1.balance of payments

7/29/2019 1.Balance of Payments

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BALANCE OF PAYMENTS (BOP)


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BOP topics to be covered

BOP definitions and meaning

Format of BOP as per IMF

Components of BOP

BOP Accounting Examples & problems

Measures to correct disequilibrium in BOP


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Balance of Payments -Definition

As per the BOP Manual of IMF :

the balance of payments (BOP) is a statistical statementthat systematically summarizes, for a specific time period,

the economic transactions of an economy with the rest ofthe world. Transactions, for the most part betweenresidents and non-residents, consist of those involvinggoods, services, and income; those involving financial

claims on, and liabilities to, the rest of the world; and those(such as gifts) classified as transfers, which involveoffsetting entries to balancein an accounting senseone-sided transactions


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Balance of Payments - DefinitionBalance of payments is the systematic recording of

summary of the economic transactions of the residentsof a country with the rest of the world during a specifiedtime period, normally a year.

Economic Transactions- arises when values areexchanged or moved between nations which may arise

from:Export and Import of goods.Rendering of services abroad and using foreign

exchange.Gifts/grants from one country to another.

Investment made abroad or received from abroad.Income on investments received from abroad orremitted abroad.

Increase or decrease in the international reserves ofthe country.


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Balance of Payments

Residents with non-residents

Residents mean the individuals, institutions,

corporate bodies, government department etc,domiciled in the country.

Units/ branches of MNCs domiciled in the countryare residents and their transactions with theirparents are reflected in the BOP.

Certain exceptions if gold is sold to the central

bank of the country which increases the monetarygold of the country, it will appear in BOP. Alsoforeign assets exchanged between residents will beincluded in the BOP


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Balance of payment

A Flow Statement BOP is compilation of the flow of economic

transactions of the country during the period andnot a statement of the position as on a date.

It is more like a funds flow statement rather thana balance sheet.

Periodicity-

Normally BOP statement is prepared covering a

period of one year.However, it can be prepared for shorter periods

also such as a month, quarter or half year.


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1. Current Account

1 Current Account (1.A+1.B+1.C)

1.A Goods & Services (1.A.a+ 1.A.b)

1.A.a Goods (1.A.a.1 to 1.A.a.3)

1.A.b Services (1.A.b.1 to 1.A.b.13)

1.A.b.1 Manufacturing services on physical inputs owned by others

1.A.b.2 Maintenance and repair services n.i.e.1.A.b.3 Transport

1.A.b.4 Travel

1.A.b.5 Construction

1.A.b.6 Insurance and pension services

1.A.b.7 Financial services

1.A.b.8 Charges for the use of intellectual property n.i.e.1.A.b.9 Telecommunications, computer, and information services

1.A.b.10 Other business services

1.A.b.11 Personal, cultural, and recreational services

1.A.b.12 Government goods and services n.i.e.

1.B Primary Income (1.B.1to1.B.3)

1.C Secondary Income (1.C.1+1.C.2)


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2. Capital Account

2 Capital Account (2.1+2.2)

2.1

Gross acquisitions (DR.)/disposals (CR.) of non-produced

nonfinancial assets

2.2 Capital transfers2.2.1 General government

2.2.1.1 Debt forgiveness

2.2.1.2 Other capital transfers

2.2.2

Financial corporations, nonfinancial corporations, households, and

NPISHs

2.2.2.1 Debt forgiveness

2.2.2.2 Other capital transfers including migrants transfers


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3.Financial Account

3 Financial Account (3.1 to 3.5)3.1 Direct Investment (3.1A+3.1B)

3.1.A Direct Investment in India

3.1.B Direct Investment by India

3.2 Portfolio Investment

3.3Financial derivatives (other than reserves) and employeestock options

3.4 Other investment

3.5 Reserve assets

3 Total assets/liabilities

3.0.1 Equity and investment fund shares

3.0.2 Debt instruments

3.0.3 Other financial assets and liabilities

4 Net errors and omissions

Of which: (by instrument):


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Credit(+) Debit (-) Net

A CURRENT ACCOUNT

I MERCHANDISE

II INVISIBLES (a+b+c)

(a) Services

(I) Travel

(ii) Transportation

(iii)Insurance

(iv)Government not indicated elsewhere

(v)Miscellaneous

of which Software Services

(b) Transfers

(i) Official

(ii)Private

(c) Income

(i)Investment Income

(ii)Compensation to Employees

Total Current Account (I+II)

Balance of Payments (OLD FORMAT)


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B CAPITAL ACCOUNT Credit (+) Debit (-) Net

1 Foreign Investment (a+b)

(a) Foreign Direct Invesment

(i) In India

EquityReinvested Earnings

Other Capital

(ii) Abroad

Equity

Reinvested Earnings

Other Capital

(b) Portfolio Investment

In India

Abroad

2 Loans (a+b+c)

(a) External Assistance

(i) By India

(ii) To India

(b) Commercial Borrowings (MT & LT)

(i) By India

(ii) To India

( c) Short-term to India3 Banking Capital (a+b)

(a) Commercial Banks

(i) Assets

(ii) Liabilities

Of which : Non-resident deposits

(b) Others

4 Rupee Debt Service

5 Other Capital

Total Capital Account (1 to 5)


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Credit (+) Debit(-) Net

C Errors & Omissions

D Overall Balance (A+B+C)

E Monetary Movements

(i) IMF

(ii) Foreign Exchange Reserves


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Indias BOP

BOP September 2012.xls

Indi's trade performance.pdf
http://localhost/var/www/apps/conversion/tmp/scratch_1/BOP%20September%202012.xlshttp://localhost/var/www/apps/conversion/tmp/scratch_1/Indi's%20trade%20performance.pdfhttp://localhost/var/www/apps/conversion/tmp/scratch_1/Indi's%20trade%20performance.pdfhttp://localhost/var/www/apps/conversion/tmp/scratch_1/BOP%20September%202012.xls


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Components of Balance of Payments

BOP statement is presented with 3 major components:Current AccountCapital Account and

Official reserves Account

Current Account refers to transactions in goods and

services, income and current transfers. It covers alltransactions between residents and non-residents.Merchandise (Goods) represents export and import of

commodities from/into India. Credit (+) refers to Exports and Debit(-) refers to Imports. The net balance being the difference betweenthese two refers to Balance of Trade. Exports are at FOB andImports are at CIF. If freight and insurance are paid separately,these are shown under transportation and insurance.

Services (Invisibles) include services, transfers and investmentincome also known as intangibles to distinguish from merchandise

trade.


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Components of Balance of Payments ..

Travel - covers expenditure incurred by non-residenttravellers during their stay in India

Transportation all receipts and payments on accountof international transportation services. Debits areexpenses of Indian companies abroad, payments to foreigntransport companies and credits include receipt of foreignearnings of Indian transport companies and other receipts.

Insurance all receipts and payments relating to alltypes of insurance and reinsurance.

Govt. not included elsewhere

receipts and paymentson government account account not included elsewhere.Includes receipts and payments on account of maintenanceembassies and diplomatic missions & offices of UNO,

WHO etc.


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Components of Balance of Payments .

Miscellaneous items receipts and payments in respectof all other services such as agency services, technicians andprofessional services, technical knowhow, royalties,subscription for periodicals etc.,

Transfer payments/unilateral transfers receipts and

payments without quid-pro-quo (grants received or extendedto foreign governments, repatriation of savings, remittancesfor family maintenance, contributions and donations toreligious organisations, charitable institutions etc.

Investment income remittances, receipts and paymentson account of profits, dividends, interest, commitmentcharges on foreign loans including IMF.

Compensation to employees wages, salaries andbenefits in cash or kind to non-resident workers (local staff of

embassies)


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Balance on Current Account two importantmeasures are Balance of Trade and Balance of Payments.

Balance of Trade - is the net difference between the valueof export and import of goods. When aggregate export ofgoods during a period exceed its aggregate imports, it is a

favourable or surplus or positive and vice versa(unfavourable or deficit or negative). During any periodbalance of trade will be either a favourable or unfavourable.

Balance of Payment includes visible trade and invisibleitems also. It represents balance of trade plus balance on

invisibles. It is a more representative as it includes netbalance of all items of current account. Similar to balance oftrade, the amounts receivable and payable do not balance &for any given period ends up with favourable orunfavourable


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Financial AccountForeign investment in India investment by non-

residents in the equity of entities in India. FDI is one ofintention of investor. FII refers to the portfolio investment,other than FDI.

Loans external assistance, commercial borrowings andshort term loans from multilateral organisation like WorldBank and bilateral sources on concessional terms.

Commercial borrowings debts owed to international

banks, borrowings in bond markets, credits from exportcredit agencies and loans provided by multilateral or bilateralinstitutions like IFC on commercial terms.

Short terms credits payable within one year

Rupee debt service payments under rupee/rouble

agreement with Russia


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Balance on Capital Account is the net inflows andoutflows on capital transactions.

Overall Balance is the total of balance on currentaccount and balance on capital account. It is also calledofficial settlements balance as it must be financed byofficial reserves or by other non-reserve transactions.

It reflects countrys overall competitive position in termsof all private transactions and has influence on theexchange rate of the countrys currency.


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BOP Accounting In conformity with business and national accounting, in the balance of

payments, the term credit is used to denote a reduction in assetsor an increase in liabilities, and the term debit is used to denote areduction in liabilities or an increase in assets.

This usage has been supplemented by the rule that every recording of adebit movement shall be matched by the recording of a credit movement

and vice versa. For example, India borrows $ 2 billion in USD from the government of

US and deposits the money with a US commercial bank. India then acquiresan asset (the bank balance) as well as incurring a liability (the debt to thegovernment of US). The asset account is debited, and the liability account iscredited.

The Indian BOP entries to record the transaction are:Credit Debit

Liabilities (obligation to US ) 200,000

Assets (bank balance in US) 200,000


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BOP AccountingIn summary form, double entry accounting conventions used in the

balance of payments consist of:Credit (CR) entries

Exports of goods and services

Income receivable

Offsets to real or financial resources received without a quid pro quo

(transfers) Increases in liabilities

Decreases in financial assets

Debit (DR) entries

Imports of goods and services

Income payable Offsets to real or financial resources provided without a quid pro quo

(transfers)

Increases in financial assets

Decreases in liabilities


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BOP AccountingCredits (+) (inflow of foreign exchange)

Current Account

Export of merchandise

Export of software

Licensing fees earned by an Indiancompany.

Interest earned on Loans given to aforeign entity.

Profits earned on Indian ownedcompanies abroad.

Amount spent in foreign currency byforeign tourists in India.

Capital /Financial Account

Purchase of real estate by a non-resident

Purchase of stocks of Indiancompanies by a non-resident

Purchase of GOI bonds by a foreignbank abroad.

Debits (-) (outflow of foreign exchange)

Current Account

Import of merchandise

Import of software

Hotel bills of Indian travellersoverseas

Amount spent by Indian travellersabroad

Profit earned by foreign companies inIndia repatriated

Remittances by foreigners working inIndia to their home country

Capital/Financial Account

New investment by an Indiancompany in USA

Purchase of gold by RBI

Purchase of US treasury bonds by RBI


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BOP components


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INDIAS BALANCE OF TRADE ASSOCHAM PROJETIONS OR 2012-13

Indias balance of trade (BoT) is projected between USD 262 billion

and USD 280 billion in the fiscal 2012-13, exerting further pressureon the countrys current account deficit (CAD), according to anASSOCHAM study.

In the fiscal 2011-12, the countrys merchandise imports totalledUSD 488 billion against exports of USD 303 billion leaving balance

of trade (BoT) of USD 185 billion. Against the backdrop of weakrecovery in the US economy and continuing troubles in theEuropean markets, export shipments were up 21 per cent as therewas some good performance in the initial months of the 2011-12fiscal. But, imports shot up by 32 per cent thanks mainly to high

crude prices and rising gold and silver imports. Import on these twocounts itself was a whopping USD 217 billion, accounting for over44 per cent of the countrys total import bill of USD 489 billion, saidThe Associated Chambers of Commerce and Industry of India(ASSOCHAM).


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Disequilibrium in BOP

The statement that BOP should always balance is true from theaccounting point of viewon account of the double entry principle.

In the economic sense,balance of payment is balanced only wheneach of the segments balances by itself. Balances that arise in each ofthe segment of the BOP indicates disequilibrium in that segment.

Each of the segments like Balance of Trade, Balance on CurrentAccount, Balance on Capital/Financial Account and OverallBalance when they are not zero means that there is adisequilibrium.

The disequilibrium is considered surplus or favourable -

When the inflow of foreign exchange into the country is greaterthan the outflow means there is a surplus : net foreign exchangeinflow into the country.

The balance is deficit or unfavourable when inflow is lower thanthe outflow. This poses a more serious problem and requires

various corrective measures from the government.


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Disequilibrium in BOP Imbalance in Current Account

Persistent surplus in the balance on current account wouldindicate that the countrys export of goods & services are morethan imports.

The total savings is not used for domestic capital formation butpartly diverted for foreign investments.

The country acquired foreign assets, but the residents are notenjoying the standard of living they are entitled to.

The production of the country is not being enjoyed by theresidents but by the importing countries

A deficit indicates imports exceed exports for which paymentsare deferred or met by borrowings.

If it persists over long term, it leads to dire consequences.

For developing countries, the problem is of facing deficit ratherthan surplus.


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Disequilibrium in BOP

Imbalance in Capital/Financial AccountSurplus in current account is generally welcome, it cannot be a

similar situation in capital account

A surplus in capital account indicates that the country is a netborrower. Unlike surplus in current account, surplus in capital

account has to be repaid with interest/dividend.A deficit in capital account indicates that the country is a net

lender or it is repaying its previous borrowings on a larger scalethan the current borrowings.

A country with surplus in current account and a deficit in

capital account indicates deployment of surplus resources.A country with deficit in current account as well as deficit in

capital account indicates a position of crisis.


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Disequilibrium in BOP.

Imbalance in Overall BOPIt relates to the combined balance in current account and

capital account.

The overall balance has an immediate effect on the exchangerate of the currency of the country as it represents demand and

supply of the currency in the foreign exchange market.The effect on foreign exchange depends on the exchange rate

policy of the country

Fixed exchange rate domestic currency is expected to sufferdue to the shortage of supply of foreign currency. The

government is expected to intervene in the market by sellingforeign currency. But the government should have foreignexchange reserves. If it has no reserves, devaluation becomesinevitable.


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Disequilibrium in BOP.

Imbalance in Overall BOPFloating rate - under the system market determines theexchange rate & government has no obligation to maintain therate. Theoretically this mechanism provides an automaticcorrection in the balance of payment disequilibrium. WhenBOP is in deficit the demand for foreign currency is more thanits supply. It will lead to strengthening of the foreign currencywhich will in turn lead to exports becoming cheaper andcompetitive and imports costlier. It will ultimately lead tobalance of payments correction.

Managed Float though the day to day exchange rate is

determined by the market forces of demand and supply, thegovernment may intervene selectively or take other actions tolend stability to the exchange rate. The government may adoptinterest rates and exchange controls to preserve the domesticcurrency value within a certain range.


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Correction of disequilibrium in BOP

In a free market economy, it is expected that any imbalances in theBOP position will get adjusted by movement in the currencies forcedby market.

However, this may take a longer time and hence governments resortto other measures to correct the situation. Some of the methodsadopted by the governments either singly or in combination are:

Devaluation Monetary & Fiscal Policies

Exchange Control

Trade Control Import restrictions

Export Promotion

Devaluation: Means lowering the value of the local currency by the

government. A currency undergoes depreciation under floatingexchange system. It is devalued under fixed exchange rate system.While the devaluation is reduction in the external value of the localcurrency by the government, depreciation refers to reduction invalue due to market forces.


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Devaluation

When the country faces chronic balance of payments deficit, withdevaluation, exports from the country is made cheaper and imports costlier.

The pre-conditions are (a) the demand for exports and imports should beprice elastic, (b) there should not be any change in the internal value of thecurrency and (c) other countries should not indulge in competitivedevaluation.

YearExchange rate (rupees

per US$)

1970 7.57

1975 8.41

1980 7.89

1985 12.37

1990 17.50

1995 32.43

2000 45.00

2006 48.34

2007 (Oct) 38.48

2008 (Jun) 42.51

2008 (Oct) 48.88

2009 (Oct) 46.37

2010 (Jan) 46.21

2011 (Apr) 44.17

2011 (Dec) 53.71


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Correction of disequilibrium in BOP..Monetary & Fiscal Policies

Monetary and fiscal policy are the two instruments available to thegovernment to affect the level of economic activity in the economyand through the balance of payments.

Monetary policy influences the economy through the changes in thesupply of money, while the fiscal policy relates to governmentexpenditure and revenue.

In a BOP deficit, the government will adopt expenditure reducingpolicies.

The monetary policy will reduce money supply by increasing thelending rates or increase in the reserve requirements of banks,issuing of government bonds in open market operations.

With the funds becoming scarce, cost of borrowing increases andtraders find it difficult to hold stocks. Imports fall as they arecostlier compared to the domestic goods and also the fall in theincome levels make the imports difficult.

In the Financial account, the rise in the interest rates would inducethe foreign investors to invest in the country.


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Correction of disequilibrium in BOP..

Exchange Control This refers to the regulation of foreign exchange transactions

through exchange restrictions, exchange intervention.

Exchange restrictions will take the form of supply side restrictionsespecially for imports (blocked accounts), multiple exchange rate for

different commodities and exchange interventionsTrade Control

Regulation of import and exports which will take the form of importrestrictions and export promotions.

Import control is one the simplest to remedy the BOP problems byeither restricting imports through licenses or by stiff import tariffs.

This is resorted to non-essential and luxury goods, but is not done inthe case of essential goods, raw materials, food and capital goods.

Export promotion measures concessional interest rates, exportincentives, encouragement to export oriented projects, value addedproducts etc.,

1.balance of payments

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