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Economy 4 Newbies Balance of Payment (BoP) made easy By Mrunal Patel Contents
What is BOP / Balance of Payment? ................................................................................................................ 2 Export here means........................................................................................................................................ 2 Import means ................................................................................................................................................. 3 Classification of BOP ........................................................................................................................................... 3 Problems with BOP Deficit.................................................................................................................................. 4 Forex Depletion................................................................................................................................................. 4 What is Foreign Exchange reserves? (forex) ........................................................................................... 4 Now how does BOP Deficit lead to Forex depletion ? ................................................................................ 4 External borrowing & forced change in foreign policy. ............................................................................... 5 Reduced foreign investments ......................................................................................................................... 5 Debt trap ............................................................................................................................................................ 5 Causes of BoP Deficit.......................................................................................................................................... 6 When importing more......................................................................................................................................... 6 When Export is less ............................................................................................................................................. 6 How to control BoP Deficit? ................................................................................................................................ 6

Balance of Payment, Currency Devaluation & Convertibility are 3 topics related to each other, Ill write on them one by one.

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Page 2 of 7 First we start with BOP [Balance of Payment]

What is BOP / Balance of Payment?

In simple terms, Balance of Payment = Export minus Import. When youre exporting more than your imports = youve Surplus BOP When youre importing more than exports = Youve BOP Deficit

Export

Import

Now lets get technically correct definition. Bop is summery record all economic transections of one nation with the rest of the world. But what exactly do we understand by this? Export = just the diamonds we sell in America? No! Export contains a lot more than that,

Export here means

1. Goods exported (like Diamond, Textiles, Chemicals) 2. Services Rendered (like Call Centres of Banglore working for American company) 3. Capital received from Abroad (like American company sending money to build factory here, Or your brother sending money from America [remittances] & you buy a restaurant here)

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Import means
1. Goods imported (like crude oil) 2. Money paid for getting services (like when you watch movie Avatar and ultimately your ticket money goes to Hollywood) 3. Capital1 purchased abroad (like Madhu Koda buys coal mines in Africa)

Classification of BOP
BOP Classication Its in 2 parts- current Account & Capital Account See the diagram below

capital is something that generates money like a Factory, building, truck etc. For more articles, visit my site www.mrunalpatel.co.nr

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Problems with BOP Deficit

BOP deficit means when youre importing more than what you export. BOP deficit is bad. Because it leads to

Forex Depletion
Foreign Exchange reserves gets depleted (= gets reduced.) First lets see

What is Foreign Exchange reserves? (forex)

Its the total sum of 1. Money with RBI 2. Gold in RBI 3. Indias special drawing right in IMF (will write on this in another article.)

Now how does BOP Deficit lead to Forex depletion ?

If youre importing something, youve to pay for it. Most of our money goes in importing the petroleum. Now you might say, lets just print 1 lakh crore rupees and give it to the Sheikh in middle east and he sells us the petrol.

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Page 5 of 7 No its not that simple, because the same Sheikh will send that same Rupees to buy something from india like food / cars= too much liquidity2 in India = everyone has more rupees than the quantity of physical products like food / car within Indian market= price rise = inflation.

So when you run into BOP deficit, you cant PRINT MORE MONEY to fill that gap.
Instead youve to sell your gold from RBI and pay for it. (like we did in 1991) or whatever dollars youve piled up in RBI, youve to give it to them.

External borrowing & forced change in foreign policy.

When you run out of your Foreign Exchange reserves, youve to borrow from another country or IMF, World Bank etc. this is called External borrowing. The problem here is that a nation in debt cant be completely independent in its foreign policy. So if we borrow a lot from IMF or America then well have to dance in their tunes on our relations with Pakis or Kashmir issue or climate change pacts etc. The Economy reforms in 1991-92 are example of it. During that that time, we barely had enough money for purchase petroleum to run India for 7 days! So we had to borrow from IMF, and they put strict conditions on us to change our economic policies. Thus we had to end the licence-quotainspector raj and open up our economy to American and other MNCs. [to read more on that LPG click me.]

Reduced foreign investments

When a nation has huge BOP deficit, the MNCs and Foreign players will not get confidence to invest in that nation.

Debt trap
Ultimately, the deficit becomes so huge that youve to borrow just to pay interest of your previous debt.

Liquidity = when there is too much money supply in the market.

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Causes of BoP Deficit

When we are importing more than our exports = we are in BOP deficit. But why are we importing more?

When importing more

1. Petroleum : we dont have it much in India so weve to import. 2. Five year plans & infrastructure = like National highways, dams for that we need to purchase foreign machinery.

When Export is less

1. The goods & products of 3rd world dont have the quality /price range to compete with 1 st world products inside 1st worlds market. E.g. Indian bicycle in American market. 2. When those nation put heavy import duty on our exported products. Like in British times they put heavy tax on our clothes sent to England = we cant compete with their Manchester clothes because our Indian cloths will be expensive in their market. a. This is called Tariff Barriers , we talked about it in WTO article, (in case you missed, click me) Apart from this, the structural bottlenecks like 1. Licence-quota-inspector raj, (abolished now) 2. red-taps in govt. administration 3. multiple taxes in interstate transport of products (GST intends to remove this) 4. Bad infrastructure (poor roads, electricity problems etc.) also reduce the exports.

How to control BoP Deficit?

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Page 7 of 7 1. Heavy duty on luxury items (Tariff Barrier) BOP Deficit = import is more than export. So we need to control import so we put heavy tax on Imported Perfumes / Gold watches / Toys and other luxury items = their MRP becomes high = less people buying = low import. This sounds great on paper, but very difficult to do after the WTO agreements. [Click me to read my previous article on WTO / Doha made easy] 2. Use the Gold Sell that Gold in RBI and pay the money for petroleum youre importing, or any other BoP Deficit. 3. Devaluation of Currency **Will write in detail, in another article 4. Rupee Convertibility (current & capital account convertibility) **Will write in detail, in another article

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