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 Explanation of the balance of payments.

 current account and capital account and Reserve Account
 Causes and consequences of balance of payments
disequilibrium.
 Policy measures for correcting balance of payments
disequilibrium.

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 The balance of payments is a record of all economic
transactions between a country and the rest of the world for
a given time period, usually one year.

 This means each international transaction is recorded twice:

credit and debit
 Debit transactions – involves making of payments to
foreigners (-): import of goods and services, unilateral
transfers to foreigners and capital and financial outflow.
 Credit transactions – involves the receipts of payments from
foreigners (+) :-The export of goods and services, unilateral
transfers from foreigners and capital and financial inflows.
a. Currency inflows = credits. earn foreign exchange
b. Currency outflows = debits, pay foreign exchange

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 They are composed of the following:
◦ The Current Account
◦ The Capital Account
◦ The Official Reserve Account

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 The BOP provides detailed information about the supply
and demand of the country’s currency.

 Balance of payments accounts provide insights into the

country’s economic performance relative to the rest of
the world.

 Viewed over time, BOP data can shed light on important

developments in a country’s comparative advantage and
international competitiveness.

 Foreign trade helps a country to utilize its natural

resources and to export its surplus production.

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Current Account
 Records flows of exports, imports, investment income, and
international financial transfers.
◦ Merchandise trade – export and import of tangible goods
◦ Services – payments and receipts for legal and consulting fees,
royalties, tourist expenditures
◦ Investment income – payments and receipts of interest, dividends,
and other income on foreign investments
◦ Unilateral Transfers – “unrequited” payments (e.g. Foreign aid).
◦ The trade statistics in the Current Account, for example, show the
composition of trade – what a country imports and what it export
 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.

The current account Bops: it relates to real and short term

transactions. Transaction in the current account are called the real
transactions because they are concerned with actual transfer of goods
and services which affect income, output expenditure of the country.

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 Current Account: Balance of payments on
current account includes the value of imports
and exports of both visible and invisible
items. Current account transactions are called
account of actual transactions of import and
export of goods and services.

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The capital account

CA Bops deals with the financial transactions.

It includes all types of short term and long term
international movements of capital.
Records sales to foreigners of Indian financial assets and
Indian purchases of foreign financial assets.

Inflows = credits: Outflows = debits

 The capital account is composed of Foreign Direct Investment (FDI),

portfolio investments, and other investment.
◦ Direct investment involves acquisitions of controlling interests in foreign
businesses.
◦ Portfolio investment represents investment in foreign shares and bonds that
do not involve acquisitions of control.
◦ Other investment includes bank deposits, currency investment, trade credit
and the like. 8
 Capital Account: Capital accounts refers to
financial transactions. It mainly includes
foreign investment and external loans. All
kinds of short term and long term
international capital transfers, foreign debts,
foreign investments etc. are also included in
capital account.
The Capital Account shows inflows and outflows of
capital in various categories.

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The Reserve Account
 The Reserve Account of BOP records changes in the
amount of “official” reserve assets held by the Bank of
India.

 Official reserves assets include gold, foreign currencies,

reserve positions in the IMF.

 If a country must make net payment to foreigners

because of BOP deficit, the country could either run down
its official reserve assets or borrow anew from foreigners.

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 Overall Balance Of Payments: Total of a country’s
balance of payments on current account and
capital account is known as overall balance of
payments.

 The official reserve account, a subdivision of the

capital account, is the foreign currency and
securities held by the government, usually by its
central bank, and is used to balance

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 Favourable Balance of Payments: When receipts are
more than payments then balance of payments
turns favourable. This situation increases foreign
exchange reserves. It is also known as surplus
balance of payments.
 Unfavourable Balance of Payments: Balance of
payments is unfavourable when its payments are
more than its receipts. This situation reduces
foreign exchange reserves. It is also known as
deficit balance of payments.
 Import of machinery.
 More demand of consumption goods.
 Price disequilibrium.
 Foreign competition.
 Less growth in exports.
 Expenditure on foreign embassies.
 Gulf war.
 Import of war equipments.
 Promotion of exports.
 Increase in production.
 Trade agreements.
 Attraction to foreign tourists.
 Devaluation of Indian currency.
 Deflation.
 Import substitution.
 Setting up of special economic zones.
 Less consumption of crude oil.
 Increasing share of gross national product.
 Less percentage in world trade.
 Increase in volume and value of foreign trade.
 Change in the composition of exports.
 Change in the composition of imports.
 Direction of foreign trade.
 Balance of trade.
 Foreign trade by government.
 State control over foreign trade.