UNIT 2 Balance of Payments Accounts

Nehal Kapadia

Learning Objectives
Meaning & definition of BOP Introduce the Balance of Payments (BOP) Describe the sub-accounts of the BOP Consider the meaning of BOP imbalances Look at some sample BOP entries Disequilibrium in BOP Types of disequilibrium Causes & measures to correct disequilibrium
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Balance of Payments Accounts

A countrys balance of payments accounts keep track of both its payments to and its receipts from foreigners. Every international transaction automatically enters in the balance of payments twice: once as a credit (+) and once as a debit (-). Double-entry bookkeeping system. Every transaction has two entries: Payment = Debit (-) Receipt = Credit (+)

Definition
Balance of Payment is a systematic record of all economic transactions between the residents of the reporting country and residents of foreign countries during a given period of time. - Kindleberger

The Accounts of BOP

The International Monetary Fund (IMF) is the multinational organization that collects the BOP statistics for over 160 different countries around the globe. Following activities are considered in invisible trade: i) Travel ii) Insurance premiums & payments of claims iii) Investment income iv) Donations, grants, migrant remittances & legacies v) Miscellaneous services : advertising, film rentals, pensions, patent fees, royalties, subscriptions to periodicals & membership fees.
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Contents of BOP A/c

The BOP is comprised of two primary sub-accounts: Current Account (Real & short term transactions) Capital / Financial Account (Financial & long term transactions) Two additional and important sub-accounts of the BOP include: Official Reserves Account Net Errors and Omissions Account

Format of BOP Account

Credits (Receipts in crores)
Current A/C 1. Goods exported 2. Service exported 3. Inc. from investment in foreign country 1. Unilateral receipts 1. 2. 3. 100 150 150 200 600

Debits (Payments in crores)

Current A/C 1. Goods imported 2. Service imported 3. Payment for investments done by foreigners 1. Unilateral payments 1. 2. 3. Capital A/C Investment abroad Short term lending Long term lending Grand Total 200 100 300 200 800 100 100 200 400 1200

Capital A/C Foreign investment 100 Short term invest. 200 Long term borrowings 300 600 Grand Total 1200

Balance of Payments Accounts

The Current Account: Exports or imports of goods or services in the current account 1. Merchandise trade (Exports or imports of goods i.e. car, food, textiles etc) 2. Invisible trade (Services) Payments for legal assistance, tourists expenditures, and shipping fees 3. Income
4. International interest and dividend payments and the earnings of domestically owned firms operating
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BOP Accounts
The Capital Account (Transfers of wealth between
countries in the capital account)

The Financial Account (Purchases or sales of financial

assets in the financial account) Financial inflow (capital inflow) A loan from the foreigners with a promise that they will be repaid Financial outflow (capital outflow) A transaction involving the purchase of an asset from foreigners It measures the difference between sales of assets to foreigners and purchases of assets located abroad. Direct investment Portfolio investment Other asset investments

Official Reserves Account

This is the total currency and metallic reserves held by official monetary authorities within the country Its significance depends on whether the country is operating under:
A fixed exchange rate regime A floating exchange rate system

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Balance of Payments Accounts

Official Reserve Transactions

Central bank
The institution responsible for managing the supply of money

Official international reserves

Foreign assets held by central banks as a cushion against national economic misfortune

Official foreign exchange intervention

Central banks often buy or sell international reserves in private asset markets to affect macroeconomic conditions in their economies.
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Balance of Payments Accounts

The Fundamental Balance of Payments Identity
Any international transaction automatically gives rise to two offsetting entries in the balance of payments resulting in a fundamental identity: Current account (CA) + financial account (FA)+ capital account (KA) = 0
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Balance of Payments Accounts

Data associated with a given transaction may come from different sources that differ in coverage, accuracy, and timing.
This makes the balance of payments accounts seldom balance in practice. Account keepers force the two sides to balance by adding to the accounts a statistical discrepancy. It is very difficult to allocate this discrepancy among the current, capital, and financial accounts.
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Indias Balance of Payments Data

Credits Current Account Debits

1
2 3

Exports
Imports Unilateral Transfers Balance on Current Account

$1,418.64
($1,809.18) $10.24 ($64.39) ($444.69) $287.68 $474.39 $262.64 ($152.44) ($124.94) ($303.27)

Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account Statistical Discrepancies Overall Balance

$444.26
0.73 $0.30 ($0.30)

Official Reserve Account

Statistical Discrepancy
-Sampling Error financial, services trades data inaccuracies -Unrecorded interest/dividends unreported borrowing from abroad and other illegal activities -Timing Discrepancies -Black Markets CA + FA + KA + Stat. Dis. = 0 That is why, it is important to know fundamentals of BOP accounting.
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Fundamentals of BOP Accounting

The balance of payments must balance
Sub accounts may be imbalanced

Three main elements to the process of measuring international economic activity include:
Identifying what is and is not an international economic transaction Understanding how the flow of goods, services, assets, and money creates debits and credits to the overall BOP Understanding the bookkeeping procedures for BOP accounting
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BOT, BOP and Economic Crises

BOT relates to trade of visible goods BOP relates to the trade of visible as well as invisible goods. BOT is narrow concept. BOP is a wider. BOT is a part of BOP. BOT may be surplus or deficit. It may be imbalanced whereas BOP must always balance.

Economic crises
The sum of cross-border international economic activity can be used by international managers to forecast economic conditions and in some cases, the likelihood of economic crises The mechanics of international economic crises often follow a similar path of development
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BOP Equilibrium
In accounting sense, BOP must balance. Receipts = Payments (BOP = 0) In functional sense , there may be disequilibrium Receipts > Payments (BOP positive) Receipts < Payments (BOP negative)

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Types of Disequilibrium
1) Cyclical disequilibrium (Trade cycle : changes in income, employment, output & prices) 2) Structural disequilibrium (Changes in demand & supply) 3) Short term disequilibrium (Temporary due to borrowings or lending) 4) Long term/ Secular/ Fundamental disequilibrium (Changes in dynamic forces like population, capital formation, technological advancement, innovations) 5) Exchange rate disequilibrium (Changes in valuation of currency)

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Causes of Disequilibrium
Desire for rapid economic development Trade cycle Changing export demand Population growth Huge external borrowings Inflation Demonstration effect Reciprocal demand Neglects of export sector Natural calamities
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Measures to correct disequilibrium

Monetary (Indirect) measures 1. 2. 3. 4. Deflation Exchange depreciation Devaluation Exchange control Non-monetary (Direct)measures 1. 2. 3. 4. Tariffs Quotas Export promotion Import substitution

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