Balance of Payments
The balance of payments is defined as a
systematic record of all economic transactions
between the residents of a country and residents
of foreign countries during a certain period of
time. Systematic record means the system
generally adopted is double entry book-keeping
system. Economic transaction include all such
transactions that involve the transfer of title or
ownership. While some transaction involve
physical transfer of goods, services, assets and
money along with the transfer of title
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Purpose
• First – the balance of payments accounts
provide extremely useful data for the economic
analysis of the country’s weakness and strength
as a partner in international trade.
• Second – balance of payments also reveals the
changes in the composition and magnitude of
foreign trade. The changes that are deterrent to
the economic well being of the country call for
necessary action by the government. For
example a regular outflow of capital or export of
essential goods causing scarcity; in the
domestic market needs to be curbed through
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policy measures of direct action.
• Third – balance of payment also provides
indications of future repercussions of country’s
past trade performances. If balance of
payments shows continuous and large trade
deficits over time, it shows the growing
international indebtedness of the country, which
may ultimately lead to financial bankruptcy.
• Finally – detailed balance of payments
accounts reveal also the weak and strong
points in the country’s foreign trade relations
and thereby invites government attention to the
need for corrective measures against the weak
spots and unhealthy developments.
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Balance of Payments Account
• The economic transactions between a country
and the rest of the world may be grouped under
two broad categories.
• Current transactions – pertain to export and
impost of goods and services that change the
current level of consumption in the country or
bring a change in the current level of national
(money) income.
• Capital transactions – are those which increase
or decrease a country’s total stock of capital,
instead of affecting the current level of
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consumption or national income.
Current Account
• The item which are entered in the current account of
the balance of payments are listed in table in the order
of their importance as suggested by the IMF and
currently followed in India. In the credit column are
entered the values receivable and in debt column the
values payable. The net balance shows the excess of
credit over the debit for each item : it may be negative
(-) or positive (+). The items listed in the current
account cab be further grouped as :
• Visible items – merchandise trade, i.e., export and
import of goods, fall under the visible items.
• Invisible items – all other items in the current account
payment and receipt for the services, such as banking,
insurance and shipping etc.
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Transactions
1 Merchandise
2 Foreign travel
Transportation
Insurance
Investment
Govt sales and
purchase of
goods and
services
Miscellaneous
Current account
Credit
Export
Earning
Earning
Receipts
Dividend
Receipt
Debit
Import
Payments
Payments
Payments
Dividend
Payment
Receipt
Payment
-
-
Net balance
-
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Surplus (+)
Capital Account
• Broad categories of capital account items are
• Short-term capital movements include (1) purchase of
short-term securities such as treasury bills,
commercial bills and acceptance bills, etc.;(2)
speculative purchase of foreign currency and (3) cash
balances held by foreigners for such reasons as fear
of war, political instability, etc.
• Long-term capital movements include: (1) direct
investments in shares, bonds and in real estate and
physical assets such as plants, buildings, equipments,
etc. (2) portfolio investments in stocks and bonds such
as governments securities, securities of firms not
entitling the holder with a controlling power and (3)
repurchase and resale of securities earlier sold to or
purchased from the foreigners.
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Balance of payments accounts are
always in balance
• The balance of payments accounting is based on the
double-entry book keeping system in which both sides
of a transaction – receipts and payments are
recorded. For example export involve outflow of goods
and inflow of foreign currency. Similarly, imports
involve inflow of goods and outflow of foreign
currency. Both inflow and outflow are recorded in this
system. However, donations, gift, aids, assistance,
etc., are unilateral transfers and do not involve transfer
of an equivalent value. In regard to these items, there
is only give, no take or there is only credit, no debit
since it is non-refundable. Since in this system of BOP
accounting international transactions are entered on
both debit and credit side, BOP accounts are always
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in balance.
Disequilibrium in balance of payment
• The BOP is always in balance also because, in the
accounting procedure, a deficit in the current account
is offset by a surplus on capital account. Balance of
payments remains always in balance. Such as it is
there should be no question of imbalance or
disequilibrium in the balance of payments. But
disequilibrium in the balance of payments does arise
because total receipts during the reference period
need not always necessarily be equal to the total
payment obligations of that period. When total receipts
do not match with total payment obligations of the
accounting period this is a positions of disequilibrium
in the balance of payments.
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Assessing the BOP
Disequilibrium
For the purpose of assessing the overall balance of
payment position of the country, the total receipts and
total payments arising out of transfer of goods and
services and long terms capital movements and all other
transactions are regrouped under the following two
categories: (a) autonomous transactions (b) induced
transactions
Autonomous transactions are those that take place on
their own due to people’s desire to consume more or to
make a large profit. For example exports and imports of
goods i.e., items of current account are undertaken with
a view to making profit or consuming more goods.10
On the other hand, the short-term
capital movements, gold
movements and accommodating
capital movements on account of
the autonomous transactions are
induced transactions. These
transactions lead to reduction in the
gold and foreign exchange reserve
of the country.
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Causes and kinds of BOP
Disequilibrium
• That disequilibrium of deficit nature arise when total imports
exceed total exports. But imports and exports are determined
themselves. The volume and value of imports and exports are
determined by a host of other factors. And, these factors
become the ultimate cause of BOP disequilibrium.
• As regards the determinants of imports, the total import of a
country depends on three factors. (1) internal demand for
foreign goods, which depends largely on the total purchasing
power of the residents of the importing country,(2) the relative
prices of imports and their domestic substitutes,(3) people’s
preference for foreign goods (4) price-elasticity of demand for
imports and (5) income-elasticity of imports. Similarly, total
export of a country depends on (1) foreign demand for its
goods, (2) competitiveness of its price and quality and (3) its
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exportable surplus
Price changes and Fundamental
Disequilibrium
• The change in the price level may be inflationary or
deflationary. Deflation normally causes a surplus in the
balance of payments, the balance of payment surplus
does not cause a serious concern form the surplus
country’s point of view. On the other hand, inflationary
changes in prices cause deficit in the balance of
payments. The BOP deficit results in increase
indebtedness, depletion of gold reserves, loss of
employment, distortions in the domestic economy and
cause other economy problem in the deficit countries.
We will therefore, discuss here only the impact of
inflationary price changes on the balance of payment
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position.
Business cycle and cyclical
Disequilibrium
• Business cycle are characterized by economics
ups and downs. The economics ups and downs
are often associated with inflationary rise or
deflationary decline in the general price level,
respectively.
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Structural changes and structural
Disequilibrium
• Structural changes in an economy are caused
by such factors as (1) depletion of the cheap
natural resources, (2) change in technology
with which a country is not in a position to keep
pace i.e., technology lag and (3) change in
consumers’ taste and preference. Such
changes cause inefficiency and high cost in the
exporting country and they found it difficult to
face the competition in the international market,
due to either high cost of production or lack of
foreign demands.
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