eco - balance of payment

8/11/2019 Eco - Balance of Payment

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1 BALANCE OF PAYMENT IN INDIA

1.INTRODUCTION :-

Balance of Payment(BoP) of a country is defined as, "Systemetic Record of all economic

transactions between the residents of a foreign countries" Thus balance of payments includes

all visible and non-visible transactions of a country during a given period, usually a year. t

represent a summation of country!s current demand and supply of the claims on foreign

currencies and of foreign claims on its currency.

alance of payments (#$) accounts are an accounting record of all monetary transactions

between a country and the rest of the world. These transactions include payments for the

country!se%portsandimportsof goods,services, financial capital, and financial transfers. The

#$ accounts summari&e international transactions for a specific period, usually a year, and

are prepared in a single currency, typically the domestic currency for the country concerned.

Sources of funds for a nation, such as e%ports or the receipts of loansand investments, are

recorded as positive or surplus items. 'ses of funds, such as for imports or to invest in

foreign countries, are recorded as negative or deficit items.
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hen all components of the #$ accounts are included they must sum to &ero with no

overall surplus or deficit. or e%ample, if a country is importing more than it e%ports, its trade

balance will be in deficit, but the shortfall will have to be counterbalanced in other ways *

such as by funds earned from its foreign investments, by running down central ban+ reserves

or by receiving loans from other countries.

hile the overall #$ accounts will always balance when all types of payments are included,

imbalances are possible on individual elements of the #$, such as the current account,

the capital accounte%cluding the central ban+!s reserve account, or the sum of the two.

mbalances in the latter sum can result in surplus countries accumulating wealth, while deficit

nations become increasingly indebted. The term "balance of payments" often refers to this

sum a country!s balance of payments is said to be in surplus (euivalently, the balance of

payments is positive) by a specific amount if sources of funds (such as e%port goods sold and

bonds sold) e%ceed uses of funds (such as paying for imported goods and paying for foreign

bonds purchased) by that amount. There is said to be a balance of payments deficit (the

balance of payments is said to be negative) if the former are less than the latter.

'nder afi%ed e%change ratesystem, the central ban+ accommodates those flows by buying

up any net inflow of funds into the country or by providing foreign currency funds to

the foreign e%change mar+etto match any international outflow of funds, thus preventing the

funds flows from affecting the e%change ratebetween the country!s currency and other

currencies. Then the net change per year in the central ban+!s foreign e%change reserves is

sometimes called the balance of payments surplus or deficit. lternatives to a fi%ed e%change

rate system include a managed float where some changes of e%change rates are allowed, or at

the other e%treme a purely floating e%change rate(also +nown as a purely fle%ible e%change

rate). ith a pure float the central ban+ does not intervene at all to protect or devalue its

currency, allowing the rate to be set by themar+et, and the central ban+!s foreign e%change

reserves do not change.

/istorically there have been different approaches to the uestion of how or even whether to

eliminate current account or trade imbalances. ith record trade imbalances held up as one of
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the contributing factors to the financial crisis of 0112*0131, plans to address global

imbalances have been high on the agenda of policy ma+ers since 0114.

hile the #$ has to balance overallsurpluses or deficits on its individual elements can lead

to imbalances between countries. n general there is concern over deficits in the current

account.5ountries with deficits in their current accounts will build up increasing debt and6or

see increased foreign ownership of their assets. The types of deficits that typically raise

concern are

visible trade deficit where a nation is importing more physical goods than it e%ports

(even if this is balanced by the other components of the current account.) n overall current account deficit.

basic deficit which is the current account plus foreign direct investment (but

e%cluding other elements of the capital account li+e short terms loans and the reserve

account.)

s discussed in the history section below, the ashington 5onsensus period saw a swing of

opinion towards the view that there is no need to worry about imbalances. #pinion swung

bac+ in the opposite direction in the wa+e of financial crisis of 0112*0114. 7ainstream

opinion e%pressed by the leading financial press and economists, international bodies li+e the

7 * as well as leaders of surplus and deficit countries * has returned to the view that large

current account imbalances do matter. Some economists do, however, remain relatively

unconcerned about imbalancesand there have been assertions, such as by 7ichael $. 8ooley,

8avid ol+erts-9andau and $eter :arber, that nations need to avoid temptation to switch toprotectionism as a means to correct imbalances.
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2.History of balance of ayments iss!es

/istorically, accurate balance of payments figures were not generally available. /owever, this

did not prevent a number of switches in opinion on uestions relating to whether or not a

nations government should use policy to encourage a favourable balance.

Pre-1"2#: mercantilism

'p until the early 34th century, international trade was generally very small in comparison

with national output, and was often heavily regulated. n the 7iddle ges, ;uropean trade

was typically regulated at municipal level in the interests of security for local industry and for

established merchants. rom about the 3


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national rules aiming to harness the countries! economic output. 7easures to promote a trade

surplus such as tariffs were generally favoured. $ower was associated with wealth, and with

low levels of growth, nations were best able to accumulate funds either by running trade

surpluses or by forcefully confiscating the wealth of others. Rulers sometimes strove to have

their countries outsell competitors and so build up a "war chest" of gold.

This era saw low levels of economic growth= average global per capita income is not

considered to have significantly risen in the whole >11 years leading up to 3>01, and is

estimated to have increased on average by less than 1.3? per year between 3211 and

3>01. ith very low levels of financial integration between nations and with international

trade generally ma+ing up a low proportion of individual nations! :8$, #$ crises were very

rare.


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1"2#$1%1&: free tra'e

:old was the primary reserve asset during the gold standard era.

rom the late 3>th century, mercantilism was challenged by the ideas of dam Smithand

other economic thin+ers favouring free trade. fter victory in the@apoleonic wars:reat

ritain began promoting free trade, unilaterally reducing her trade tariffs. /oarding of gold

was no longer encouraged, and in fact ritain e%ported more capital as a percentage of

hernational incomethan any other creditor nation has since.AB>C:reat ritain!s capital e%ports

further helped to correct global imbalances as they tended to be counter cyclical, rising when

ritain!s economy went into recession, thus compensating other states for income lost from

e%port of goods.

ccording to historian 5arroll Duigley,:reat ritain could afford to act benevolently in the

34th century due to the advantages of her geographical location, its naval power and

economic ascendancy as the first nation to enEoy anindustrial revolution. view advanced by

economists such as arry ;ichengreenis that the first age of:lobali&ationbegan with the

laying of transatlantic cables in the 3>21, further

contributing to close economic integration between nations. The period saw substantial global

growth, in particular for the volume of international trade which grew tenfold between 3>01

and 3>21 and then by about B? annually from 3>21 to 343B. #$ crises began to occur,

though less freuently than was to be the case for the remainder of the 01th century. rom

3>>1 to 343B, there were appro%imately > #$ crises and > twin crises* a twin crises being

a #$ crises that coincides with a ban+ing crises.
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1%1&$1%&(: 'e)lobalisation

The favorable economic conditions that had prevailed up until 343B were shattered by the

first world war, and efforts to re-establish them in the 3401s were not successful. Several

countries reEoined the gold standard around 340F. ut surplus countries didn!t "play by therules", sterilisinggold inflows to a much greater degree than had been the case in the pre-war

period. 8eficit nations such as :reat ritain found it harder to adEust by deflation as wor+ers

were more enfranchised and unions in particular were able to resist downwards pressure on

wages. 8uring the :reat 8epressionmost countries abandoned the gold standard, but

imbalances remained an issue and international trade declined sharply. There was a return to

mercantilist type "beggar thy neighbour" policies, with countries competitively devaluing

their e%change rates, thus effectively competing to e%port unemployment. There wereappro%imately 3< #$ crises and 3F twin crises (and a comparatively very high level of

ban+ing crises.)

1%&($1%*1: Bretton +oo's

ollowing orld ar , the retton oods institutions (the nternational 7onetary

undand orld an+) were set up to support aninternational monetary systemdesigned to

encourage free trade while also offering states options to correct imbalances without having

to deflate their economies. i%ed but fle%ible e%change rates were established, with the

system anchored by the dollar which alone remained convertible into gold. The retton

oods system ushered in a period of high global growth, +nown as the:olden ge of

5apitalism, however it came under pressure due to the inability or unwillingness of

governments to maintain effective capital controls and due to instabilities related to the

central role of the dollar.

mbalances caused gold to flow out of the 'S and a loss of confidence in the 'nited States

ability to supply gold for all future claims by dollar holders resulted in escalating demands to

convert dollars, ultimately causing the 'S to end the convertibility of the dollar into gold,

thus ending the retton oods system The 34BF*23 era saw appro%imately 0B #$ crises

and no twin crises for advanced economies, with emerging economies seeing 3< #$ crises

and Eust one twin crises.

1%*1$2##%: transition, +asin)ton Consens!s, Bretton +oo's II
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7anmohan Singh, currently $7 of ndia, showed that the challenges caused by imbalances

can be an opportunity when he led his country!s successful economic reform programme after

the 3443 crisis.

The retton oods system came to an end between 3423 and 342G. There were attempts to

repair the system of fi%ed e%changed rates over the ne%t few years, but these were soon

abandoned, as were determined efforts for the '.S. to avoid #$ imbalances. $art of the

reason was displacementof the previous dominant economic paradigm *Heynesianism* by

the ashington 5onsensus, with economists and economics writers such as 7urray

Rothbardand 7ilton riedmanarguing that there was no great need to be concerned about

#$ issues.

n the immediate aftermath of the retton oods collapse, countries generally tried to retain

some control over their e%change rate by independently managing it, or by intervening in

the foreign e%change mar+etas part of a regional bloc, such as the Sna+ewhich formed in

3423. The Sna+e was a group of ;uropean countries who tried to retain stable rates at least

with each other= the group eventually evolved into the;uropean ;%change Rate

7echanism(;R7) by 3424. rom the mid-3421s however, and especially in the 34>1s and

early 3441s, many other countries followed the 'S in liberalising controls on both their

capital and current accounts, in adopting a somewhat rela%ed attitude to their balance of

payments and in allowing the value of their currency to float relatively freely with e%change

rates determined mostly by the mar+et.

8eveloping countries who chose to allow the mar+et to determine their e%change rates would

often develop si&eable current account deficits, financed by capital account inflows such as

loans and investments, though this often ended in crises when investors lost confidence. The

freuency of crises was especially high for developing economies in this era * from 342G to

3442 emerging economies suffered F2 #$ crises and 03 twin crises. Typically but not

always the panic among foreign creditors and investors that preceded the crises in this period

was usually triggered by concerns over e%cess borrowing by the private sector, rather than by

a government deficit. or advanced economies, there were G1 #$ crises and < ban+ing

crises.

turning point was the3442 sian #$ 5risis, where unsympathetic responses by western

powers caused policy ma+ers in emerging economies to re-assess the wisdom of relying on

the free mar+et= by 3444 the developing world as a whole stopped running current account
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deficits while the '.S. current account deficit began to rise sharply. This new form of

imbalance began to develop in part due to the increasing practice of emerging economies,

principally 5hina, in pegging their currency against the dollar, rather than allowing the value

to freely float. The resulting state of affairs has been referred to as retton oods .

ccording to laistair 5han, "t the heart of the imbalance is 5hina!s desire to +eep the

value of the yuanstable against the dollar. 'sually, a rising trade surplus leads to a rising

value of the currency. rising currency would ma+e e%ports more e%pensive, imports less so,

and push the trade surplus towards balance. 5hina circumvents the process by intervening in

e%change mar+ets and +eeping the value of the yuan depressed." A


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countries do matter= for e%ample mainstream '.S. economist 5. red ergstenhas argued the

'.S. deficit and the associated large inbound capital flows into the '.S. was one of the causes

of the financial crisis of 0112*0131. Since the crisis, government intervention in #$ areas

such as the imposition of capital controls or foreign e%change mar+et intervention has

become more common and in general attracts less disapproval from economists, international

institutions li+e the 7 and other governments.

n 0112, when the crises began, the global total of yearly #$ imbalances was I31 billion.

#n the credit side, the biggest current account surplus was 5hina with appro%. IGF billion, with oil producing countries such

as Saudi rabia also having large surpluses. #n the debit side, the 'S had the biggest current

account deficit at over I3311 billion, with the 'H, Spain and ustralia together accounting

for close to a further IG11 billion.

hile there have been warnings of future cuts in public spending, deficit countries on the

whole did not ma+e these in 0114, in fact the opposite happened with increased public

spending contributing to recovery as part of global efforts to increase demand. The emphases

has instead been on the surplus countries, with the 7, ;' and nations such as the '.S.,

ra&il and Russia as+ing them to assist with the adEustments to correct the imbalances.

;conomists such as :regor rwin and $hilip R. 9anehave suggested that increased use of

pooled reserves could help emerging economies not to reuire such large reserves and thus

have less need for current account surpluses. riting for the T in Jan 0114, :illian Tett says

she e%pects to see policy ma+ers becoming increasingly concerned about e%change rates overthe coming year. n June 0114, #livier lanchardthe chief economist of the 7 wrote that

rebalancing the world economy by reducing both si&eable surpluses and deficits will be a

reuirement for sustained recovery.

n 011> and 0114, there was some reduction in imbalances, but early indications towards the

end of 0114 were that maEor imbalances such as the '.S. current account deficit are set to

begin increasing again.
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Japan had allowed her currency to appreciate through 0114, but has only limited scope to

contribute to the rebalancing efforts than+s in part to her aging population. The euro used by

:ermany is allowed to float fairly freely in value, however further appreciation would be

problematic for other members of the currency union such as Spain, :reece and reland who

run large deficits. Therefore :ermany has instead been as+ed to contribute by further

promoting internal demand, but this hasn!t been welcomed by :erman officials.

5hina has been reuested to allow the renminbito appreciate but until 0131 had refused, the

position e%pressed by her premier en Jiabaobeing that by +eeping the value of the

renmimbi stable against the dollar 5hina has been helping the global recovery, and that calls

to let her currency rise in value have been motivated by a desire to hold bac+ 5hina!s

development. fter 5hina reported favourable results for her 8ecember 0114 e%portshowever, the inancial Times reported that analysts are optimistic that 5hina will allow some

appreciation of her currency around mid-0131.

n pril 0131 a 5hinese official signalled the government is considering allowing the

renminbi to appreciate, but by 7ay analysts were widely reporting the appreciation would

li+ely be delayed due to the falling value of the ;uro following the 0131 ;uropean sovereign

debt crisis. 5hina announced the end of the renminbi!s peg to the dollar in June 0131= the
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move was widely welcomed by mar+ets and helped defuse tension over imbalances prior to

the 0131 :-01 Toronto summit. /owever the renminbi remains managed and the new

fle%ibility means it can move down as well as up in value= two months after the peg ended the

renminbi had only appreciated against the dollar by about 1.>?

y January 0133, the renminbi had appreciated against the dollar by G.2?, which means it!s

on trac+ to appreciate in nominal terms by


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e%ports. ra&il has been one of the few maEor economies lac+ing a reserve currency to abstain

from significant currency intervention,with therealrising by 0F? against the dollar since

January 0114. Some economists such as arry ;ichen green have argued that competitive

devaluation may be a good thing as the net result will effectively be euivalent to

e%pansionary global monetary policy. #thers such as 7artin olf saw ris+s of tensions

further escalating and advocated that coordinated action for addressing imbalances should be

agreed on at the @ovember :01 summit.

5ommentators largely agreed that little substantive progress was made on imbalances at

the@ovember 0131 :01. n 7 report released after the summit warned that without

additional progress there is a ris+ of imbalances appro%imately doubling to reach pre-crises

levels by 013B.

/.C0U O3 BOP I4B050NC
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There are conflicting views as to the primary cause of #$ imbalances, with much attention

on the 'S which currently has by far the biggest deficit. The conventional view is that current

account factors are the primary cause * these include the e%change rate, the government!s

fiscal deficit, business competitiveness, and private behaviour such as the willingness of

consumers to go into debt to finance e%tra consumption. n alternative view, argued at length

in a 011F paper by en ernan+e,is that the primary driver is the capital account, where

aglobal savings glutcaused by savers in surplus countries, runs ahead of the available

investment opportunities, and is pushed into the 'S resulting in e%cess consumption and asset

price inflation.

&.B050NC O3 P064NT CRII
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#$ crisis, also called a currency crisis, occurs when a nation is unable to pay for essential

imports and6or service its debt repayments. Typically, this is accompanied by a rapid decline

in the value of the affected nation!s currency. 5rises are generally preceded by large capital

inflows, which are associated at first with rapid economic growth./owever a point is reached

where overseas investors become concerned about the level of debt their inbound capital is

generating, and decide to pull out their funds. The resulting outbound capital flows are

associated with a rapid drop in the value of the affected nation!s currency. This causes issuesfor firms of the affected nation who have received the inbound investments and loans, as the

revenue of thosefirms is typically mostly derived domestically but their debts are often

denominated in a reserve currency. #nce the nation!s government has e%hausted its foreign

reserves trying to support the value of the domestic currency, its policy options are very

limited. t can raise its interest rates to try to prevent further declines in the value of its

currency, but while this can help those with debts denominated in foreign currencies, it

generally further depresses the local economy.

5.B050NCIN7 4CH0NI4

#ne of the three fundamental functions of an international monetary systemis to provide

mechanisms to correct imbalances.

roadly spea+ing, there are three possible methods to correct #$ imbalances, though in

practice a mi%ture including some degree of at least the first two methods tends to be used.

These methods are adEustments of e%change rates= adEustment of a nations internal prices
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along with its levels of demand= and rules based adEustment. mproving productivity and

hence competitiveness can also help, as can increasing the desirability of e%ports through

other means, though it is generally assumed a nation is always trying to develop and sell its

products to the best of its abilities.

1. Rebalancin) by can)in) te e8can)e rate

n upwards shift in the value of a nation!s currency relative to others will ma+e a

nation!s e%ports less competitive and ma+e imports cheaper and so will tend to correct

a current account surplus. t also tends to ma+e investment flows into the capital

account less attractive so will help with a surplus there too. 5onversely a downward

shift in the value of a nation!s currency ma+es it more e%pensive for its citi&ens to buy

imports and increases the competitiveness of their e%ports, thus helping to correct

adeficit (though the solution oftendoesn!t have a positive impact immediately due to

the4arsall$5erner con'ition).

;%change rates can be adEusted by governmentin a rules based or managed currency

regime, and when left tofloat freely in the mar+et they also tend to change in the

direction that will restore balance. hen a country is selling more than it imports, the

demand for its currency will tend to increase as other countries ultimatelyneed the

selling country!s currency to ma+e payments for the e%ports. The e%tra demand tends

to cause a rise of the currency!s price relative to others. hen a country is importing

more than it e%ports, the supply of its own currency on the international mar+et tends

to increase as it tries to e%change it for foreign currency to pay for its imports, and this

e%tra supply tends to cause the price to fall. #$ effects are not the only mar+et

influence on e%change rates however, they are also influenced by differences in

national interest rates and by speculation.

2. Rebalancin) by a'9!stin) internal rices an' 'eman'

hen e%change rates are fi%ed by a rigid gold standard, or when imbalances e%ist between

members of a currency union such as the ;uro&one, the standard approach to correct

imbalances is by ma+ing changes to the domestic economy. To a large degree, the

change is optional for the surplus country, but compulsory for the deficit country. n

the case of a gold standard, the mechanism is largely automatic. hen a country has a
http://en.wikipedia.org/wiki/Marshall%E2%80%93Lerner_conditionhttp://en.wikipedia.org/wiki/Floating_exchange_ratehttp://en.wikipedia.org/wiki/Marshall%E2%80%93Lerner_conditionhttp://en.wikipedia.org/wiki/Floating_exchange_rate


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favourable trade balance, as a conseuence of selling more than it buys it will

e%perience a net inflow of gold. The natural effect of this will be to increase the

money supply, which leads to inflation and an increase in prices, which then tends to

ma+e its goods less competitive and so will decrease its trade surplus. /owever the

nation has the option of ta+ing the gold out of economy (sterilising the inflationary

effect) thus building up a hoard of gold and retaining its favourable balance of

payments. #n the other hand, if a country has an adverse #$ it will e%perience a net

loss of gold, which will automatically have a deflationary effect, unless it chooses to

leave the gold standard. $rices will be reduced, ma+ing its e%ports more competitive,

and thus correcting the imbalance. hile the gold standard is generally considered to

have been successfulup until 343B, correction by deflation to the degree reuired by

the large imbalances that arose after proved painful, with deflationary policies

contributing to prolonged unemployment but not re-establishing balance. part from

the 'S most former members had left the gold standard by the mid-34G1s.

possible method for surplus countries such as :ermany to contribute to re-balancing efforts

when e%change rate adEustment is not suitable, is to increase its level of internal demand (i.e.

its spending on goods). hile a current account surplus is commonly understood as the

e%cess of earnings over spending, an alternative e%pression is that it is the e%cess of savings

over investment. That is

where 5 L current account, @S L national savings (private plus government

sector), @ L national investment.

f a nation is earning more than it spends the net effect will be to build up savings, e%cept

to the e%tent that those savings are being used for investment. f consumers can be

encouraged to spend more instead of saving= or if the government runs afiscal deficitto

offset private savings= or if the corporate sector divert more of their profits to investment,

then any current account surplus will tend to be reduced. /owever in 0114 :ermany

amended its constitution to prohibit running a deficit greater than 1.GF? of its

:8$AG>Cand calls to reduce its surplus by increasing demand have not been welcome by

officials,adding to fears that the 0131s will not be an easy decade for the euro&one. n

their pril 0131 world economic outloo+ report,the 7 presented a study showing how
http://en.wikipedia.org/wiki/Balance_of_payments#cite_note-36http://en.wikipedia.org/wiki/Fiscal_deficithttp://en.wikipedia.org/wiki/Balance_of_payments#cite_note-38http://en.wikipedia.org/w/index.php?title=IMF_world_economic_outlook_report_(April_2010)&action=edit&redlink=1http://en.wikipedia.org/wiki/Balance_of_payments#cite_note-36http://en.wikipedia.org/wiki/Fiscal_deficithttp://en.wikipedia.org/wiki/Balance_of_payments#cite_note-38http://en.wikipedia.org/w/index.php?title=IMF_world_economic_outlook_report_(April_2010)&action=edit&redlink=1


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with the right choice of policy options governments can transition out of a sustained

current account surplus with no negative effect on growth and with a positive impact on

unemployment.

/. R!les base' rebalancin) mecanisms

@ations can agree to fi% their e%change rates against each other, and then correct any

imbalances that arise by rules based and negotiated e%change rate changes and other

methods. The retton oods system of fi%ed but adEustable e%change rates was an

e%ample of a rules based system, though it still . John 7aynard Heynes, one of the

architects of the retton oods system had wanted additional rules to encourage surplus

countries to share the burden of rebalancing, as he argued that they were in a stronger

position to do so and as he regarded their surpluses as negative e%ternalitiesimposed on

the global economy.Heynes suggested that traditional balancing mechanisms should be
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supplemented by the threat of confiscation of a portion of e%cess revenue if the surplus

country did not choose to spend it on additional imports. /owever his ideas were not

accepted by the mericans at the time. n 011> and 0114, merican economist $aul

8avidson had been promoting his revamped form of Heynes!s plan as a possible solution

to global imbalances which in his opinion would e%pand growth all round without the

downside ris+ of other rebalancing methods.

;.TRUCTUR O3 B050NC O3

P064NT
http://en.wikipedia.org/wiki/Paul_Davidson_(economist)http://en.wikipedia.org/wiki/Paul_Davidson_(economist)http://en.wikipedia.org/wiki/Paul_Davidson_(economist)http://en.wikipedia.org/wiki/Paul_Davidson_(economist)


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1. Tra'e Balance :-

Trade balance is the difference between e%port and import of goods, usually referred as

visible or tangible items. f the e%ports are more than imports, there will be trade surplus

and if imports are more than e%ports, there will be trade deficit. 8eveloping countries

have most of the time suffered a deficit in their balance of payments. The trade balance

forms a part of current account. n 011>-14, trade deficit of ndia was 33>.< 'S I billion.

2.C!rrent 0cco!nt Balance :-

t is the difference between the receipts and payments on account of current account

which includes trade balance. The current account includes e%port of services, interest,

profits, dividends and unilateral receipts from abroad and the import of services, profits,

interest, dividends and unilateral payments abroad. There can be either surplus or deficit

in current account. hen debits are more than credits or when payments are more than

receipts deficit ta+es place. 5urrent account surplus will ta+e place when credits are more

and debits are less.

5urrent account balance is very significant. t shows a country!s earning and payments in

foreign e%change. surplus balance strengthens the country!s international financial

position. t could be used for development of the country. deficit is a problem for any


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country but it creates a serious situation for developing countries. n 0114-31 ndiaMs

current account deficit was G>.B 'S I billion.

/. Caital 0cco!nt Balance :-

t is the difference between receipts and payments on account of capital account. The

transactions under this title involves inflows and outflows relating to investments, short

term borrowings lending, and medium term to long term borrowings 6 lending. There can

be surplus or deficit in capital account. hen credits are more than debits surplus will

ta+e place and when debits are more than credits deficit will ta+e place. n 0114-31.

ndiaMs capital account surplus was F3.> 'S I billion.

&. rrors an' Omissions :-

The double entry boo+ - +eeping principle states that for every credit, there is a

corresponding debit and therefore, there should be a balance in #$ as well. n reality

#$ may not balance, due to errors and omissions. ;rrors may be due to statistical


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discrepancies (differences) and omissions may be due to certain transactions may not get

recorded. or ;g., remittance by an ndian wor+ing abroad to ndia may not get recorded

etc. f the current and capital account shows a surplus of 01,111 I, then the #$ should

show an increase of 01,111 I. ut, if the statement shows an increase of 00,111 I, then

there is an error or omission of 0,111 I on credit side.

(. 3orei)n 8can)e Reseres :-

The balance of foreign e%change reserve is the combined effect of current and capital

account balances. The reserves will increase when-

a) The surplus capital account is much more than the deficit in current account.

b) The surplus in current account is much more than deficit in capital account.

c) oth the current account and capital account shows a surplus.

n 0114-31 ndiaMs foreign e%change reserves increased by 3G.B 'S I billion.

*.


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R L Receipts from oreigners

$ L $ayments made to oreigners

hen L Nero, there is said to be euilibrium in balance of payments.

hen is positive there is favourable balance of payments= hen O. is negative there

is unfavourable or adverse balance of payments.! hen there is a surplus or a deficit in

balance of payments there is said to be diseuilibrium in balance of payments. Thus

diseuilibrium refers to imbalance in balance of payments.

".T6P O3 DI


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1. tr!ct!ral Dise=!ilibri!m :-

Structural diseuilibrium is caused by structural changes in the economy affecting

demand and supply relations in commodity and factor mar+ets. Some of the structural

diseuilibrium are as follows -

i. shift in demand due to changes in tastes, fashions, income etc. would decrease or

increase the demand for imported goods thereby causing a 8iseuilibrium in #$.

ii. f foreign demand for a country!s products declines due to new and cheaper substitutes

abroad, then the country!s e%ports will decline causing a deficit.

5hanges in the rate of international capital movements may also cause structural

diseuilibrium.

iii. f supply is affected due to crop failure, shortage of raw-materials, stri+es, political

instability etc., then there would be deficit in #$.

iv. war or natural calamities also result in structural changes which may affect not only

goods but also factors of production causing diseuilibrium in #$.

v. nstitutional changes that ta+e place within and outside the country may result in #$

diseuilibrium. or ;g.if a trading bloc+ imposes additional import duties on products

imported in member countries of the bloc+, then the e%ports of e%porting country would

be restricted or reduced. This may worsen the #$ position of e%porting country.


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2. Cyclical Dise=!ilibri!m :-

;conomic activities are subEect to business cycles, which normally have four phases

oom or $rosperity, Recession, 8epression and Recovery. 8uring boom period, imports

may increase considerably due to increase in demand for imported goods. 8uring

recession and depression, imports may be reduced due to fall in demand on account of

reduced income. 8uring recession e%ports may increase due to fall in prices. 8uring

boom period, a country may face deficit in #$ on account of increased imports.

5yclical diseuilibrium in #$ may occur because

a) Trade cycles follow different paths and patterns in different countries.

b) ncome elasticities of demand for imports in different countries are not identical.

c) $rice elasticities of demand for imports differ in different countries.

/. ort - R!n Dise=!ilibri!m :-

This diseuilibrium occurs for a short period of one or two years. Such #$

diseuilibrium is temporary in nature. Short - run diseuilibrium arises due to une%pected

contingencies li+e failure of rains or favourable monsoons, stri+es, industrial peace or

unrest etc. mports may increase e%ports or e%ports may increase imports in a year due to

these reasons and causes a temporary diseuilibrium e%ists.

nternational borrowing or lending for a short - period would cause short - run

diseuilibrium in balance of payments of a country. Short term diseuilibrium can be

corrected through short - term borrowings. f short - run diseuilibrium occurs repeatedly

it may pave way for long - run diseuilibrium.

&. 5on) - R!n I ec!lar Dise=!ilibri!m :-


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9ong run or fundamental diseuilibrium refers to a persistent deficit or a surplus in the

balance of payments of a country. t is also +nown as secular diseuilibrium. The causes

of long - term diseuilibrium are

i. 5ontinuous increase in demand for imports due to increasing population.

ii. 5onstant price changes - mostly inflation which affects e%ports on continuous basis.

iii. 8ecline in demand for e%ports due to technological improvements in importing

countries, and as such the importing countries depend less on imports.

The long run diseuilibrium can be corrected by ma+ing constant efforts to increase

e%ports and to reduce imports.

(. 4onetary Dise=!ilibri!m :-

7onetary diseuilibrium ta+es place on account of inflation or deflation. 8ue to inflation,

prices of products in domestic mar+et rises, which ma+es e%ports e%pensive. Such a

situation may affect #$ euilibrium. nflation also results in increase in money income

with people, which in turn may increase demand for imported goods. s a result imports

may turn #$ position in diseuilibrium.

;. 8can)e Rate 3l!ct!ations :-

high degree of fluctuation in e%change rate may affect the #$ position. or ;g.if

ndian Rupee gets appreciated against dollar, then ndian e%porters will receive lower

amounts of foreign e%change, whereas, there will be more outflow of foreign e%change

on account of higher imports. Such a situation will adversely affect #$ position. ut, if

domestic currency depreciates against foreign currency, then the #$ position may have

positive impact.


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%.DI33RNC BT+N CURRNT

0CCOUNT > TR0D D3ICIT

1. Tra'e 'eficit

This is the difference between the amount of goods and services a nation e%ports, and the

amount of goods and services it imports. 9et!s simplify it. 9et!s say there are 0 nations in

the world nation and nation . f nation sells 311 dollars worth of stuff to nation ,

but buys 331 dollars worth of stuff from nation at the same time, then nation is said

to have a trade deficit of 31 dollars it!s buying more goods and services from abroad than

it is selling.

2. C!rrent acco!nt 'eficit

This is a deficit in the current account. The current account is a broader measure than the

trade deficit. t!s one of the components of the balance of payments balance of payments

Eust shows all financial transactions between one country and the rest of the world. The


29/42


current account deficit is eual to the trade balance (whether it!s a surplus or deficit) P

factor income (this is simply earnings on foreign investments by the citi&ens of the

country subtracted from payments going to foreigners who have investments in the

country) P cash transfers (li+e remittances from wor+ers in the country to their families

abroad).

So the difference is that the trade deficit (or surplus) is a component of the current

account. The current account is a much broader measure.


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1#.?ariations in te !se of term @balance of

ayments@

;conomics writer J. #rlin :rabbewarns the term balance of payments can be a source of

misunderstanding due to divergent e%pectations about what the term denotes. :rabbe says the

term is sometimes misused by people who aren!t aware of the accepted meaning, not only in

general conversation but in financial publications and the economic literature.

common source of confusion arises from whether or not the reserve account entry, part of

the capital account, is included in the #$ accounts. The reserve account records the activity

of the nation!s central ban+. f it is e%cluded, the #$ can be in surplus (which implies the

central ban+ is building up foreign e%change reserves) or in deficit (which implies the central

ban+ is running down its reserves or borrowing from abroad).
http://en.wikipedia.org/wiki/James_Orlin_Grabbehttp://en.wikipedia.org/wiki/James_Orlin_Grabbe


31/42


The term "balance of payments" is sometimes misused by non-economists to mean Eust

relatively narrow parts of the #$ such as the trade deficit, which means e%cluding parts of

the current account and the entire capital account.

nother cause of confusion is the different naming conventions in use. efore 342G there was

no standard way to brea+ down the #$ sheet, with the separation into invisible and visible

payments sometimes being the principal divisions. The 7 have their own standards for

#$ accounting which is euivalent to the standard definition but uses different

nomenclature, in particular with respect to the meaning given to the term capital account.
http://en.wikipedia.org/wiki/Trade_deficithttp://en.wikipedia.org/wiki/Trade_deficit


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The IMF definition

The nternational 7onetary und (7) use a particular set of definitions for the #$

accounts, which is also used by the #rganisation for ;conomic 5o-operation and

8evelopment(#;58), and the 'nited @ations System of @ational ccounts(S@).

The main difference in the 7!s terminology is that it uses the term "financial account" tocapture transactions that would under alternative definitions be recorded in the capital

account. The 7 uses the term capital account to designate a subset of transactions that,

according to other usage, form a small part of the overall capital account. The 7 separates

these transactions out to form an additional top level division of the #$ accounts. ;%pressed

with the 7 definition, the #$ identity can be written

The 7 uses the term current account with the same meaning as that used by other

organi&ations, although it has its own names for its three leading sub-divisions, which

are

The goods and services account (the overall trade balance)

The primary income account (factor income such as from loans and investments)

The secondary income account (transfer payments)
http://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Organisation_for_Economic_Co-operation_and_Developmenthttp://en.wikipedia.org/wiki/Organisation_for_Economic_Co-operation_and_Developmenthttp://en.wikipedia.org/wiki/United_Nations_System_of_National_Accountshttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Organisation_for_Economic_Co-operation_and_Developmenthttp://en.wikipedia.org/wiki/Organisation_for_Economic_Co-operation_and_Developmenthttp://en.wikipedia.org/wiki/United_Nations_System_of_National_Accounts


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11.Difference betAeen Balance of Payments

an' Balance of Tra'e

alance of Trade alance of $ayment

The alance of Trade includes only visible imports and

e%ports, i.e. imports and e%ports of merchandise, the

difference of imports and e%ports is called alance of

Trade. f imports are more than e%ports, it is

unfavourable balance of trade. f e%ports e%ceeds

imports, it is favourable balance of trade.

The alance of $ayments includes

all those visible and invisible items

e%ported from and imported into the

country in addition to e%ports and

imports of merchandise.

alance of Trade includes revenues received or paid on

account of imports and e%ports of merchandise. t shows

only revenue items.

alance of $ayments includes all

revenue and capital items whether

visible or non-visible. alance of

Trade thus form a part of alance of

$ayments.

alance of Trade can be favourable or unfavourable. fimports are more than e%ports, it is unfavourable

balance of trade. f e%ports e%ceeds imports, it is

favourable balance of trade.

alance of $ayments is always

balanced Eust li+e Trading and $rofit

and 9oss 6c of a business.

n case of alance of Trade, there is no deficit or surplus

balance. The balance shows favourable or non-

favourable. So, e%ternal assistance is not reuired.

n case of alance of $ayments, any

balance, deficit or surplus is to be

financed by e%ternal source or

assistance or be utilised.


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12.Deeloments in In'ias Balance of

Payments '!rin) te econ'

etemberE of 2#1/-1&

$reliminary data on ndiaMs balance of payments (o$) for the second uarter (D0), i.e., July-September 013G, of the financial year 013G-3B, are now available and presented inStatements and . hile Statement presents o$ data in $7< format, Statementprovides the same as per the old format.
http://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S1.xlshttp://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S2.xlshttp://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S2.xlshttp://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S1.xlshttp://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S2.xlshttp://rbidocs.rbi.org.in/rdocs/content/DOCs/IEPR11121213_S2.xls


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Deeloments in In'ias BoP '!rin) !ly-etember 2#1/

ndiaMs current account deficit (58) narrowed sharply to 'SI F.0 billion (3.0 per

cent of :8$) in D0 of 013G-3B from 'SI 03.1 billion (F.1 per cent of :8$ in D0 of0130-3G), also much lower than B.4 per cent of :8$ in D3 of 013G-3B. The lower

58 was primarily on account of a decline in the trade deficit as merchandise e%portspic+ed up and imports moderated, particularly gold imports.

#n a o$ basis, merchandise e%ports increased by 33.4 per cent to 'SI >3.0 billion in

D0 of 013G-3B on the bac+ of significant growth especially in the e%ports of Qte%tileand te%tile productsM, Qleather O leather productsM and chemicals.

#n the other hand, merchandise imports at 'SI 33B.F billion, recorded a decline of

B.> per cent in D0 of 013G-3B as compared with a decline of G.1 per cent in D0 of0130-3G, primarily led by a steep decline in gold imports,which amounted to 'SI G.4

billion as compared to 'SI 3.B billion recorded a growth of 30.F per centin D0 of 013G-3B (y-o-y) mainly on account of Qcomputer servicesM.

@et outflow on account of primary income (profit, dividend and interest) amounting

to 'SI


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Q9oansM(net) availed by deposit ta+ing corporations (commercial ban+s)witnessed an

outflow of 'SI .G billion in D0 of 013G-3B as compared to 'SI 0.> billion in the corresponding uarter of 0130-3G. 9oans

(net) availed by others (;5s) at 'SI3.G billion, however, showed an increase of >.>per cent over the same uarter of the preceding year. Trade credits and advancesrecorded a decline mainly on account of higher repayments.

#n a o$ basis, there was a drawdown of foreign e%change reserves of 'SI 31.Bbillion in D0 of 013G-3B as compared to that of 'SI 1.0 billion in D0 of 0130-3G .


37/42


Deeloments in In'ias BoP '!rin) 0ril-etember 2#1/

The turnaround in e%port growth and decline in imports from July 013G onwards led

to a sharp improvement in the trade deficit to 'SI >G.> billion in /3 of 013G-3B from'SI 43.< billion in /3 of 0130-3G.

5ontraction in the trade deficit coupled with a rise in net invisibles receipts resulted in

a reduction of the 58 to 'SI 0


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Trade balance and :old


39/42


Comosition of te balance of ayments

seet

#$ The two principal parts of the #$ accounts are the current accountand the capital

account.

The current account shows the net amount a country is earning if it is in surplus, or spending

if it is in deficit. t is the sum of thebalance of trade(net earnings on e%ports minus payments

for imports), factor income(earnings on foreign investments minus payments made to foreign

investors) and cash transfers. t is called the current account as it covers transactions in the

"here and now" * those that don!t give rise to future claims.

The 5apital ccountrecords the net change in ownership of foreign assets. t includes

the reserve account(the foreign e%change mar+et operations of a nation!s central ban+), along

with loans and investments between the country and the rest of world (but not the future

regular repayments6dividends that the loans and investments yield= those are earnings and

will be recorded in the current account). The term "capital account" is also used in the

narrower sense that e%cludes central ban+ foreign e%change mar+et operations Sometimes

the reserve account is classified as "below the line" and so not reported as part of the capital

account.

;%pressed with the broader meaning for the capital account, the #$ identityassumes thatany current account surplus will be balanced by a capital account deficit of eual si&e * or

alternatively a current account deficit will be balanced by a corresponding capital account

surplus

The balancing item, which may be positive or negative, is simply an amount that

accounts for any statistical errors and assures that the current and capital accounts sum to

&ero. y the principles of double entry accounting, an entry in the current account gives

rise to an entry in the capital account, and in aggregate the two accounts automatically

balance. balance isn!t always reflected in reported figures for the current and capitalaccounts, which might, for e%ample, report a surplus for both accounts, but when this

happens it always means something has been missed * most commonly, the operations of

the country!s central ban+ * and what has been missed is recorded in the statistical

discrepancy term (the balancing item).

n actual balance sheet will typically have numerous sub headings under the principal

divisions. or e%ample, entries under C!rrent acco!ntmight include

Trade * buying and selling of goods and services ;%ports * a credit entry
http://en.wikipedia.org/wiki/Current_accounthttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Balance_of_tradehttp://en.wikipedia.org/wiki/Factor_incomehttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Capital_account#Central_Bank_operations_and_the_reserve_accounthttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Accounting_identityhttp://en.wikipedia.org/wiki/Double_entry_accountinghttp://en.wikipedia.org/wiki/Current_accounthttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Balance_of_tradehttp://en.wikipedia.org/wiki/Factor_incomehttp://en.wikipedia.org/wiki/Capital_accounthttp://en.wikipedia.org/wiki/Capital_account#Central_Bank_operations_and_the_reserve_accounthttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Accounting_identityhttp://en.wikipedia.org/wiki/Double_entry_accounting


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mports * a debit entry

Trade balance * the sum of ;%ports and mports

actor income * repayments and dividends from loans and investments actor

earnings * a credit entry

actor payments * a debit entry

actor income balance * the sum of earnings and payments.

;specially in older balance sheets, a common division was between visible and invisible

entries. isible trade recorded imports and e%ports of physical goods (entries for trade in

physical goods e%cluding services is now often called the merchandise balance). nvisibletrade would record international buying and selling of services, and sometimes would be

grouped with transfer and factor income as invisible earnings.

The term "balance of payments surplus" (or deficit * a deficit is simply a negative

surplus) refers to the sum of the surpluses in the current account and the narrowly defined

capital account (e%cluding changes in central ban+ reserves). 8enoting the balance of

payments surplus as #$ surplus, the relevant identity is


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1/. CONC5UION

The balance of payments accounts of a country record the payments and receipts of the

residents of the country in their transactions with residents of other countries. f all

transactions are included, the payments and receipts of each country are, and must be, eual.

ny apparent ineuality simply leaves one country acuiring assets in the others.

lthough the totals of payments and receipts are necessarily eual, there will be ineualities

e%cesses of payments or receipts, called deficits or surplusesin particular +inds of

transactions. Thus, there can be a deficit or surplus in any of the following merchandise trade

(goods), services trade, foreign investment income, unilateral transfers (foreign aid), private

investment, the flow of gold and money between central ban+s and treasuries, or any

combination of these or other international transactions.

1&.BIB5IO7R0PH6


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3.www.economictimes.com

0.www.rbi.org.in

G.www.bop.encyclopedia.com

eco - balance of payment

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