NIASOM

Balance of Payment
International Finance

Submitted by : Submitted to : Prof. Hemant Abhyankar Namit Jain Roll Number-101213 PGDM-II Year

Balance of Payments
The Balance of Payments is the statistical record of a country s international transactions over a certain period of time presented in the form of double-entry bookkeeping. When we say a country s balance of payments we are referring to the transactions of its citizens and government. The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. BoP positions indicate various signals to businesses. BoP comprises current account, capital account and financial account and services, income and current transfers. In the capital account, transactions of capital transfers, capital acquisition and non-produced non-financial assets like buildings and patents are included, while in the financial account, transactions relating to financial assets and liabilities like portfolio investments and foreign exchange reserves are included. However, the BoP account of most countries still classifies transactions under two heads only capital account and current account. In such a case, financial and capital accounts are treated as one. Transactions in BoP are recorded on a double-entry bookkeeping system that is, a transaction is recorded on each side debit and credit of the BoP account. There are many signals that the BoP account of a country gives out. For example, large current account transactions indicate towards openness of an economy. This was the case with India as reduction in trade restrictions and duties led to increase in both exports and imports after 1991. Also large capital account transactions may indicate well-developed capital markets of an economy.

They are composed of the following:

 The Current Account  The Capital Account  The Official Reserves Account  Statistical Discrepancy 1. The Current Account  Includes all imports and exports of goods and services.  Includes unilateral transfers of foreign aid.  If the debits exceed the credits, then a country is running a trade deficit.

 If the credits exceed the debits, then a country is running a trade surplus. 2. The Capital account The capital account measures the difference between Indian sales of assets to foreigners and Indian purchases of foreign assets.  India have huge capital account deficit Indian borrowing from foreigners, this increase our trade deficit.  The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments. 3. Statistical Discrepancy There s going to be some omissions and misreported transactions so we use a plug figure to get things to balance. 4. The Official Reserves Account Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF. Standard components of BOP

CURRENT ACCOUNT (+) Export fob (-) Import fob = Trade Balance (+) Exports on Non-financial services (-) Imports on Non-financial services (+) Investment Income(Credit) (-) Investment Income(Debit) +(-) Private unrequited transfers +(-) Official unrequited transfers = Current Account balance

CAPITAL ACCOUNT +(-) Direct Investment +(-) Portfolio Investment +(-) Other Long term Capital +(-) Other Short term Capital +(-) Net errors and omissions +(-) Counterpart items +(-) Total change in reserves

= Capital Account balance

How does BoP influence economic policy?

The policies of a nation are highly affected and determined by the position and status of its BoP. While formulating or deciding any economic policy, BoP position and policy effect on BoP is given special consideration. While all the policies affect BoP, policies like tariff policy, those related to foreign flows etc affect it in greater magnitude. Earlier, trade-related policies used to have special focus. But over the years the share of current account transactions in total BoP transactions has decreased. For example, in India its share was almost 60% in 1991-92, but reduced to around quietly in 2010-11. Also, mismatch has been much greater in capital account in recent years, which gave rise to India s foreign exchange reserves. Over the years, these trends have forced policy makers to make policies keeping in mind foreign flows (capital) and effects of policies on them. However, policies at the same time could be held responsible for such flows. To improve BoP positions countries have lately often leaned towards the capital account side. The trend has shifted from import substituting policies, that is, policies in which imports are discouraged by way of tariffs, quotas toward more of foreign inflows enhancing policies in the belief that such inflows may make a country crisis-proof and lead to investments that would increase productive capacity and also may increase exports that would earn foreign exchange in future. However, BoP position in itself affects decisions of policy makers. Often, a deteriorating current account is supported by capital or financial account. A healthy BoP position often allows countries to open up their trade and to appropriate gains from it.