balance of payment1

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BALANCE OF

PAYMENT



Trade

Buying and selling goods and servicesfrom other countries

The purchase of goods and services from abroad

that leads to an outflow of currency – Imports(M)

The sale of goods and services to buyers fromother countries leading to an inflow of currency – Exports (X)



Specialisation and Trade

Different factor endowments mean somecountries can produce goods and services moreefficiently than others – specialisation istherefore possible:

Absolute Advantage: Where one country can produce goods with fewer

resources than another

Comparative Advantage:

Where one country can produce goods at a loweropportunity cost – it sacrifices less resources inproduction



The Terms of Trade

The Terms of Trade looks at the relationshipbetween the price received for exports and theamount of imports we are able to buy with that

money.

Average Price of Exports

Terms of Trade = ----------------------------------------

Average Price of Imports



Exchange Rates

Floating Exchange Rates: Price determined only by demand and supply of

the currency – no government intervention

Fixed Exchange Rates: The value of a currency fixed in relation to an

anchor currency – not allowed to fluctuate

Dirty Floating or Managed Exchange Rate:

– rate influenced by government via central bankaround a preferred rate



BALANCE OF PAYMENT

The balance of payments of a country is asystematic record of all economic transactionsbetween the residents of a country and the rest

of the world. It presents a classified record of allreceipts on account of goods exported, servicesrendered and capital received by residents andpayments made by theme on account of goods

imported and services received from the capitaltransferred to non-residents or foreigners.



IMPORTANCE OF THE BOP

BOP records all the transactions that createdemand for and supply of a currency. Thisindicates demand-supply equation of thecurrency. This can drive changes in exchangerate of the currency with other currencies.

BOP may confirm trend in economy’sinternational trade and exchange rate of thecurrency. This may also indicate change orreversal in the trend.

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



BOP may confirm trend in economy’sinternational trade and exchange rate ofthe currency. This may also indicate

change or reversal in the trend.

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



The General Rule in BOP

Accounting

a) If a transaction earns foreign currencyfor the nation, it is a credit and is recordedas a plus item.

b) If a transaction involves spending offoreign currency it is a debit and isrecorded as a negative item.



Double-entry bookkeeping

a. Currency inflows = credits

earn foreign exchange

b. Currency outflows = debitsexpend foreign exchange

BALANCE-OF-PAYMENTCATEGORIES



The various components of aBOP statement

Current Account

Capital Account

IMF SDR Allocation

Errors & Omissions

Reserves and Monetary Gold



Current Account

BOP on current account refers to theinclusion of three balances of namely – Merchandise balance, Services balance

and Unilateral Transfer balance. In otherwords it reflects the net flow of goods,services and unilateral transfers (gifts).The net value of the balances of visible

trade and of invisible trade and ofunilateral transfers defines the balance oncurrent account.



Capital Account

The capital account records allinternational transactions that involve aresident of the country concerned

changing either his assets with or hisliabilities to a resident of another country.Transactions in the capital account reflect

a change in a stock – either assets orliabilities.



The Reserve Account

Three accounts: IMF, SDR, & Reserve andMonetary Gold are collectively called as TheReserve Account.

The IMF account contains purchases (credits)and re-purchase (debits) from InternationalMonetary Fund. Special Drawing Rights (SDRs)are a reserve asset created by IMF and allocatedfrom time to time to member countries. It canbe used to settle international paymentsbetween monitary authorities of two differentcountries.



The Balance of Payments

Identity

BCA + BKA + BRA = 0

where

BCA = balance on current accountBKA = balance on capital account

BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0



U.S. Balance of Payments Data

Credits Debits Current Account

1 Exports $1,418.6

42 Imports ($1,809.18)

3 Unilateral Transfers $10.24 ($64.39)

Balance on Current Account ($444.69)Capital Account

4 Direct Investment $287.68 ($152.44)

5 Portfolio Investment $474.39 ($124.94)

6 Other Investments $262.64 ($303.27)Balance on Capital Account $444.26

7 Statistical Discrepancies

Overall Balance $0.30

Official Reserve Account ($0.30)

0.73




In 2000, the

U.S. imported

more than itexported, thus

running a

current account

deficit of$444.69

billion.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73




During the

same year, the

U.S. attracted

net investmentof $444.26

billion — clearly

the rest of the

world found theU.S. to be a

good place to

invest.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73




Under a pure

flexible

exchange rateregime, these

numbers would

balance each

other out.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73




In the real

world, there

is a statisticaldiscrepancy.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73




Including that,

the balance of

paymentsidentity should

hold:

BCA + BKA = – BRA

($444.69) + $444.26 + $0.73 = $0.30= –

($0.30)


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73



Balance of Payments and the

Exchange Rate

Q

P

Exchange rate $Credits Debits Current Account

1 Exports $1,418.6

42 Imports ($1,809.18)









0.73

S

D




Exchange Rate

Q

P

As U.S. citizens import, they are supply dollars to the FOREX market.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73

Exchange rate $

S

D




Exchange Rate

Q

P

As U.S. citizens export, others demand dollars at the FOREX market.


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73

Exchange rate $

S

D




Exchange Rate

Q

P S

D

As the U.S. government sells dollars, the supply of dollars increases.

S 1


1 Exports $1,418.6

42 Imports ($1,809.18)









0.73

Exchange rate $



Factors causing Disequilibrium1]. Economic factors

Development disequilibriumCyclical disequilibrium Lawrence W. Towle “Depression

always brings about a drastic shrinkage in world trade, whileprosperity stimulates it.”

Secular disequilibrium

Structural disequilibrium

2]. Political factors

political instability

wars

change in world trade routes

3]. Social factors

changes in tastes preferences, fashion, etc.



Correction of Disequilibrium

Automatic Corrections Deliberate Measures

Monetarymeasures

1) Monetary

contraction /

expansions

2) Devaluation/

Revaluation

3) Exchange control

Trade measures Miscellaneousmeasures

1. Foreign loans

2. Incentives for

foreign investments

3. Tourismdevelopment

4. Incentives for

inward remittances

5. Import substitutions

Export Promotion

1. Abolition of export

duties

2. Export subsidies3. Incentives

Import control

1. Import duties

2. Import quota

3. Importprohibition



TRENDS IN INDIA’S BALANCE

OF PAYMENTS

A country, like India, which is on the pathof development generally, experiences adeficit balance of payments situation.

This is because such a country requiresimported machines, technology and capitalequipments in order to successfully launch

and carry out the programme ofindustrialization



FIRST PLAN

During the first plan period, the balance ofpayments was affected by the Korean Warboom, American recession of 1953 and

favorable monsoon at home which helpedto boost agricultural and industrialproduction.

balance of payment during the first planwas only Rs. 42 crores.



SECOND PLAN

An important feature of the second planperiod was the heavy deficit in the balanceof trade which aggregated to Rs. 2339

crores.

The foreign exchange reserves sharplydeclined and the country was left with no

choice but to think of ways and means torestrict imports and expand exports.



THIRD PLAN

The balance of current account wasunfavorable during the third plan .

The serious adverse balance of paymentswhich started with the second plancontinued relentlessly during the third andannual plans.

Heavy amount had to be paid by India inthe form of interest payments on loans



FOURTH PLAN

One of the objectives of the fourth planwas self-reliance – i.e., import substitutionof certain critical commodities on the one

side and export promotion so as to matchthe rising import bill, on the other

Accordingly the government managed to

restrict imports and succeeded inexpanding exports.



FIFTH PLAN

During the whole of the Fifth Plan Indiaexperienced a surplus balance of payments dueto a sharp increase in the exports surplus on

account of invisibles. From 1979-80 onwards, India started

experiencing very adverse balance of payments.

India had to meet this colossal deficit in thecurrent account through withdrawals andborrowings from IMF .



SIXTH PLAN

The Sixth plan characterize the balance ofpayments position acute.

The annual average current accountdeficit was of the order of rs.2600 croresduring the Sixth Plan.

During the Sixth Plan, the trade deficit

was 3.3 per cent of GDP and currentaccount deficit was 1.4 per cent of GDP.



SEVENTH PLAN

Exports performance substantially improved inthe Seventh Plan with average volume growthexceeding 7 per cent.

The share of net invisible earnings in financingtrade deficit declines from 63 per cent duringthe Sixth Plan to 29.5 per cent during theSeventh Plan.

The average current account deficit as a percenr of GDP increased to 2.4 per cent in theSeventh Plan.



DEVELOPMENT SINCE 1993-2000

In the year 1993-94, India saw aremarkable turnaround from a foreign-exchange constrained control regime to amore open, market driven by liberalized

economy.

During the last three years exportearnings, on average, accounted for nearly

90 per cent of the value of imports



Exports recorded a growth of 20 per centin dollar terms. The surplus on theinvisible account doubled.

Foreign currency reserves which were just$1205 million in 990 reached the level of$19386 million in 1994.

The economy thus moved to a morestable and sustainable balance ofpayments position.

Balances on the Current (BCA) and



Balances on the Current (BCA) andCapital (BKA) Accounts of Five

Major Countries

-500

-400

-300

-200

-100

0

100

200

300

400

500

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

China BCA

China BKA

Japan BCA

Japan BKA

Germany BCA

Germany BKA

UK BCAUK BKA

U.S. BCA

U.S. BKA

Source: IMF International Financial Statistics Yearbook, 2000

India's Foreign Trade: 2005 06



India's Foreign Trade: 2005-06

(In US$ million)

(April, 2005-Oct. 2006)

Exports

2004-05 42200.62

2005-06 51516.87

Y-O-Y Growth 22.08

Imports

2004-05 56381.09

2005-06 75032.08

Y-O-Y Growth 33.08

Trade Balance

2004-05 -14180.47

2005-06 -23515.21

Source: Federal Ministry of Commerce, Govt. of India



India's Balance of Payments(2001-05)US $ million

Items 2004-05 (P) 2003-04 2002-03 2001-02 2000-01 1990-91

Trade Balance -38,130 -15,454 -10,690 -11574 -12460 -9437

Invisibles, net 31,699 26,015 17,035 17,035 9,794 -243

Current

Account

Balance

-6,431 10,561 6,345 6,345 2,666 -9,680

Capital

Account 32,175 20,542 10,840 10,840 8,840 7,056

Overall

Balance 26159 31,421 16,985 16,985 5,868 -2,492

Foreign

ExchangeReserve

Increase

(+)/Decrease

(-)

-26,159 -31,421 -16,985 -16,985 -5,842 1,278

Source: Reserve Bank of India Annual report (2004-05)



India's Foreign Trade (2004-05)(In US $ million)

April, 2004-March, 2005

EXPORTS

2003-2004* 63978.78

2004-2005 79593.59

% Growth 24.41

IMPORTS

2003-2004* 78250.86

2004-2005 106121.18

% Growth 35.62

TRADE BALANCE

2003-04* -14272.08

2004-05 -26527.59

Source: Federal Ministry of Commerce, Government of India

* Final figures as given by DGCI&S



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