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BALANCE OF PAYMENTS
AND ITS IMPACT ON
INDIAN ECONOMY


















Submitted to, Submitted By,
Prof S. Rajitha Kumar, Ashish Kumar,
Associate Professor, Faculty of Finance, Roll No-12, M.B.A. Full Time 3
rd
Semester,
School of Management Studies, School of Management Studies,
Cochin University of Science and Technology. Cochin University of Science and Technology.



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1.0. BALANCE OF PAYMENTS
According to the famous economist BO SOUDERTON The Balance of Payment is merely a way of listing
Receipts and Payments in International Transaction for a Country.
Balance of Payments (BOP) is the systematic record of all economic transactions of an economy with the rest
of the World for a specific period. A countrys balance of payments is commonly defined as the systematic record of
all economic transactions between its residents to rest of world in a given period. Each transaction is recorded in
accordance with the principles of double-entry bookkeeping, meaning that the amount involved is entered on each of
the two sides of the balance-of-payments accounts. Consequently, the sums of the two sides of the complete balance-
of-payments accounts should always be the same, and in this sense the balance of payments always balances. The
Reserve Bank of India (RBI) is responsible for compilation and dissemination of BOP data. BOP is broadly consistent
with the guidelines contained in the BOP Manual of the International Monetary Fund.
Balance of payment (BOP) comprises of:
1. Current account.
2. Capital account.
3. Errors and omissions.
4. Changes in foreign exchange reserves.
Under current account of the BOP, transactions are classified into merchandise (exports and imports) and
invisibles. Invisible transactions are further classified into three categories, namely (a) Services-travel, transportation,
insurance, Government not included elsewhere (GNIE) and miscellaneous (such as, communication, construction,
financial, software, news agency, royalties, management and business services); (b) Income; and (c) Transfers (grants,
gifts, remittances, etc.) which do not have any quid pro quo.
The data on merchandise trade are available from two sources namely; (a) from the Directorate General of
Commercial Intelligence and Statistics (DGCI&S) on customs basis; and (b) from RBI on payments (which includes
both receipts and payments) basis. The Daily Trade Return (DTR) is the primary source of recording exports data at
DGCI&S, while RBI relies mainly on the R-return furnished by Authorized Dealers (Ads) to compile the exports and
imports data. The data on merchandise exports in BOP are compiled on the basis of information available from the
DGCI&S, after adjusting for time and exchange rate differences. The merchandise export data is recorded on free on
board (F.O.B.) basis. It may be noted that export of software in physical form is captured by DGCI&S.
Under the Capital Account, capital inflows can be classified by instrument (debt or equity) and maturity (short
or long-term). The main components of the capital account include foreign investment, loans and banking capital.
Foreign investment, comprising Foreign Direct Investment (FDI) and Portfolio Investment consisting of Foreign
Institutional Investors (FIIs) investment, American Depository Receipts/Global Depository Receipts (ADRs/GDRs)


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represents non-debt liabilities, while loans (external assistance, external commercial borrowings and trade credit) and
banking capital, including non-resident Indian (NRI) deposits are debt liabilities.
Under the Capital Account, both equity and debt flows are covered. Debt flows comprise commercial
borrowings, external assistance, short-term trade credits and Non-Resident Indian (NRI) deposits, while the equity
flows comprise Foreign Direct Investment (FDI) and Portfolio Investment. At present, direct investment into the
country by non-residents is freely allowed in most sectors subject to certain sectorial ceilings on equity holdings. The
FDI within the prescribed sectorial ceilings is freely allowed under RBI automatic route, FDI in restricted activities
and in excess of the prescribed sectorial ceilings requires prior Government approval through the Secretariat for
Industrial Assistance (SIA) and the Foreign Investment Promotion Board (FIPB). The non-resident FDI investors are
also allowed to raise their stakes through acquisition of shares. The portfolio investment consists of the amount raised
by Indian corporate through Global Depositary Receipts (GDRs) or American Depositary Receipts (ADRs),
investments in Indian stock markets by foreign institutional investors (FIIs) and high net worth individuals and
offshore funds.
The customs record data on imports on the basis of the Bill of Entry prepared for goods entering in the
customs area. The data on imports under BOP statistics are compiled mainly on the basis of returns submitted by Ads
supplemented by information on the transactions not passing through the banking channel such as imports financed
through credit taken abroad. Imports under the BOP data are recorded on the basis of date of payment or date of
disbursal of loans, which may differ significantly from the recording of imports at the Customs end on the basis of
actual arrival of goods.
The highlights of BOP developments during 2010-11 were higher exports, imports, invisibles, trade, CAD and
capital flows in absolute terms as compared to fiscal 2009-10. Both exports and imports showed substantial growth of
37.3 per cent and 26.8 per cent respectively in 2010-11 over the previous year. The trade deficit increased by 10.5 per
cent in 2010-11, over 2009-10. However, as a proportion of gross domestic product (GDP), it improved to 7.8 per cent
in 2010-11 (8.7 per cent in 2009-10). Net invisible balances showed improvement, registering a 5.8 per cent increase in
2010-11. The CAD widened to US$ 45.9 billion in 2010-11 from US$ 38.2 billion in 2009-10, but improved
marginally as a ratio of GDP to 2.7 per cent in 2010-11 via-a-via 2.8 per cent in 2009-10. Net capital flows at US$
62.0 billion in 2010-11 were higher by 20.1 per cent as against US$ 51.6 billion in 2009-10, mainly due to higher
inflows under ECBs, external assistance, short-term trade credit, NRI deposits, and bank capital. In 2010-11, the CAD
of US$ 45.9 billion was financed by the capital account surplus of US$ 62.0 billion and it resulted in accretion to
foreign exchange reserves to the tune of US$ 13.1 billion (US$ 13.4 billion in 2009-10).
During the first half (H1April-September 2011) of 2011-12, CAD in absolute terms was higher than in the
corresponding period of the previous year, mainly due to higher trade deficit. The net capital flows in absolute terms
were also higher during H1 of 2011-12 via-a-via the corresponding period of 2010-11. During 2010-11, exports
crossed the US$ 200 billion mark for the first time, increasing by 37.3 per cent from US$ 182.4 billion in 2009-10 to


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US$ 250.5 billion. This increase was largely driven by engineering goods, petroleum products, gems and jeweler, and
chemicals and related products.

1.1. INVISIBLES
The invisibles account of the BOP reflects the combined effect of transactions relating to international trade in
services, income associated with non-resident assets and liabilities, labor and property, and cross-border transfers,
mainly workers remittances. In 2010-11, there was a sharp increase in both exports and imports of services. Services
exports increased by 38.4 per cent from US$ 96.0 billion in 2009-10 to US$ 132.9 billion in 2010-11. Business
services increased by 113.3 per cent from US$ 11.3 billion in 2009-10 to US$ 24.8 billion in 2010-11 and financial
services by 75.7 per cent to US$ 6.5 billion in 2010-11 from US$ 3.7 billion in 2009-10. Receipts on account of
software services also witnessed a rise, mainly on account of improved efficiency and diversified export destinations.
Software receipts at US$ 55.5 billion, accounting for 41.8 per cent of total service receipts, showed an increase of 11.7
per cent in 2010-11 (7.3 per cent a year earlier). Software receipts were 12.4 per cent of total current receipts. Net
service exports increased to US$ 48.8 billion in 2010-11 from 36.0 billion in 2009-10, registering 35.5 per cent
increase. Private transfer receipts, comprising mainly remittances from Indians working overseas, also increased by 3.7
per cent to US$ 55.6 billion in 2010-11 from US$ 53.6 billion in the previous year.
Private transfer receipts constituted 12.4 per cent of current receipts (15.5 per cent in 2009-10). A modest
increase was observed in other categories of receipts (transportation, insurance, communication, and GNIE). Invisible
payments increased by 36.2 per cent from US$ 83.4 billion in 2009-10 to US$ 113.6 billion in 2010-11. The growth of
36.2 per cent in invisible payments outstripped the 21.3 per cent growth recorded in 2010-11. Increase in invisible
payments was mainly attributed to business services, financial services, travel, and investment income. Even though
the surplus on account of service-sector exports was significantly higher in 2010-11, growth in net receipts on account
of transfers was moderate and net outflow of investment income increased during the same period. As a result, the net
invisible balance (receipts minus payments) posted an increase of 5.5 per cent to US$ 84.6 billion in 2010-11 as
against US$ 80.0 billion in 2009-10. As a proportion of GDP, net invisible balance declined from 5.9 per cent in 2009-
10 to 5.0 per cent in 2010-11. At this level, the invisible surplus financed 64.8 per cent of trade deficit as against 67.7
per cent during 2009-10. During H1 of 2011-12, invisible receipts of invisibles, namely services, transfers, and
income, showed increase. Growth in exports of services moderated to 17.1 per cent during H1 of 2011-12 as against
32.7 per cent during H1 of 2010-11, while growth in imports was substantially lower at 1.0 per cent during H1 of
2011-12 as against 48.3 per cent during H1 of 2010-11. On net basis, the services surplus increased to US$ 31.1 billion
in H1 of 2011- 12 from US$ 21.5 billion in the corresponding period a year earlier. Investment income receipt declined
by 3.8 per cent to US$ 4.2 billion during H1 of 2011-12, while payments amounted to US$ 13.6 billion (US$ 12.2
billion a year earlier). Transfer receipts that primarily comprise personal transfers increased to US$ 32.3 billion during
H1 of 2011-12 (US$ 27.2 billion a year earlier). Recorded an increase in 17.4 percent, i.e., from US$ 106.0 billion via-


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a-via US$ 90.3 billion during the corresponding period of 2010-11. All broad categories Invisible payments of US$
53.0 billion during H1 of 2011-12 recorded an increase of 3.9 per cent over US$ 51.0 billion in H1 of 2010-11. Net
invisibles balance (receipts minus payments) recorded a 34.6 per cent increase to US$ 52.9 billion (5.8 per cent of
GDP) in H1 of 2011-12 from US$ 39.3 billion (5.1 per cent of GDP) in H1 of the previous year. At this level, the
invisibles surplus financed about 62.0 per cent of trade deficit during H1 of 2011, as against 57.0 per cent during the
same period a year earlier.
Goods and services deficit (i.e. trade balance plus services) decreased marginally to US$ 81.8 billion (4.9 per
cent of GDP) during 2010-11 as compared to US$ 82.2 billion (6.0 per cent of GDP) in 2009-10. In fiscal 2011-12, it
widened to US$ 54.7 billion up to H1 as compared to US$ 47.4 billion during the corresponding period a year earlier
on account of increase in trade deficit. However, as a ratio of GDP, it marginally declined to 6.0 per cent in 2011-12
(up to H1) from 6.1 per cent in 2010-11 (up to H1).
1.2. FOREIGN EXCHANGE RESERVES
Indias foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights
(SDRs), and reserve tranche position (RTP) in the International Monetary Fund (IMF). The level of foreign exchange
reserves is largely the outcome of the RBIs intervention in the foreign exchange market to smoothen exchange rate
volatility and valuation changes due to movement of the US dollar against other major currencies of the world. Foreign
exchange reserves are accumulated when there is absorption of the excess foreign exchange flows by the RBI through
intervention in the foreign exchange market, aid receipts, and interest receipts and funding from the International Bank
for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development
Association (IDA), etc. FCAs are maintained in major currencies like the US dollar, euro, pound sterling, Australian
dollar, and Japanese yen. Both the US dollar and euro are intervention currencies; however, reserves are denominated
and expressed in the US dollar only, which is the international for the purpose. The movement of the US dollar against
other currencies in which FCAs are held therefore impacts the level of reserves in US dollar terms. The level of
reserves declines when the US dollar appreciates against major international currencies and vice versa. The twin
objectives of safety and liquidity have been the guiding principles of foreign exchange reserves management in India
with return optimization being embedded strategy within this framework.
1.3. INDIAS FOREIGN EXCHANGE RESERVES
Beginning from a low level of US$ 5.8 billion at end March 1991, Indias foreign exchange reserves gradually
increased to US$ 25.2 billion by end March 1995, US$ 38.0 billion by end March 2000, US$ 113.0 billion by end
March 2004, and US$ 199.2 billion by end March 2007. The reserves stood at US$ 314.6 billion at end May 2008,
before declining to US$ 252.0 billion at the end of March 2009. The decline in reserves in 2008-09 was inter alia
fallout of the global crisis and strengthening of the US dollar via- via other international currencies. During 2009-10,
the level of foreign exchange reserves increased to US$ 279.1 billion at end March 2010, mainly on account of


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valuation gain as the US dollar depreciated against most of the major international currencies. In fiscal 2010-11,
foreign exchange reserves have shown an increasing trend and reached US$ 304.8 billion at end March 2011, up by
US$ 25.7 billion from the US$ 279.1 billion level at end March 2010. Of the total increase in reserves, US$ 12.6
billion was on account of valuation gains arising out of depreciation of the US dollar against major currencies and the
balance US$ 13.1 billion were on BOP basis. In 2011-12, the reserves increased by US$ 6.7 billion from US$ 304.8
billion at end March 2011 to US$ 311.5 billion at end September 2011.
Out of this total increase, US$ 5.7 billion was on BOP basis and the balance US$ 1.0 billion was on account of
valuation effect. In the current fiscal, on month-on-month basis, the foreign exchange reserves have shown twin trends.
The reserves reached an all-time high level of US$ 322.0 billion at end August 2011. However, they declined to US$
311.5 billion at end September 2011 before increasing to US$ 316.2 billion at end October 2011. In the months of
November and December 2011, reserves again showed a declining trend. At end December 2011, they stood at US$
296.7 billion, indicating a decline of US$ 8.1 billion from US$ 304.8 billion at end March 2011. The decline in
reserves is partly due to intervention by the RBI to stem the slide of the rupee against the US dollar. This level of
reserves provides about eight months of import cover.

1.4. ERRORS AND OMISSIONS
When all actual balance of payments entries are totaled, the resulting balance will almost inevitably show a net
credit or a net debit. That balance is the result of errors and omissions in compilation of statements. Some of the errors
and omissions may be related to recommendations for practical approximation to principles. In balance of payments,
the standard practice is to show separately an item for net errors and omissions. Labeled by some compilers as a
balancing item or statistical discrepancy, that item is intended as an offset to the overstatement or understatement of
the recorded components.
1.5. EQUILIBRIUM IN BOP
When demand for and supply of foreign currency in a nation in a given period is equal it is viewed as
equilibrium position in BOP.
But in case of most of nations, it is not so i.e. They either enjoy a surplus BOP or deficit. It represents
disequilibrium in BOP.
Two forms of Disequilibrium.
A): Unfavorable balance of payment-Balance of payment is unfavorable when the payment (import) of the
country is more than its receipts (export).
B): Favorable balance of payment-Balance of payment is favorable when the receipts (export) of the country
are more than its payment (import).



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1.6. CAUSES FOR DISEQUILIBRIUM.
Disequilibrium in BOP is caused by:
Economic Factors.
Natural factors
Population explosion
Foreign capital investment
Demonstration effect
Political Factor.
Social Factor.
Economic Factors may cause
1) Development Disequilibrium
2) Cyclical Disequilibrium
3) Secular disequilibrium and
4) Structural Disequilibrium
1. Development Disequilibrium Developing countries mostly take up activities like establishment of industries,
infrastructure etc. which require greater imports of capital goods, machinery etc. In addition it also shoots up imports
of consumer goods on account of increase in per capita income and aggregate demands. Thus increased developmental
activities result in greater outflow of foreign currency leading to deficit in BOP.
2. Cyclical Disequilibrium It occurs due to business cycles. The cyclical changes cause disequilibrium in the balance
of payment. When prices rise during prosperity and fall during depression, the country which has highly elastic
demand or imports faces a fall in the value of imports and if it counties its exports it will have a surplus in the BOP and
vice versa.
3. Secular Disequilibrium it mostly happens in developed countries where disposable income of people is very high. It
raises in turn the cost of production and price of goods and services. Consequently, developed countries prefer to
outsource goods and services from other countries where quality of goods is high and cost of production is low. It may
lead to secular disequilibrium in BOP of nation.
4. Structural Disequilibrium Sometimes notable shift comes in nature of economy of countries e.g. from agriculture to
Services. These may call for structural changes in developing alternative items, sources of supply, and changes in
transport Channels and also costs. These structural changes may enhance imports of capital goods and consumer goods
resulting in deficits in BOP.



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Indias BOP Disequilibrium due to Structural Changes
Between 1999-2000 & 2000-2001, structural changes in Indias economy increased POL imports from $ 5.64 b to
$ 9.77 b; electronic goods from $ 1.47 b to $ 2.05 b etc.
Natural factors
Sometimes due to natural and other factors, industrial and agricultural production in the country falls. Consequently
exports of fall and if import are not cut off , BOP becomes adverse.
Population Explosion
In the underdeveloped country aggregate consumption demand increases due to rapid increase in population. As a
result of this export surplus falls down
Foreign capital investment flow.
When a country induced by profit motive makes large capital investment in the foreign countries then then this capital
out flow has an adverse effect on bop capital expenditure.
Demonstration effect.
Nurkse opined that people of under developed countries try to imitate the consumption pattern of the people of the
developed country. So their import increases very much and cause disequilibrium in BOP.
Political Factors
Political uncertainties, instability, internal disturbances, external wars etc. create threatening situation for local industry
and investments. In such cases domestic production declines leading to increase in imports and outflow of capital
It results in deficit in BOP as it happened in Sri Lanka, Pakistan etc.
Social Factors
Changes in culture, taste, preference, fashion etc. bring about changes in nature of import of consumer items first,
followed by capital goods leading to deficit in BOP.
Correction of BOP Disequilibrium When BOP becomes surplus, nations enjoy the same as it offers a number of
desirable situation like increased purchasing power and influence in global market. In cases of disequilibrium due to
deficit, countries adopt measures to eliminate the same completely, if not possible at least reduce it.











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IMPACT OF BOP IN INDIAN ECONOMY
Global economy have impacted the Indian economy causing drop in growth, higher current account deficit (CAD) and
declining capital inflows. During 2011-12, Current Account Deficit in absolute terms (`3760 billion) was higher than
in 2010-11(`2101 billion). The widening of Indias CAD during 2011-12 reflects the impact of growth asymmetry
between India and the rest of the world. Indias export and import growth momentum, gained in 2010-
11, continued during 2011-12. This is mainly due to higher trade deficit of`3165 billion in 2011-12 as compared to
2010-11.
Inward FDI and outward FDI are showing a declining trend in 2011-12 vis2010-11. Inward FDI declined from `13159
billion in 2011-12 to 11212 billion in 2010-11. The gross capital inflow (`3190) in 2011-12 has increased by 12.6 %
(From `2833 billion) in 2010-11. The net capital flows in absolute terms were also higher during 2011-12 vis-a-vis the
corresponding period of 2010-11
During 2011-12, large net capital amount inflows (`3190 billion) is higher than net capital amount inflows in 2010-11
(`2833 billion). It is mainly on account of higher Non-Resident Deposits of `710 billion in 2011-12 as compared to`
220 billion in 2010-11.
Portfolio investment witness net inflow of `1394 billion in 2010-11 as against a net inflow of `856 billion in 2011-12.
During 2011-12, India has taken maximum loan of `162 billion from Japan, Followed by`155 billion from International
Bank for Reconstruction and Development (IBRD) and `114 billion from International Development Association
(IDA). During the same period a loan of `.107 billion has also been taken. Whereas in 2010-11 India has taken loan
around 49.2% of total loan from International Development Association (IDA), followed by International Bank for
Reconstruction and Development (IBRD) (24.8%) and then Asian Development Bank (ADB) (21.1%). During the
same period i.e. in 2011-12, in India, only 53% of fund from Japan has been utilized. Out of total utilized funds 23%
are from Japan, 2 3 % % from International Development Association (IDA), followed by 20 % are from Asian
Development Bank (ADB).