Balance of Payments

Smita

What is Balance of Payments?

The Balance of Payments is an accounting record of all economic transactions between residents of a country and residents of rest of the world. All transfers whether requited or unrequited find place in the Balance of Payments.

Parts of Balance of Payments

Current Account Capital Account and Reserve Account

Current Account
Merchandise Visible item of BOP. Invisibles Services Travel, Transportation, Insurance, Government n.i.e., Miscellaneous. Investment Income. Compensation to Employees. Transfer Payments.

1.

2.

3.
4.

Capital Account
Foreign Investment Loans 1. External Assistance 2. Commercial Borrowings (MT & LT) 3. Short term borrowings Banking

Reserve Account
IMF Account Reserves and Gold Account

BOP Statement
BOP 2009 (1).pdf BOP 2010-11.pdf BOP Q4 2011.pdf

Accounting Rules for Balance of Payments

BOP is a double entry book keeping system and is subject to all rules of book keeping systems. The Accounting rule is
1.

All transactions which lead to immediate or prospective payments from rest of the world to the country should be recorded as credit entries. The payment themselves actual or prospective must appear as debit entries. A transaction which results in an increase in demand for foreign exchange in the country for payments to the rest of world should be recorded as debit entry and the actual or prospective payment should be given a credit entry.

2.

Importance of Balance of Payments statistics

Deficit in the Current account indicates deficit in the trade of goods of services which in other words means excessive imports in comparison to the exports. Such a scenario leads to increase in demand for the foreign currency resulting in its appreciation of foreign currency and depreciation of the domestic currency. On the other hand surplus results in vice versa.

A deficit in the Capital account means outflow of foreign financial assets from the country indicating less faith in the Capital / Debt / Goods markets of the country in terms of return on investment. Such a scenario results in appreciation of foreign currency and depreciation of the domestic currency. On the other hand a surplus in the Capital account results in vice versa.

BOP crisis of 1990-91 and its impact

For the first time in the economic history of India, India had negative balance both in the balance of trade account and in the invisible account. This resulted in outflow of investment income and huge current account deficit. On account of crisis of 1990-91 India borrowed from IMF and on its advise adopted economic reforms which included following Changes in the Industrial policy, Exchange Rate Policy, Investment Policy etc.

Current Account Balance Source RBI (In Crores)

Year First Plan 1979-80 1990-91 2004 - 05 2007-08 2010-11 (p) Trade Deficit -542 -3,374 -16,934 -1,64,542 -12, 66, 096 20, 420 billion Invisibles +500 +3140 -433 +1,39,756 13, 29, 575 22, 521 billion Total -42 -234 -17,367 -24,786 -63, 479 -2, 101 billion

BOP Trends
Reserve Bank of India BOP acc.htm

How to Correct imbalance in BOP?

Devaluation of domestic currency. Depreciation of Domestic currency. Export Promotion / Import Substitution. Import tariffs Exchange Control. Economic Growth.

Trends in Import of Goods

Petroleum, Oil and Lubricants (POL) are the main constituents of Indian imports. Their value is roughly 30 - 40% of the value of total Indian imports of goods. During the last decade the imports of POL products has grown by per annum average rate of 17.8% while non POL imports has grown by 14.2%. Other important import items are Edible oils, Capital goods, Pearls and Precious stones.

Average Annual Import of Goods (In Crores)

Item Food grains Capital Goods Mineral Oils Metals Chemicals Fertilizers Pearls and other Precious stones Source- RBI 1951-61 141 191 77 93 44 81-85 374 2,515 5,264 1,448 660 698 730 91-99 624 14,976 27,469 7,003 1,921 4,707 9,993 2001-05 2,170 21,430 88,650 9,825 4,977 3,707 26,690

Import Trends
Reserve Bank of India imports.htm

Pattern of export of goods (In Percentage)

Item Agriculture and Allied products 1970-71 31.7 1980-81 30.6 2004-05 10.1

Ores and Minerals

Manufactured Goods

10.7
50.3

6.2
55.8

5.3
73.4

Mineral Fuels including coal Others Source- RBI

0.8
6.5

0.4
6.9

8.6
2.6

Export Trends
Reserve Bank of India exports.htm

Foreign Exchange Reserves

Forex Reserves 2010.pdf Forex Reserves 2012 begining.pdf

Indian Growth Drivers

In India Information technology is becoming the key growth driver. Today India is Services economy and the chief contributors to the growth in services sector are IT companies /ITES /BPOs/ KPOs etc.
In addition to the above in the manufacturing sector there are some technology based industries which are today significantly contributing to Indian growth dream for example - Machine Tools Industry, Forging Industry, Pumps and Valves Industry, Pharmaceutical Industry etc.

Reforms In Foreign Exchange Market

July 1991 Rupee devalued. 1992 Introduction of LERMS. 1993 - Unified Forex market with market determined forex rates. 1997 Tarapore committee recommendations made public. 1999-2000 - FEMA enacted to replace FERA. 2005 - Lahiri committee submits report. 2006 Tarapore Committee II submits report.

FDI Norms
pn7_2008 FDI.pdf

Issues against and in favour of CAC

1. 2. 3.

Capital controls have helped India in Preserving independent Monetary policy. Containing pressure on Exchange rate. Protecting Monetary and Financial stability.

1. 2. 3. 4.

CAC will help in Availability of larger capital stock to supplement domestic capital stock. Reduction in cost of capital. Gains from international investments to the residents and companies. Alignment with global economy.

Pre conditions for CAC (As Stated by Tarapore com. I)

GFD to GDP ratio to be 3.5%. Inflation Rate around 3-5%. Gross NPA of banks to come down to 5%. CRR to be brought down from 9% to 3%. Sinking fund to meet government debt obligations. Exchange rate to be monitored around +/%5 of REER.

Tarapore Committee I
Road Map to Convertibility- Phase I (97-98), Phase II (98-99), Phase III (99-2000). Indian companies should be permitted to invest abroad up to $ 50 million per annum. Corporate should be allowed to freely open their branch offices abroad. No ceiling on ECB on loans having maturity more than 10 years. Restriction on end use of ECB should be scrapped. Exporters/ Exchange earners be allowed 100% retention of forex earning in EEFC account. Direct and portfolio investment should be open to all residents on par with NRIs and FIIs.

Tarapore I.
Banks should be allowed to borrow from abroad. Borrowings can be up to 50% of their Tier I capital in Phase I and limit can be increased up to 75% in Phase II and 100% in Phase III. SEBI registered MF should be allowed to invest abroad subject to overall limit of $ 500 million in Phase I, $1 billion in Phase II, $ 2 billion in Phase III. Individuals may be allowed to invest abroad in foreign financial markets up to $ 25,000 in Phase I, $ 50,000 in Phase II and up to $ I,00,000 in Phase III. Residents be allowed to borrow loans from non residents $2,50,000 with no restrictions on use of funds. Currency Futures should be introduced in India with screen based trading and efficient settlement system.

Tarapore Committee II
Road map for fuller capital account convertibility in three Phases (2006-07) Phase I, (2007-09) Phase II, (200911) Phase III. Lifting restrictions on the end use of ECBs. No ceilings on ECB for period more than 10 years in Phase I. No ceilings on ECB for period more than 7 years in the Phase II. Raising automatic approval limit for the external commercial borrowings up to $ 1 billion from current $ 500 million.. Corporate Investments abroad should be permitted up to 250% of their net worth in Phase I, Up to 300% in Phase II, up to 400% in Phase III.

Tarapore II.
Banks should be allowed to borrow up to 50% of their net worth in Phase I, Up to 75% in the Phase II, Up to 100% in the Phase III. Raising individual investment limits up to $50,000 in Phase I, Up to $ I,00,000 in Phase II, $ 2,00,000 in Phase III. Ban Investments through participatory notes and allowing residents to invest in Indian market directly through SEBI registered MF and portfolio management schemes Raising MF investment limits up to $ 3 billion in Phase I, $ 4 billion in Phase II, up to $ 5 billion in Phase III etc.

Forex Rates and impact of Macro economic variables on them

Inflation Rate Interest Rate

Terms used in Forex Market

Inter bank rates. TT Buying and Selling rates. Bill Buying and Selling rates. TC Buying and TC selling rates Currency Buying and Selling rates.