BALANCE OF PAYMENTS

Refer
Dewett Page nos 444/449
Uni. Text 113/122
 Balance of Payments
• Balance of Trade
• A comparison of total imports and exports
of a country is its balance of trade.
• The balance of trade is regarded as
favorable or active or positive when the
value of exported goods exceeds that of
imported goods. It is unfavorable or
adverse or negative when imports exceed
the value of exports.
 Favorable/Unfavorable
• These terms are only technical and favorable
balance may not really the favorable and make
the country rich.
• For a long time, under British regime. India had
a favorable balance of trade, still India was poor.
Britain had an unfavorable balance, but she has
always been prosperous. So it is not the balance
of trade, but balance of payments which shows
light on the economic condition of the country.
 Balance of Payments.
• Balance of trade includes only the visible
items in foreign trade. They are material
goods exported and imported. Only these
are entered in the port registers
maintained by custom authorities.
• But there are a large number other items
which are called invisible. The balance of
payments includes all ‘visible’ and ‘non-
visible’ items.
 Invisible items
• The invisible items are
• Services
• Tourists expenses
• Interest on borrowed capital
• Gifts/donations/money remitted home by
foreign settlers etc
 Services
• India uses a good deal of foreign banking,
shipping and insurance services. She
does not have enough of her own ships,
insurance companies and exchange
banks. India has to pay for such services.
• India, is filling up the gaps nowadays
 Tourist’s expenses
• When Indian students and tourists
purchase goods and services in Europe, it
is like importing these goods and services.
 Interest on borrowed capital

• An investment made abroad is an export

item and remain so till withdrawn.
 Balance of payments
• The sum total of visible and invisible is
called the balance of payments
• Definition
• The balance of payments is a
comprehensive record of economic
transactions of the residents of a country
with the rest of the world during a given
period of time.
 Current and Capital account

• Balance of payments has two parts,

balance on current a/c and balance of
capital a/c
 Current and Capital account
Current a/c Capital a/c

Imports Borrowing and lending

Exports capital
Expenses on travel Repayment of capital
Transportation Sale/purchase of
securities
Insurance
investments
• The nation earns foreign currencies by
exporting goods and services and
receiving capital inflows ( ie investments
and loans). All of these are credits and are
entered with a plus sign.
• The nation spends these foreign
currencies to import goods and services
and to invest and lend abroad. These are
debits and shown as a minus.
US BALANCE OF PAYMENTS
1992
THE US BALANCE OF PAYMENTS (1992)
1 CURRENT ACCOUNT USD-
BILLIONS
EXPORTS OF GOODS & SERVICES +730

IMPORTS OF GOODS & SERVICES -764

US GOVT GRANTS -33 -67

2 CAPITAL ACCOUNT
CAPITAL INFLOW +89

CAPITAL OUTFLOW -53

DISCREPANCY -12

BALANCE ON CAPITAL ACOUNT +24

DEFICIT IN 1992 US BALANCE OF PAYMENTS -43

3. OFFICIAL RESERVE ACCOUNT +43

0
 How does balance of payments
balance?
• The balance of payments (on current a/c) is
said to balance when the total of credit items is
exactly equal to the total of debit items.
• Suppose there is a deficit in the current a/c of
balance of payments, it will be covered by
3. Drawing from country’s foreign exchange
reserve
4. By borrowing from outside
5. By exporting gold
Now the I.M.F grants temporary accommodation to
bridge the gap
 Equilibrium, Disequilibrium and adjustment
in the balance of payments
• Equilibrium is a state of Balance of payments over the
relevant time period. It is a sign of soundness .
• The period is generally one year. Thus, seasonal
inequality between exports and imports is not a sign of
disequilibrium.
• When the balance of payments of a country is in
equilibrium, the demand for domestic currency is equal
to its supply. The demand and supply situation is neither
favorable nor unfavorable.
• If balance of payments move against the country,
adjustments may be made by encouraging exports of
goods, services or by discouraging imports.
 Measures
• Export promotion
• Import restriction
• Deflation
• Exchange control
• devaluation
 Exports/Imports
• A country having an adverse balance of
payments must reduce imports or stimulate
exports or do both.
• Imports can be checked either by total
prohibition, levying import duties or by quota
system. Another method is import substitution –
ie produce in the country .
• Export can be stimulated by measures of export
promotion – giving concession to industrialists
and exporters.
 Deflation
• Under deflation, total money income in the
country is made to reduce, so that aggregate
demand in the country falls.
• As a result, the people tend to import less and
their demand for home made goods too become
less.
• Owing to fall in demand, prices also fall
• So country becomes good market to buy from an
a bad market to sell in.
• In this way, imports get discouraged and exports
are stimulated
 Exchange control
• Under exchange control, all exporters are asked
to surrender their claims on foreign currencies to
the central bank which pays in return the home
currency which the exporters really want. This
available foreign exchange is rationed out by
central bank among the licensed importers of
the essential commodities. Thus imports are
restricted to the foreign exchange available and
no danger of more goods being imported than
exported.
 Devaluation
• Common method of correcting an adverse
balance of payments.
• The home currency is devalued against
foreign currency so that foreigners have to
pay less in terms of their own currencies
for our goods.
• The importers have to pay more for
foreign goods.