BALANCE OF PAYMENTS (BoP)

Presentation by YASHODA RANI CHAUHAN (11K41E0044) MBA 2nd Semester

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INDEX 1. 2. 3. 4. 5. 6. 7. 8. Introduction Concept of BoP IMF Definition Indian Definition Chart Structure BoP Crisis Balancing Methods

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Introduction
A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa.

Definition by IMF

Indian Definition
The Manual defines BoP as a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. Transactions between residents and non-residents consist of those involving goods, services, and income; involving financial claims on and liabilities to the rest of the world; and those classified as transfers, involving offsetting entries to balance one-sided transactions. The data are received from the banking system as part of the Foreign Exchange Management Act (FEMA), 1999.

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Chart

Structure
The basic structure of the Balance of Payments (BOP) of India consists of: (i) Current account: exports and imports of goods, services, income (both investment income and compensation of employees) and current transfers; (ii) Capital account: assets and liabilities covering direct investment, portfolio investment, loans, banking capital and other capital; (iii) Statistical discrepancy; (iv) International reserves and IMF transactions.

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5.1.1. Current Account 5.1.1.1. Merchandise Trade Merchandise credit relates to export of goods while merchandise debit represent import of goods. These are mainly based on reporting from the authorized dealers (ADs) supplemented by the information from other sources such as DGCI&S, USAID, Government of India. The item Non-monetary Gold Movement has been excluded from Invisibles in conformity with the IMF Manual on BOP (4th edition) from May 1993 onwards; these entries have been included under merchandise. Data on gold and silver brought in by the Indians returning from abroad have been included under imports payments with contra entry under Private Transfer Receipts since 1992-93. 5.1.1.2. Services Services receipts and payments are compiled based on the information received from ADs supplemented with other sources such as Air India, embassies, NASSCOM, Full-fledged money changers, Government of India. 5.1.1.2.1. Travel Travel represents all expenditure by foreign tourists in India on the receipts side and all expenditure by Indian tourists abroad on payments side. Travel receipts largely depend on the arrival of foreign tourists in India during a given time period. 5.1.1.2.2. Transportation Transportation records receipts and payments on account of the carriage of goods and natural persons as well as other distributive services (like port charges, bunker fuel, stevedoring, cabotage, warehousing, etc.) linked to merchandise trade. 5.1.1.2.3. Insurance Insurance receipts consist of insurance on exports, premium on life and non-life policies and reinsurance premium from foreign insurance companies. Insurance on exports is directly related to total exports from India. 5.1.1.2.4. Government not included elsewhere (GNIE) Government not included elsewhere (GNIE) receipts represent inward remittances towards maintenance of foreign embassies, diplomatic missions and offices of international/regional institutions in India, while GNIE payments record the remittances on account of maintenance of Indian embassies and diplomatic missions abroad and remittances by foreign embassies on their account. 5.1.1.2.5. Miscellaneous Miscellaneous services comprise of a host of business services, viz., communication, construction, financial, software and news agency services, royalties, copyright and license fees, management services and others. Of late, data on software services receipts and payments, are presented separately.

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5.1.1.3. Transfers (Official, Private) Transfers represent one-sided transactions, i.e., transactions that do not have any quid pro quo, such as grants, gifts, and migrants transfers by way of remittances for family maintenance, repatriation of savings and transfer of financial and real resources linked to change in resident status of migrants. Official transfer receipts include grants, donations and other assistance received by the Government from bilateral and multilateral institutions. Similar transfers by Indian Government to other countries are recorded under official transfer payments. 5.1.1.4. Income Transactions are in the form of interest, dividend, profit and others for servicing of capital transactions. Investment income receipts comprise interest received on loans to nonresidents, dividend/profit received by Indians on foreign investment, reinvested earnings of Indian FDI companies abroad, interest received on debentures, floating rate notes (FRNs), Commercial Papers (CPs), fixed deposits and funds held abroad by ADs out of foreign currency loans/export proceeds, payment of taxes by nonresidents/refunds of taxes by foreign governments, interest/discount earnings on RBI investment etc 5.1.2. Capital Account The data on capital account are compiled on the basis of various returns filed by the entities engaged in capital account transactions to the Reserve Bank of India or Government of India. These include reporting on foreign direct investment, foreign institutional investment/ ADR/GDR, external commercial borrowing (ECBs)/foreign currency convertible bonds (FCCBs), trade credit, NRI deposits and other banking liabilities/assets. The data on external assistance are obtained from the Government of India. 5.1.2.1. Foreign Investment Foreign investment has two components, namely, foreign direct investment and portfolio investment. Foreign direct investment (FDI) to and by India up to 1999-2000 comprise mainly equity capital. In line with international best practices, the coverage of FDI has been expanded since 2000-01 to include, besides equity capital. reinvested earnings (retained earnings of FDI companies) and other direct capital (inter-corporate debt transactions between related entities). 5.1.2.2. Portfolio Investment Portfolio investments mainly include FIIs investment, funds raised through GDRs/ADRs by Indian companies and through offshore funds. Data on investment abroad, hitherto reported, have been split into equity capital and portfolio investment since 2000-01. 5.1.2.3. External Assistance External assistance by India denotes aid extended by India to other foreign Governments under various agreements and repayment of such loans. External Assistance to India denotes multilateral and bilateral loans received under the agreements between Government of India and other Governments/International institutions and repayments of such loans by India, except loan repayment to erstwhile Rupee area countries that are covered under the Rupee Debt Service.

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5.1.2.4. Commercial Borrowings Commercial borrowings cover all medium/long term loans. Commercial Borrowings by Indiadenote loans extended by the Export Import Bank of India (EXIM bank) to various countries and repayment of such loans. Commercial Borrowings - to India denote drawls/ repayment of loans including buyers credit, suppliers credit, floating rate notes (FRNs), commercial paper (CP), bonds, foreign currency convertible bonds (FCCBs) issued abroad by the Indian corporate, etc. It also includes India Development Bonds (IDBs), Resurgent India Bonds (RIBs), India Millennium Deposits (IMDs). 5.1.2.5. Short-Term Loans to India It is defined as the drawls in respect of loans, utilized and repayments with a maturity of less than one year. 5.1.2.6. Banking Capital It comprises three components: a) foreign assets of commercial banks (ADs), b) foreign liabilities of commercial banks (ADs), and c) others. Foreign assets of commercial banks consist of (i) foreign currency holdings, and (ii) rupee overdrafts to non-resident banks. Foreign liabilities of commercial banks consists of (i) Non-resident deposits, which comprises receipt and redemption of various non-resident deposit schemes, and (ii) liabilities other than nonresident deposits which comprises rupee and foreign currency liabilities to non-resident banks and official and semi-official institutions. 5.2. EXTERNAL DEBT The definition of gross external debt adopted by India is based on the definition provided in 1988 by the International Working Group on External Debt Statistics (IWGEDS), which was set up jointly by the Bank for International Settlements (BIS), the International Monetary Fund (IMF), the Organization for Economic Cooperation and Development (OECD) and the World Bank. The core definition of external debt given by the IWGEDS is gross external debt is the amount, at any given time, of disbursed and outstanding contractual liabilities of residents of a country to non-residents to repay principal, with or without interest, or to pay interest, with or without principal. The coverage of data is broadly consistent with the recommendations made in IMFs External Debt Statistics Guide for Compilers and Users, 1993. The external debt classification distinguishes between type of debtor/creditor, by maturity, i.e., long term and short term, by type of transactions, i.e., deposit or trade related and by element of concessionality.

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Imbalances in BoP
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: 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.)

As discussed in the history section below, the Washington Consensus period saw a swing of opinion towards the view that there is no need to worry about imbalances. Opinion swung back in the opposite direction in the wake of financial crisis of 20072009. Mainstream opinion expressed by the leading financial press and economists, international bodies like the IMFas well as leaders of surplus and deficit [9] countrieshas returned to the view that large current account imbalances do matter. Some economists do, however, remain relatively unconcerned about imbalances and there have been assertions, such as by Michael P. Dooley, David Folkerts-Landau and Peter Garber, that nations need to avoid temptation to switch to protectionism as a means to correct imbalances.

BoP Crisis
A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at [25] first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their [26] funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy

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Balancing the Bop

An upwards shift in the value of a nation's currency relative to others will make a nation's exports less competitive and make imports cheaper and so will tend to correct a current account surplus. It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. Conversely a downward shift in the value of a nation's currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports, thus helping to correct a deficit (though the solution often doesn't have a positive impact immediately due to the MarshallLerner condition). Exchange rates can be adjusted by government in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance. When a country is selling more than it imports, the demand for its currency will tend to increase as other countries ultimately need the selling country's currency to make payments for the exports. The extra demand tends to cause a rise of the currency's price relative to others. When a country is importing more than it exports, the supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports, and this extra supply tends to cause the price to fall. BOP effects are not the only market influence on exchange rates however, they are also influenced by differences in national interest rates and by speculation.

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