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International Financial Management

P G Apte

What is the Balance of Payments?


The Balance of Payments of a country is a systematic, double-entry
accounting record of all economic transactions during a given
period of time between the residents of the country and foreign
residents

Some Simple Rules of Thumb


All transactions which lead to an immediate or prospective
payment from the Rest of the World (ROW) to the country should
be recorded as credit entries. The payments themselves, actual or
prospective, should be recorded as the offsetting debit entries.
All transactions which lead to an immediate or prospective
payment to the ROW from the country should be recorded as
debit entries. The payments themselves, actual or prospective,
should be recorded as the offsetting credit entries.

A transaction which results in an increase in demand


for or reduction in supply of foreign exchange is a debit
entry while a transaction which results in an increase in
the supply of or reduction in demand for foreign
exchange is a credit entry.
Thus : Exports are credit entries; payments for exports
increase our forex balance a use of forex balancing
debit entries. Conversely, an import transaction is a
debit entry while payment for imports is a credit entry.

Components of the BOP


Three Main Categories
The Current Account: Includes imports and
exports of goods and services and unilateral
transfers.
The Capital Account: All transactions leading to
changes in foreign assets and liabilities of the
country.
The Reserve Account: In this category only
"reserve assets" are included.
Further sub-categories within each main category.

The Current Account


Merchandise Trade
Merchandise trade should cover all
transactions relating to tangible goods.
Exports (+), Imports(-), Net Balance:
Merchandise Trade Balance.
The valuation should be on f.o.b. basis so that
international freight and insurance are treated
as distinct services and not merged with the
value of the goods themselves.
Contra-entries in capital account unless barter
trade.

The Current Account


Invisibles
The invisibles account includes services such as
transportation and insurance, bpo services, consultancy
services, income payments and receipts for factor
services - labour and capital - and unilateral transfers.
Services rendered to ROW (+); Services bought from
ROW (-); Transfers received (+), transfers given (-).
Net Balance: Balance on Invisibles Account
Contra-entries in Capital Account

Merchandise Trade Balance + Invisibles Balance


= Current

Account Balance

The Capital Account


Banking, Government, Other
Records changes in foreign assets and liabilities.
Capital inflows are credits, outflows are debits.
Hence increase in foreign assets or reduction in liabilities are
debits; reduction in foreign assets or increase in liabilities are
credits.
Loans raised, portfolio investments by foreigners, direct inward
investment credits
Loans repaid, investments by residents abroad, disinvestment by
foreigners debits.
Net Balance : Capital Account Balance

The Reserve Account


Other Accounts and Forex Reserves
The IMF account contains purchases (borrowings) and repurchases
(repayments) from the IMF. Former are credits, latter debits.
The Foreign Exchange Reserves account records increases (debits)
and decreases (credits) in reserve assets (RBI's holdings of gold and
foreign exchange, SDRs)
* (Current+Capital) Account Balance (+) implies reserves increase,
reserve account (-)
* (Current+Capital) Account Balance (-) implies reserves decrease,
reserve account (+)

Meaning of Deficit and Surplusin the


Balance of Payments
In a double-entry accounting statement total credit
entries must equal total debit entries.
The terms Deficit" or Surplus" cannot then refer to
the entire BOP but must indicate imbalance on a
subset of accounts included in the BOP
In popular parlance, BOP deficit or surplus refers to
deficit or surplus on current account.
An economically meaningful distinction is between
autonomous and compensating transactions.
Balance on autonomous transactions- above the
line; on compensating transactions- below the line

Meaning of Deficit and


Surplusin the BOP
Several concepts of "balance" have
evolved
Trade Balance: This is the balance on
the merchandise trade account.
Balance on Goods and Services: This is
the balance between exports and
imports of goods and services.
Current Account Balance: This is the net
balance on the entire current account.

Meaning of Deficit and


Surplusin the BOP
Balance on Current Account and Long
Term Capital: This is sometimes called
Basic Balance. This is supposed to
indicate long term trends in the BOP, the
idea being that while short term capital
flows are highly volatile, long term capital
flows are of a more permanent nature and
indicative of the underlying strengths or
weaknesses of the economy.

No. 41: Foreign


Year / Month
Rupees Crore
Export
Import Balance
1
2
3
4
2002-03
2,55,137 2,97,206
-42,069
2003-04
2,93,367 3,59,108
-65,741
2004-05
3,75,340 5,01,065 -1,25,725
2005-06
4,56,418 6,60,409 -2,03,991
2006-07
5,71,779 8,40,506 -2,68,727
2007-08
6,40,172 9,64,850 -3,24,678
2006-07
April
38,612
56,342
-17,729
May
45,588
64,963
-19,375
June
47,920
64,683
-16,764
July
48,934
67,558
-18,624
August
49,649
68,658
-19,009
September
49,486
77,611
-28,125
October
44,589
76,047
-31,458
November
43,943
68,812
-24,868
December
47,368
66,848
-19,479
January
48,357
60,992
-12,636
February
46,484
62,470
-15,986
March
56,628
75,445
-18,817
2007-08 R
April
46,164
74,895
-28,731
May
49,794
78,760
-28,966
June
48,400
79,200
-30,800
July
50,331
74,091
-23,759
August
51,491
80,460
-28,969
September
50,243
68,616
-18,373
October
57,641
83,472
-25,832
November
50,353
80,171
-29,819
December
50,580
73,395
-22,815
January
58,267
88,786
-30,519
February
58,861
82,477
-23,616
March
61,542
94,016
-32,474
2008-09 P
April
57,633
97,151
-39,518
May
58,057 1,03,409
-45,352

Trade (Annual and Monthly)


US Dollar Million
SDR Million
Export
Import Balance Export
Import Balance
5
6
7
8
9
10
52,719
61,412
-8,693
39,785
46,345
-6,560
63,843
78,149
-14,307
44,663
54,672
-10,009
83,536 1,11,517
-27,981
56,081
74,866
-18,785
1,03,091 1,49,166
-46,075
70,774 1,02,405
-31,632
1,26,361 1,85,749
-59,388
85,018 1,24,975
39,957
1,59,007 2,39,651
-80,644 1,02,181 1,54,005
-51,824
8,590
10,040
10,405
10,533
10,669
10,730
9,807
9,798
10,612
10,908
10,527
12,862

12,535
14,307
14,044
14,542
14,753
16,829
16,725
15,342
14,977
13,758
14,147
17,137

-3,944
-4,267
-3,640
-4,009
-4,085
-6,098
-6,919
-5,545
-4,364
-2,850
-3,620
-4,274

5,915
6,741
7,040
7,128
7,173
7,242
6,655
6,580
7,038
7,294
7,030
8,534

8,630
9,606
9,502
9,841
9,920
11,358
11,350
10,304
9,932
9,200
9,448
11,370

-2,716
-2,865
-2,463
-2,713
-2,746
-4,116
-4,695
-3,724
-2,894
-1,906
-2,418
-2,836

10,953
12,210
11,870
12,454
12,614
12,455
14,588
12,768
12,825
14,798
14,814
15,250

17,769
19,313
19,424
18,333
19,710
17,010
21,126
20,329
18,609
22,550
20,758
23,297

-6,817
-7,103
-7,554
-5,879
-7,096
-4,555
-6,538
-7,561
-5,785
-7,751
-5,944
-8,047

7,196
8,046
7,855
8,144
8,245
8,069
9,360
8,048
8,131
9,343
9,344
9,336

11,675
12,726
12,853
11,989
12,884
11,019
13,554
12,814
11,799
14,237
13,093
14,263

-4,479
-4,680
-4,999
-3,844
-4,639
-2,951
-4,195
-4,766
-3,668
-4,894
-3,749
-4,927

14,400
13,782

24,274
24,548

-9,874
-10,766

8,801
8,487

14,836
15,117

-6,035
-6,630

Capital Flows
Capital flows during 2006-07 were substantially higher than a
year ago, led by foreign direct investment (FDI) flows, on the
back of strong growth prospects and buoyant investment demand.
FDI inflows at US $ 16.4 billion during April-January 2006-07
were substantially higher than the inflows in the corresponding
period of the previous year. FDI was channeled mainly into
financial services, manufacturing, banking services, information
technology services and construction. Mauritius, the US and
United Kingdom remain the dominant sources of FDI to India.
Outward direct investment from India also exhibited a significant
rise to US $ 8.7 billion during April-December 2006 from US $ 1.9
billion a year ago due to some large overseas acquisitions by
Indian corporates.

Capital Flows 2008-09

During 2008-09 so far capital flows have remained volatile. Net capital
flows during 2008-09 so far were lower than those in the corresponding
period of 2007-08, mainly on account of outflows by foreign
institutional investors (US $ 7.3 billion) during 2008-09 (up to October
10, 2008) in contrast to net FII inflows (US $ 18.9 billion) during the
corresponding period of 2007-08.

On the other hand, net FDI flows into India were placed higher at US $

The funds raised through issuances of ADRs/GDRs abroad were at US


$ 1.1 billion during April-August 2008 (US $ 2.8 billion in AprilAugust 2007).

NRI deposits recorded a net inflow of US $ 273 million during AprilAugust 2008 mainly due to inflows under the rupee deposit accounts
as against a net outflow (US $ 168 million) during April-August 2007.

With net capital flows being higher than the current account deficit,

Capital Flows (US $ billion)


Components

2008-09
(April-March)

2009-10
(January-June)

Foreign Direct Investment


FDI into India

35.0

10.0

FDI Abroad

17.5

7.4

FIIs (net)

-15.0

5.6

ADRs/GDRs

1.2

0.06

External Aid (Net)

2.6

0.88

ECB (Net)

8.2

1.50

Short-term
Trade Credits (Net)

-5.8

-8.6

NRI Deposits (Net)

-7.7

-10.6

Source: RBI

INDIAS FOREIGN EXCHANGE RESERVES

Why BOP Statistics Are Important


BOP statement contains useful information for
financial decision makers.
In the short run, BOP deficits or surpluses may
have an immediate impact on the exchange rate
When exchange rates are market determined,
BOP figures indicate excess demand or supply
for the currency and the possible impact on the
exchange rate
May signal a policy shift on the part of the
monetary authorities of the country, unilaterally
or in concert with its trading partners

BOP and the Macroeconomy


Persistent imbalance- exchange rate changes and/or
policy responses.
Reserve loss, not sterilized, leads to monetary
contraction, higher interest rates, economic slowdown
Reserve gain leads to monetary expansion, lower
interest rates, economic upturn
No intervention leads to exchange rate depreciation or
appreciation quantity impacts on exports, imports
thereby other sectors
Excessive imbalance (-), may lead to crises/panics.

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