INDIAS

Balance
Of
Payments

Balance Of Payments - BOP

What Does Balance Of Payments - BOP Mean?
A record of all transactions made between one particular country and all
other countries during a specified period of time. BOP compares the dollar
difference of the amount of exports and imports, including all financial
exports and imports. A negative balance of payments means that more
money is flowing out of the country than coming in, and vice versa.

Balance Of Payments - BOP

Balance of payments may be used as an indicator of economic and
political stability. For example, if a country has a consistently positive BOP,
this could mean that there is significant foreign investment within that
country. It may also mean that the country does not export much of its
currency.
This is just another economic indicator of a country's relative value and,
along with all other indicators, should be used with caution. The BOP includes
the trade balance, foreign investments and investments by foreigners.
A balance of payments (BOP) sheet is an accounting record of all
monetary transactions between a country and the rest of the world. These
transactions include payments for the country's exports and imports of
goods, services, and financial capital, as well as financial transfers. The BOP
summarises international transactions for a specific period, usually a year,

and is prepared in a single currency, typically the domestic currency for the
country concerned. Sources of funds for a nation, such as exports or the
receipts of loans and investments, are recorded as positive or surplus items.
Uses of funds, such as for imports or to invest in foreign countries, are
recorded as a negative or deficit item.
When all components of the BOP sheet are included it must balance that is,
it must sum to zero there can be no overall surplus or deficit. For example,
if a country is importing more than it exports, its trade balance will be in
deficit, but the shortfall will have to be counter balanced in other ways
such as by funds earned from its foreign investments, by running down
reserves or by receiving loans from other countries.
While the overall BOP sheet will always balance when all types of payments
are included, imbalances are possible on individual elements of the BOP,
such as the current account. This can result in surplus countries
accumulating hoards of wealth, while deficit nations become increasingly
indebted. Historically there have been different approaches to the question
of how to correct imbalances and debate on whether they are something
governments should be concerned about. With record imbalances held up as
one of the contributing factors to the financial crisis of 20072010, plans to
address global imbalances are now high on the agenda of policy makers for
2010.

Composition of the balance of payments sheet

Since 1974, the two principal divisions on the BOP have been 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. It is the sum of the balance of trade (net

earnings on exports payments for imports) , factor income (earnings on

foreign investments payments made to foreign investors) and cash
transfers. Its called the current account as it covers transactions in the "here
and now" - those that don't give rise to future claims.
The capital account records the net change in ownership of foreign assets. It
includes the reserve account (the international operations of a nation's
central bank), along with loans and investments between the country and
the rest of world (but not the future regular repayments / dividends that the
loans and investments yield, those are earnings and will be recorded in the
current account).
Expressed with the standard meaning for the capital account, the BOP
identity is:

The balancing item is simply an amount that accounts for any statistical
errors and make sure the current and capital accounts sum to zero. At high
level, by 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 should balance. A balance isn't always reflected in reported
figures, which might, for example, report a surplus for both accounts, but
when this happens it always means something has been missedmost
commonly, the operations of the country's central bank.[3]
An actual balance sheet will typically have numerous sub headings under the
principal divisions. For example, entries under Current account might
include:

Trade buying and selling of goods and services

o Exports a credit entry

o Imports a debit entry

Trade balance the sum of Exports and Imports

Factor income repayments and dividends from loans and investments

o Factor earnings a credit entry
o Factor payments a debit entry

Factor income balance the sum of earnings and

payments.

Especially in older balance sheets, a common division was between visible

and invisible entries. Visible trade recorded imports and exports of physical
goods (entries for trade in physical goods excluding services is now often
called the merchandise balance). Invisible trade would record international
buying and selling of services, and sometimes would be grouped with
transfer and factor income as invisible earnings.

Discrepancies in the use of term "balance of payments"

According to economics writer J. Orlin Grabbe the term Balance of Payments
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.
A common source of confusion is to exclude the reserve account entry which
records the activity of the nation's central bank. Once this is done, the BOP
can be in surplus (which implies the central bank is building up foreign
exchange reserves) or in deficit (which implies the central bank is running

down its reserves or borrowing from abroad ) The term can also be misused
to mean just relatively narrow parts of the BOP such as the trade deficit,
which means excluding parts of the current account and the entire capital
account. Another cause of confusion is the different naming conventions in
use. Before 1973 there was no standard way to break down the BOP sheet,
with the separation into invisible and visible payments sometimes being the
principal divisions. The IMF have their own standards for the BOP sheet, at
high level it's the same as the standard definition, but it has different
nomenclature, in particular with respect to the meaning given to the term
capital account.

Balance of Payments: CRISIS

The lead up to the crisis: 1990-91
I.

Breakup of the Soviet Union: The Soviet Union had been one of the
largest export markets for India prior to its breakup in India. The Soviet
breakup therefore negatively affected Indias precarious trade balance,
which slipped further into red.

II.

The Gulf war: Current account defi cit averaging 2.2% of the
GDP hit hard by the Gulf war .The Gulf war began in August
1990 with Iraqs Invasion of Kuwait. Both Iraq and Kuwait were among
the largest suppliers of oil to India, especially Iraq with whom India had
long term arrangements .Due to the war many of these long term
contracts were hit, which forced the government to buy from
the spot market at high prices resulting in the oil bill ballooning to
$2 billion in the latter half of 1990.

III.

Fall in remittances: The Gulf war also caused many Indian workers
working in Kuwait and Iraq to return, resulting in a fall in remittances.

This was significant since NRI remittances had been an important

source of inflows to the country throughout the eighties thus reducing
the severity of the balance of payments. The situation was further
aggravated further with the government having to airlift Indian
residents in Kuwait.
IV.

Political uncertainty: The period between1990-91 was marked

with high political uncertainty at the central level with the
country seeing three successive government changes. This reduced
the focus of the government on the looming economic crisis as there
was no clear policy to deal with the unexpected situation. When a
stable majority government did was setup in 1991, it was a little too
late as the damage had been done.

The Crisis: The rapid loss of foreign exchange reserves had prompted the
government to take steps to reduce the trade deficit, by restricting the
imports .In October 1990; the RBI imposed a cash margin of 25percent on all
imports other than capital goods. Capital goods imports were allowed only
with foreign sources of credit. Additionally, a surcharge of 50 percent was
imposed on all Petroleum and oil imports except domestic gas. Along with
increases in custom duties, the above mentioned policies had the desired
impact of controlling the imports, which started falling in the latter half of
1991. By late of 1991, the decline of imports had reached a stage where it
was starting to affect the domestic production, which started declining (as
shown). Hence any further measured in this direction was ruled out.

Indias Export

Indias export was worth 1041.52 Billion USD in April of 2011 and it increased
throughout the year to march of 2012 with export worth 1421.73 Billion at
the end of their FY 2011-2012. Export growth has continued to be a major
component supporting India's rapid economic growth. Exports of goods and
services constitute 24.64% of its GDP. Indias major exports are: agriculture
and allied products, ores and minerals, leather and manufactures, chemicals
and related products, engineering goods, textile Products, gems and
jewellery, handicrafts (excluding handmade carpets) & petroleum products.
Indias largest exports markets are European Union, United States, Hong
Kong, Sri-Lanka and Singapore.

From the following graph, we can see that Indias exports are increasing from
May 2011 and it was highest in March 2012.

Figure 1: Export of India in US$ Billion for year 2011-12

Indias Imports
Indias import was worth 1623.93 Billion USD in April of 2011. Then it
increased gradually and made highest import in January 2012. Indias main
imports of commodities are: Petroleum, Crude and Products, Consumption
Goods and Capital Goods. Indias main imports partners are: Germany,
Belgium, USA, South Korea and Asian countries.

From the following graph, we can see that India imports are increasing from
May 2011 to March 2012.

Figure 2: Import of India in US$ Billion for year 2011-12.

India is still categorized under Developing Countries. In 1991 India's

industrial system changed from socialism to capitalism. As a result, India's
economy started growing at 6% per year double the earlier rate. Later it
started growing at 9% per year triple the earlier rate. That is, after adopting
capitalism in 1991, India's rate of industrialization/modernization has now
tripled. India is now industrializing /modernizing thrice as fast as she was
doing during the period 19471991.

Balance of trade and current account balance

Historically India has been running current account deficits.
Trade deficit hit a record high of $184.9bn or 9.9 per cent of GDP
for the fiscal year 2011 compared to 7.1 percent of GDP in FY
2010
Oil imports soared 46.9 per cent to $155.6bn.
Exports grew 21 per cent, to $303.7bn, but imports surged 32.1
per cent over the previous fiscal year, to $488.6bn.
Indias current account deficit is estimated to reach an all- time
high of ~-4% of GDP in F2012
The driver for this rise in current account deficit is savings
declining faster than investment.
Some investors have argued that gold imports are the key cause
for the high current account deficit and therefore the underlying
current account deficit is not as bad as it appears. But higher gold
imports as a symptom of loose fiscal policy (high revenue deficit
and low productivity nature of government capital spending)
keeping inflation high relative to growth trend.
Foreign investment was insufficient to bridge a record currentaccount gap, highlighting the fragile state of Asia's third-largest
economy even as the government takes steps to curb its spending
and boost growth.

Strengths in Balance of Payments

Transfer account and services account are the strengths in the
BOP, as India expects to receive high remittance than other Asian
countries.
India has wide natural resources like Coal, Iron, Oil, etc. Experts
say that more of these would be found out soon.
The country is agriculture based so if it can bring some local
investment or FDI in the agriculture processing industry than it can
have a more favorable growth.
The country is self-sufficient in many areas and was endowed with
fertile land, dense forests, and swift rivers.

Risks in Balance of Payments:

The most important balance of payment risk is the dependence on
agricultural export products.
India imports more than three-fourths of the crude oil it requires,

making this the biggest driver of the trade gap.

Analysts blame the government's large fuel subsidy for keeping
the demand for fuel products artificially high and stoking the trade

deficit.
Rising inflation can make export costlier and may induce more
imports from other countries of consumption goods.
Moreover, increasing population and income level will induce more
imports which will eventually lead to balance of trade deficit. But,
as it is not optimum to reduce consumption in consumer goods and
goods for industrialization structural deficit is to be found.

Capital Account
Although, over 2004-07, when global capital markets were buoyant and
capital inflows continued to be higher than Indias current account deficit
funding needs, in the current environment, when risk of systemic sudden
stop in capital inflows is high, a wider current account deficit means that
balance of payment could be under stress.
Over the three years, out of total capital inflows of US$120 billion, about
60% have been from non-FDI inflows. Over the last 12 months, as the
portfolio equity inflows have slowed, dependence on debt- creating inflows
has shot up. The share of debt-creating inflows is expected to increase to
65% in F2012 compared to 44% in the 10-year period of F2001-10.
Balance of payment stress will keep short-term cost of capital high and
hurt growth: The governments desire to stimulate domestic demand
with less-productive spending at a time when productive private
investment has been declining as % of GDP has been the key driver
behind the wider current account deficit. In particular, the current
account deficit could widen further, exposing India to even more
volatility in global capital inflows. If a slowdown in capital inflows were
to occur, it would create significant depreciation pressures on the
rupee and increase market-oriented short-term cost of capital and hurt
growth.

Effect on various factors due to Deficit in BOP statement

Persistent deficit in the BOP statement of a country indicates a fundamental

disequilibrium in the economy. This may be the cumulative effect on the
variety of factors such as

Changes in consumer tastes in the country or abroad which reduces

the countrys exports and increases its imports

Low competitive strength in world market which adversely affects

exports

Continuous fall in the countrys foreign exchange to reserves due to

supply inelasticities of exports, and excessive demand for foreign
goods and services

Inflationary pressures in the economy which make exports dearer

Changes in the supply or direction of long-term capital flows

GDP growth or decline which is likely to affect exports and imports of a

country

Other Items In The BOP Statement

The Balance of Payments statement has three more items, namely
Errors and Omissions
Overall Balance(total of Current and Capital Accounts and Errors and
Omissions)
Monetary Movements
IMF
Foreign exchange reserves(increase/decrease)

Errors and Omissions

The large volume of statistical data required for the presentation of the
Balance of Payments statement is collected partly from official records and
partly on the basis of estimates. As a result, the total credits and total debits
are unlikely to match. There is likely to be some statistical discrepancy in the
BOP statement. This is recorded as Errors and Omissions in BOP statement

Overall Balance
Overall balance is arrived at by summing up all the items in the current
account , capital account and the errors and omissions figures. It is the net
balance between international receipt and payments of the country. The
Overall Balance may show deficit or surplus depending on whether the total
debits exceeds the total credits or vice versa

IMF
The IMF has created a reserve asset termed SDRs (Special Drawing Rights)
which are allocated to member countries. SDRs may be held as reserves by
member countries and used for settling international payments between
countries. A countries facing overall deficit in the BOP statement may
purchase SDRs from the IMF for meeting the deficit

Foreign Excahange Reserves

Foreign exchange reserves of countries include different types of assests

such as gold, foreign currencies, deposits of foreign currencies in foreign
central banks, investment in foreign government securities and SDR
holdings. These assests are held by the central bank for the purpose of
meeting intenational commitments arising from international transactions.
So when a country faces overall deficit in its BOP statement, it may use its
foreign exchange resereves to meet the deficits

Conclusion
The Indian economy is the third largest in the world in purchasing power
parity and ninth largest by nominal GDP criterion. .Goldman Sachs has
predicted that by 2035, the Indian economy will be the third largest, behind
USA and China. The economy would be as large as 60% of US economy. In
2011, the per capita income was $ 3073, making it relatively a lower middle
class economy.
Since independence, India's balance of payments on its current account has
been negative. Since economic liberalization in the 1990s, precipitated by a
balance of payment crisis, India's exports rose consistently, covering 80.3%
of its imports in 200203, up from 66.2% in 199091. However, the global
economic slump followed by a general deceleration in world trade saw the
exports as a percentage of imports drop to 61.4% in 200809. India's
growing oil import bill is seen as the main driver behind the large current
account deficit, which rose to $118.7 billion, or 9.7% of GDP, in 200809.
Between January and October 2010, India imported $82.1 billion worth of
crude oil.

Due to the global late-2000s recession, both Indian exports and imports
declined by 29.2% and 39.2% respectively in June 2009. The steep decline
was because countries hit hardest by the global recession, such as United
States and members of the European Union, account for more than 60% of
Indian exports. However, since the decline in imports was much sharper
compared to the decline in exports, India's trade deficit reduced to 25,250
crore (US$4.6 billion). As of June 2011, exports and imports have both
registered impressive growth with monthly exports reaching $25.9 billion for
the month of May 2011 and monthly imports reaching $40.9 billion for the
same month. This represents a year on year growth of 56.9% for exports and
54.1% for imports.
India's reliance on external assistance and concessional debt has decreased
since liberalization of the economy, and the debt service ratio decreased
from 35.3% in 199091 to 4.4% in 200809. In India, External Commercial
Borrowings (ECBs), or commercial loans from non-resident lenders, are being
permitted by the Government for providing an additional source of funds to
Indian corporate. The Ministry of Finance monitors and regulates them
through ECB policy guidelines issued by the Reserve Bank of India under the
Foreign Exchange Management Act of 1999. India's foreign exchange
reserves have steadily risen from $5.8 billion in March 1991 to $283.5 billion
in December 2009.

Bibliography
Website
www.rbi.org.in

www.tradingeconomics.com
www.federalreserve.gov
www.worldbank.org
www.adb.org
www.bangaladeshbangk.org
www.wikipedia.org

Book:
International Financial Management by Jeff Madura 9th Edition.