Balance of Payments

BoP
 Balance of Payments can be defined as a systematic
record of all economic transactions between the residents
of the reporting country and the residents of the rest of
the world, for a specified period of time.
 BoP is maintained as an accounting statement based on
the double-entry book-keeping. Transactions are
recorded as credits and debits. Foreign exchange receipts
are recorded as credits and the loss in the foreign
exchange is recorded as debits. If the credit entries are
more than the debit, country has a favorable balance. If
the debit entries are more than the credit, a country is
said to have an unfavorable or negative BoP situation.
 BoP
 The BoP consists of two accounts: Current and Capital.
Current account contains details of trade in merchandise and
services like travel, insurance and transfer payments (i.e.
payment made by the government in the nature of pension
funds etc). Such services are called invisibles. Under
“credits”, the current account gives details of goods and
services exported out of the country and under “debits” it
provides details of goods and services imported into the
country. The capital account records the transactions relating
to inflow and outflow of short and long-term capital. Short-
term capital instruments are those with maturity upto one year.
Long-term capital flows may be in the nature of portfolio
investment, direct investment (FDI), foreign institutional or
governmental loans.
 Current Account
I.A. goods, services, and income:
1.Merchandise
2. Shipment and other transportation
3. Travel
4. Investment income
5. Other official
6. Other private

B. Unrequited transfers:
1. Private
2. Officials
 Capital Account
II.C. Capital excluding reserves
1. Direct investment
2. Portfolio investment
3.Other long-term, official
4. Other long- term, Private
5. Other short- term, official
6. Other short – term, private
Reserves

III. D. Reserves
1. Monetary gold
2. Special Drawing Rights
3. IMF reserve position
4. Foreign Exchange assets
 Import proportion (in %)
45

40

35
petroleum, crude &
30 products
bulk consumption
25 goods
other bulk items
20
capital goods
15
mainly export related
10
items
5

0
1970-71 1980-81 1990-91 2004-05
 Export proportion (%)
80
70
agriculture & allied
60 products
ores & minerals
50
40 manufactured goods
30
minerals fuels
20
others
10
0
1970-71 1980-81 2004-05
 BoP in five year plans
300000

200000

100000

0
trade deficit
-100000 net invisibles
-200000 BoP

-300000

-400000
1st 2nd 3rd 4th 5th 6th 7th 8th 9th
plan plan plan plan plan plan plan plan plan
 In 10 five year plan
th

150000

100000

50000

0 trade deficit
net invisibles
-50000
BoP
-100000

-150000

-200000
2002-03 2003-04 2004-05
Countries with which India trade
 OPEC
 OECD
 Iran
(1)European union
 Indonesia
-France
 Saudi Arabia
-Belgium
 UAE
-Germany
 Eastern Europe
-UK
 Russia
-Italy
 Developing countries
(2) North America
 China
-Canada
 Hong-Kong
-USA
 South Korea
(3) Other OECD
 Malaysia
-Australia
 Sigapore
-Japan
 SAARC
-Switzerland
 Africa
 others
Direction of india’s exports

developing countries
euopean union
eastern europe
OPEC

other OECD
north america
Direction of india’s imports

developing countries

european union
eastern europe

OPEC
north america
other OECD
BoP equilibrium
 BoP equilibrium is a condition in which exports equal
imports on current account or official statement
account. The Balance of Payment as a whole must
show a final zero balance to be in equilibrium. A
country's BoP is a clear indication of its economic
position. BoP is an instrument through which the
government of a country can measure the economic
transactions of the country and can take appropriate
monetary and fiscal measures to achieve equilibrium
and to control the foreign exchange of the country.
 Causes and Types of Disequilibrium in
BoP
 Disequilibrium in BoP may not always refer to a situation in
which a country's credit is not equal to the debit. Even when the
credit is equal to the debit in an accounting sense, there may be
disequilibrium in the economy.
 The BoP can be denoted as:

B= C- D
 where, B denotes the BoP, C is credit and D is debit.
 When B is zero, the BoP is in equilibrium. A country's BoP is
favorable when B is positive when the total receipts exceed the
total payment. A country's BoP is unfavorable when the total
debit exceeds the total credit. Disequilibrium in BoP can occur
due to surplus or deficit in the BoP. Disequlibrium in BoP can be
of three types:
Types of Disequilibrium
Cyclical disequilibrium
Secular disequilibrium
Structural disequilibrium
Cyclical Disequilibrium
 Cyclical disequilibrium in BoP can arise due to
cyclical fluctuations in the BoP brought about by
changes in the trade cycle, stabilization policies
in various countries, and varying income and
price elasticities of exports and imports in
different countries. During a boom period,
income increases and so do imports whereas,
during a depression income decreases and also
the imports. When imports are more than exports
there is a deficit in the BoP and when exports are
more than imports there is a surplus in the BoP.
Secular Disequilibrium
 Secular disequilibrium is a result of long term
disequilibrium, due to continuous deep rooted dynamic
changes taking place in the country. During the early
stages of economic development, domestic investment
is more than domestic savings and imports are more
than exports. There is lack of funds to finance the
import surplus and this leads to a disequilibrium. In the
next stage, domestic savings are more than domestic
investments and exports are more than imports. Surplus
savings are more than investment opportunities abroad
and there is a disequilibrium. Later when domestic
savings is equal to domestic investment, long term
capital movements balance to become zero.
Structural Disequilibrium
Structural disequilibrium occurs when
structural changes takes place in some
sectors of the economy that alter the demand
and supply forces which influences the
import and export pattern in the country. For
example, when a substitute of jute is
available, the demand for jute may go down.
Change in taste, fashion, and income of the
people and economic progress also change
the import and export pattern of the country.
 Disequilibrium may also occur as a result of the
investments made by the government for developing the
economy. For faster economic development, large-scale
import of goods is necessary. This brings about structural
changes in the economy which affects its equilibrium in
BoP. An increase in income encourages people to
consume more. The excess demand for goods and
services increases the price. The increase in price
encourages the country to import and discourage export.
This may lead to deficit in BoP.
 Developed countries usually discourage imports from
developing countries. This adversely affects the BoP
situation in these countries. An increase in population
also adversely affects the BoP in a developing country.
 Measures to Correct Disequilibrium
 Measures to check the inflation can be broadly classified as
Monetary and non Monetary.
 Monetary measures include deflation, exchange rate
depreciation, devaluation and exchange control. 
 Deflation: Deflation can be defined as the reduction in the
quantity of money to reduce prices and incomes. Deflation of
currency results in reduction of prices of goods, leading to
growth in the exports.
 Exchange Rate Depreciation:
 Exchange rate depreciation reduces the value of the home
currency. This result in costlier imports and exports become
cheaper. Before taking the decision to devalue the currency,
government should analyze the elasticity of demand.
 Measures to Correct Disequilibrium
 Devaluation: Devaluation can be defined as the lowering of the
exchange value of the official currency. A clear distinction has to be
made between depreciation and devaluation. Depreciation, results
in lowering of the exchange rate due to market forces, whereas,
devaluation is lowering of exchange rates by governments.

 Exchange Control: Exchange control is the most effective way to

correct any disequilibrium in the BoP. All exporters are directed by
the monetary authority of the country to surrender their foreign
exchange earnings, and the total available foreign exchange is
rationed among the licensed importers. The license-holder can
import any good but the amount he can import is fixed by the
monetary authority of the country.
 Non-monetary measures
Non-monetary measures include tariffs,
import quotas and export promotion policies
and programs. Import duties are levied on
certain imported items so that the variations in
the price may not affect the BoP of the
country. In the quotas system, government
fixes the maximum quantify of the value of
goods and services that can be imported
during a particular period of time.
 EXCHANGE RATE POLICY 
 When countries of the world trade with each other, the
transactions are made through foreign exchange.
Foreign exchange is any currency issued by a foreign
government. It is used to pay for imported goods and
to meet foreign debt repayment obligations. In a
foreign exchange market, individuals, banks and other
institutions trade in currencies. The principal purpose
of the foreign exchange market is to transfer funds of
a particular currency and nation to another. This is
done mainly through commercial banks which act as
clearing houses by buying and selling foreign
currencies.
 India’s Balance of Payment and Trade
Policy
 In 1990s there were major changes in the BoP position of India. There was a major
BoP crisis in India in the early 1990s. As a result of the external shocks, India’s
foreign exchange reserves declined considerably in the 1980s. From $5.97 billion in
1985-86 it declined to $4.23 billion in 1988-89 and it further declined to $3.37 in
1989-90. There was a huge increase in the trade deficit. Current account deficit also
increased sharply.
 The reasons for the crisis were increased interest burden. Further, the Gulf war
resulted in sharp rise in the crude oil prices. The condition got worsened with the
outflow of deposits held by Non–resident Indians during 1990-91. Foreign exchange
reserves declined to a low of $0.9 billion in January 1991. The current account deficit
as a percent of GDP also increased to 3.24.
 Government’s initial response to the crisis was to cut the imports and control on
consumption of petroleum products. Various confidence building measures were
taken up by the new government. Currency was devalued. The rupee was partially
freed in February 1992. Import restrictions on capital goods, raw materials and
components were virtually eliminated. Moreover, the cash margins and interest
surcharge on import credit was abolished. As a result of these measures, international
community started regaining the faith in the Indian economy.
 Trade Policy
 The trade policy of India after independence was focused on self-
sufficiency over foreign trade. More emphasis was given to develop local
manufacturing. As India was isolated in the international trade, its share
in the international trade fell drastically in 1960s. In 1970s, the rise in the
oil prices made the situation worse. This trend continued till 1980s,
where the share of India in international trade was as low as 0.4 percent.

 Thelate 1980s, witnessed a change in the government policies, where the

emphasis on liberalization was felt. The 1991 economic reform package
gave a further fillip to the liberalization process. In the late 1990s, the
government continued with its liberalization policy and in 2001, to meet
WTO commitments, India eliminated import restrictions on more than
700 products ranging from automobiles to watches. India's foreign trade
in 2001 was 25% of the GDP (in rupee terms), up from 14.1 percent in
1990-91.