BALANCE OF PAYMENT

Balance of payment (BOP) is a summary record of all economic transactions between residents of one country and the rest of the world. It is classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by them on account of goods imported and services received from and capital transferred to non-residents or foreigners. BOP may be balanced, surplus or deficit. BOP in India can be classified into (i) (ii) BOP on current account (transactions relating to goods, services and income), and BOP on capital account (Transactions relating to claims and liabilities of a financial nature, which go to finance the deficit on current account, or to absorb its surplus) Current account includes visible trade relating to imports and exports, invisible items, for instance, services, payments and receipts for shipping, transport, foreign travel, banking, insurance etc; and unilateral transfers e.g. donations. Capital account shows the implications of current transaction for the countrys international financial position and includes payments and receipts of a long-term nature, loans amortization, NRI deposits, withdrawals from IMF and similar institutions. The BOP deficit is ultimately financed by an external assistance, loans and grants, drawing from IMF and allocation of SDRs by IMF. In spite of all this, it deficit continues, the countrys foreign exchange will decline (i.e. devolution) to make up for the deficit.

Causes of BOP Problems

The main causes of large deficit in BOP in India are big rise in imports, small growth in exports and to an extent deficit on account of capital transactions.

(1) Expansion of imports

The plan strategy required large scale imports of capital goods, equipments, maintenance goods and industrial raw materials besides technical services of various kinds. There is heavy outflow of funds also on imports of petroleum products, edible oils and imports of food grains when the domestic crop falls.

(2) Slow growth in Export Earnings

Exports of developing economy are slow to pick up because (a) Generally, a developing economy has only agricultural surpluses to offer for exports, demand for which is income inelastic (b) A developing country economy may not have sufficient expendable surpluses. If it increases its exports by curtailing domestic supplies, it will lead to domestic inflation. Higher domestic prices will, in turn, adversely affect exports. (c) The goods sought to be exported may not be competitive internationally and (d) Foreign countries also impose barriers in the form of heave impact duty.

(3) Deficits on Capital Transactions

In recent year growing deficits on account of capital transaction has been responsible for deficit in BOP. Of its different components namely private capital transactions, govt. capital transactions amortisation payments, purchase of rupee from IMF and banking capital the major source of deficit has been the rising obligation to meet amortization payments. This has involved large sums on the return of loans which became due and large interested payments thereon.

Measure to Control BOP Deficits

The Govt. of India, in recent times, has taken several measures to overcome the serious problem of deficits. Some of these are

(1) Use of Gold

Gold was made use of in 1991 for acquiring foreign currency to meet the payment obligation which had become due.

(2) Devaluation
It implies a reduction in the external value of domestic currency which makes the domestic goods more attractive to foreigner. Simultaneously, it makes foreign goods costlier and discourages their imports.

(3) Export promotion

The following measures are adopted to promote exports (1) An active policy of encouraging exports by creating promotional infrastructure. (2) Export incentives such as full convertibility of rupee and (3) Export credit and finance.

(4)

Import compression
The impact of non-essential goods must be restricted so that capital equipment, machinery, spares parts; crucial raw materials, technical know how etc would be imported in requisite quantity.

Several other measure to control BOP deficits have been introduced by new trade policy of 1991 and successive exim policies.

Devaluation
Devaluation refers to deliberate reduction in the external value of domestic currency in terms of foreign currency or currencies. Devaluation, in general increases exports and decreases imports. In fact in most of the cases this course is adopted to improve the BOP position of country through raising the earning form exports and reducing expenditures on imports. The increase in exports takes place because the price of export-goods fall in foreign currency and thus the foreign demand for export-goods increases. This means that devaluation gives a price-advantage to the exporting country. The exporter is also motivated to export more as trade in export-goods because more profitable. Apart from increase in exports there also takes place a fall in the demand for imports. This happens because imports become expensive in rupee-term on account of devaluation. The importer will have to pay more in rupees to buy the some amount of foreign currency to buy the same import commodity. Taken together, the increase in demand for export goods enable the developing country to earn more of foreign currency and the decrease in demand for imports goods means lesser expenditure of foreign currency on imports. This improve balance of payments.

Convertibility
Convertibility of currency in a financial concept related to the exchange of one currency into another currency at the market rate. It has several variants. The one that India has adopted at present is a system of one or unified exchange rate, making it a fully convertible rupee system. Earlier the system was that of dual exchange rate. It was partial convertible rupee system. A currency is said to be convertible when it may be freely exchanged for another currency. Opposed to this is the inconvertible currency. Such a currency is not freely convertible for an other currency. This happens when govt. through exchange controls, allocates the supply of foreign exchange to different uses and the rate or rates at which it deems fit.

Under this system, the availability of foreign exchange is determined by the Govt. The rate of exchange too is a fixed rate. This is a situation which prevailed in India till recently.

Benefits of Convertibility
The fully convertible currencies have rendered a number of benefits to the countries who have adopted this system. Even the partial convertible rupee system has the potential of several advantages: (1) Significant gains in enhancement of incentives to exporters of India. The increase in the incentive will result from the fact that the entitlement ratio will be more then under the old system. (2) The convertible rupee system also benefits large no of workers who are working abroad and have been remitting money. By including them in the system, they would immediately gain since they would also be eligible for the conversion of their remittances at the market rates. (3) The currency convertibility aligns the relative prices of the country with the world prices. This may result in productivity/gain/efficiency in the use of resources. Efficiency will also result from the dismantling of controls on exchange trade. (4) Convertible rupee system has a self- balancing property for a considerable segment of BOP. This automatic equilibrating mechanism is thus a replacement of the govts budgeting of foreign exchange to equate the receipts and payments. (5) The system assists in making the production structure compatible with the resources endowments of a country.

Present Situation Regarding Current and Capital Account Convertibility of Rupee in India.
India at present follows current Account convertibility but the restriction on invisible like private transfers, for study purpose and medical treatment, for gifts and donations continues. Measures have been taken by the Govt. to slowly move towards Capital Account convertibility based on the recommendations of Tarapore Committee I and II and Persy misry committee. Rupee became partially convertible (60:40) in Aug 1994 in the Capital Account. Indias cautious approach towards opening of the capital account and viewing Capital Account liberalisation as a process contingent upon certain pre-conditions has served India well. Given the changes that had taken place over the last two decades, however, there was merit in moving towards Fuller Account convertibility within a transparent framework as it will increase the capital inflow.