BALANCE OF PAYMENTS
BOP: The balance of payments of a country is a systematic record of all economic transactions b/w its residence and the rest of the world during a fiscal year.
Significance of Balance Of Payments A/c:
- This shows exports and imports status a country.
- Higher exports point to the higher GDP of the domestic economy. On the other hand, imports point to dependence on Row
- BOP A/c reflects investments by foreign in the purchase of shares, bonds, etc (portfolio investment) of the domestic industries higher investment point higher growth potential of domestic industry.
- It also affects FDI higher FDI leads to higher GDP growth it also generates opportunities for employment of foreign.
- International borrowings are an important component of BOP A/c. It reflects the backwardness of the domestic economy.
- BOP A/c reflects the stock of forex with RBI. A rise in this stock is a sign of better performance of a domestic economy. It helps to formulate a suitable strategy for growth.
Operation of items in Balance Of Payments A/c
The principal item of BOP A/c are recorded as a debit (-) and credit (+) shown on the left side and right side respectively. For e.g. when a payment is received from a foreign country, it is termed as a credit transaction that is all the flows or influx of foreign exchange are recorded on the credit side. The principal items shown on the credit side are the export of goods and services, transfers from foreigners, borrowings from abroad, investment by foreigners in the country.
On the other hand payment to a foreign country is a debit transaction. The principal item on the debit side includes imports of goods and services, transfer payment to foreigners, lending to foreign countries, investments by residents to foreign countries, etc.
Balance Of Payments always balances
BOP of a country always balances because it is based on a double-entry system that is receipts and payments are always equal due to their dual recording i.e. debit and credit. However, this subject needs to be elucidated by appreciating the distinction between BOP in the accounting sense and in the operational sense.
Balance Of Payments in accounting sense
In the accounting sense BOP of a country always balances because accounts are prepared on a dual entry system. Under this system receipts sides are equal to the payment side, therefore from this point of view BOP is always balances.
Balance Of Payments in operational sense
From the practical point of view is not necessary to balances. In the operational sense, it is also termed economic balance. When the current a/c is in deficit or surplus then the balances restore with the help of capital A/c. in other words deficit of current a/c is balanced with the help of surplus of capital A/c.
CLASSIFICATION OF ECONOMICS TRNASCATION IN BALANCE OF PAYMENTS
- Visible items: In this category, all types of physical goods in this category all items which are exported and imported are included. The movement of all such items is open and can be verified by the customs officials.
- Invisible items: It refers to all types of services rendered and availed these include non-factor services like shipping, banking, insurance, etc. factor services includes compensation of employees, rent, interest, dividend, etc.
- Unilateral transfer: It includes gifts, personal remittances’ and other one-way transactions, they are not trading transactions.
- Capital transfer: It includes all such transactions b/w the residence of a country and ROW which cause the change in the asset or liability of a country or change in ownership of official reserve.
Components of Balance Of Payments A/c
Balance of payments account are broadly split into: (a) Current A/c (b) Capital A/c
- Current A/c: BOP is a statement of receipt and payments of a currently relating to exports and imports of goods and services as well as current transfer to and from the rest of the world.
Export (X) and Import (M) of goods are considered as “visible trade” while the export and import of services are considered as “invisible trade” The reason is:
- Goods are seen crossing the border but services are not
- Goods are intangible but services are not.
Services are further split up into:
- Factor services: it includes payments in terms of factor income such as investment income, compensation of employees, etc.
- Non- factor services: Such as shipping, insurance banking, etc. it involves payments in terms of revenue.
Current transfers refer to “transfer for free” there is the unilateral transfer by the way of gifts, grants, and workers remittances. For BOP accounting current transfers are also considered as an element of invisible.
STRUCTURE OF CURRENT A/C BALANCE OF PAYMENTS
Current A/c records all payments to the rest of the world as debit indicated by (-) sign and all receipts from the rest of the world is credit indicated by the (+) sign. Net receipts refer to the differences b/w the receipts and payments.
DIFFERENCE BETWEEN BOP AND BOT
Balance on Current A/c: The net value of credit and debit balances is the balance on current a/c.
Current A/c surplus (CAS) arises when credit items are more than debit items. It indicates not an inflow of foreign exchange.
The current A/c deficit (CAD) arises when debit items are more than the credit items i.e. when foreign exchange receipts in the current a/c fall short of foreign exchange payment, it leads to the current a/c deficit.
- Capital A/c
Note: It needs to address that export and imports of capital goods are a part of merchandise a/c and an element of current A/c BOP.
Capital A/c of BOP records all such transactions b/w the residence of a country and the rest of the world which cause a change in the assets or liabilities of the residents of the country or its government. It includes only financial transactions, involving the transfer of ownership.
Components of capital A/c
- Borrowings and lending to and from abroad
- All transactions relating to borrowings from abroad by the private sector, govt. receipts of such loans and repayment of loans by foreigns are recorded on the positive (credit) side.
- All transactions relating to lending from abroad by the private sector, govt. repayment of the loan abroad is recorded on the negative (debit) side.
Borrowings are classified into two categories:
- Commercial borrowings: It refers to a loan availed by a country from the international market at the market rate of interest.
- External assistance: External assistance terms largely by way of capital grants or loans at subsides rate.
- Investment to and from Abroad: investment by rest of the world in shares of an Indian company, real estate in India, etc. such investment from abroad are recorded on the positive (credit side) as they bring forex. Investment by India to rest of the world such investment to abroad are recorded on the negative (debit side) forex goes out.
Investments are classified into two parts:
- Foreign Direct Investment (FDI): It involves changes in ownership of domestic firms by the non-residents and changes in ownership of foreign firms by the residence of a country for e.g. investment by the general motor in India, Apple incorporation in India implies ownership of the domestic firm by the non-resident’s Investment by the TATA motors abroad implies ownership of the foreign firm by their residences of the country
- Foreign institutional investment (FII): refers to such investment by the non-resident in shares and bonds of the domestic companies.
- NRI deposit: Current transfer by NRIs (transfer to their relatives or donations to the political parties) are treated as a component of capital a/c.
- Banking Capital: Banking capital is another component of capital a/c. It refers to foreign asset holding commercial bank purchase and sales of such asset influence the outflow and inflow of forex respectively.
- Short-term Debt refers to short-term trade credit provided or availed by the domestic economy.
Similar to current a/c capital a/c records all payments to the rest of the world as a debit (negative sign) and all receipts to the rest of the world as credit indicated by the positive sign.
The positive balance indicates that the inward flow of foreign exchange is greater than the outward flow, while the negative balance indicates the opposite.
Overall balance: In the Indian BOP accounting system overall balance is estimated as
Overall balance = Current A/c Balance + Capital A/c Balance + errors and commissions
Equilibrium and disequilibrium in Balance Of Payments:
BOP equilibrium is struck when current A/c Balance + Capital A/c + errors and commission = O and there is no movement of official reserve of the central bank.
Thus in a state of BOP equilibrium inward flow of forex is exactly equal to the outward flow of forex and there is no change in official reserves (forex, gold) with the central bank of the country.
Disequilibrium in BOP: A disequilibrium in BOP occurs when sum total of current a/c balance and Capital a/c balance i.e. either some positive number or some (-ve) number
- (+) BOP surplus: Current a/c balance + Capital a/c Balance is some (+ve) no., pointing to the net inward flow of foreign exchange and leading to an increase in official reserve.
- (-) BOP deficit: Current a/c balance + capital a/c balance is some negative no., pointing to the net outward flow of foreign exchange and leading to a decrease in official reserve.
Autonomous and accommodating items of BOP:
Autonomous items: Autonomous items refer to that international economics transaction that occurs due to the motive of earning profits these items are also known as “Above the line items” for e.g. if a foreign company is making investments in India with the aim of earning profit then such a transaction is independent of the countries BOP situation. It can take place on both current & capital A/c.
Accommodating items: It refers to those transactions which are undertaken by the central bank of a country with a view to correcting BOP in balance and restoring BOP equilibrium. Such transactions are determining by net consequences of autonomous transactions these items are also known as “below the line items”. Accommodating items don’t cause any movement of goods and services across the border. These relate to the movement of the official reserve with a view to correcting BOP in balances. For e.g. if there is a current a/c deficit, then this deficit is settled by capital inflow from abroad. The sources used to meet a deficit in the BOP are:
Foreign exchange reserve
Borrowing from IMF or foreign monetary authority.
Differences b/w autonomous and accommodating items.
|Autonomous items||Accommodating items|
|It refers to that international economics transaction that is undertaken for consideration of profit.||It refers to the transaction which is free from consideration of profits.|
|Autonomous items are the cause of BOP in balance.||Accommodation items are meant to restore BOP balance.|
|These items may involve the movement of goods across the border i.e. export and import of consumer and capital goods.||These don’t involve the movement of goods across the borders. These items only involve the movement of the official reserve with the RBI.|
|These items are also known as “above the line items”.||These items are also known as “below the line items”.|
Differences b/w Current A/c BOP and Capital A/c BOP
|Current A/c BOP||Capital A/c BOP|
|It records exports and imports of visible, invisible, and current transfer items.||It records all such transactions b/w residence of a country and rest of the world which cause a change in ownership of the assets.|
|Transaction of the current A/c doesn’t affect the assets/ liability of the country in relation to Row.||Transaction of capital A/c affects the asset/ liabilities status of the country in relation to Row.|
|Current A/c transactions are short-term transactions.||Capital A/c transactions are largely long-term transactions.|
|Current A/c transactions impact capital A/c transactions e.g. deficit on current A/c often leads to borrowings. The principal component of current A/c Export and Import of goods Export and Imports of services Current transfer.||Capital A/c transaction impacts current A/c transaction for e.g. FDI leads to factor income. The principal component of Capital A/c is Borrowing and Foreign investment.|
Balance Of Payments