WHAT IS BOP ?

The balance of payments accounts are those that record all

transactions between the residents of a country and residents of all

foreign nations.

The BOP is determined by the country's exports and imports of

goods, services, and financial capital, as well as financial transfers.

It reflects all payments and liabilities to foreigners (debits) and all

payments and obligations received from foreigners (credits).

Balance of payments is one of the major indicators of a country's

status in international trade

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CURRENT ACCOUNT

Includes all imports and exports of goods and

services.

Includes unilateral transfers of foreign aid.

If the debits exceed the credits, then a

country is running a trade deficit.

If the credits exceed the debits, then a

country is running a trade surplus.

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CAPITAL ACCOUNT

1. Foreign Investment(FDI, FII)2. Banking Capital (NRI Deposits)3. Short term credit 4. External Commercial Borrowings(ECB)

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OFFICIAL INTERNATIONAL RESERVES

The official international reserve account records the change in stock of official international reserve assets (also known as foreign exchange reserves) at the country's monetary authority .

Official reserves assets include gold reserves, foreign currencies, SDRs, reserve positions in the IMF.

{Special Drawing Rights (SDRs) are potential claims on the freely usable currencies of IMF members.}

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NET ERRORS AND OMISSIONS

This is the last component of the balance of payments and principally exists to correct any possible errors made in accounting for the three other accounts.

They are often referred to as "balancing items".

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BALANCE OF PAYMENTS

•It is s a macro level statement showing inflow and outflow of foreign exchange

•The system of recording is based on the concept of double entry book keeping- where the credit side shows the receipt of foreign exchange from abroad and debit side shows the payments in foreign exchange to foreign residents.

•Receipts and payments are compartmentalized into 2 heads•Current account •Capital account

•Basic distinction between the two is that former represents transfer of real income and latter accounts only for transfer of funds without effecting a shift in real income.

CURRENT ACCOUNT

•It is the part of BOP showing the flow of real income or foreign exchange transactions on account of trade of goods and invisibles.

•The current account records the receipts and payments of foreign exchange in the following ways.

Current account receipts1. Export of goods2. Invisibles

a) Servicesb) Unilateral transfersc) Investment income

3. Non-monetary movement of gold

Current account payments1. Import of goods2. Invisibles

a) Servicesb) Unilateral transfersc) Investment income

3. Non-monetary movement of gold

•Export of goods effects the Inflow of foreign exchange into the country, while import of goods causes outflow of foreign exchange from the country.

•The difference between the two is known as the Balance Of Trade.

If export exceeds import ,balance of trade is surplus.If import exceeds export ,balance of trade is deficit.

•Trade in services, the unilateral transfers and the investment income form the ‘invisibles’.

•Trade in services includes receipts and payments on account of travel and tourism, financial charges concerning banking, insurance, transportation and so on.

•Unilateral transfers include pension, remittances, gifts and other transfer for which no specific services are rendered. They are called unilateral transfers because they represent the flow of funds only in one direction. They are unlike export and import, where goods flow in one direction and the payment flows in the other.

•Investment income include interest, dividend and other such payments and receipts.

Non monetary movement of gold

There are 2 types of sale and purchase of gold.1.One is termed as monetary sale and purchase that influence the international monetary reserves.2.The other is non monetary sale and purchase of gold

this is for industrial purposes and is shown in the current account, either separately from or along with trade in merchandise.

The debit and credit sides of two accounts- trade in merchandise and invisibles – are balanced.

oIf credit side>debit side current account surplusoIf debit side> credit side current account deficit

CAPITAL ACCOUNT

•It is the part of bop statement showing flow of foreign loans/investments and banking funds

•Capital account transactions takes place in the following ways:

Capital account receipts1.Long term inflow of funds2.Short term inflow of funds

Capital account payments1.Long term outflow of funds2.Short term outflow of funds

•The flow of capital account is long term as well as short term.•Long term flows involves maturity over one year•Short term flows are effected for one year or less.

•The credit side records The official and private borrowing from abroad net of repaymentsDirect and portfolio investment Short term investments into the country The bank balances of non residents held in the country.

•The debit side includes disinvestment of capitalcountry’s investment abroadloans given to the foreign government or a foreign party the bank balances held abroad.

•The difference between credit side of the current account along with the credit side of long term capital account transactions is compared with the transactions on the debit side of current account and the long term account is known as the basic balance, which may be negative or positive.

•As per the practice adopted by the RBI, basic balance is not shown in the BOP statement.

•The capital account balancing is not complete with the basic balance

•The debit side and credit side of short term capital transactions are added to respective sides.

•Difference between these sides is known as Capital Account Balance

•Errors and omissions is an important item on the BOP statement and taken into account for arriving at the overall balance.

•Also known as statistical discrepancy

•Statistical Discrepancy refers to estimate of foreign exchange flow on account of either variations in the collection of related figures or unrecorded illegal transaction of foreign exchange.

•It arises on different accounts

It arises because of the difficulties involved in collecting BOP Data. There are different sources of data, which sometimes differ in their approach.

For example: In India, trade figures compiled by RBI and the DGCIS(Director general of commercial intelligence and statistics) differ.

The movement of funds may lead or lag the transactions that they are supposed to be finance.

For example: goods are shipped in March but payments are received in April.

Certain figures are derived on estimatesFor example: figures of earning on travel and tourism are estimated on basis of sample Cases. If sample is defective, errors are sure.

Unrecorded illegal transactions either on debit side or credit side or both

•After the statistical discrepancy is located,the overall balance is arrived at.

•Overall balance represents the balancing between the credit items and the debit items appearing on the current account, capital account, and the statistical discrepancy.

•If the overall balance of payments is in surplus, the surplus amount is used for repaying the borrowings from the IMF and then the rest is transferred to the official reserves account.

•On the contrary, when the overall balance is found deficit, the monetary authorities arrange for capital flows to cover up the deficit.

•Such inflows may take the form of drawing down of foreign exchange reserves or official borrowings or purchases from the IMF.

•From this point of view, capital flows are bifurcated into autonomous and accommodating ones.

•Accommodating or compensatory capital flow is the inflow of foreign exchange to meet the balance of payments deficit, normally from the IMF . On other words, it aim at putting the balance of payments in equilibrium.

•Autonomous capital flow refers to flow of loans/investment in normal course of a business.

OFFICIAL RESERVES ACCOUNT

•Official reserves are held by the monetary authorities of a country.

•They comprise monetary gold, SDR allocations by the IMF, and foreign currency assets.

•Foreign currency assets are normally held in form of balances with foreign central banks and investment in foreign government securities.

•If the overall BOP is in surplus, it adds to the official reserves account.

•If overall BOP is in deficit, and if accommodating capital is not available, the official reserves account is debited by the amount of deficit.

BALANCE OF PAYMENTS

•Balance of Trade= Export of Goods – Import of Goods

•Balance of Current Account= Balance Of Trade + Net Earnings on Invisibles

•Balance of Capital Account = Foreign Exchange Inflow – Foreign Exchange outflow, on account of foreign investment, foreign loans, banking transactions, and other capital flows

•Overall Balance of Payments = Balance of Current Account + Balance of Capital Account + Statistical Discrepancy

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CAUSES OF BOP DISEQUILIBRIUM

Disequilibrium = there is surplus or deficit in BOP

Deficit = demand for forex exceeds the supply Reasons:

Economic factors Political factors Sociological factors

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ECONOMIC FACTORS1. Development Disequilibrium:

Large scale development expenditure = increase in purchasing power + increase in demand & prices.--Leads to huge imports (also of Capital Goods)--Hence adverse BOT adverse BOP.

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2. CAPITAL DISEQUILIBRIUM Due to cyclical fluctuations in general

business activity. If domestic economy experiences a

boom, while the rest of the world not so--then more purchasing power & demand and higher prices--hence more imports

But exports difficult because of slackness in world economy.

Hence……

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3. SECULAR DISEQUILIBRIUM

If long term BOP problem, then it is due to some secular trends in the economy.

If domestically: persistent high demand and high domestic prices (eg.USA) then imports will always be more than exports.

( if high production costs locally: but high disposable incomes and hence very high aggregate demand and high prices….)

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4.STRUCTURAL DISEQUILIBRIUM

Affects exports & imports Because of development of alternative sources

of supply, discovery of better substitutes, exhaustion of productive resources, changes in transport routes and costs etc.

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II. POLITICAL FACTORS

Continuous political instability, wars, etc., will lead to capital outflows and inadequacy of domestic investment and production

Hence BOP problems.

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III. SOCIAL FACTORS

Changes in tastes, preferences, fashions etc., will affect the exports and imports.

Hence BOP…

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CORRECTION OF DISEQUILIBRIUM

Automatic Correction & Deliberate Measures Automatic: If adverse BOP fall in the external

value of the domestic currency--So, exports will become cheaper and imports will become costlier--this will restore …

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DELIBERATE MEASURES

1. Monetary Measures:a) Contraction in money supply —will reduce purchasing powerreduce demand-- so less imports

b) fall in prices cheaper—so more exports

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DEVALUATION

Exports cheaper and imports costlier

E.g.: 1966 June: 4.76 to 7.50

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EXCHANGE CONTROL

To conserve forexCentral Bank

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TRADE MEASURES

Export incentivesHigh import duties and restrictions

Canalisation

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OTHER MEASURES

Getting foreign loansForeign assistance, Aid…Development of tourismExport of services, BPOs, ITES, etc.

•India’s external sector witnessed further improvement with the recovery seen in the global economy as reflected in the turnaround in exports, buoyancy in capital inflows and further accretion to the country’s foreign exchange reserves.

• Exports recovered from 12 months of consecutive decline and posted an average growth of 20.5 per cent during November 2009-February 2010.

•Imports also turned around and exhibited an average growth of about 43.0 per cent during December 2009-February 2010, mirroring the impact of strong recovery in growth.

•India’s balance of payments position during April-December 2009 remained comfortable with a modest increase in current account deficit, despite a lowertrade deficit, on account of decline in invisibles surplus.

•There has been a turnaround in capital inflows, mainly led by portfolio inflows, reflecting the buoyant growth prospects of the Indian economy.

•India’s foreign exchange reserves during 2009-10 increased by US$ 27.1 billion to reach US$ 279.1 billion as at end-March 2010.

•As on April 9, 2010, foreign exchange reserves stood at US$ 280.0 billion.

The impact of global economic recovery was visible in different accounts of India’s balance of payments. The current account position during the third quarter of 2009-10 witnessed a turnaround in both exports and imports. India’s merchandiseexports (on BoP basis) registered a robustgrowth in the third quarter of 2009-10 ascompared with decline in the correspondingperiod of 2008-09. Imports (on BoP basis)increased moderately during the quarter ascompared with a higher growth in thecorresponding quarter of the previous year.Trade deficit was lower during the thirdquarter of 2009-10 as compared with thepreceding quarter and the correspondingquarter a year ago. During April-December2009 also, trade deficit remained lower (US$ 89.5 billion) as compared with thecorresponding period of the preceding year(US$ 98.4 billion) led by decline in bothoil and non-oil imports (Table III.5).

InvisiblesThe robust growth observed ininvisibles receipts and payments in the past few years was reversed during 2009-10, reflecting the lagged impact of the recession in advanced economies. The decline wasseen in both factor and non-factorcomponents. Although software exportswitnessed a turnaround, the decline in nonsoftwareExports Despite lower trade deficit, the fall ininvisibles surplus led to marginally highercurrent account deficit during the thirdquarter of 2009-10 The currentaccount deficit during April-December 2009stood at US$ 30.3 billion, higher than US$27.5 billion during April-December 2008.During 2008-09, current account deficit asa per cent of GDP stood higher at 2.4 percent as compared to 1.3 per cent a year ago.

Capital AccountCapital flows continued to remainbuoyant during the third quarter of 2009-10, mainly led by large inflows under foreign direct investments, portfolio investments and short-term trade credits

The latest available informationon certain indicators of the capital accountindicates that the revival in capital inflows,which started at the beginning of 2009-10and gathered momentum in the second andthird quarters, has remained buoyant evenin the last quarter Strongerrecovery in 2009-10 ahead of the global economy coupled with positive sentimentsof global investors about India’s growthprospects are the factors that underlie themomentum of sustained capital inflowsduring the year.

During 2009-10, India’s foreignexchange reserves increased by US$ 27.1billion to reach US$ 279.1 billion as at end-March 2010Foreign currency assets (FCAs) increasedby US$ 13.3 billion during the year.the Reserve Bank purchased200 metric tonnes of gold from the IMFon November 3, 2009 as part of the ReserveBank’s foreign exchange reservemanagement operations. The foreignexchange reserves, however, remainedunaffected by this transaction as it merelyreflected substitution of foreign currencyassets by gold. The IMF made additionalallocations of SDRs to India in twotranches, viz., general allocation of SDR3,082 million (equivalent to US$ 4.82

Both long-term and shorttermdebt increased at end-December2009 from their levels at end-March2009. Of the total increase in India’sexternal debt at end-December 2009, thevaluation effect on account ofdepreciation of US dollar against majorinternational currencies accounted for36.9 per cent.

India’s external sector, thus,improved alongside the recovery in globaleconomy and further stabilisation in global financial conditions. This wasreflected in the turnaround in exports andcontinued buoyancy in capital inflows.

Despite higher net capital inflows during2009-10, reflecting improved absorptivecapacity of the economy, capital inflowsmostly financed the higher current accountdeficit. Reflecting easy global liquidityconditions and both interest rate and growthdifferentials in favour of India, capital inflows are expected to be strong, which mayput pressure on asset prices and exchangerate. Global commodity price trends,particularly possible firming up of oil pricescould exert pressures on the balance ofpayments through higher imports. Fordealing with the external shockstransmitting through various accounts of thebalance of payments, it is important to haveadequate foreign exchange reserves

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