Balance of payments

A balance of payments (BOP) sheet is an accounting record of all

monetary transactions between a country and the rest of the world.
These transactions include payments for the country's exports and
imports of goods, services, and financial capital, as well as financial
transfers. The BOP summarises international transactions for a specific
period, usually a year, and is prepared in a single currency, typically the
domestic currency for the country concerned. Sources of funds for a
nation, such as exports or the receipts of loans and investments, are
recorded as positive or surplus items. Uses of funds, such as for imports
or to invest in foreign countries, are recorded as a negative or deficit
item.

Kindleberger says: “Balance of payments is a systematic record of all

economic transactions between the residents of the reporting country and
the residents of foreign countries during a given period of time”
In the words of Benham, ”Balance of payments of a country is a record
of the monetary transactions over a period with the rest of the world”

Balance of payments account has the following

features:
(a)It is a systematic record of all economic transactions between one
country and the rest of the world.
(b)It includes all the transactions visible as well as invisible.
(c)It relates to a period of time.Generally,it is an annual statement.
(d)In the accounting sense, total credits and debits in the balance of
payments statement always balance each other.
(e)When receipts are equal to payments, the balance of payments is in
equilibrium: when receipts are greater than payments,ther is surplus in
the balance of payments:when payments are greater than receipts,there
is deficit in the balance of payments.
Structure of balance of payment:-(1)current account
(2)capital account.
Current account
The balance of payments measures all flows of money between a country
and the rest of the world. The current account records the movements of
all goods and services into and out of the country. The capital account
measures all capital flows carried out by individuals, firms and
governments (usually for investment purposes).
The current Account:-The current account of balance of payments includes
the following iteams:-

1.Merchandise:-Export and imports of goods form the visible account and

have a dominant position in the curent account part of balance of
payments.Exports constitute the credit side and imports the debit side.

2.Government Transactios:-Government transactions refer to the

expenditure incurred by a government for the upkeep of its organisations
a broad.Such payments as are received by a government from abroad
constitute the credit iteam and made to other governments form form the
debit iteam.
3.Travel:-Travel is an invisible item in the balance of payments.travel may
be for reasons of business,education,health,international conventions or for
pleasures.Expenditure by foreign tourists in our country forms the credit
item and expenditure by our tourists abroad constitutes the debits item in
our balance of payment.

The capital account

The Capital account measures all the short term and long term monetary
transactions between a country and the rest of the world. Generally, these
flows of money are associated with saving and investment, but speculation
has become a big part of the account in recent years.
The main iteams of capital accounts are:-
(1)Private Loans:-Foreign loans received by the private sector is a credit
item and foreign loans repaid by the private sector is a debit item.
(2)Movement in Banking capital.Inflow of banking capital excluding the
central bank(credit iteam);and outflow of banking capital excluding the
central bank(debit iteam)
                   
  Statement 1 : INDIA'S OVERALL BALANCE OF PAYMENTS
  ( US $ million)
  April-June 2010 P April-June 2009 PR January-March
  Item Credit Debit Net Credit Debit Net Credit Debit
  1 2 3 4 5 6 7 8 9
  A.CURRENT ACCOUNT  
- -
34,19 25,63
  I. MERCHANDISE 53,726 87,920 4 39,164 64,799 5 52,419 83,91
20,46 21,18
  II.INVISIBLES (a+b+c) 42,725 22,263 2 37,616 16,435 1 42,845 24,35
10,05 10,37
  a) Services 26,116 16,059 7 21,322 10,949 3 26,942 18,89
  i) Travel 2,950 2,261 689 2,297 2,035 262 3,403 2,63
  ii) Transportation 3,097 3,134 -37 2,490 2,777 -287 3,100 3,57
  iii) Insurance 404 310 94 387 314 73 421 32
  iv) G.n.i.e. 94 143 -49 100 103 -3 116 15
10,32
  v) Miscellaneous 19,571 10,211 9,360 16,048 5,720 8 19,901 12,19
  of which  
12,08 10,61
  Software Services 12,655 575 0 11,004 391 3 14,297 30
- -
  Business Services 4,819 5,902 1,083 2,586 3,872 1,286 3,818 5,57
  Financial Services 1,228 1,404 -176 1,116 928 188 1,103 1,51
  Communication Services 325 241 84 418 312 106 245 38
13,05 12,87
  b) Transfers 13,754 700 4 13,344 470 4 13,216 64
  i) Official 59 115 -56 46 110 -64 126 14
13,11 12,93
  ii) Private 13,695 585 0 13,298 360 8 13,090 50
- -
  c) Income 2,855 5,504 2,649 2,950 5,016 2,066 2,686 4,81
- -
  i) Investment Income 2,628 5,042 2,414 2,723 4,665 1,942 2,455 4,32
  ii) Compensation of Employees 227 462 -235 227 351 -124 231 49
-
110,18 13,73 - 108,2
  Total Current Account (I+II) 96,451 3 2 76,780 81,234 4,454 95,264
                   
  B. CAPITAL ACCOUNT                
14,38
  1. Foreign Investment (a+b) 52,635 44,880 7,755 48,422 34,033 9 49,315 37,35
  a) Foreign Direct Investment (i+ii) 8,569 5,419 3,150 9,797 3,676 6,121 7,912 4,71
  i. In India 8,275 2,302 5,973 9,672 926 8,746 7,588 2,47
  Equity 5,991 2,278 3,713 7,290 900 6,390 5,353 1,51
  Reinvested Earnings 2,166 0 2,166 2,020 - 2,020 2,020
  Other Capital 118 24 94 362 26 336 215 96
- -
  ii. Abroad 294 3,117 2,823 125 2,750 2,625 324 2,24
 - -
  Equity 294 1,914 1,620 125 2,053 1,928 324 91
  Reinvested Earnings 0 271 -271 - 271 -271 - 27

  Other Capital 0 932 -932 - 426 -426 - 1,06

  b) Portfolio Investment 44,066 39,461 4,605 38,625 30,357 8,268 41,403 32,63
  In India 43,972 39,320 4,652 38,602 30,332 8,270 41,169 32,49
  of which FIIs 42,858 39,320 3,538 38,559 30,332 8,227 41,023 32,49
  ADRs/GDRs 1,114 - 1,114 43 - 43 146
  Abroad 94 141 -47 23 25 -2 234 14
10,58 -
  2.Loans (a+b+c) 24,696 14,110 6 12,920 14,746 1,826 24,439 18,47
  a) External Assistance 3,090 754 2,336 821 725 96 1,577 74
  i) By India 14 20 -6 13 105 -92 13 10
  ii) To India 3,076 734 2,342 808 620 188 1,565 63
  b) Commercial Borrowings (MT&LT) 4,521 1,850 2,671 1,973 2,432 -459 5,026 4,88
  i) By India 185 243 -58 244 333 -89 297 38
  ii) To India 4,336 1,607 2,729 1,729 2,099 -370 4,729 4,49
-
  c) Short Term to India 17,085 11,506 5,579 10,126 11,589 1,463 17,836 12,84
i) Suppliers' Credit >180days & Buyers'
  Credit 15,579 11,506 4,073 10,126 9,590 536 15,396 12,84
-
  ii) Suppliers' Credit up to180 days 1,506 - 1,506 - 1,999 1,999 2,440
-
  3. Banking Capital (a+b) 16,747 12,742 4,005 15,577 18,943 3,366 14,207 15,10
-
  a) Commercial Banks 16,745 12,718 4,027 15,577 18,704 3,127 14,195 15,10
-
  i) Assets 3,263 2,558 705 4,368 6,946 2,578 3,531 4,70
  ii) Liabilities 13,482 10,160 3,322 11,209 11,758 -549 10,664 10,39
  of which : Non-Resident Deposits 11,254 10,133 1,121 11,172 9,354 1,818 9,665 10,21
  b) Others 2 24 -22 - 239 -239 12
  4. Rupee Debt Service - 16 -16 - 23 -23 - 7
- -
  5. Other Capital 1,206 5,151 3,945 177 5,332 5,155 2,263 3,11
18,38
  Total Capital Account (1 to 5) 95,284 76,899 5 77,096 73,077 4,019 90,224 74,13
  C. Errors & Omissions - 912 -912 550 - 550 - 94
191,73 187,99 154,42 154,31 185,48 183,3
  D. Overall Balance 5 4 3,741 6 1 115 7
(Total Current Account, Capital
  Account                
  and Errors & Omissions (A+B+C))                
-
  E. Monetary Movements (i+ii) - 3,741 3,741 - 115 -115 - 2,14
  i) I.M.F. - - - - - - -
-
  ii) Foreign Exchange Reserves - 3,741 3,741 - 115 -115 - 2,14
  ( Increase - / Decrease +)                
  of which: SDR allocation - - - - - - -
  P : Preliminary. PR: Partially Revised.                
                   
                    
                   
                   
                   
                   
                   
                   

Why does the Balance of payment always Balances?

In the accounting sense, the balance of payments of a country is always in
equilibrium.The statement of balance of payments is prepared in terms of
credits and debits based on the system of double-entry-book-keeping.In the
double-entry system,each transaction gives rise to two equal entries;a credit
entry and a debit entry.Thus the sum of all credits equals the sum of all debits.

Current account balance + Capital account balance + net

errors and omissions = 0

Here errors and omissions simply reflect mistakes. Assuming no

mistakes are made, then the formula will look like this.

Current account + Capital account = 0, hence Current

account = Capital account.

In other words, if a country has a deficit on the current account

(more imports than exports) then it must have an equal and
opposite surplus on the capital account (and vice versa).

Disequilibrium in the balance of payments:-

Normally balance of payments of a country should be in equilibrium i.e

imports and exports or goods and services should be equal.But in reality
it is not so.Disequilibrium often arises in the balance of
payments.Balance of payments may be unfavourable when ther is excess
of imports over exports.The capital account is used to settle the
imbalance in the current account through changes in the international
flows of fund .

Ther are mainly four types of disequilibrium in the the balance of

payments

(a)cyclical disequilibrium:-cyclical disequilibrium is caused by countries

having different cyclical patterns of income, or the same income pattern
with different income elasticities or idenical income pattens and income
elasticities by different price elasticities.these factors bring changes in
the terms of trade as well as the volume of trade which causes a deficit
or surplus in the balance of payment

(b) Secular Disequilibrium:

Sometimes, the balance of payments diequilibrium persists fora long

time because of certain secular trends in the economy.For instance, in a
developed country, the disposable income isgenerally very high and,
therefore, the aggregate demand, too, isvery high. At the same time,
production costs are very highbecause of the higher wages. This
naturally results in higherprices. These two factors - high aggregate
demand and higherdomestic prices may result in the imports being much
higherthan the exports.

(c) Structural Disequilibrium:

Structual changes in the economy may also cause balance of

payments disequilibrium. Such structural changes include the
development of alternative sources of supply, the development
of better substitutes, the exhaustion of productive resources, the
changes in transport routes and costs, etc.
(d)Fundmental Disequilibrium:-The term fundamental
disequilibrium has been originally used by the I.M.F to indicate
a persistent, long tem disequilibrium in a countries balance of
payments .Fundamental disequilibrium is caused by such factors
as particularly lead to chronic deficit in the balance of payments.
IMPORTANCE OF BALANCE OF PAYMENT:-
 The BOP accounts provide an extremely useful data for the
economic analysis of the country’s weakness and strength
as a partner in international trade.
 BOP reveals the changes in the composition and magnitude
of foreign trade.
 BOP also provides indications of future repercussions of
country’s past trade performances. Given today's economic woes,
developing an understanding of macroeconomics is critical for the savvy trader.  Balance of
payments is one of the most important elements of understanding a nation's fiscal health and
its ability to acquire capital. The balance of payments data is very much like a cash flow
statement for an individual company.  Unlike the balance of trade, the balance of payments
reflects only how and by what degree capital is flowing in and out of a nation

The main causes of fundamental disequilibrium are

(1)Excessive internal demand for foreign goods. (2)poor
competitiv strength of the countrys exports in the world market,
(3)Excessive capital outflow.