Balance of Payment

Balance of Payment
The Balance of Payment records the flow of Economic Transactions between the residents of a country and the rest of world carried out in a specific period of time.

Balance of Payment Accounting Principle

1.

It is a double-entry statistical statement, classified as:

Credit Transaction- It involves the receipt of payments from foreigners. These transactions are entered with (+) sign.

Debit Transaction It involves the making of payments to foreigners. It entered with (-) sign.

2.

Double-Entry Book-keeping
Accounting process of International transaction is known asDouble-entry bookkeepingIn this system every international transaction is recorded twice, once as a credit and once as a debit of an equal amount.

Use of BOP
It provides necessary information on the strength & weakness of the country in international economic status.
It provides warning signals for future policy formulation.

Example of Book Keeping

Receipts Credits
Exports goods Exports of services Amount (Rs.Crore) 600 100 Payments Debits Imports of goods Imports of services
Unilateral
Payments

Amount Rs.Crore 700 50

Unilateral receipts (gift)

Capital Receipts Sale of Gold Total Receipts

100

30

150 50

Capital Payments Purchase of Gold

Total Payments

200 20

1,000

1,000

The Fundamental Identity of Balance of Payments

International transaction in Balance of Payment can be grouped under three broad accounts:
The Current Account The Capital Account The official International Reserve Account

1. Current Account

It is divided into three categoryi) Merchandise Trade: (Trade Balance) It includes Export and import of goods. As per IMF manual, imports and exports of goods should be presented on free-on-board (f.o.b.) basis. (without freight and insurance cost).

Balance of Trade
difference between exports and imports of goods

If EX > IM BOT is favourable or in surplus. If EX<IM BOT is unfavourable or in deficit.

ii) Services/Invisibles Trade: (Balance on Services)

It includes items, such as Travel/tourists expenditure Shipping and freight services Insurance services Investment income/Income Payments (interest $ dividend on foreign investment and wages that workers earn) Miscellaneous (receipts/payments for patents and royalties)

iii) Unilateral Transfer

It is one way transaction, such as Gifts, personal remittances, Grants etc. Gifts and grants received by a country from foreign individuals, institution and govt. recorded under credit side. Gift and grants are provided by govt. individual and institution to other country is recorded under debit side.

A surplus on current account implies a net inflow of income into the country. A deficit on current account is considered a loss of income for the country.

2. Capital Account

There are three broad categories:

i)

Long Term Capital

It includes sale and purchase of long-term securities (maturity period is greater than one). It includes Portfolio investment. it implies acquisition of an asset that does not give the purchase control.

It includes Foreign direct investment in the country. This is the act of purchasing an asset and at the same time acquiring control of it.

For example establishment of a foreign branch in the country or acquiring a controlling equity interest by a foreign company in a domestic company. A major part of foreign investment comes in this way particularly through MNCs.

ii) Short-term Capital

It includes sale and purchase of shortterm govt. and corporate securities (maturity period is less than one year).
It includes foreigners balances in the banks of the country.

iii) Loans

Loans received by the government of one country from other is also form a part of capital account. It includes:

Loans provided by international financial institution to the govt. of country. A country may also receive funds in repayment of loans it had earlier extended to foreign government. In fact all capital inflows are credit items under capital account in BOP and all capital outflows are debit item.

3. Official Reserve Account

It includes the purchase or sale of official reserves asset by central bank. It held in three forms :
i) Foreign Currencies: The most important currency is dollar. In fact, most foreign govt. keep a portion of their foreign exchange reserve in the form of dollar.

ii) Monetary Gold

It is classified into two categories: i) Non-monetary Gold It refers as commodity. In this case it is recorded in current account in merchandise trade. ii) Monetary Gold is used as means of payment. Accordingly, it is considered under official reserves.

iii) SDRs

This also part of official reserves. When country joined the IMF, it is deposited with the IMF for its subscription, of which 25% was paid in gold and 75% in own currency. On the basis of its subscription, the country has drawing rights by which it draw other convertible currencies. A countrys drawing from IMF enters as a Credit item in BOP

Error and Omission

Generally, it is very difficult to record all entries in the BOP accurately .

For example-when goods are smuggled, the merchandise side of transaction goes unreported.

Parties engaged in importing and exporting of goods resort to underreporting in order to reduce their tax liabilities. There are some genuine difficulties in recording all items accurately. Such as

There are various agencies involved to record export and import and some mistake are bound to occur. In some cases sample is taken because of large number transaction .

Indias Balance of Payment 1998-99 to 2008-2009

Year
1998-99 1999-2000 2000-01 2001-02 2002-03

Trade Balance -13246 -17841 -12460 -11574 -10690

Invisible (Net) 9208 13143 9794 14974 17035

CA (Net) -4038 -4698 -2666 3400 6345

CPA (Net) 7867 10840 8535 8357 10640

Reserve (-increase) -3829 -6142 -5842 -11757 -16895

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

-13718 -33702 -51904 -61782 -91626 -119403

27801 31232 42002 52217 74592 89586

14083 -2470 -9902 -9565 -17034 -29817

17338 28629 24954 46171 109198 9737

-31421 -26159 -15052 -36606 -92164 +20080

Equilibrium in Balance of Payment

BOP is the net aggregate of :

Balance of Current Account (CA) Balance of Capital Account (CPA)

Basic Balance (BB) = CA+CAP-shortterm capital Overall Balance (OB) = CA+CAP

Disequilibrium in the BOP

Disequilibrium of BOP can be assessed on the basis of international transaction which can be groped under: i) Autonomous Transaction

It takes place regardless of the size of other items on the balance of payments. It includes all commercial transactions like exports and imports of goods and services and movements of capital to earn profit.

ii) Accommodating/Induced Transaction

These transactions are necessitated by the disequilibrium in the BOP as

Exports < Imports , it requires some balancing transaction such as borrowing for making payments for imports.

It includes short-term capital movements, monetary gold movements and changes in foreign exchange reserves to bring about a balance into the foreign account.

Types of Disequilibrium
1. Secular :

This is a long-term phenomenon in BOP caused by persistent and deep rooted dynamic changes which slowly takes place in the economy over a long period of time, such as :

Capital formation, population growth, and technological development.

2. Structural

This disequilibrium arises due to structural changes in few sectors of the economy at home or abroad which may alter the demand or supply conditions of exports or imports.

Change in demand for exports may arise because of : Change in fashion trend, in technology, invention of cheaper substitute.

Income declines in buyer nation because of weak economic condition as well as stringent policies.

Change in supply may arise because of :

Change

in volume of production because of political disturbance, strikes and natural calamities.

3. Short-Run Disequilibrium:

This type of disequilibrium lasting for a short period, which may occur once in a while because of :
One-sided

movement in the items of BOP

4. Fundamental or Long-Term Disequilibrium

This disequilibrium refers to deep rooted persistent deficit or surplus in the BOP of a country. It is caused by accumulated short-term disequilibrium-deficit or surplus. -- It endangers the exchange rate stability of the country because of long-tem BOP deficit.

It depletes foreign exchange reserves and country may also be unable to raise loans from foreigners on account of such persistent deficit.