Assignment on Unit – 5

Macro Economics and policy

BALANCE OF PAYMENT

Submitted to :Dr. Y. C. ZalaPrinciple & Deancollege of IABM AAU Anand - 388110

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Submitted by : sondarva yagnesh m Reg. no. 04-2664-2015 M.Sc. (Agri.) 1st Sem.

BALANCE OF BALANCE OF PAYMENTSPAYMENTS

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Contents

1.Explaination of the balance of payments.

2.Distinguish between the current account and capital account.

3.Causes and consequences of balance of payments disequilibrium.

4.Policy measures for correcting balance of payments disequilibrium.

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BALANCE OF PAYMENT:

The balance of payments of a country is a systematic record of all economic transactions between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by theme on account of goods imported and services received from the capital transferred to non-residents or foreigners.

- Reserve Bank of India

IMPORTANCE OF THE BALANCE OF PAYMENTS BOP records all the transactions that create demand for and

supply of a currency. This indicates demand-supply equation of the currency. This can drive changes in exchange rate of the currency with other currencies.

BOP may confirm trend in economy’s international trade and exchange rate of the currency. This may also indicate change or reversal in the trend.

This may indicate policy shift of the monetary authority (RBI) of the country.

BOP may confirm trend in economy’s international trade and exchange rate of the currency. This may also indicate change or reversal in the trend.

This may indicate policy shift of the monetary authority (RBI) of the country

The General Rule in BOP Accounting

a) If a transaction earns foreign currency for the nation, it is a credit and is recorded as a plus item.

b)  If a transaction involves spending of foreign currency it is a debit and is recorded as a negative item.

The various components of a BOP statement A.   Current Account

B.   Capital Account C.   IMF D.   SDR Allocation E.   Errors & Omissions F.   Reserves and Monetary Gold

Balance of Payments

The The balance of paymentsbalance of payments is a record of is a record of all economic transactions conducted all economic transactions conducted between a country and the rest of the between a country and the rest of the world for a given time period, usually world for a given time period, usually one year.one year.

An economic transaction is an exchange of value. It involves a receipt and a payment of money in exchange for economic goods and services.

Accounting Treatment of Items

In standard accounting double entry book-keeping, each transaction will result in a debit and a credit entry of equal size or amount.

Thus in that sense, a country’s balance of payments accounts for any given year always balances.

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Accounting Treatment of Items

In terms of actual receipts and payments, a country may be faced in any given year with one of two situations.

(a)A surplus or favourable balance on the BOP accounts.

(b)A deficit or unfavourable balance on the BOP accounts.

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Accounting Treatment of Items (Debit and Credit Items) Any item which gives rise to a sale of foreign

exchange (an inflow) is recorded as a credit item (+) in the accounts e.g. export of goods and services

Any item which gives rise to the purchase of foreign exchange (an outflow) is recorded as a debit item (-) in the accounts e.g imports of goods and services.

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The Components of the BOP Account

The Balance of Payments Account consists of two parts:

(i) A current accountcurrent account(ii) A capitalcapital (and financial) accountaccount

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The Components of the BOP Account

The Current Account generally comprises two sections:

(a) Visible balance (balance of visible trade): primarily the

import and export of merchandise or goods)

(b) Invisible balance (Balance of invisible trade): primarily the import and export of services.

N.B. The sum of the two balances is referred to as the balance on the current balance on the current accountaccount.

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The Components of the BOP Account

The Current Account generally comprises four main items:

(a) Merchandise Trade Balance

(b) Services Balance

(c) Net Property Income Balance

(d) Current Transfers Balance

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The Capital Account deals primarily with short term and long term flows/movements of capital, that is, it is concerned with international loans and investments.

It may consist of transfer of ownership of a fixed asset; direct investments, portfolio investments, other investments and reserve assets

It must be noted that when the balances of both sections are added there can be a surplus or a deficit.

The account must therefore show the treatments of any of these two situations as well as the item to “balance off” the account. This is strictly for accounting purposes. All surplus or deficits must be dealt with.

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Sample BOP Accounts 16

Sample BOP Accounts 05/01/23

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Sample BOP Accounts 05/01/23

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Balance of Payments Disequilibrium

A deficit or an unfavourable balance exists when the value of autonomous debit items exceeds the value of autonomous credit items.

A surplus or a favourable balance exists when the value of autonomous credit items exceeds the value of autonomous debit items.

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Affects on the Economy Is a nations current account balance, by itself, a

good measure of its economic health? NO; there is no law, economic or political, which states

that the current account balance must be positive. Unlike running a budget deficit in which a person or institution spends more than it makes, running a deficit in the current account, simply means a country imports more than it exports.

Is a current account surplus and financial account deficit by itself an indication of economic strength?

NO, particularly not if the exodus of the financial capital occurs because there are a few good investment opportunities in the country.

Is the net inflow of capital bad? . NO, if the capital is being invested in such a way as

to enhance the productive capacity of the country

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Do monetary and fiscal policies affect the exchange rates and BOP components

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• Monetary Policy: An unanticipated shift to expansionary monetary policy will lead to more rapid economic growth, accelerated inflation and lower real interest rates

• BOP effects: Higher income and higher domestic prices stimulate imports and discourage exports. Lower real rates discourage foreign and domestic investment at home.

• Exchange rate effects : The adverse impact of the country’s current account will increase the supply of currency in the fx markets; causing the currency to depreciate. The adverse impact of the country’s financial account will decrease demand for the country’s currency, causing it to depreciate.

Do monetary and fiscal policies affect the exchange rates and BOP components?

Fiscal Policy: An unanticipated shift to more expansive fiscal policy will result in budget deficits, increase in aggregate demand, inflation and an increase in real interest rates.

BOP effect: Increase demand will encourage imports & discourage exports, which moves the current account towards deficit.

Meanwhile, the higher interest rates attract foreign investment and discourage domestic investment from leaving the country, moving the financial account surplus.

Exchange rate effects: The adverse impact of the current account will increase the SUPPLY of the country’s currency, causing the currency to depreciate.

The positive impact of the KA will increase demand causing the currency to appreciate.

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THANK YOU

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