6 Bop

The Balance of Payments
 The Balance of Payment is the

summary of the flow of economic
transactions between the resident of a
country and the rest of the world.
 It measures the flow of international
payments and receipts
3-0
Principles of Valuation
 The transaction should be valued at market

price.
 Both Exports and Imports should be valued
at FOB basis.
 Foreign currency should be converted in to
the domestic currency at the prevailing
exchange rate.
3-1
The Balance of Payments
When all components of the BOP accounts are included
they must sum up to zero with no overall surplus or deficit.
For example, if a country is importing more than it exports,
its trade balance will be in deficit, but the shortfall will
have to be counterbalanced in other ways – such as by funds
earned from its foreign investments inflows, by running
down existing central bank reserves or by accepting loans
(with stringent conditionalities) from outside.
Balance of Payments :
Explanation of Disequilibrium
The Balance of Payments of a Country is said to be in equilibrium when
the demand for foreign exchange is exactly equivalent to the supply of
it. The BoP is in disequilibrium when there is a deficit. When there is a
deficit in the Balance of Payments, the demand for foreign exchange
exceeds the ACTUAL AVAILABILITY. A number of factors may cause
disequilibrium in the Balance of Payments. These various causes may be
broadly categorized into :
(a) Economic Factors
(b) Political Factors
(c) Sociological Factors

Balance of Payments :
Explanation of Disequilibrium
1. Economic Factors : A number of economic factors may cause disequilibrium in the BOP. These are :
(a) ‘Developmental’ Disequilibrium : Large-scale developmental expenditures usually increase the purchasing power,
aggregate demand and prices, resulting in substantially large imports. The development disequilibrium is common in
developing countries, because large-scale capital goods imports give rise to a deficit in the Balance of Payments.
(b) ‘Capital’ Disequilibrium : Cyclical fluctuations in general business activity are one of the prominent reasons for the
balance of payments disequilibrium. Depression always brings about a drastic shrinkage in world trade, while prosperity
stimulates it. A Country enjoying an economic boom experiences more rapid growth in its imports than its exports.
(c) ‘Secular’ Disequilibrium : Sometimes, the BoP disequilibrium persists for a long time because of certain secular
trends in the economy. The factors of high aggregate demand and high domestic prices (eg of petroleum and gold)
may result in imports being higher than exports. This could be one of the reasons for the persistent Balance of Payments
deficit of India.
(d) ‘Structural’ Disequilibrium : Structural changes in the economy may also cause Balance of Payments disequilibrium.
Such structural changes include the requirement of alternative sources of supply, enhanced consumer demand, the
exhaustion of productive resources, inefficient domestic manufacturing capabilities, excessive regulative mechanisms
and cost-overun.
2. Political Factors : Certain internal or external political factors may also produce a BoP disequilibrium. A country
plagued with political instability may experience large capital outflows, inadequacy of domestic investment, etc.
3. Social Factors : Sometimes social factors also influence the BoP. For instance a laidback attitude of the people,
excessive taxation regime, lack of incentives etc. will affect Volumes of Imports and Exports.
Principles of BoP Accounting
 Use of Double entry Book-keeping system
 Transactions that creates demand for domestic
currency in forex market are credited
 These transactions are result into source or receipt
of Foreign currency. i.e. Exports (+ sign)
 Transactions that increases supply of domestic
currency in forex market are debited
 These transactions are result into use or payment
of Foreign currency. i.e. Imports (- sign)
3-5
Examples of Transactions
 Credit Transactions (+ve):
 Provision of goods and services to non-residents
 Income receivable from non-residents
 A decrease in foreign financial assets
 An increase in foreign financial liabilities
 Debit Transactions (-ve):
 Purchase of goods & services from non-residents
 Income payable to non-residents
 An increase in foreign financial assets
 A decrease in foreign financial liabilities
Example
 1. Export of Goods USD 200 ml.
Bank B/s Abroad Dr. To Export of Goods A/c Cr.
 2. Import of Goods USD 150 ml.
Import of Goods A/c Dr To Bank B/s Abroad A/c Cr.
 3. 40 ml USD spent by foreign tourist in India
Bank B/s Abroad Dr. To Export of Services A/c Cr.
 4. 60 ml USD worth Goods received as Gift
Import of Goods A/c Dr To Unilateral Transfer A/c Cr.
 5. Export of Goods 80 ml USD by GOI
Official Reserve A/c Dr. To Export of Goods A/c Cr.
3-7
Balance of Payment
Credit (+) Debit (-) Balance
A. Current Account
1. Merchandise Trade 280 210 +70
2. Trade in Services 40 +40
3. Unilateral Transfer 60 +60
Current Account Balance 380 210 +170
B. Capital Account
Bank Balance Abroad 150 240 -90
C. Official Reserve Account 80 -80

3-8
FORMAT of BOP
3-9
Components of BOP
 Current Account
 Capital Account
 Official Reserve Account
3-10
Current Account
 Records all income related flows
 Trade in goods
Exports and Imports , Merchandise Trade

 Trade in services
Payments and Receipts for legal, consulting and

other services
 Factor Income
Interest, Dividends
 Unilateral Transfer
Gift, Donations and Scholarships

3-11
The
Current
Current
Account
Account
 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.
Capital Account
 Records all international purchase and

sale of Assets and wealth
 Foreign Direct Investment
 Portfolio Investment
EquitySecurities
Debt Securities
 Other Investment
3-13
Official Reserve Account
 Means of International Payments
 Gold
 Foreign Exchange
 Special Drawings Rights (SDR)
 B/s with IMF
 If Net Surplus in Current or Capital A/c, increase
in Official Reserve (Debit Entry)
 Any transaction appearing as credit entry in
current or capital a/c also appear as debit entry in
official reserve
3-14
Statistical Discrepancy
 There’s going to be some omissions and

misrecorded transactions—so we use a “plug”
figure to get things to balance.
 US BOP shows a discrepancy of $0.73 billion in
2000.
The Balance of Payments Identity
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,

BCA + BKA = 0
3-16
INDIA'S OVERALL BALANCE OF PAYMENTS
(US $ million)
Item/Year 2010-11 2011-12 2012-13
Credit Debit Net Credit Debit Net Credit Debit Net
1 2 3 4 5 6 7 8 9 10
A. Current Account
1. Merchandise 256159 383481 -127322 309774 499533 -189759 306581 502237 -195656
2. Invisibles (a+b+c) 190488 111218 79269 219229 107625 111604 224044 116551 107493
a) Services 124636 80555 44081 142325 78227 64098 145678 80763 64915
i) Travel 15793 11026 4768 18462 13762 4699 17999 11823 6176
ii)Transportation 14246 13880 366 18241 16382 1859 17334 14806 2528
iii) Insurance 1945 1400 545 2632 1497 1134 2227 1409 818
iv) G.n.i.e. 535 820 -285 478 780 -302 574 813 -239
v) Miscellaneous 92117 53430 38687 102513 45806 56707 107544 51912 55632
of which : Software services 53100 2194 50905 62212 1256 60957 65867 2363 63504
Business services 24050 27694 -3644 25910 26788 -878 28447 30349 -1902
Financial services 6508 7483 -975 5967 7984 -2018 4949 4633 316
Communication services 1562 1152 410 1600 1557 43 1686 741 945
b) Transfers 56265 3125 53140 66761 3267 63494 68090 4057 64034
i) Official 647 631 16 632 607 25 463 772 -309
ii) Private 55618 2494 53125 66129 2660 63469 67627 3285 64342
c) Income 9587 27538 -17952 10144 26131 -15988 10276 31731 -21455
i) Investment income 8471 25546 -17075 7676 24141 -16465 7202 29572 -22370
ii) Compensation of employees 1116 1992 -876 2468 1991 477 3074 2159 914
Total Current account (1+2) 446647 494700 -48053 529003 607158 -78155 530625 618788 -8816
INDIA’S BALANCE OF PAYMENTS POSITION 2013
BoP Position as on 31 March 2013
A Current Account (in Billion $) Earnings Spendings
1. Merchandise Exports 306.58
2. Merchandise Imports 502.34
3. BALANCE OF TRADE - 195.66

4. Invisibles (which include :-) 107.49
(a) Software Exports less Imports : 64.92
(b) Private Transfers less Income Outflow : 42.89
Total Current Account Deficit = - 88.16

INDIA’S CURRENT ACCOUNT DEFICIT
Points to Note
1. Current Account Deficit is 4.2 % of GDP.
2. Average BOT Deficit was running @ - 16.31 Billion $ / Month !
3. Share of Manufactured Goods & Engineering Goods in Exports was

only 41 %. This needs to expand @ 15-20 % every year over the
next 5 Years by a CCEA monitored strategy, if we have to quickly get
into the Safety Zone.
4. Petroleum Imports was $ 169.4 Billion $. Urgent need to give priority

to Oil & Gas Exploration & Production to cut down imports from the
present 80 % to < 50 % over the next 7 Years.
B BoP Position as on 31 March 2013
Capital Account (in Billion $) Earnings Spendings
1. FDI 19.82
2. Portfolio Investment (FII) 26.89
3. External Assistance 0.98
4. Commercial Borrowings 8.49
5. Suppliers Credits 21.66
6. Banking Capital (mainly NRI Deposits) 16.57
7. Other Capital Outflow - 5.05
8. Foreign Exchange Reserves Interventions - 3.83
9. Errors and Omissions 2.69
NET CAPITAL ACCOUNT 88.16
=
INDIA’S BALANCE OF PAYMENTS POSITION 2013:
Comments
1. India’s CAD Problem has been saved by the ‘Factors’ of Remittances

by Indians Working Abroad + Invisible Exports (Software, BPO etc). But these
Factors are reliable, only under favourable circumstances.
2. Tourism and Transit facilities Industry needs to be given a tremendous

‘Boost’ by quickly improving the Quality. Each State of ours must become
an International Tourist Destination with good connectivity.
3. We must not rely on FII inflows, as these are ‘volatile’ and not
available when there is ‘Stress’.
How to correct the Balance of Payment ?
 Earning more foreign exchange through

additional exports or reducing imports
 Quantitative changes in exports and imports
require FURTHER policy changes
 Such policy measures are in the form of
monetary, fiscal and non-monetary measures.
U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies 0.73
Overall Balance $0.30
Official Reserve Account ($0.30)
3-23
Credits Debits
Current Account In 2000, the
1 Exports $1,418.64
U.S. imported
2 Imports ($1,809.18)
more than it
Balance on Current Account ($444.69) exported, thus
Capital Account
running a
5 Portfolio Investment $474.39 ($124.94) current account
6 Other Investments
Balance on Capital Account
$262.64 ($303.27) deficit of
$444.26
7 Statistical Discrepancies 0.73 $444.69 billion.
3-24
Credits Debits During the same
Current Account
year, the U.S.
1 Exports $1,418.64
2 Imports ($1,809.18)
attracted net
3 Unilateral Transfers $10.24 ($64.39) investment of
Balance on Current Account ($444.69) $444.26
Capital Account
billion—clearly
5 Portfolio Investment $474.39 ($124.94) the rest of the
world found the
7 Statistical Discrepancies 0.73 U.S. to be a
good place to
invest.
3-25
Credits Debits
Current Account
1 Exports $1,418.64
Under a pure
2 Imports ($1,809.18)
flexible
3 Unilateral Transfers $10.24 ($64.39) exchange rate
Balance on Current Account ($444.69) regime, these
Capital Account
4 Direct Investment $287.68 ($152.44) numbers would
5 Portfolio Investment $474.39 ($124.94) balance each
other out.
3-26
Credits Debits
Current Account
1 Exports $1,418.64
In the real
2 Imports ($1,809.18)
world, there
3 Unilateral Transfers $10.24 ($64.39) is a statistical
Balance on Current Account ($444.69) discrepancy.
Capital Account
3-27
Credits Debits
Current Account
1 Exports $1,418.64
Including that,
2 Imports ($1,809.18)
the balance of
3 Unilateral Transfers $10.24 ($64.39) payments identity
Balance on Current Account ($444.69) should hold:
Capital Account
4 Direct Investment $287.68 ($152.44) BCA + BKA = – BRA
($444.69) + $444.26 + $0.73 = $0.30= –($0.30)
3-28
Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
6 Other Investments $262.64 ($303.27) D
Overall Balance $0.30 Q
3-29
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
As U.S. citizens import, they are supply dollars to the FOREX market.
3-30
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
As U.S. citizens export, others demand dollars at the FOREX market.
3-31
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
S1
Capital Account
As the U.S. government sells dollars, the supply of dollars increases.
3-32
Measures of external balance
US 2004-2013
3-33
India’s BOP
3-34
India BOP : Current a/c: Trends
3-35
INR Vs Other currencies
3-36
INR Vs USD
3-37
Balance of Payments Trends
 Since 1982 the U.S. has experienced continuous
deficits on the current account and continuous
surpluses on the capital account.
 During the same period, Japan has experienced the
opposite.
Balances on the Current (BCA) and Capital
(BKA) Accounts of the United States
U.S. Balance of Payments Trend: 1982-2004
800
Balance of Payments ($B)
600
400
200
U.S. BCA
0
U.S. BKA
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
-200
-400
-600
-800
Year
Source: IMF International Financial Statistics Yearbook, various issues

US BOP
 The current account deficits of U.S. may have
reflected a few reasons
 such as
 (I) a historically high real interest rate in the U.S.,
which is due to ballooning federal budget deficits,
that kept the dollar strong, and
 (ii) weak competitiveness of the U.S. industries.
3-40
US BOP
 U.S. capital account surplus may cause the
country’s current account deficit.
 Suppose foreigners find the U.S. a great place to
invest and send their capital to the U.S., resulting
in U.S. capital account surplus.
 This capital inflow will strengthen the dollar,
hurting the U.S. export and encouraging imports
from foreign countries, causing current account
deficits.
3-41
(BKA) Accounts of United Kingdom
40
30
20
10
0 UK BCA
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
-10 UK BKA
-20
-30
-40
-50

(BKA) Accounts of Japan
150
100
50
Japan BCA
0
Japan BKA
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
-50
-100
-150

JAPAN BOP
 Japan’s continuous current account surpluses may have
reflected a weak yen and high competitiveness of Japanese
industries.
 Massive capital exports by Japan prevented yen from
appreciating more than it did. At the same time,
foreigners’ exports to Japan were hampered by closed
nature of Japanese markets.
 Continuous current account surpluses disrupt free trade by
promoting protectionist sentiment in the deficit country.
 It is not desirable especially when it is brought about by
the mercantilist policies.
3-44
(BKA) Accounts of Germany
80
60
40
20
0 Germany BCA
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
-20 Germany BKA
-40
-60
-80
-100

(BKA) Accounts of China
60
50
40
30
China BCA
20
China BKA
10
0
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
-10
-20

Balance of Payments Trends
 Germany traditionally had current account
surpluses.
 Since 1991 Germany has been experiencing
current account deficits.
 This is largely due to German reunification and
the resultant need to absorb more output
domestically to rebuild the former East Germany.
 What matters is the nature and causes of the
disequilibrium.
Balances on the Current (BCA) Accounts
of Major Countries
3-48
Quiz Time
1. Define the balance of payments. Comment on India’s BOP.
2. Why would it be useful to examine a country’s balance of
payments data?
3. Explain official reserve assets and its major components.
4. The United States has experienced continuous current account
deficits since the early 1980s. What do you think are the main
causes for the deficits? What would be the consequences of
continuous U.S. current account deficits?
5. Comment on the following statement: “Since the U.S. imports
more than it exports, it is necessary for the U.S. to import
capital from foreign countries to finance its current account
deficits.”
3-49
Case Study
Mexico’s Balance-of
Payments Problem
3-50
My Observation
 Despite the fact that Mexico had experienced
continuous trade deficits until December 1994, the
country’s currency was not allowed to depreciate
for political reasons.
 The Mexican government did not want the peso
devaluation before the Presidential election held in
1994.
 If the Mexican peso had been allowed to gradually
depreciate against the major currencies, the peso
crisis could have been prevented.
3-51
Key Lessons
 The key lessons that can be derived from the peso crisis are: First, Mexico
depended too much on short-term foreign portfolio capital (which is easily
reversible) for its economic growth. The country perhaps should have saved
more domestically and depended more on long-term foreign capital. This can
be a valuable lesson for many developing countries.
 Second, the lack of reliable economic information was another contributing
factor to the peso crisis. The Salinas administration was reluctant to fully
disclose the true state of the Mexican economy. If investors had known that
Mexico was experiencing serious trade deficits and rapid depletion of foreign
exchange reserves, the peso might have been gradually depreciating, rather
than suddenly collapsed as it did.
 The transparent disclosure of economic data can help prevent the peso-type
crisis. Third, it is important to safeguard the world financial system from the
peso-type crisis. To this end, a multinational safety net needs to be in place to
contain the peso-type crisis in the early stage.
3-52

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The Balance of Payments

 The Balance of Payment is the

 The transaction should be valued at market

(b) Political Factors

(c) Sociological Factors

1. Merchandise Trade 280 210 +70

2. Trade in Services 40 +40

3. Unilateral Transfer 60 +60

Current Account Balance 380 210 +170

Bank Balance Abroad 150 240 -90

C. Official Reserve Account 80 -80

 Official Reserve Account

Exports and Imports , Merchandise Trade

Payments and Receipts for legal, consulting and

Gift, Donations and Scholarships

 Records all international purchase and

 There’s going to be some omissions and

Under a pure flexible exchange rate regime,

2. Merchandise Imports 502.34

3. BALANCE OF TRADE - 195.66

(a) Software Exports less Imports : 64.92

(b) Private Transfers less Income Outflow : 42.89

Total Current Account Deficit = - 88.16

1. Current Account Deficit is 4.2 % of GDP.

2. Average BOT Deficit was running @ - 16.31 Billion $ / Month !

3. Share of Manufactured Goods & Engineering Goods in Exports was

4. Petroleum Imports was $ 169.4 Billion $. Urgent need to give priority

1. India’s CAD Problem has been saved by the ‘Factors’ of Remittances

2. Tourism and Transit facilities Industry needs to be given a tremendous

 Earning more foreign exchange through

Source: IMF International Financial Statistics Yearbook, various issues

Source: IMF International Financial Statistics Yearbook, various issues

Source: IMF International Financial Statistics Yearbook, various issues

Source: IMF International Financial Statistics Yearbook, various issues

Source: IMF International Financial Statistics Yearbook, various issues

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