Reserves#                              -2,235       -115      4,734        -9,418    17,881     -1,767

(-Indicates increase;+ indicates decrease)

*: Including errors and omissions.            #: On BOP basis (i.e., excluding valuation).

P: Preliminary.      PR: Partially Revised.




                                                                                                            46
The major items of the BOP for the third quarter of 2009-10 are set out
below

(i) India‟s merchandise exports recorded a growth of 13.2 per cent in Q3 of 2009-10 as
against a decline of 8.4 per cent in Q3 of 2008-09.

(ii) Import payments while, on a BOP basis, registered a growth of 2.6 per cent in Q3 of
2009-10 as compared with an increase of 9.2 per cent in Q3 of 2008-09, grew by 6.6 per
cent on Directorate General of Commercial Intelligence and Statistics (DGCI&S) basis
during the quarter under review. The low growth in imports is mainly attributed to
decline in oil related import payments due to lower international crude oil prices during
the period.

(iii) The trade deficit, on a BOP basis, was lower at US$ 30.7 billion as compared to US$
34.0 billion during Q3 of 2008-09.

(iv) The decline in invisibles receipts, which started in the Q4 of 2008-09, continued
during Q3 of 2009-10. Invisibles receipts registered a decline of 3.1 per cent during the
quarter (as against an increase of 5.4 per cent in Q3 of 2008-09) mainly on account of
decline in business, communication and financial services, and investment income
receipts. Although, software exports recorded a robust growth of 15.3 per cent, services
exports as a whole witnessed a decline of 12.3 per cent during the quarter as against an
increase of 11.8 per cent during the corresponding quarter of 2008-09.

(v) Invisibles payments recorded a growth of 12.9 per cent during Q3 of 2009-10, as
compared with a low growth of 2.4 per cent in Q3 of 2008-09, mainly led by increase in
payments under almost all components of services.

(vi) As decline in services exports was made up by strong private transfers receipts (24.1
per cent in Q3 of 2009-10), net invisibles (invisibles receipts minus invisibles payments)
recorded a surplus of US$ 18.7 billion in Q3 of 2009-10 (US$ 22.4 billion in Q3 of 2008-
09).


                                                                                       47
(vii) Size of invisibles surplus in Q3 of 2009-10 was, however, lower than Q3 of
preceding year. Therefore, despite low trade deficit, the current account deficit was
higher at US$ 12.0 billion in Q3 of 2009-10 (US$ 11.7 billion in Q3 of 2008-09).

(viii) Continuing buoyancy in capital inflows mainly led by large inflows under foreign
direct investments, portfolio investments and short-term trade credits resulted in a net
capital account surplus of US$ 14.7 billion during Q3 of 2009-10 as against a net deficit
of US$ 6.1 billion during Q3 of 2008-09.

(ix) Net FDI flows (net inward FDI minus net outward FDI) amounted to US$ 3.9 billion
in Q3 of 2009-10 (US$ 0.4 billion in Q3 of 2008-09). Net inward FDI stood at US$ 7.1
billion during Q3 of 2009-10 (US$ 6.3 billion in Q3 of 2008-09). Net outward FDI
remained lower at US$ 3.2 billion in Q3 of 2009-10 (US$ 5.9 billion in Q3 of 2008-09).
Net portfolio investments were higher at US$ 5.7 billion mainly supported by strong net
inflows by the foreign institutional investors amounting to US$5.3 billion during Q3 of
2009-10.

(x) Net External Commercial Borrowings (ECBs) remained lower at US$ 1.5 billion in
Q3 of 2009-10 (US$ 3.8 billion in Q3 of 2008-09) mainly due to increased repayments
and low disbursements of commercial loans to India. Short-term trade credits to India
recorded a net inflow of US$ 3.3 billion in Q3 of 2009-10 as against a net outflow of US$
4.2 billion during Q3 of 2008-09.

(xi) Net inflows under banking capital was higher at US$ 1.9 billion mainly due to
drawdown of foreign assets of commercial banks and a net inflow of US$ 0.6 billion
under non-resident Indian (NRI) deposits.

(xii) There was an increase in foreign exchange reserves on BOP basis (i.e., excluding
valuation) of US$ 1.8 billion in Q3 of 2009-10 as against a decline of US$ 17.9 billion in
Q3 of 2008-09. In nominal terms (including valuation changes), foreign exchange
reserves rose by US$ 2.2 billion during Q3 of 2009-10.




                                                                                       48
Conclusion

       The Balance of Payments is the sum of the Current Account and the Capital Account and the
Financial Account. The Balance of Payments Identity states that:

       Current Account + Capital Account + Financial Account + Net Errors and Omissions = Change
in Official Reserve Account

       An Account deficit means more money is going out of the country to purchase goods than is
coming in. An 'Account Surplus' is just the opposite by definition, bop account always balances. Yet,
the individual may or may not balance. There in reality gives rise to the widely discussed deficit
surplus arising in bop account a net inflow in account of merchandise trade results in a trade surplus,
while a net outflow, result in trade deficit in the same way, a net inflow after taking all entries in the
current account into consideration is referred to as the current account surplus, and a net outflow as
current account deficit. Significant two way movements in capital flows dominated the Bop outcome
in 2005-6.the strong improvement in India macroeconomic performance created a preferred habitat of
private capital flows which accounted 30.6 percent of global flows to EME and developing countries
in 2006. This was also reflected in an up gradation of the sovereign rating to investment grade during
2003-4.for the first time since 1997-1998.

       The presence of a trade deficit or an increase in the trade deficit in a previous month or quarter
is commonly reported as a sign of economic weakness. Similarly, a decrease in a trade deficit, or the
presence or increase in a trade surplus is commonly viewed as a sign of strength in an economy.

   Unfortunately, these perceptions and beliefs are somewhat misguided. It is simply not true in
general, that a trade deficit is a sign of a weak economy and a trade surplus is a sign of a strong
economy. Merely knowing that a country has a trade deficit, or that a trade deficit is rising, is not
enough information to say anything about the current or future prospects for a country. And yet, that is
precisely how the statistics are often reported. Thus Trade deficits can be a good thing for less
developed countries. Corporate finance managers must monitor the BOP data being put out by
government agencies on a regular basis because they have both short term and long term implications
for a host of economic and financial variables affecting the fortunes of the company


                                                                                             49
                         Bibliography


Websites
   1. http://www.indiabudget.nic.in/es2001-02/chapt2002/chap62.pdf
   2. http://www.indiaonestop.com/economy/balanceofpayments/economy-macro-
        balance%20of%20payments.htm
   3. http://en.wikipedia.org/wiki/Balance_of_payments
   4. http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=22270
   5. http://ezinearticles.com/?Focus-on-Importance-and-Requirements-of-a-Current-
        Account&id=1406517
   6. http://www.emsnow.com/newsarchives/archivedetails.cfm?ID=15580
   7. http://mpettis.com/category/balance-of-payments/


Books


1. Public Finance and International Trade by T.R. Jain (pages 164-182)
2. International Money and Finance by Michael Melvin (pages 62-69)
3. International Business by Andrew Harrison, Ena Esly, Ertugru (pages 110-112)




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