1

A PROJECT REPORT ON

ANALYSIS OF INDIA’S BALANCE OF PAYMENT

SUBMITTED BY

ALKA AHUJA

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT

FOR

POST GRADUATE DIPLOMA IN FINANCIAL SERVICES

OF

UNIVERSITY OF PUNE

SINHGAD BUSINESS SCHOOL, PUNE

MARCH, 2010

UNDER THE GUIDANCE OF

MISS RACHNA PHADAKE

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Bonafide Certificate

This is ti certify that Miss Alka Ahuja studying in the 2nd Semester of Post Graduate
Diploma In Financial services of University Of Pune is a Bonafide Student of SINHGAD
BUSINESS SCHOOL, Pune.

Director:

Sinhgad Business School

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STUDENT DECLARATION

I hereby declare that the project report entitled

ANALYSIS OF INDIA’S BALANCE OF PAYMENT

Submitted in partial fulfillment of the requirement for the award of Diploma in POST
GRADUATE DIPLOMA IN FINANCIAL SERVICES

To University of Pune, India, is my original work.

Place:____________ Signature of the Student

Date:_____________ Roll No. FS-01

(SBS946855)
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APPROVAL CERTIFICATE

The project report of

Miss ALKA AHUJA

ANALYSIS OF INDIA’S BALANCE OF PAYMENT

Is approved and is acceptable in quality and form.

Internal Examiner External Examiner

Signature: _______________ Signature:_______________

Name:___________________ Name:__________________
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GUIDE’S CERTIFICATE

This is to certify that the Project report entitled

ANALYSIS OF INDIA’S BALANCE OF PAYMENT

Submitted in partial fulfillment of the requirement for the award of diploma of

Post Graduate Diploma In Financial Services

Of

University Of Pune

Miss ALKA AHUJA

has worked under my supervision and guidance .The project report is original work of the
student.

GUIDED AND CERTIFIED BY

Miss Rachna Phadake

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ACKNOWLEDGEMENT

It gives me great pleasures to present this report entitled,

“ANALYSIS OF INDIA’S BALANCE OF PAYMENT”

I would like to express my sincere gratitude to Miss Rachna Phadake for giving me this
opportunity and for his kind support.

I extended my gratitude towards my institute SINHGAD BUSINESS SCHOOL, PUNE

CAMPUS for helping me to successfully complete the project work.

My special thanks to our Director Ms. M.S. SATHE

I
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CONTENTS

1. INTRODUCTION………………………………………………………………..08

2. Contents…………………………………..…………………………….................08

3. Causes of Imbalance…………………. …………………………………...…….11

4. Component of balance of payment……………..…………………………..…....14

5. India International Trade………………………………………………...……...23

6. India’s Major Trading Partner.....…………………………………………….....24

7. India’s Trade Basket………………….………………………………...………...25

8. Crisis…………………………………………………………………….…………31

9. Capital Account Of Convertibility (CAC)………………………….....................40

10. Discuss the relevance/ importance of the BOP statements.……………………. 41

11.In the accounting sense the BOP always balances………………………………42

12.CONCLUSION……………………..……………………………………………..53

13.REFERANCES………………….…………………………………………….......54

s
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BALANCE OF PAYMENT
A Balance of payments (BOP) sheet is an accounting record of all monetary transactions
between a country and the rest of the world. [1] 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 2007–2010, plans to address
global imbalances are now high on the agenda of policy makers for 2010.

CONTENTS:
Make up of the Balance of Payments sheet
Standard Definition
Since 1973, the two principle 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.
The capital account records the net change in ownership of foreign assets. It includes
the reserve account (the international operations of a nations 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:

(+ or - Balancing item)
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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 missed--most
commonly, the operations of the country's central bank. [2]
An actual balance sheet will typically have numerous sub headings under the principle
divisions. For example, entries under Current account might include:
• Trade - buying and selling of goods and services
○ Exports - a credit entry
○ Imports - a debit entry
 Trade balance - the sum of Exports and Imports
• Factor income - repayments and dividends from loans and investments
○ Factor earnings - a credit entry
○ 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. [1]
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. [2]
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 ) [1] [2]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. [3] Before
1973 there was no standard way to break down the BOP sheet, with the separation into
invisible and visible payments sometimes being the principle 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.
The IMF Definition
The IMF use a particular set of definitions for the BOP, which is also used by the OECD ,
and the United Nations' SNA. [4]
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The main difference with the IMF definition is that they use the term financial account to
capture transaction that in the standard definition are recorded in the capital account.
The IMF do use the term capital account, to designate a sub set of transactions that
according to usage common in the rest of the world form a small part of the overall
capital account. [5] The IMF separate these transaction out to form an additional top level
division of the BOP sheet. Expressed with the IMF definition, the BOP identity can be
written:

(+ or -
Balancing item)
The IMF use the term current account with the same meaning as the standard definition,
although they have their own names for their 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)
Imbalances

The US dollar has been the leading reserve asset since the end of the gold standard.
While the BOP has to balance overall, surpluses or deficits on its individual elements can
lead to imbalances between countries. In general there is concern over deficits in the
current account. Countries with deficits in their current accounts will build up increasing
debt and/or see increased foreign ownership of their assets. The types of deficits that
typically raise concern are [1]
• A visible trade deficit where a nation is importing more physical goods than it
exports (even if this is balanced by the other components of the current account.)
• An overall current account deficit.
• A basic deficit which is the current account plus foreign direct investment (but
excluding other elements of the capital account like short terms loans and the
reserve account.)

Causes of BOP Imbalances

There are conflicting views as to the primary cause of BOP imbalances, with much
attention on the US who currently have by far the largest deficit. The conventional view is
that current account factors are the primary cause [9] - these include the exchange rate,
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the government's fiscal deficit, business competitiveness , and private behaviour such as
the willingness of consumers to go into debt to finance extra consumption. [10] The
alternatively view, argued at length in a 2005 paper by Ben Bernanke , 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
US resulting in TABLE OF CONTENTS

BALANCE OF PAYMENTS
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
-

-
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Top
of Form
/w EPDw ULLTE0N

Mar 26 2009

Balance of Payment (2009-2010)

Apr 11 2008

Balance of Payments (2008-2009)

Apr 4 2007

Balance of Payments (2007-2008)

Apr 5 2006

Balance of Payments (2006-2007)

Apr 1 2005

Balance of Payments (2005-2006)

Apr 17 2004

Balance of Payments (2004-2005)

Dec 31 2003

Balance of Payments (2003-2004)

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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:

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
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.
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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.

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.

The various components of a BOP statement are:

A. Current Account
B. Capital Account
C. IMF
D. SDR Allocation
E. Errors & Omissions
F. Reserves and Monetary Gold

BALANCE OF TRADE
Balance of trade may be defined as the difference between the value of goods and
services sold to foreigners by the residents and firms of the home country and the value
of goods and services purchased by them from foreigners. In other words, the difference
between the value of goods and services exported and imported by a country is the
measure of balance of trade.
If two sums (1) value of exports of goods and services and (2) value of imports of goods
and services are exactly equal to each other, we say that there is balance of trade
equilibrium or balance; if the former exceeds the latter, we say that there is a balance of
trade surplus; and if the later exceeds the former, then we describe the situation as one
of balance of trade deficit. Surplus is regarded as favourable while deficit is regarded as
unfavourable.
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BALANCE OF CURRENT ACCOUNT

BOP on current account refers to the inclusion of three balances of namely –
Merchandise balance, Services balance and Unilateral Transfer balance. In other words
it reflects the net flow of goods, services and unilateral transfers (gifts). The net value of
the balances of visible trade and of invisible trade and of unilateral transfers defines the
balance on current account.
BOP on current account is also referred to as Net Foreign Investment because the sum
represents the contribution of Foreign Trade to GNP.
Thus the BOP on current account includes imports and exports of merchandise (trade
balances), military transactions and service transactions (invisibles). The service account
includes investment income (interests and dividends), tourism, financial charges
(banking and insurances) and transportation expenses (shipping and air travel).
Unilateral transfers include pensions, remittances and other transfers for which no
specific services are rendered.

BASIC BALANCE
The basic balance was regarded as the best indicator of the economy’s position visà-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:
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 OFFICIAL SETTLEMENT CONCEPT

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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 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.

THE 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 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
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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 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 realise 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.
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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 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.

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, 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
favourable to a country and a negative sum is considered as unfavourable. 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.’
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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).

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’s) 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 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.
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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. The United States
foreign aid to India, for BOP but a debit item in the US BOP). These are government to
government donations or gifts. There no well worked out theory to explain the behaviour
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 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.
21
 22

s
repayments)

INDIA’S INTERNATIONAL TRADE

 23

INDIA’S MAJOR TRADING PARTNERS

24
 25

INDIA’S TRADE BASKET

 26

APRIL – JUNE Quarter 2008-09

(In US $
Billion )
27
 28

India’s Bop position during the 1st half of

2008-09
(April-Sept)

• Widening of Tr. Deficit resulting in large CAD, and moderation in capital

flows.

• Merchandise trade deficit recorded a sharp increase during April-November

2008 on account of higher crude oil prices for most of the period and loss
of momentum in exports since September 2008.

• Net surplus under invisibles remained buoyant, (led by increase in software

exports and private transfers.)
 29

• Net capital inflows reduced sharply and have remained volatile during 2008-
09 so far.

• While the net inward FDI remained buoyant net outward FDI also remained
high during April-September 2008.

• So the gross capital inflows were higher on account of higher FDI inflows
and NRI deposits during the period.

• The revised short-term debt maturing up to March 2009, was estimated at

around US $ 85 billion as at end-March 2008.

• India’s merchandise exports during April-Nov 2008 increased by 18.7 % whil

eimports recorded a higher growth of 32.5 %, largely due to the rise in (POL)
imports.The rise in oil imports was primarily due to the elevated
international crude oil prices, while the volume of oil imports moderated.

EXPORTS

• Decline in exports

1.1% drop to $ 12.7 billon in Dec 08

12.1% drop in Oct 08 9.9% drop in Nov 08

• 22% drop in Jan 09

• Decline of exports in following sectors: (Dec 08)

Handicraft & Handlooms 64%

Textile 13%

Gems & Jewellery 21%

Chemicals 21%

Exports

• Increase in exports

Eng. Goods, Phama & Agri. Products

 30

(in the range of 19-25%)

• India’s estimated exports $ 170 billion FY 08-09

$ 160 billion FY 07-08

Govt set target $ 200 billion

Imports

• Imports grew by 8.8% to $ 20.25 b in Dec 08

Non oil imports 30.9% to $15.54 b

(consisting of Capital Equipment & Proj. Goods)

This suggests a robust domestic activity.

Trade Deficit

• $ 7.57 Billion in Dec 08

$ 10.07 Billion in Nov 08

• Tr. Deficit for 1st 9 months is $ 93.8 billion

(74% higher than S 58.98 b in the year ago period )

• Lower Oil Imports over Jan- Mar will enable to end this fiscal
with a Tr.

Deficit of about 40%

higher than last year’s.

Inward Remittances

• Indicated to touch $ 40 billion in year 2008

(World Bank projection was $ 30 billion )

 31

• In 2007, No. 1 was India (27 billion)

No.2 was China (25.7 billion)

• Unlike FIIs flows, inward remittances are considered to be

extremely sticky

• Mostly from Blue collar workers(not more than

$ 500 per month)

FOREX RESERVES

• Import cover of India’s foreign exchange reserves declined to

11.2 months as at end-September ‘08 as against 14.4 months
as at end-March ‘08 in sync with the fall in reserves, the RBI
said in its half-yearly report on forex reserves.

• As of January 16, 2009, foreign exchange reserves at US $

252.2 billion declined by US $ 57.5 billion over the level at end-
March 2008.

ECB & FCCB

• Even after Indian govt. relaxed overseas borrowing norms for

corporates, loans have failed to pick up.(as foreign banks curb
lending)

• During Oct- Dec 2008, inflows through ECB & FCCB were only $
4.5 b against $ 8.1 b in Oct –Dec 2007

• Borrowings through ECB & FCCBs dipped 32% in 2008.

Indian companies borrowed $ 22.7 b during the year as

compared to $33.1b in 2007

The Global Scene

 32

• Commodity & oil prices have come down

• Subprime crisis

INDIAN (BOP) CRISIS 1990

The Crisis: 1990-92
The gulf crisis of 1990 led to an unprecedented crisis in the balance of payments. The
balance of payments crisis reached its peak in the summer of 1991 when the foreign
currency reserves had fallen to almost $1 billion, inflation had risen to an annual rate of
17 percent, industrial production was falling and overall economic growth had declined to
1.1 percent in1991-92. The payments crisis became evident in 1990-91 when the oil
prices increased due to the Gulf War. This resulted in worsening of current accounts
deficit which increased to 3.2% of GDP in 1990-91.

There was also a deterioration in the invisible account because of lower remittances and
higher interest payments. Foreign exchange reserves started to decline from September
1990. They declined from Rs.5480 crores ($3.1 billion) in August 1990 to Rs.1666 crores
(896 million) in January 1991. During this period the Government had to take recourse to
IMF to overcome the balance of payments difficulties. The main factor responsible for the
sharp fall in reserves was the sharp rise in the imports of POL. However, the payments
crisis of 1990-91 was not simply due to deterioration on the trade account, it was
accompanied by other adverse developments on the capital account reflecting the loss at
home, coupled governments ability to manage the situation. Political uncertainty at
home, coupled with rising inflation and widening fiscal deficits, led to a loss of
international confidence.

India’s recourse to the commercial borrowings totally dried up as the credit rating
agencies down graded India. Simultaneously, there began an outflow of non-resident
Indian deposits. In addition there were serious difficulties in the rolling over of short term
credit, which was roughly of the order of $5 billion. While current account deficit of the
order of $8 billion was easily financed in 1988-89, a deficit of $9.7 billion in 1990-91
became almost impossible to finance.

By June 1991, the balance of payments crisis had become overwhelmingly a crisis of
confidence, i.e. a crisis of confidence in the
governments’ ability to manage the balance of payments. A default on payments had
become a serious possibility in June 1991 for the first time in the Indian history. A default
is essentially a failure to repay debts, but its ramifications are never confined to debt. A
 33

default in payments inevitably leads to a breakdown in credit availability and normal

payments arrangements. Suppliers become reluctant to sell goods and services
and insist on advance payments through banks of their own country. This leads to
severe trade disruptions which in turn forces severe and prolonged import compression
and results in shortages, industrial dislocation, and severe unemployment and high
inflation.

The new government of Mr. P. V. Narshima Rao which assumed office in June 1991
acted swiftly and took measures which relied on a combination of macro economic
stabilization and structural reforms in industrial and trade policies. The exchange rate
was also adjusted downwards. As a result of these policy reforms and successful
mobilization of exceptional financing, the balance of payments position slowly stabilized
during 1991-92.The increase in foreign exchange reserves combined with stabilization
and structural reforms restored international confidence. With the sharp decline in the
absolute level of imports, 1991-92 ended with a current account deficit of less than one
percent of GDP.

LIBERALISATION STRENGTHNS INDIA’S

BALANCE OF PAYMENTS
India has emerged stronger in its external payments position at the end of the first
decade of liberalisation and structural reforms that have transformed the country’s
standing in the world economy. The 1991 balance of payments crisis was turned into an
opportunity by Government to re-set the directions of the economy to become
outward-oriented and move closer to integration with the world economy.

The reforms covered trade and industrial policies, the exchange rate, tax and foreign
investment policies and the banking system. The launching of a truly liberalised trade
regime, with a two-step devaluation of the rupee in 1991 leading later to market-
determined exchangerate, and the ushering in of a conducive climate for foreign
investment inflows, have had a dramatic impact on the country’s external
transactions.The effect of liberlisation on the balance of payment can be compared:

Trade and Investment Flows

The early 1990s saw a surge in exports, a significant rise in foreign direct investment and
other capital flows including portfolio capital from foreign institutional investors and a
substantial increase in ‘private transfers’ under the category of ‘invisibles’ in balance of
payments account. In ten years, 1991-2001, over 37 billion dollars of foreign investment
flowed. Of these 18 billion dollars was direct investment, i.e., an average of 2.2 billion
dollars a year. The private transfers, which averaged two to three billion dollars in the
1980s – mainly the remittances of Indians employed abroad – grew to a level of 10-12
billion dollars in the latter half of 1990s. The export growth momentum resulting from the
gradual opening of the economy and the exchange rate reforms including the
convertibility of the rupee for current account transactions in August 1994 triggering the
 34

surge in invisible receipts, are the two major factors which helped contain the current
account deficit in BOP to 1 to 1.5 per cent of GDP between 1991 and 2001.

Balance of Payment Surplus

A low current account deficit is a healthy indicator of the country’s balance of payment
position. With the strong capital flows (net) from 1993-94 onwards, India could easily
finance the current account deficit and add sizeable amounts to the foreign exchange
reserves. NRI deposits with the banking system in India have also been on the rise from
13 billion dollars in 1991-92 to 23.8 billion dollars by March 2001.The balance of
payments has recorded an overall surplus in most of the years and consecutively for five
years from 1996-97. India’s foreign exchange reserves, which were barely one billion
dollars in the pre-crisis year, have now reached a level of 40 billion dollars (other than
gold and SDR), the average annual addition being 4.5 billion dollars.

This order of reserves is equivalent to eight to nine months of imports. The external
sector strength has to be derived essentially from exports. And, after a few years of
slowdown, there has been a revival with growth rates moving upto 11 and 20 percent in
the two years ended March 2001. But no less important is the management of the
external sector as a whole including exchange rate stability. India has successfully
withstood the fall-out effects of the Asian financial turmoil in 1997, the economic
sanctions imposed by USA and other countries following the nuclear tests inMay 1998
and the sharp rise in international oil prices since the closing months of 1999. Inspite of a
heavy outgo of over 10 billion dollars from imports of higher priced oil, India’s trade
deficit has been contained within manageable limits.

Recording of Transactions: General Principles

The double-entry bookkeeping used in accounting for the balance of payments is similar
to that used by business firms in accounting for their transactions. In ordinary business
accounting the amount of each transaction is recorded both as a debit and a credit, and
the sum of all debit entries must, therefore, equal the sum of all credit entries., in
business accounting it is recognized that the total value of the assets employed by the
firm must be equal to the total value of the claims against those assets, that is, that all
the assets belong to someone. As is well known, the claims against the assets are called
the liabilities of the firm. (Assets of the firm not subject to the claims of creditors are, of
course, the property of stockholders, so that, broadly speaking; the firm has two classes
of liabilities: those due to creditors and those due to stockholders.) By accounting
convention, a debit entry is used to show an increase in assets or a decrease in
liabilities, while a credit entry is used to show an increase in liabilities or a decrease in
assets. Since a debit entry is always accompanied by a credit entry, it follows that the
value of total assets on the books of a going concern is always equal to the value of total
liabilities (including the claims of stockholders).

These elementary principles can be applied to

the recording of transactions in the balance of payments. For example, when a foreigner
 35

gives up an asset to a resident of this country in return for a promise of future payment, a
debit entry is made to show the increase in the stock of assets held by U.S. residents,
and a credit entry is made to show the increase in U.S. liabilities to foreigners (that is, in
foreign claims on U.S. residents).

Or when a U.S. resident transfers a good to a foreigner, with payment to be made

in the future, a debit entry is made to record the increase in one category of U.S. assets
(U.S. financial claims on foreigners, that is, U.S. holdings of foreign IOUs), and a credit
entry is made to record the decrease in another category (goods). These principles are
illustrated in greater detail in the following section, which through a series of examples
constructs a hypothetical balance-of-payments statement.

Recording of Typical Transactions

The balance-of-payments accounts are commonly grouped into three major categories:

(1) accounts dealing with goods, services, and income;

(2) Accounts recording gifts, or unilateral transfers; and

(3) Accounts dealing basically with financial claims (such as bank deposits and stocks
and bonds).

This section shows how typical transactions in each of these major categories are
recorded.

COMMERCIAL EXPORTS: TRANSACTION 1

Suppose that a firm in the United States ships merchandise to an overseas buyer with
the understanding that the price of $50 million, including freight, is to be paid within 90
days. In addition, assume that the merchandise is transported on a U.S. ship. In this
case U.S. residents are parting with two things of value, or two assets: merchandise and
transportation service. (Transportation service, like other services supplied to foreigners,
can be viewed as an asset that is created by U.S. residents, transferred to
foreigners, and consumed by foreigners all at the same time.)

In return for giving up these foreign customer to make payment within 90 days. In
accordance with the principles outlined above, the bookkeeping entries required to
record these transactions are as follows: first, a debit of $50 million to an account we
shall call, “U.S. private short term claims,” to show the increase in this kind of asset held
by U.S. residents; second, a credit of $49 million to “Goods,” and third, a credit of $1
million to “Services.”

The credit entries, both in the export category, show the decreases in the assets
available to U.S. residents. These figures are entered on lines 19, 2, and 3 in the table
 36

on page 2 and are preceded by the number (1) in parentheses to identify them with the
first transaction discussed .

PAYMENT FOR COMMERCIAL EXPORTS:

TRANSACTION 2
To make payment in dollars for the merchandise received from the United States, the
foreign customer might purchase from his local bank a demand deposit held by his bank
in a U.S. bank, then transfer the deposit to the U.S. exporter.

As a result U.S. demand deposit liabilities to foreign residents (that is, foreign private
short-term claims) would be diminished (debited). The payment by the foreign buyer
would also cancel his obligation to the U.S. exporter, so that U.S. private short-term
claims on foreigners would be reduced (credited). The appropriate entries, preceded by
the number (2), are on lines 19 and 22 of the table.

RECEIPT OF INCOME FROM INVESTMENTS

ABROAD: TRANSACTION 3

Each year residents of the United States receive billions of dollars in interest and
dividends from capital investments in foreign stocks, bonds, and the like. U.S. residents
receive these payments in return for allowing foreign residents to use U.S. capital that
otherwise could be put to work in the United States. Foreign residents receive similar
returns from investments in the United States. Suppose that a U.S. firm has a long-
standing capital investment in a profitable subsidiary abroad, and that the subsidiary
transfers to the U.S. parent (as one of a series of such transfers) some $10 million in
dividends in the form of funds held in a foreign bank.

The U.S. firm then has a new (or enlarged) demand deposit in a foreign bank, as
compensation for allowing its capital (and associated managerial services) to be used by
its subsidiary. A debit entry on line 19 shows that U.S. private short-term claims on
foreigners have increased, and a credit entry on line 4 reflects the fact that U.S.
residents have given up an asset (the services of capital over the period covered) that is
valued at $10 million.

COMMERCIAL IMPORTS: TRANSACTION 4

In the balance-of-payments accounts U.S. commercial imports of goods and services

have opposite results from U.S. commercial exports. Residents of the United States are
acquiring goods and services rather than giving them up, and in return are transferring
 37

financial claims to foreigners rather than acquiring them. To take an illustration, assume
that U.S. residents import merchandise valued at $65 million, making payment by
transferring $10 million from balances that they hold in foreign banks and $55 million
from balances held in U.S. banks. A debit entry on line 6 records the increase in goods
available to U.S. residents, while credit entries on lines 19 and 22 record the decrease in
U.S. claims on foreigners and the increase in U.S. liabilities.

EXPENDITURES ON TRAVEL ABROAD:

TRANSACTION 5

Residents of the United States who tour abroad purchase foreign currency with which to
meet their expenses. If U.S. residents transfer balances of $5 million in U.S. banks to
foreigners in exchange for foreign currency that they spend traveling abroad, the end
result is that imports of services must be debited $5 million to reflect U.S. purchases of
the “asset,” “travel,” from foreigners, and “Foreign private short-term claims” must be
credited $5 million to show the increase in U.S. demand deposit liabilities.

GIFTS TO FOREIGN RESIDENTS: TRANSACTION

6

Many residents of this country, some of them recent immigrants, send gifts of money
to relatives abroad. If individuals in the United States acquire balances worth $1 million
that U.S. banks have held in foreign banks and then transfer these balances to relatives
overseas, there must be a credit entry of $1 million showing the decrease in U.S. private
short-term claims on foreigners.

This transaction differs from the other transactions analyzed in that U.S. residents obtain
nothing of material value in return for the asset given up. Yet if the books are to balance,
there must be a debit entry of $1 million. The bookkeeping convention followed in such
cases is to debit an account called “Unilateral transfers” (line 9). In the official U.S.
balance-of-payments presentation, this account is divided into several subsidiary
accounts, some of which are used to record grants by the federal government under
foreign aid programs.

LOANS TO BORROWERS ABROAD:

TRANSACTION 7

A financial loan by a resident of the United States to a borrower in another country

entails the transfer of money by the U.S. resident in exchange for a promise from the
borrower to repay at a future time. Suppose that U.S. residents purchase $40 million in
 38

longterm bonds issued by Canadian borrowers. Also assume that the bonds are
denominated in U.S. dollars, so that payment for them is made by transferring U.S. dollar
demand deposits.

A debit entry on line 18 records the increase in U.S. holdings of foreign bonds, and a
credit entry on line 22 records the increase in demand deposits held by foreigners in U.S.
banks. In principle, direct investment abroad by a U.S. firm could have required the same
accounting entries.

For the $40 million bond purchase to qualify as a direct investment (line 17), the bonds
would have to be the obligations of a Canadian firm in which a U.S. party (or affiliated
parties) owned at least 10 percent of the voting securities. Typically, however, direct
investment abroad by a U.S. firm takes some other form, such as a purchase of foreign
equity securities or a simple advance of funds to a foreign subsidiary.

PURCHASES AND SALES OF DOLLAR

BALANCES BY FOREIGN CENTRAL
BANKS: TRANSACTION 8

At this point it is appropriate to examine the net result of the foregoing seven
transactions on the short-term claims of U.S. residents and of foreign residents. As the
table shows, these transactions have involved almost the same volume of debits as
credits to U.S. private short-term claims on foreigners, with the net result that these
claims have been diminished (credited) by $1 million (the figure on line 19 in the last
column). By contrast, as shown on line 22, foreign private short-term claims on this
country have risen by $50 million (excluding the effects of transaction 8, which remains
to be discussed). It happens that all of this $50 million is in the form of demand deposits,
and private foreigners might not wish to retain all of these newly acquired dollar
balances.

Those who hold demand deposit dollar balances typically do so for purposes such as
financing purchases from the United States (or from non-U.S. residents desiring dollars),
and no guarantee exists that such motivations will be just strong enough to make the
dollar-balance holders exactly satisfied with the $50 million increase in their holdings.

For purposes of illustration, assume that foreign residents attempt to sell $40 million of
this increase in exchange for balances in their native currencies, but that U.S. residents
do not want to trade any of their foreign currency balances for the proffered dollar
balances at the going rates of exchange between the dollar and foreign currencies. In
circumstances such as these the foreign-exchange value of the dollar (the price of the
dollar in terms of foreign currencies) will decline.

However, some central banks might hold the view that the foreign exchange value of
their currencies was inappropriately high—that the foreign-exchange value of the dollar
 39

was inappropriately low—in which case they might sell foreign currencies in exchange
for dollar balances in order to moderate the decline in the exchange price of the dollar. In
the present case, suppose that foreign central banks purchased 25 million in dollar
balances from commercial banks within their territories. (Typically, of course, the
amounts involved would be much larger.) The U.S. balance-of payments accounts would
register an increase of $25 million in U.S. liabilities held by foreign monetary authorities
(line 21) and an equivalent decrease in short-term liabilities held by private foreigners
(line 22).

It should be noted that such purchases of dollar balances by foreign central banks supply
the commercial banks that sell the dollars with new reserves in their native currencies. In
general, these reserves can be used by the banks to expand loans and thus to inflate the
money supplies in the countries concerned, if nothing else is changed.

STATISTICAL DISCREPANCY

At the beginning of this monograph it was noted that a country’s balance of payments
is commonly defined as the record of transactions between its residents and foreign
residents over a specified period. Compiling this record presents difficult problems, and
errors and omissions sometimes occur in collecting the data.

Take first the matter of coverage. In spite of attempts to gather data on them, some
international transactions go unreported. One category of transactions that probably is
often substantially underreported is purchases and sales of short-term financial claims;
such unreported movements of short-term capital are widely believed to be a major
component of total errors and omissions. No attempt is made to collect complete data on
certain other transactions, which are estimated by balance-of-payments statisticians.

The sample observations on which these estimates are based are sometimes of doubtful
reliability, and even the best sampling and estimating techniques will not prevent errors
of estimation. Or take the matter of valuation. While import documentation, for example,
may state a precise value for the merchandise imported, a different amount may
eventually be paid the exporter. The discrepancy can arise for a number of reasons,
ranging from default by the importer to incorrect valuation of the merchandise on the
import documents. Because of such problems total recorded debits do not equal total
recorded credits in the actual balance-of-payments accounts in any given year.

To provide a specific illustration of how this discrepancy arises, suppose that U.S. export
documentation valued an item at $10,000, while in fact the terms of sale called for
payment of only $9,000 by the foreign importer, who drew down his bank balance in the
United States to make the payment. On the basis of the export documentation, balance-
of-payments accountants would credit merchandise exports by $10,000; but when they
turned their attention to U.S. short-term liabilities to private foreigners, they would find
that U.S. banks had reported a decrease of only $9,000 (assuming no other
transactions).
 40

Consequently, recorded credits would mistakenly exceed recorded debits by $1,000. In

fact, of course, the credit entry should have been in the amount of $9,000. It is to
accommodate such discrepancies that the residual account, “Statistical discrepancy,”
was created. An excess of credits in all other accounts is offset by an equivalent debit to
this account, or an excess of debits in other accounts is offset by an equivalent credit to
this account.

The account thus serves at least two purposes; it gives an indication of the net error in
the balance-of-payments statistics, so that users can have some idea of the reliability of
the balance-of-payments data, and it provides a means of satisfying the requirement of
double entry bookkeeping that total debits must equal total credits. Of course, no need
exists for the account in our hypothetical balance-of-payments table, which displays
equality between total debits and total credits.
 41

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.
 42

DESCRIPTIVE QUESTIONS

DISCUSS THE RELEVANCE / IMPORTANCE OF THE 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 wherethe information provided by BOP accounting is
very necessary:1. Judging the stability of a floating exchange rate system is easier with
BOP as therecord of exchanges that take place between nations help track
theaccumulation of currencies in the hands of those individuals more willing to holdon to
them.

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.
 43

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
attractshort term capital inflows to prevent depreciation of its currency. Countries
sufferingfrom chronic deficits may find their credit ratings being downgraded
because themarkets interpret the data as evidence that the country may have
difficulties itsdebt.s

BOP accounts are intimately with the overall saving investment balance in
acountry’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
financemanagers must monitor the BOP data being put out by government agencies
on aregular 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.

IN THE ACCOUNTING SENSE THE 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
bothtransactions and the money flows associated with those transactions. For
instance,exports (like sales of a business) are credits, and imports (like the
purchases of abusiness) 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
3
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
 44

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).

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.

DETAILED OUTLINE OF THE BOP STATEMENT

& SUB ACCOUNTS

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. A BOP
statement(revised) includes the following sub accounts, as shown in the table below.
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HOW WILL YOU IDENTIFY A DEFICIT

OR SURPLUS IN BALANCE OF
PAYMENTS? / MEANING OF “DEFICIT” AND
“SURPLUS” IN THE BALANCE OF PAYMENTS .

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 with in 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 BOP 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 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 he
deficit and surplus figures, will be economically meaningful. Suggestions 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 realise 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
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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.

ANALYSIS OF BALANCE OF PAYMENT OF INDIA

Balance of Payment Summary

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The Balance of Payment statistics during the 90s have changed under the entire major
head s that is, trade balance, current account balance, capital account balance
(net) and reserves. Between 1990-91 and 2003-04, the current account balance,
the most important among all the balances has shown an improvement, that is, it
recorded a surplus of US$10,561 million. The capital account (net) also has
remained steady. The position of foreign exchange reserve also accordingly changed
over this period
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Selected indicators of external factors

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The various aspects of a countrys balance of payments indicate the strength and
weakness of that economy. This table brings out the changes in indicators for
external sector between 1990 and 2003-04

Exports/Imports:

The growth of exports and imports as percentage of balance of payment is not very
favorable till 2003-04, where exports increased by 20. 4% as against 24.4 % of
imports. The major part of increase in imports through the 90s except in 97-98 and 98-
99 was due to the imports of petroleum, oil and lubricants (POL). The percentage of
exports/imports to BOP has been increasing from 66.2 in 1990-91 to 83.4 in 2002-
03 indicating an improvement in our export growth but declined to 80.7 percent in
2003-04.

Import cover of Foreign Exchange Reserve

which was too low in 1990-91, was just enough for 2.5 months. This was below
the norm which is a minimum of 3 months. In the subsequent years it has
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increased reaching to 16.9 months in 2003-04. India at present is in a very

comfortable position with regards to foreign exchange reserves which now has
crossed $130 billion.
External sector variables as a percentage of
GDP
decade. Exports have increased from
have also shown improvement in the last
5.8% in 1990-91 to 10.8% of GDP in 2003-04.
However the imports all the time outstripped the exports. It increased from 8.8% to 13.3%
of GDP during the above period.

Trade Balance was always negative, ranging from -3. 0 (90-91) to -4.0
(99-00) and again showed an improvement by reaching to -2.5 (2003-04).

Invisibles have played an important role in imp roving our BOP position.

From negative position (-0.1)in 1990-91 it reached 4.3% of GDP in 2003-04.

Current account balance was the one which was causing

concern since it crossed the safe limit of one percent of GDP in 1990-91(3.1) but
fortunately declined over the period reaching to - 1.1 in 99-2000 but increased again to
1.8 % in 2003-04.

External Debt which was 28.7 percent of GDP in 1990-91 has come down
to 17.2 percent in 2003-04.

Debt service has shown a positive change by declining from 2.8 percent in
1990-91 to 2. 4%of GDP in 2001-02 but again has shot up to 2.9%in 2002-03.
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CONCLUSION & PREDICTION

On the basis of the balance of payment account till date it ca n be concluded that
India is a Developing Country however not for long.

Future prediction for India on the basis

Balance of Payment:

The Balance of Payment of any country reflects the Developmental stage of the
country. According to The International Monetary Fund India will be counted as
the tenth country to join the list of developed countries on 9 December, 2009
When the current Account of the balance of payment account will have a surplus.
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BIBLIOGRAPHY

Balance of Payments - Paul Madson

International Financial Management - P G Apte

Sites visited
• WWW . SCRIBD. COM

• WWW WIKIPEDIA. COM

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