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. They are Current account receipts 1. Export of goods 2. Invisibles a) Services b) Unilateral transfers c) Investment income 3. Non-monetary movement of gold Current account payments 1. Import of goods 2. Invisibles a) Services b) Unilateral transfers c) 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. o If credit side>debit side o If debit side> credit side current account surplus 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 receipts 1. Long term inflow of funds 2. Short term inflow of funds Capital account payments 1. Long term outflow of funds 2. 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 repayments, direct and portfolio investment and short term investments into the country and also the bank balances of non residents held in the country. The debit side includes disinvestment of capital, countrys investment abroad, loans given to the foreign government or a foreign party and 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.

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

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 estimates For 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.