Balance of Payments

Balance of Payment is a statement showing the

economic transactions of country with the rest of the
world during a year.
The Bop is prepared based on the accounting principle of
double entry system. All the inflows of foreign exchange
are considered as credit transactions and all the outflows
of foreign exchange are considered as debit transactions
Purpose
1. Strength and weakness of the country in international
economic status.
2. Improvement and deterioration in economic conditions
3. Warning signals

Components of Bop
Current Account: is a combination of trade
account and the services account. visible :
include export and import of goods called
merchandise trade. ii. invisible items are
services
Capital Account : records the net flow of FDI in
plant, equipment and long term, short term
portfolio(debt & equity) investment.
a. Short term capital movements : i. purchase of
short term foreign securities eg treasury bills,
commercial bills and acceptance bills. ii.
Speculative purchase of foreign currency iii.
Cash balance held by foreigners.

 Long term capital movements i. direct

investment in shares, bonds, real estate
or physical assets like plant, building
and equipment ii. Portfolio investment
including all other stocks and bonds iii.
Amortization of capital . FDI and FIIs
Export of capital is debt as it is outflow
of capital, and import of capital is credit
as there is inflow of capital.

Equilibrium and Disequilibrium

Balance of Payment = R-P

B = 0 Bop is in equilibrium
B = (+) Bop is Surplus
B = (-) Bop is deficit.
Kinds of Bop disequilibrium
Fundamental Disequilibrium persistent
inflation leads to a persistent deficit in BOP.
Cyclical Disequilibrium : cyclical fluctuations
caused by the changes in the trade cycle,
stabilization policies in various countries, and
varying income and price elasticity exports and
imports in various countries are few of the
factors that lead to cyclical disequilibrium.

 structural disequilibrium : Structural

disequilibrium occurs due to the structural
changes in some sectors of the economy.
That affects the demand and supply forces,
which in turn leads to changes in import
and export patterns in the economy.
Short term Disequilibrium: i. seasonal
deficits caused by crop failure ii. Rapid
growth of population iii. Development
plans iv demonstration effects.

Causes of disequilibrium
(deficit)

Natural calamities
Increase in incomes
Development
Import prices rising and exports of prices are
stable. In LDCs.
Structural changes
High rate of growth of population
Import restrictions and tariffs
Reduction in Exports : government policies,
increase in income

Correction of Disequilibrium
Monetary Measures:
Deflation : decline in the general price
levels, which is caused by a reduction in
the supply of money. In the market prices
are allowed to fall, currency deflation
results when there is a fall in the income
of the people. Which in turn leads to
decrease in the domestic consumption,
which leads to increase in exports and fall
in imports.

 Exchange rate depreciation : Exchange rate

depreciation devalues the domestic currency
relative to foreign currency. Import are costlier and
export are cheaper.
Devaluation : official reduction of currency .
Exchange control: Government regulation of
exchange rate as well as restriction on the
conversion of local currency into foreign currency.
All exporters are asked to surrender their foreign
exchanges to the central bank. Then foreign
exchanges are rationed out to licensed importers.

 Non monetary measures

Import duties :
Quotas : is a situation where the
government determines a fixed
amount or quantity of goods to be
imported in specific period of time.

Expenditure changing
Expenditure adjusting policies are monetary and fiscal
tools. A restrictive monetary policy leads to a
reduction in investment and income, thus reducing
imports.
Operation twist short term rate of interest is raised to
attract short term capital from abroad which will cure
the bop deficit and does not disturb economic growth.
Fiscal policy may be very helpful for reducing
expenditure . Taxes may be raised . Both restrictive
monetary and fiscal policies are deflationary in
character and will stimulate exports and discourage
imports.

expenditure switching
polices
Aims at changing relative prices and
it includes variation in exchange
rate, exchange control, devaluation,
import control and export promotion.