Balance of Payments Analysis

Balance of Payments

It is a systematic record of all economic transactions that take place between the residents of the reporting country and the rest of the world (ROW) during a specific period of time.

Balance of Payments

Double entry book keeping system All transactions that involve a transfer of title or ownership

Nationals of the reporting country : individuals,

business organisations, government departments etc

Generally one year

The structure of BOP Accounts

Current Account : current transactions involving import and export of goods and services Capital Account : Capital transactions resulting in increase or decrease in countys total stock of capital Official Settlement Account :Changes in Foreign Exchange reserves and reserves of monetary gold held by monetary authorities

Current Account

Export and Import of merchandise / visibles / goods

Export and Import of invisibles / services Incomes on investments interest and dividends paid and received

Unilateral transfers gifts and charities

Current Account
Invisible transactions

Travel on account of business, education , health Insurance premium and payments of claims

Incomes from services like advertising, commissions, pensions, patent fees, royalties, membership fees, subscription to periodicals etc

Capital Account

Long term capital movements :

direct investment in shares or bonds, real estate, physical assets like plant, building, equipment etc Portfolio investments in government securities or securities of firms

Amortisation of capital

Capital Account

Short term capital movements:

Purchase of short term securities such as treasury bills, commercial bills etc Speculative purchases of foreign currencies Cash balances held by foreigners

Official Settlement Account

Gold and Foreign Exchange Reserves

To impart stability to the exchange rate

To enable payments of dues

Assistance provided by international financial institutions like the IMF, World Bank etc

Indias Balance of Payments

Items
1 1.1 1.2 Current Account Merchandise Invisibles

Credit Debit

Net

a. Services b. Transfer Payments c. Investment Income

2. 2.1

Capital Account Foreign Investment a. Direct b. Portfolio

2.2

Loans

a. External Assistance b. Commercial borrowings c. Short Term Borrowings 2.3 2.4 2.5 Banking Capital Rupee Debt Service Other capital

3. 4.

Errors and Omissions Balance of payments

5.
5.1 5.2

Official reserve Account* IMF Position

Foreign Exchange Reserve

*decrease +; increase -

Balance of Trade

Difference between the value of import and export of merchandise or visible items
Exports > imports : Favourable Balance of Trade Exports < Imports : Adverse Balance of Trade

Balance on Current Account

Balance of Trade

+ Balance on Services
+ Net income on Investment

+ Net Unilateral Transactions

A deficit on Current Account implies that the reporting country is a net debtor i.e. it owes money to the rest of the world.

Balance on Capital Account

Net long term borrowings + Net short term borrowings + Net change in the Foreign Exchange Reserves + Net change in the stock of monetary gold

+ Errors and omissions

Overall Balance
Balance on Current Account + Balance on Capital Account

Balance of Payments always balances

Double entry accounting system Any adverse balance on current account is made good by a surplus on current account and viceversa This is the accounting point of view

The Economic Point of View

There are two types of transactions

Autonomous Transactions : these are genuine transactions of current or capital nature. They are guided by long term considerations and are intended at optimisation of returns
Accommodating Transactions : these are short term adjustments, induced transactions

Basic Balance
Basic Balance = Balance on Autonomous Transactions = Balance on Current Account + Net long term capital movements

BOP Equilibrium
Balance of payments is said to be in Equilibrium when the Basic Balance is zero. i.e. Balance on Current Account + Net long term capital movements = 0

Disequilibrium in BOP

The BOP is said to be in disequilibrium when a countrys autonomous payments are not equal to the autonomous receipts

Disequilibrium in BOP implies a non-zero basic Balance

Causes of Disequilibrium in BOP

Huge Amounts of Developmental Expenditure

Population growth
Import of technology Imports for price stabilisation

Business cycles
Changes in demand for exports

Primary goods market is not very attractive

Heavy External Borrowings leading to increasing debt servicing

Causes of Disequilibrium in BOP

Inflation

More imports and less exports

Flight of capital

Capital account convertibility

Speculative movement of capital

International demonstration effect Non-tariff barriers

Countervailing duties in the name of Social clause Child labour content

Measures to correct Disequilibrium

1.
1. 2. 3. 4.

Monetary measures
Deflation Depreciation Devaluation Exchange control

Non-monetary measures
Export promotion measures Import control measures

Trade Policy

Export and Import Policy

It influences: Volume Direction, & Composition of Trade

Objectives

Balanced Growth Price Stability Exchange Rate Stability BOP Equilibrium

Two Theoretical Policy options

Free Trade: No Artificial Restrictions on Import and Export Protection/ Protective Trade Policy: Barriers to Free Trade

Tools/Instruments of Trade Policy

Quantitative Tools

Qualitative Tools
Export Promotion Policies Child Labour content Environmental considerations Preferential Buying by the Government

Tariffs: Import Duties/ Custom Duties Quotas Subsidies: Land, electricity, lower interest rates, Tax concessions, other facilities at lower than market rates

Advantages of Free Trade

Optimum Allocation of Global Resources Greater Employment, income, consumption leading to Greater Welfare Availability of wider variety of goods and services at cheaper rates Greater Competition and no monopoly Greater Equality of Incomes and wealth

Greater Interdependence leading to Stability and World Peace

Arguments in Favour of Protection

Diversification of Industry Argument

Employment Promotion Argument

BOP Argument Balanced Growth Argument Cheap Labour Argument Anti- Dumping Argument

Self Sufficiency Argument

Defence Argument