Eco - Balance of Payment

1 BALANCE OF PAYMENT IN INDIA
1.INTRODUCTION :-
Balance of Payment (BoP) of a country is defined as, "Systemetic Record of all economic
transactions between the residents of a foreign countries" Thus balance of payments includes
all visible and non-visible transactions of a country during a given period, usually a year. t
represent a summation of country!s current demand and supply of the claims on foreign
currencies and of foreign claims on its currency.
"alance of payments ("#$) accounts are an accounting record of all monetary transactions
between a country and the rest of the world. These transactions include payments for the
country!s e%ports andimports of goods, services, financial capital, and financial transfers. The
"#$ accounts summari&e international transactions for a specific period, usually a year, and
are prepared in a single currency, typically the domestic currency for the country concerned.
Sources of funds for a nation, such as e%ports or the receipts of loans and investments, are
recorded as positive or surplus items. 'ses of funds, such as for imports or to invest in
foreign countries, are recorded as negative or deficit items.
(hen all components of the "#$ accounts are included they must sum to &ero with no
overall surplus or deficit. )or e%ample, if a country is importing more than it e%ports, its trade
balance will be in deficit, but the shortfall will have to be counterbalanced in other ways *
such as by funds earned from its foreign investments, by running down central ban+ reserves
or by receiving loans from other countries.
(hile the overall "#$ accounts will always balance when all types of payments are included,
imbalances are possible on individual elements of the "#$, such as the current account,
the capital accounte%cluding the central ban+!s reserve account, or the sum of the two.
mbalances in the latter sum can result in surplus countries accumulating wealth, while deficit
nations become increasingly indebted. The term "balance of payments" often refers to this
sum, a country!s balance of payments is said to be in surplus (e-uivalently, the balance of
payments is positive) by a specific amount if sources of funds (such as e%port goods sold and
bonds sold) e%ceed uses of funds (such as paying for imported goods and paying for foreign
bonds purchased) by that amount. There is said to be a balance of payments deficit (the
balance of payments is said to be negative) if the former are less than the latter.
'nder a fi%ed e%change rate system, the central ban+ accommodates those flows by buying
up any net inflow of funds into the country or by providing foreign currency funds to
the foreign e%change mar+et to match any international outflow of funds, thus preventing the
funds flows from affecting the e%change rate between the country!s currency and other
currencies. Then the net change per year in the central ban+!s foreign e%change reserves is
sometimes called the balance of payments surplus or deficit. .lternatives to a fi%ed e%change
rate system include a managed float where some changes of e%change rates are allowed, or at
the other e%treme a purely floating e%change rate (also +nown as a purely fle%ible e%change
rate). (ith a pure float the central ban+ does not intervene at all to protect or devalue its
currency, allowing the rate to be set by the mar+et, and the central ban+!s foreign e%change
reserves do not change.
/istorically there have been different approaches to the -uestion of how or even whether to
eliminate current account or trade imbalances. (ith record trade imbalances held up as one of
the contributing factors to the financial crisis of 0112*0131, plans to address global
imbalances have been high on the agenda of policy ma+ers since 0114.
(hile the "#$ has to balance overallsurpluses or deficits on its individual elements can lead
to imbalances between countries. n general there is concern over deficits in the current
account.5ountries with deficits in their current accounts will build up increasing debt and6or
see increased foreign ownership of their assets. The types of deficits that typically raise
concern are
. visible trade deficit where a nation is importing more physical goods than it e%ports
(even if this is balanced by the other components of the current account.)
.n overall current account deficit.
. basic deficit which is the current account plus foreign direct investment (but
e%cluding other elements of the capital account li+e short terms loans and the reserve
account.)
.s discussed in the history section below, the (ashington 5onsensus period saw a swing of
opinion towards the view that there is no need to worry about imbalances. #pinion swung
bac+ in the opposite direction in the wa+e of financial crisis of 0112*0114. 7ainstream
opinion e%pressed by the leading financial press and economists, international bodies li+e the
7) * as well as leaders of surplus and deficit countries * has returned to the view that large
current account imbalances do matter. Some economists do, however, remain relatively
unconcerned about imbalancesand there have been assertions, such as by 7ichael $. 8ooley,
8avid )ol+erts-9andau and $eter :arber, that nations need to avoid temptation to switch to
protectionism as a means to correct imbalances.
2.History of balance of ayments iss!es

/istorically, accurate balance of payments figures were not generally available. /owever, this
did not prevent a number of switches in opinion on -uestions relating to whether or not a
nations government should use policy to encourage a favourable balance.
Pre-1"2#: mercantilism
'p until the early 34th century, international trade was generally very small in comparison
with national output, and was often heavily regulated. n the 7iddle .ges, ;uropean trade
was typically regulated at municipal level in the interests of security for local industry and for
established merchants. )rom about the 3<th century, mercantilism became the dominant
economic theory influencing ;uropean rulers, which saw local regulation replaced by
national rules aiming to harness the countries! economic output. 7easures to promote a trade
surplus such as tariffs were generally favoured. $ower was associated with wealth, and with
low levels of growth, nations were best able to accumulate funds either by running trade
surpluses or by forcefully confiscating the wealth of others. Rulers sometimes strove to have
their countries outsell competitors and so build up a "war chest" of gold.
This era saw low levels of economic growth= average global per capita income is not
considered to have significantly risen in the whole >11 years leading up to 3>01, and is
estimated to have increased on average by less than 1.3? per year between 3211 and
3>01. (ith very low levels of financial integration between nations and with international
trade generally ma+ing up a low proportion of individual nations! :8$, "#$ crises were very
rare.
1"2#$1%1&: free tra'e
:old was the primary reserve asset during the gold standard era.
)rom the late 3>th century, mercantilism was challenged by the ideas of .dam Smith and
other economic thin+ers favouring free trade. .fter victory in the@apoleonic wars :reat
"ritain began promoting free trade, unilaterally reducing her trade tariffs. /oarding of gold
was no longer encouraged, and in fact "ritain e%ported more capital as a percentage of
her national income than any other creditor nation has since.
AB>C
:reat "ritain!s capital e%ports
further helped to correct global imbalances as they tended to be counter cyclical, rising when
"ritain!s economy went into recession, thus compensating other states for income lost from
e%port of goods.
.ccording to historian 5arroll Duigley, :reat "ritain could afford to act benevolently in the
34th century due to the advantages of her geographical location, its naval power and
economic ascendancy as the first nation to enEoy an industrial revolution. . view advanced by
economists such as "arry ;ichengreen is that the first age of :lobali&ation began with the
laying of transatlantic cables in the 3><1s, which facilitated a rapid increase in the already
growing trade between "ritain and .merica.
Though 5urrent .ccount controls were still widely used (in fact all industrial nations apart
from :reat "ritain and the @etherlands actually increased their tariffs and -uotas in the
decades leading up to 343B, though this was motivated more by a desire to protect "infant
industries" than to encourage a trade surplus, capital controls were largely absent, and people
were generally free to cross international borders without re-uiring passports.
. gold standard enEoyed wide international participation especially from 3>21, further
contributing to close economic integration between nations. The period saw substantial global
growth, in particular for the volume of international trade which grew tenfold between 3>01
and 3>21 and then by about B? annually from 3>21 to 343B. "#$ crises began to occur,
though less fre-uently than was to be the case for the remainder of the 01th century. )rom
3>>1 to 343B, there were appro%imately > "#$ crises and > twin crises * a twin crises being
a "#$ crises that coincides with a ban+ing crises.
1%1&$1%&(: 'e)lobalisation
The favorable economic conditions that had prevailed up until 343B were shattered by the
first world war, and efforts to re-establish them in the 3401s were not successful. Several
countries reEoined the gold standard around 340F. "ut surplus countries didn!t "play by the
rules", sterilising gold inflows to a much greater degree than had been the case in the pre-war
period. 8eficit nations such as :reat "ritain found it harder to adEust by deflation as wor+ers
were more enfranchised and unions in particular were able to resist downwards pressure on
wages. 8uring the :reat 8epression most countries abandoned the gold standard, but
imbalances remained an issue and international trade declined sharply. There was a return to
mercantilist type "beggar thy neighbour" policies, with countries competitively devaluing
their e%change rates, thus effectively competing to e%port unemployment. There were
appro%imately 3< "#$ crises and 3F twin crises (and a comparatively very high level of
ban+ing crises.)
1%&($1%*1: Bretton +oo's
)ollowing (orld (ar , the "retton (oods institutions (the nternational 7onetary
)und and (orld "an+) were set up to support an international monetary system designed to
encourage free trade while also offering states options to correct imbalances without having
to deflate their economies. )i%ed but fle%ible e%change rates were established, with the
system anchored by the dollar which alone remained convertible into gold. The "retton
(oods system ushered in a period of high global growth, +nown as the :olden .ge of
5apitalism, however it came under pressure due to the inability or unwillingness of
governments to maintain effective capital controls and due to instabilities related to the
central role of the dollar.
mbalances caused gold to flow out of the 'S and a loss of confidence in the 'nited States
ability to supply gold for all future claims by dollar holders resulted in escalating demands to
convert dollars, ultimately causing the 'S to end the convertibility of the dollar into gold,
thus ending the "retton (oods system The 34BF*23 era saw appro%imately 0B "#$ crises
and no twin crises for advanced economies, with emerging economies seeing 3< "#$ crises
and Eust one twin crises.
1%*1$2##%: transition, +as-in)ton Consens!s, Bretton +oo's II
7anmohan Singh, currently $7 of ndia, showed that the challenges caused by imbalances
can be an opportunity when he led his country!s successful economic reform programme after
the 3443 crisis.
The "retton (oods system came to an end between 3423 and 342G. There were attempts to
repair the system of fi%ed e%changed rates over the ne%t few years, but these were soon
abandoned, as were determined efforts for the '.S. to avoid "#$ imbalances. $art of the
reason was displacement of the previous dominant economic paradigm *Heynesianism * by
the (ashington 5onsensus, with economists and economics writers such as 7urray
Rothbard and 7ilton )riedman arguing that there was no great need to be concerned about
"#$ issues.
n the immediate aftermath of the "retton (oods collapse, countries generally tried to retain
some control over their e%change rate by independently managing it, or by intervening in
the foreign e%change mar+et as part of a regional bloc, such as the Sna+e which formed in
3423. The Sna+e was a group of ;uropean countries who tried to retain stable rates at least
with each other= the group eventually evolved into the ;uropean ;%change Rate
7echanism (;R7) by 3424. )rom the mid-3421s however, and especially in the 34>1s and
early 3441s, many other countries followed the 'S in liberalising controls on both their
capital and current accounts, in adopting a somewhat rela%ed attitude to their balance of
payments and in allowing the value of their currency to float relatively freely with e%change
rates determined mostly by the mar+et.
8eveloping countries who chose to allow the mar+et to determine their e%change rates would
often develop si&eable current account deficits, financed by capital account inflows such as
loans and investments, though this often ended in crises when investors lost confidence. The
fre-uency of crises was especially high for developing economies in this era * from 342G to
3442 emerging economies suffered F2 "#$ crises and 03 twin crises. Typically but not
always the panic among foreign creditors and investors that preceded the crises in this period
was usually triggered by concerns over e%cess borrowing by the private sector, rather than by
a government deficit. )or advanced economies, there were G1 "#$ crises and < ban+ing
crises.
. turning point was the 3442 .sian "#$ 5risis, where unsympathetic responses by western
powers caused policy ma+ers in emerging economies to re-assess the wisdom of relying on
the free mar+et= by 3444 the developing world as a whole stopped running current account
deficits while the '.S. current account deficit began to rise sharply. This new form of
imbalance began to develop in part due to the increasing practice of emerging economies,
principally 5hina, in pegging their currency against the dollar, rather than allowing the value
to freely float. The resulting state of affairs has been referred to as "retton (oods .
.ccording to .laistair 5han, ".t the heart of the imbalance is 5hina!s desire to +eep the
value of the yuan stable against the dollar. 'sually, a rising trade surplus leads to a rising
value of the currency. . rising currency would ma+e e%ports more e%pensive, imports less so,
and push the trade surplus towards balance. 5hina circumvents the process by intervening in
e%change mar+ets and +eeping the value of the yuan depressed."
A<1C
.ccording to economics
writer 7artin (olf, in the eight years leading up to 0112, "three--uarters of the foreign
currency reserves accumulated since the beginning of time have been piled up".
A<3C
n contrast
to the changed approach within the emerging economies, 'S policy ma+ers and economists
remained relatively unconcerned about "#$ imbalances. n the early to mid-3441s, many
free mar+et economists and policy ma+ers such as '.S. Treasury secretary $aul #!@eill and
)ed 5hairman .lan :reenspan went on record suggesting the growing 'S deficit was not a
maEor concern. (hile several emerging economies had intervening to boost their reserves and
assist their e%porters from the late 34>1s, they only began running a net current account
surplus after 3444. This was mirrored in the faster growth for the 'S current account deficit
from the same year, with surpluses, deficits and the associated build up of reserves by the
surplus countries reaching record levels by the early 0111s and growing year by year. Some
economists such as Henneth Rog off and 7aurice #bstfeld began warning that the record
imbalances would soon need to be addressed from as early as 0113, Eoined by @ouriel
Roubini in 011B, but it was not until about 0112 that their concerns began to be accepted by
the maEority of economists.
2##% an' later: ost +as-in)ton Consens!s
Spea+ing after the 0114 :-01 9ondon summit, :ordon "rown announced "the (ashington
5onsensus is over". There is now broad agreement that large imbalances between different
countries do matter= for e%ample mainstream '.S. economist 5. )red "ergsten has argued the
'.S. deficit and the associated large inbound capital flows into the '.S. was one of the causes
of the financial crisis of 0112*0131. Since the crisis, government intervention in "#$ areas
such as the imposition of capital controls or foreign e%change mar+et intervention has
become more common and in general attracts less disapproval from economists, international
institutions li+e the 7) and other governments.
n 0112, when the crises began, the global total of yearly "#$ imbalances was I3<>1 billion.
#n the credit side, the biggest current account surplus was 5hina with appro%. IG<0 billion,
followed by Japan at I03Gbn and :ermany at K3>F billion, with oil producing countries such
as Saudi .rabia also having large surpluses. #n the debit side, the 'S had the biggest current
account deficit at over I3311 billion, with the 'H, Spain and .ustralia together accounting
for close to a further IG11 billion.
(hile there have been warnings of future cuts in public spending, deficit countries on the
whole did not ma+e these in 0114, in fact the opposite happened with increased public
spending contributing to recovery as part of global efforts to increase demand. The emphases
has instead been on the surplus countries, with the 7), ;' and nations such as the '.S.,
"ra&il and Russia as+ing them to assist with the adEustments to correct the imbalances.
;conomists such as :regor rwin and $hilip R. 9ane have suggested that increased use of
pooled reserves could help emerging economies not to re-uire such large reserves and thus
have less need for current account surpluses. (riting for the )T in Jan 0114, :illian Tett says
she e%pects to see policy ma+ers becoming increasingly concerned about e%change rates over
the coming year. n June 0114, #livier "lanchard the chief economist of the 7) wrote that
rebalancing the world economy by reducing both si&eable surpluses and deficits will be a
re-uirement for sustained recovery.
n 011> and 0114, there was some reduction in imbalances, but early indications towards the
end of 0114 were that maEor imbalances such as the '.S. current account deficit are set to
begin increasing again.
Japan had allowed her currency to appreciate through 0114, but has only limited scope to
contribute to the rebalancing efforts than+s in part to her aging population. The euro used by
:ermany is allowed to float fairly freely in value, however further appreciation would be
problematic for other members of the currency union such as Spain, :reece and reland who
run large deficits. Therefore :ermany has instead been as+ed to contribute by further
promoting internal demand, but this hasn!t been welcomed by :erman officials.
5hina has been re-uested to allow the renminbi to appreciate but until 0131 had refused, the
position e%pressed by her premier (en Jiabao being that by +eeping the value of the
renmimbi stable against the dollar 5hina has been helping the global recovery, and that calls
to let her currency rise in value have been motivated by a desire to hold bac+ 5hina!s
development. .fter 5hina reported favourable results for her 8ecember 0114 e%ports
however, the )inancial Times reported that analysts are optimistic that 5hina will allow some
appreciation of her currency around mid-0131.
n .pril 0131 a 5hinese official signalled the government is considering allowing the
renminbi to appreciate, but by 7ay analysts were widely reporting the appreciation would
li+ely be delayed due to the falling value of the ;uro following the 0131 ;uropean sovereign
debt crisis. 5hina announced the end of the renminbi!s peg to the dollar in June 0131= the
move was widely welcomed by mar+ets and helped defuse tension over imbalances prior to
the 0131 :-01 Toronto summit. /owever the renminbi remains managed and the new
fle%ibility means it can move down as well as up in value= two months after the peg ended the
renminbi had only appreciated against the dollar by about 1.>?
"y January 0133, the renminbi had appreciated against the dollar by G.2?, which means it!s
on trac+ to appreciate in nominal terms by <? per year. .s this reflects a real appreciation of
31? when 5hina!s higher inflation is accounted for, the '.S. Treasury once again declined to
label 5hina a currency manipulator in their )ebruary 0133 report to 5ongress. /owever
Treasury officials did advise the rate of appreciation was still too slow for the best interests of
the global economy.
n )ebruary 0133, 7oody!s analyst .laistair 5han has predicted that despite a strong case for
an upward revaluation, an increased rate of appreciation against the dollar is unli+ely in the
short term. .nd as of )ebruary 0130, 5hina!s currency had been continuing to appreciate for
a year and a half, while drawing remar+ably little notice.
(hile some leading surplus countries including 5hina have been ta+ing steps to boost
domestic demand, these have not yet been sufficient to rebalance out of their current account
surpluses. "y June 0131, the '.S. monthly current account deficit had risen bac+ to IF1
billion, a level not seen since mid-011>. (ith the 'S currently suffering from high
unemployment and concerned about ta+ing on additional debt, fears are rising that the 'S
may resort to protectionist measures.
Cometiti.e 'e.al!ation after 2##%
"y September 0131, international tensions relating to imbalances had further increased.
"ra&il!s finance minister :uido 7antega declared that an "international currency war" has
bro+en out, with countries competitively trying to devalue their currency so as to boost
e%ports. "ra&il has been one of the few maEor economies lac+ing a reserve currency to abstain
from significant currency intervention, with the realrising by 0F? against the dollar since
January 0114. Some economists such as "arry ;ichen green have argued that competitive
devaluation may be a good thing as the net result will effectively be e-uivalent to
e%pansionary global monetary policy. #thers such as 7artin (olf saw ris+s of tensions
further escalating and advocated that coordinated action for addressing imbalances should be
agreed on at the @ovember :01 summit.
5ommentators largely agreed that little substantive progress was made on imbalances at
the @ovember 0131 :01. .n 7) report released after the summit warned that without
additional progress there is a ris+ of imbalances appro%imately doubling to reach pre-crises
levels by 013B.
/.C0U121 O3 BOP I4B050NC2

There are conflicting views as to the primary cause of "#$ imbalances, with much attention
on the 'S which currently has by far the biggest deficit. The conventional view is that current
account factors are the primary cause * these include the e%change rate, the government!s
fiscal deficit, business competitiveness, and private behaviour such as the willingness of
consumers to go into debt to finance e%tra consumption. .n alternative view, argued at length
in a 011F paper by "en "ernan+e, is that the primary driver is the capital account, where
a global savings glut caused by savers in surplus countries, runs ahead of the available
investment opportunities, and is pushed into the 'S resulting in e%cess consumption and asset
price inflation.
&.B050NC2 O3 P0642NT1 CRI1I1
. "#$ crisis, also called a currency crisis, occurs when a nation is unable to pay for essential
imports and6or service its debt repayments. Typically, this is accompanied by a rapid decline
in the value of the affected nation!s currency. 5rises are generally preceded by large capital
inflows, which are associated at first with rapid economic growth./owever a point is reached
where overseas investors become concerned about the level of debt their inbound capital is
generating, and decide to pull out their funds. The resulting outbound capital flows are
associated with a rapid drop in the value of the affected nation!s currency. This causes issues
for firms of the affected nation who have received the inbound investments and loans, as the
revenue of thosefirms is typically mostly derived domestically but their debts are often
denominated in a reserve currency. #nce the nation!s government has e%hausted its foreign
reserves trying to support the value of the domestic currency, its policy options are very
limited. t can raise its interest rates to try to prevent further declines in the value of its
currency, but while this can help those with debts denominated in foreign currencies, it
generally further depresses the local economy.
5.B050NCIN7 42CH0NI141
#ne of the three fundamental functions of an international monetary system is to provide
mechanisms to correct imbalances.
"roadly spea+ing, there are three possible methods to correct "#$ imbalances, though in
practice a mi%ture including some degree of at least the first two methods tends to be used.
These methods are adEustments of e%change rates= adEustment of a nations internal prices
along with its levels of demand= and rules based adEustment. mproving productivity and
hence competitiveness can also help, as can increasing the desirability of e%ports through
other means, though it is generally assumed a nation is always trying to develop and sell its
products to the best of its abilities.
1. Rebalancin) by c-an)in) t-e e8c-an)e rate
.n upwards shift in the value of a nation!s currency relative to others will ma+e a
nation!s e%ports less competitive and ma+e imports cheaper and so will tend to correct
a current account surplus. t also tends to ma+e investment flows into the capital
account less attractive so will help with a surplus there too. 5onversely a downward
shift in the value of a nation!s currency ma+es it more e%pensive for its citi&ens to buy
imports and increases the competitiveness of their e%ports, thus helping to correct
adeficit (though the solution oftendoesn!t have a positive impact immediately due to
the 4ars-all$5erner con'ition).
;%change rates can be adEusted by governmentin a rules based or managed currency
regime, and when left to float freely in the mar+et they also tend to change in the
direction that will restore balance. (hen a country is selling more than it imports, the
demand for its currency will tend to increase as other countries ultimately need the
selling country!s currency to ma+e payments for the e%ports. The e%tra demand tends
to cause a rise of the currency!s price relative to others. (hen a country is importing
more than it e%ports, the supply of its own currency on the international mar+et tends
to increase as it tries to e%change it for foreign currency to pay for its imports, and this
e%tra supply tends to cause the price to fall. "#$ effects are not the only mar+et
influence on e%change rates however, they are also influenced by differences in
national interest rates and by speculation.
2. Rebalancin) by a'9!stin) internal rices an' 'eman'
(hen e%change rates are fi%ed by a rigid gold standard, or when imbalances e%ist between
members of a currency union such as the ;uro&one, the standard approach to correct
imbalances is by ma+ing changes to the domestic economy. To a large degree, the
change is optional for the surplus country, but compulsory for the deficit country. n
the case of a gold standard, the mechanism is largely automatic. (hen a country has a
favourable trade balance, as a conse-uence of selling more than it buys it will
e%perience a net inflow of gold. The natural effect of this will be to increase the
money supply, which leads to inflation and an increase in prices, which then tends to
ma+e its goods less competitive and so will decrease its trade surplus. /owever the
nation has the option of ta+ing the gold out of economy (sterilising the inflationary
effect) thus building up a hoard of gold and retaining its favourable balance of
payments. #n the other hand, if a country has an adverse "#$ it will e%perience a net
loss of gold, which will automatically have a deflationary effect, unless it chooses to
leave the gold standard. $rices will be reduced, ma+ing its e%ports more competitive,
and thus correcting the imbalance. (hile the gold standard is generally considered to
have been successful
:
up until 343B, correction by deflation to the degree re-uired by
the large imbalances that arose after (( proved painful, with deflationary policies
contributing to prolonged unemployment but not re-establishing balance. .part from
the 'S most former members had left the gold standard by the mid-34G1s.
. possible method for surplus countries such as :ermany to contribute to re-balancing efforts
when e%change rate adEustment is not suitable, is to increase its level of internal demand (i.e.
its spending on goods). (hile a current account surplus is commonly understood as the
e%cess of earnings over spending, an alternative e%pression is that it is the e%cess of savings
over investment. That is,
where 5. L current account, @S L national savings (private plus government
sector), @ L national investment.
f a nation is earning more than it spends the net effect will be to build up savings, e%cept
to the e%tent that those savings are being used for investment. f consumers can be
encouraged to spend more instead of saving= or if the government runs a fiscal deficit to
offset private savings= or if the corporate sector divert more of their profits to investment,
then any current account surplus will tend to be reduced. /owever in 0114 :ermany
amended its constitution to prohibit running a deficit greater than 1.GF? of its
:8$
AG>C
and calls to reduce its surplus by increasing demand have not been welcome by
officials,adding to fears that the 0131s will not be an easy decade for the euro&one. n
their .pril 0131 world economic outloo+ report, the 7) presented a study showing how
with the right choice of policy options governments can transition out of a sustained
current account surplus with no negative effect on growth and with a positive impact on
unemployment.
/. R!les base' rebalancin) mec-anisms
@ations can agree to fi% their e%change rates against each other, and then correct any
imbalances that arise by rules based and negotiated e%change rate changes and other
methods. The "retton (oods system of fi%ed but adEustable e%change rates was an
e%ample of a rules based system, though it still . John 7aynard Heynes, one of the
architects of the "retton (oods system had wanted additional rules to encourage surplus
countries to share the burden of rebalancing, as he argued that they were in a stronger
position to do so and as he regarded their surpluses as negative e%ternalities imposed on
the global economy.Heynes suggested that traditional balancing mechanisms should be
supplemented by the threat of confiscation of a portion of e%cess revenue if the surplus
country did not choose to spend it on additional imports. /owever his ideas were not
accepted by the .mericans at the time. n 011> and 0114, .merican economist $aul
8avidson had been promoting his revamped form of Heynes!s plan as a possible solution
to global imbalances which in his opinion would e%pand growth all round without the
downside ris+ of other rebalancing methods.
;.1TRUCTUR2 O3 B050NC2 O3
P0642NT
1. Tra'e Balance :-
Trade balance is the difference between e%port and import of goods, usually referred as
visible or tangible items. f the e%ports are more than imports, there will be trade surplus
and if imports are more than e%ports, there will be trade deficit. 8eveloping countries
have most of the time suffered a deficit in their balance of payments. The trade balance
forms a part of current account. n 011>-14, trade deficit of ndia was 33>.< 'S I billion.
2.C!rrent 0cco!nt Balance :-
t is the difference between the receipts and payments on account of current account
which includes trade balance. The current account includes e%port of services, interest,
profits, dividends and unilateral receipts from abroad and the import of services, profits,
interest, dividends and unilateral payments abroad. There can be either surplus or deficit
in current account. (hen debits are more than credits or when payments are more than
receipts deficit ta+es place. 5urrent account surplus will ta+e place when credits are more
and debits are less.
5urrent account balance is very significant. t shows a country!s earning and payments in
foreign e%change. . surplus balance strengthens the country!s international financial
position. t could be used for development of the country. . deficit is a problem for any
country but it creates a serious situation for developing countries. n 0114-31 ndiaMs
current account deficit was G>.B 'S I billion.
/. Caital 0cco!nt Balance :-
t is the difference between receipts and payments on account of capital account. The
transactions under this title involves inflows and outflows relating to investments, short
term borrowings lending, and medium term to long term borrowings 6 lending. There can
be surplus or deficit in capital account. (hen credits are more than debits surplus will
ta+e place and when debits are more than credits deficit will ta+e place. n 0114-31.
ndiaMs capital account surplus was F3.> 'S I billion.
&. 2rrors an' Omissions :-
The double entry boo+ - +eeping principle states that for every credit, there is a
corresponding debit and therefore, there should be a balance in "#$ as well. n reality
"#$ may not balance, due to errors and omissions. ;rrors may be due to statistical
discrepancies (differences) and omissions may be due to certain transactions may not get
recorded. )or ;g., remittance by an ndian wor+ing abroad to ndia may not get recorded
etc. f the current and capital account shows a surplus of 01,111 I, then the "#$ should
show an increase of 01,111 I. "ut, if the statement shows an increase of 00,111 I, then
there is an error or omission of 0,111 I on credit side.
(. 3orei)n 28c-an)e Reser.es :-
The balance of foreign e%change reserve is the combined effect of current and capital
account balances. The reserves will increase when,-
a) The surplus capital account is much more than the deficit in current account.
b) The surplus in current account is much more than deficit in capital account.
c) "oth the current account and capital account shows a surplus.
n 0114-31 ndiaMs foreign e%change reserves increased by 3G.B 'S I billion.
*.2<UI5IBRIU4 0ND
DI12<UI5IBRIU4 IN BOP
"alance of payments is the difference between the receipts from and payments to
foreigners by residents of a country. n accounting sense balance of payments, must
always balance. 8ebits must be e-ual to credits. So, there will be e-uilibrium in balance
of payments.
Symbolically, " L R - $
(here , - " L "alance of $ayments
R L Receipts from )oreigners
$ L $ayments made to )oreigners
(hen " L Nero, there is said to be e-uilibrium in balance of payments.
(hen " is positive there is favourable balance of payments= (hen O. " is negative there
is unfavourable or adverse balance of payments.! (hen there is a surplus or a deficit in
balance of payments there is said , to be dise-uilibrium in balance of payments. Thus
dise-uilibrium refers to imbalance in balance of payments.
".T6P21 O3 DI12<UI5IBRIU4 IN BOP
The following are the main types of dise-uilibrium in the balance of payments,-
1. 1tr!ct!ral Dise=!ilibri!m :-
Structural dise-uilibrium is caused by structural changes in the economy affecting
demand and supply relations in commodity and factor mar+ets. Some of the structural
dise-uilibrium are as follows ,-
i. . shift in demand due to changes in tastes, fashions, income etc. would decrease or
increase the demand for imported goods thereby causing a 8ise-uilibrium in "#$.
ii. f foreign demand for a country!s products declines due to new and cheaper substitutes
abroad, then the country!s e%ports will decline causing a deficit.
5hanges in the rate of international capital movements may also cause structural
dise-uilibrium.
iii. f supply is affected due to crop failure, shortage of raw-materials, stri+es, political
instability etc., then there would be deficit in "#$.
iv. . war or natural calamities also result in structural changes which may affect not only
goods but also factors of production causing dise-uilibrium in "#$.
v. nstitutional changes that ta+e place within and outside the country may result in "#$
dise-uilibrium. )or ;g.if a trading bloc+ imposes additional import duties on products
imported in member countries of the bloc+, then the e%ports of e%porting country would
be restricted or reduced. This may worsen the "#$ position of e%porting country.
2. Cyclical Dise=!ilibri!m :-
;conomic activities are subEect to business cycles, which normally have four phases
"oom or $rosperity, Recession, 8epression and Recovery. 8uring boom period, imports
may increase considerably due to increase in demand for imported goods. 8uring
recession and depression, imports may be reduced due to fall in demand on account of
reduced income. 8uring recession e%ports may increase due to fall in prices. 8uring
boom period, a country may face deficit in "#$ on account of increased imports.
5yclical dise-uilibrium in "#$ may occur because
a) Trade cycles follow different paths and patterns in different countries.
b) ncome elasticities of demand for imports in different countries are not identical.
c) $rice elasticities of demand for imports differ in different countries.
/. 1-ort - R!n Dise=!ilibri!m :-
This dise-uilibrium occurs for a short period of one or two years. Such "#$
dise-uilibrium is temporary in nature. Short - run dise-uilibrium arises due to une%pected
contingencies li+e failure of rains or favourable monsoons, stri+es, industrial peace or
unrest etc. mports may increase e%ports or e%ports may increase imports in a year due to
these reasons and causes a temporary dise-uilibrium e%ists.
nternational borrowing or lending for a short - period would cause short - run
dise-uilibrium in balance of payments of a country. Short term dise-uilibrium can be
corrected through short - term borrowings. f short - run dise-uilibrium occurs repeatedly
it may pave way for long - run dise-uilibrium.
&. 5on) - R!n I 1ec!lar Dise=!ilibri!m :-
9ong run or fundamental dise-uilibrium refers to a persistent deficit or a surplus in the
balance of payments of a country. t is also +nown as secular dise-uilibrium. The causes
of long - term dise-uilibrium are
i. 5ontinuous increase in demand for imports due to increasing population.
ii. 5onstant price changes - mostly inflation which affects e%ports on continuous basis.
iii. 8ecline in demand for e%ports due to technological improvements in importing
countries, and as such the importing countries depend less on imports.
The long run dise-uilibrium can be corrected by ma+ing constant efforts to increase
e%ports and to reduce imports.
(. 4onetary Dise=!ilibri!m :-
7onetary dise-uilibrium ta+es place on account of inflation or deflation. 8ue to inflation,
prices of products in domestic mar+et rises, which ma+es e%ports e%pensive. Such a
situation may affect "#$ e-uilibrium. nflation also results in increase in money income
with people, which in turn may increase demand for imported goods. .s a result imports
may turn "#$ position in dise-uilibrium.
;. 28c-an)e Rate 3l!ct!ations :-
. high degree of fluctuation in e%change rate may affect the "#$ position. )or ;g.if
ndian Rupee gets appreciated against dollar, then ndian e%porters will receive lower
amounts of foreign e%change, whereas, there will be more outflow of foreign e%change
on account of higher imports. Such a situation will adversely affect "#$ position. "ut, if
domestic currency depreciates against foreign currency, then the "#$ position may have
positive impact.
%.DI332R2NC2 B2T+22N CURR2NT
0CCOUNT > TR0D2 D23ICIT
1. Tra'e 'eficit
This is the difference between the amount of goods and services a nation e%ports, and the
amount of goods and services it imports. 9et!s simplify it. 9et!s say there are 0 nations in
the world, nation . and nation ". f nation . sells 311 dollars worth of stuff to nation ",
but buys 331 dollars worth of stuff from nation " at the same time, then nation . is said
to have a trade deficit of 31 dollars, it!s buying more goods and services from abroad than
it is selling.
2. C!rrent acco!nt 'eficit
This is a deficit in the current account. The current account is a broader measure than the
trade deficit. t!s one of the components of the balance of payments balance of payments
Eust shows all financial transactions between one country and the rest of the world. The
current account deficit is e-ual to the trade balance (whether it!s a surplus or deficit) P
factor income (this is simply earnings on foreign investments by the citi&ens of the
country subtracted from payments going to foreigners who have investments in the
country) P cash transfers (li+e remittances from wor+ers in the country to their families
abroad).
So the difference is that the trade deficit (or surplus) is a component of the current
account. The current account is a much broader measure.
1#.?ariations in t-e !se of term @balance of
ayments@
;conomics writer J. #rlin :rabbe warns the term balance of payments can be a source of
misunderstanding due to divergent e%pectations about what the term denotes. :rabbe says the
term is sometimes misused by people who aren!t aware of the accepted meaning, not only in
general conversation but in financial publications and the economic literature.
. common source of confusion arises from whether or not the reserve account entry, part of
the capital account, is included in the "#$ accounts. The reserve account records the activity
of the nation!s central ban+. f it is e%cluded, the "#$ can be in surplus (which implies the
central ban+ is building up foreign e%change reserves) or in deficit (which implies the central
ban+ is running down its reserves or borrowing from abroad).
The term "balance of payments" is sometimes misused by non-economists to mean Eust
relatively narrow parts of the "#$ such as the trade deficit, which means e%cluding parts of
the current account and the entire capital account.
.nother cause of confusion is the different naming conventions in use. "efore 342G there was
no standard way to brea+ down the "#$ sheet, with the separation into invisible and visible
payments sometimes being the principal divisions. The 7) have their own standards for
"#$ accounting which is e-uivalent to the standard definition but uses different
nomenclature, in particular with respect to the meaning given to the term capital account.
The IMF definition
The nternational 7onetary )und (7)) use a particular set of definitions for the "#$
accounts, which is also used by the #rganisation for ;conomic 5o-operation and
8evelopment (#;58), and the 'nited @ations System of @ational .ccounts (S@.).
The main difference in the 7)!s terminology is that it uses the term "financial account" to
capture transactions that would under alternative definitions be recorded in the capital
account. The 7) uses the term capital account to designate a subset of transactions that,
according to other usage, form a small part of the overall capital account. The 7) separates
these transactions out to form an additional top level division of the "#$ accounts. ;%pressed
with the 7) definition, the "#$ identity can be written,
The 7) uses the term current account with the same meaning as that used by other
organi&ations, although it has its own names for its three leading sub-divisions, which
are,
The goods and services account (the overall trade balance)
The primary income account (factor income such as from loans and investments)
The secondary income account (transfer payments)
11.Difference betAeen Balance of Payments
an' Balance of Tra'e
"alance of Trade "alance of $ayment
The "alance of Trade includes only visible imports and
e%ports, i.e. imports and e%ports of merchandise, the
difference of imports and e%ports is called "alance of
Trade. f imports are more than e%ports, it is
unfavourable balance of trade. f e%ports e%ceeds
imports, it is favourable balance of trade.
The "alance of $ayments includes
all those visible and invisible items
e%ported from and imported into the
country in addition to e%ports and
imports of merchandise.
"alance of Trade includes revenues received or paid on
account of imports and e%ports of merchandise. t shows
only revenue items.
"alance of $ayments includes all
revenue and capital items whether
visible or non-visible. "alance of
Trade thus form a part of "alance of
$ayments.
"alance of Trade can be favourable or unfavourable. f
imports are more than e%ports, it is unfavourable
balance of trade. f e%ports e%ceeds imports, it is
favourable balance of trade.
"alance of $ayments is always
balanced Eust li+e Trading and $rofit
and 9oss .6c of a business.
n case of "alance of Trade, there is no deficit or surplus
balance. The balance shows favourable or non-
favourable. So, e%ternal assistance is not re-uired.
n case of "alance of $ayments, any
balance, deficit or surplus is to be
financed by e%ternal source or
assistance or be utilised.
12.De.eloments in In'iaBs Balance of
Payments '!rin) t-e 1econ' <!arter CD!ly-
1etemberE of 2#1/-1&

$reliminary data on ndiaMs balance of payments ("o$) for the second -uarter (D0), i.e., July-
September 013G, of the financial year 013G-3B, are now available and presented in
Statements and . (hile Statement presents "o$ data in "$7< format, Statement
provides the same as per the old format.
De.eloments in In'iaBs BoP '!rin) D!ly-1etember 2#1/
ndiaMs current account deficit (5.8) narrowed sharply to 'SI F.0 billion (3.0 per
cent of :8$) in D0 of 013G-3B from 'SI 03.1 billion (F.1 per cent of :8$ in D0 of
0130-3G), also much lower than B.4 per cent of :8$ in D3 of 013G-3B. The lower
5.8 was primarily on account of a decline in the trade deficit as merchandise e%ports
pic+ed up and imports moderated, particularly gold imports.
#n a "o$ basis, merchandise e%ports increased by 33.4 per cent to 'SI >3.0 billion in
D0 of 013G-3B on the bac+ of significant growth especially in the e%ports of Qte%tile
and te%tile productsM, Qleather O leather productsM and chemicals.
#n the other hand, merchandise imports at 'SI 33B.F billion, recorded a decline of
B.> per cent in D0 of 013G-3B as compared with a decline of G.1 per cent in D0 of
0130-3G, primarily led by a steep decline in gold imports,which amounted to 'SI G.4
billion as compared to 'SI 3<.B billion in D3 of 013G-3B and 'SI 33.3 billion in D0
of 0130-3G.
.s a result, the merchandise trade deficit ("o$ basis) contracted to 'SI GG.G billion in
D0 of 013G-3B from 'SI B2.> billion a year ago.
@et invisibles during D0 of 013G-3B improved, essentially reflecting a rise in net
services e%ports. @et services at 'SI 3>.B billion recorded a growth of 30.F per cent
in D0 of 013G-3B (y-o-y) mainly on account of Qcomputer servicesM.
@et outflow on account of primary income (profit, dividend and interest) amounting
to 'SI <.G billion in D0 of 013G-3B was higher than that in the preceding -uarter
('SI B.> billion) as well as the corresponding -uarter ('SI F.< billion) of 0130-3G.
:ross transfers receipts at 'SI 32.G billion showed an increase of 0.< per cent (y-o-
y).
(hile foreign direct investment recorded net inflows of 'SI <.4 billion in D0 of
013G-3B, net portfolio investment registered an outflow of 'SI <.< billionin the wa+e
of indication given by 'S )ederal Reserve about the tapering of its -uantitative easing
programme. There was a marginal net outflow of 'SI 1.> billion under e-uities while
the debt component of net ) flows recorded a higher outflow of 'SI F.2 billion.
Q9oansM(net) availed by deposit ta+ing corporations (commercial ban+s)witnessed an
outflow of 'SI <.2 billion in D0 of 013G-3B owing to repayments of overseas
borrowings and a build-up of their overseas foreign currency assets. 'nder Qcurrency
O depositsM, net inflows of @R deposits amounted to 'SI >.G billion in D0 of 013G-
3B as compared to 'SI 0.> billion in the corresponding -uarter of 0130-3G. 9oans
(net) availed by others (;5"s) at 'SI3.G billion, however, showed an increase of >.>
per cent over the same -uarter of the preceding year. Trade credits and advances
recorded a decline mainly on account of higher repayments.
#n a "o$ basis, there was a drawdown of foreign e%change reserves of 'SI 31.B
billion in D0 of 013G-3B as compared to that of 'SI 1.0 billion in D0 of 0130-3G .
De.eloments in In'iaBs BoP '!rin) 0ril-1etember 2#1/
The turnaround in e%port growth and decline in imports from July 013G onwards led
to a sharp improvement in the trade deficit to 'SI >G.> billion in /3 of 013G-3B from
'SI 43.< billion in /3 of 0130-3G.
5ontraction in the trade deficit coupled with a rise in net invisibles receipts resulted in
a reduction of the 5.8 to 'SI 0<.4 billion (G.3 per cent of :8$) in /3 of 013G-3B
from 'SI G2.4 billion (B.F per cent of :8$) in /3 of 0130-3G.
@et inflows under the capital and financial account (e%cluding change in foreign
e%change reserves) declined to 'SI 3F.3 billion in /3 of 013G-3B from 'SI G2.1
billion in /3 of 0130-3G owing to net outflows of portfolio investment.
@otwithstanding a lower 5.8 during /3 of 013G-3B, there was a drawdown of
foreign e%change reserve to the tune of 'SI 31.2 billion as against an accretion of
'SI 1.B billion in /3 of 0130-3G mainly due to a decline in net capital inflows under
the financial account.
Trade balance and :old
Comosition of t-e balance of ayments
s-eet
"#$ The two principal parts of the "#$ accounts are the current account and the capital
account.
The current account shows the net amount a country is earning if it is in surplus, or spending
if it is in deficit. t is the sum of the balance of trade (net earnings on e%ports minus payments
for imports), factor income (earnings on foreign investments minus payments made to foreign
investors) and cash transfers. t is called the current account as it covers transactions in the
"here and now" * those that don!t give rise to future claims.
The 5apital .ccount records the net change in ownership of foreign assets. t includes
the reserve account (the foreign e%change mar+et operations of a nation!s central ban+), along
with loans and investments between the country and the rest of world (but not the future
regular repayments6dividends that the loans and investments yield= those are earnings and
will be recorded in the current account). The term "capital account" is also used in the
narrower sense that e%cludes central ban+ foreign e%change mar+et operations, Sometimes
the reserve account is classified as "below the line" and so not reported as part of the capital
account.
;%pressed with the broader meaning for the capital account, the "#$ identity assumes that
any current account surplus will be balanced by a capital account deficit of e-ual si&e * or
alternatively a current account deficit will be balanced by a corresponding capital account
surplus,
The balancing item, which may be positive or negative, is simply an amount that
accounts for any statistical errors and assures that the current and capital accounts sum to
&ero. "y the principles of double entry accounting, an entry in the current account gives
rise to an entry in the capital account, and in aggregate the two accounts automatically
balance. . balance isn!t always reflected in reported figures for the current and capital
accounts, which might, for e%ample, report a surplus for both accounts, but when this
happens it always means something has been missed * most commonly, the operations of
the country!s central ban+ * and what has been missed is recorded in the statistical
discrepancy term (the balancing item).
.n actual balance sheet will typically have numerous sub headings under the principal
divisions. )or e%ample, entries under C!rrent acco!nt might include,
Trade * buying and selling of goods and services ;%ports * a credit entry
mports * a debit entry
Trade balance * the sum of ;%ports and mports
)actor income * repayments and dividends from loans and investments )actor
earnings * a credit entry
)actor payments * a debit entry
)actor income balance * the sum of earnings and payments.
;specially in older balance sheets, a common division was between visible and invisible
entries. Risible trade recorded imports and e%ports of physical goods (entries for trade in
physical goods e%cluding services is now often called the merchandise balance). nvisible
trade would record international buying and selling of services, and sometimes would be
grouped with transfer and factor income as invisible earnings.
The term "balance of payments surplus" (or deficit * a deficit is simply a negative
surplus) refers to the sum of the surpluses in the current account and the narrowly defined
capital account (e%cluding changes in central ban+ reserves). 8enoting the balance of
payments surplus as "#$ surplus, the relevant identity is
1/. CONC5U1ION
The balance of payments accounts of a country record the payments and receipts of the
residents of the country in their transactions with residents of other countries. f all
transactions are included, the payments and receipts of each country are, and must be, e-ual.
.ny apparent ine-uality simply leaves one country ac-uiring assets in the others.
.lthough the totals of payments and receipts are necessarily e-ual, there will be ine-ualities
Se%cesses of payments or receipts, called deficits or surplusesSin particular +inds of
transactions. Thus, there can be a deficit or surplus in any of the following, merchandise trade
(goods), services trade, foreign investment income, unilateral transfers (foreign aid), private
investment, the flow of gold and money between central ban+s and treasuries, or any
combination of these or other international transactions.
1&.BIB5IO7R0PH6
3.www.economictimes.com
0.www.rbi.org.in
G.www.bop.encyclopedia.com

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1 BALANCE OF PAYMENT IN INDIA

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