Chapter 14 - Balance of Payment - Chapter Notes, Macro Economics - Commerce PDF Download

BALANCE OF PAYMENT

MEANING :: Balance of payment refers to statement of accounts ( based on double entry system) recording all economic transaction of a given country with the Rest of the World in an accounting year .

It is statement of accounts of receipts and payments that causes transfer of value by the resident of one country to resident of another country .
It is prepared as per double entry system , Inflows of foreign exchange are recorded on the credit side and outflows on the debit side
BOP is a flow concept as it is related to a given period of time

(A) CURRENT ACCOUNT :: It is that account which records imports and exports of Goods & Services and Unilateral transfer during a given period of time.

COMPONENT’S OF CURRENT ACCOUNT

BOT = Export of goods - Import of Goods

These are called visible as these are made of some matter or material and thus can be touched , seen and measured.
INVISIBLES ITEMS :: These are the items which are not tangible and cannot be seen . Invisible items are classified into three groups

(2) EXPORT and IMPORT OF SERVICES ( INVISIBLE TRADE) :: It includes large variety of non - factor services ( like transportation, travelling, insurance , banking, shipping and tourism ) sold to and purchased by resident of a country with rest of the world

Balance of invisible Trade = Export of services - Import of Services

(3) UNILATERAL TRANSFERS :: These are one sided transfer from one country to another in forms of gifts , donations , personal remittance and other one way transaction

Since these transaction donot involve any claim of repayment , these are also known as “unrequitted receipts” .

It can be

Private Transfers which resident receive from or make to foreign resident. E.g An Indian in America sending money to his relative in India
Official Transfer :: Receipt of or Giving of foreign aid from developed countries or
to developing countries

(4) INCOMES :: Incomes are classified into

INVESTMENT INCOME :: It is in form of Rent , interest and dividend received from or paid due to investment done.
COMPENSATION OF EMPLOYEE :: It includes wages and salaries received from or paid to rest of the world
(B) CAPITAL ACCOUNT :: It is that account which records all such transaction between the ressident of a country and rest of the world which causes change in assets and liabilities status of resident of a country or government
Capital account donot involve the movement of goods and services between one country and rest of the world . It records only such transaction which relate to flow of foreign exchange between the countries
on account of change in ownership of assets [ Physical (land) assets or Financial assets (shares , debenture )
on account of loans / borrowings

COMPONENT’S OF CAPITAL ACCOUNT

(1) BORROWING AND LENDINGS :: It includes
(a) EXTERNAL COMMERCIAL BORROWING :: It refers to borrowing done at market rate of interest e.g Loan taken by Country ‘A’ from country ‘B’.
(b) EXTERNAL ASSISTANCE :: It refers to borrowing at concessional rate of interest e.g loan taken by India from World bank to remove problem of poverty
All transaction relating to borrowings from abroad by private sector , government and its agencies etc. like receipts of such loans and repayment of loans by foreigners are recorded on the positive (credit side)
All transaction of lending to abroad by private sector , government its agencies etc. like lending to abroad and repayment of loans to abroad are recorded on the negative (debit side)

(2) INVESTMENTS :: It includes
DIRECT INVESTMENT :: It refers to purchase of assets abroad along with the power to control them e.g Transfer of fund by Parent company to Subsidies company abroad to acquire assets or Purchase of house by individual abroad
 

It basically refers to as FDI ( foreign direct investment )

PORTFOLIO INVESTMENT :: It refers to purchase of assets without the power to control them e.g Purchase of share of foreign company by resident.

It basically refers to as FII ( foreign institution ivestors)

Investment by rest of the world in shares of India companies , real estate in India etc are recorded on the positive (credit side) as this result in inflow of foreign exchange Investment by Indian resident in shares of Foreign companies , real estate abroad etc. are recorded on the negative (debit side) as this result in outflow of foreign exchange

(3) MOVEMENT IN BANKING CAPITAL EXCEPT CENTRAL BANK :: It refers to foreign exchange transaction and investment in foreign currency by Indian Bank in foreign countries.

Inflow is shown at credit side and outflow is shown at debit side

(4) GOLD MOVEMENT :: It refers to sale and purchase of gold by Central bank

When Central bank of a country sells gold to abroad, it receives foreign exchange and hence sale of Gold is shown at credit side.
When Central bank of a country buys gold from abroad, it make payment and hence it is shown at debit side

(5) CHANGE IN FOREIGN EXCHANGE RESERVE OF COUNTRY :: The foreign exchange reserves are the financial assets of the goverment held in central bank. 

These transaction are carried by Government or Central Bank keeping in mind the international economic policy and thus results in change in Demand / Supply situation of foreign exchange

Decrease in Official reserve implies there is sale of Foreign Exchange which causes inflow of funds and hence it is shown as (+) credit item
Increase in Official reserve implies there is Purchase of Foreign Exchange which causes outflow of funds and hence it is shown as (-) debit item

(C) ERRORS AND OMISSIONS :: Due to a large number of transaction and of different variety , it is often not possible to record all of them with 100 percent accuracy.This errors and omissions are added as balancing items in BOP accounts.

_________________________________________________

CHECK YOUR CONCEPT’s

(Q1) Identify the following items as visible items or invisible items:
(i) Export of computer software. (ii) Import of LCD screen from Malaysia.
(iii) Banking service to NRI. (iv) Export of Tea to Thailand.
(v) Consultancy services of TCS used by a foreign firm.

(Q2) State the head under whihg following should be caterosied
(i) export of jute product (ii) Software services experts
(iii) borrowing from rest of the world (iv) lending to rest of the world

(Q3) State whether the following transactions will be recorded on debit or credit side of BOP.
(i) Loan from IMF to cover deficit of BOP.
(ii) Indian Government repays loan taken from IMF.
(iii) Purchase of shares of Infosys by a Japanese resident.
(iv) Export of Jute to Sri Lanka.
(v) Acquisition of a foreign company by Tata.
(vi) Purchase of toys from China.
(vii) Foreign investment (from abroad)
(viii) Payment for services.

(Q4) Classify the following transactions into current account or capital account.
(i) Purchase of shares of Reliance by Microsoft.
(ii) Imports of computer spare parts from Germany.
(iii) Borrowings from World Bank.
(iv) Repayment of loan by Indian Government taken from Japan.
(v) Gifts received from a relative in America.
(vi) Purchase of Land in England.
(vii) Shipping service by an Indian company to a foreign company.

(Ans. Current Account : (ii), (v), (vii). Capital Account : (i), (iii), (iv), (vi)).

(Q5) Classify the following transactions into current account or capital account and debit or
credit side of BOP ( CBSE 2013(C) )
(a) Investment from abroad
(b) transfer of fund to relative abroad

_______________________________________________

DOES BALANCE OF PAYMENT ALWAYS BALANCES

This question can be explained in two senses ::

(1) BOP IN ACCOUNTING SENSE :: The transaction are recorded in BOP account in double entry book keeping.Thus each transaction by the country will result in a credit entry ( + entry ) and debit entry of equal size (- entry). In this sense BOP accounting always balances.

(2) BOP IN OPERATIONAL SENSE :: From practical point of view, it is not possible that BOP will always be balanced . It may turned out be unbalanced ( Deficit or Surplus ) .This is also called ECONOMIC BALANCE .

However when current account is deficit it is balanced with the help of surplus of capital
account and vice-versa.
Lets take an example

(i) Balance of trade (X-M) is -250
(ii) Balance of Services (S) is 100
(iii) Balance of unilateral transfer (T) 20

Thus Balance of current account will be (X-M)+ S + T = -250 + 100 + 20 = -130 i.e deficit
In this case the govt may decide to borrow from IMF or World bank for Rs.130 . This will be the surplus balance of Capital account .This positive value actually represent country indebtness, obligation of country for another country.

AUTONOMOUS ITEMS VS. ACCOMMODATING ITEMS

DISEQUILIBRIUM IN BOP :: It is a state when all receipt of a country is not equal to all payment made of the country.It can be
SURPLUS BOP :: All receipt is greater than all payment i.e net balance is positive.
DEFICIT BOP :: All receipt is less than all payment i.e net balance is negative.

CAUSES OF DISEQUILIBRIUM

(1) ECONOMIC FACTORS ::
(i) Huge development expenditure by the govt. resulting in large scale import and thus causing deficit BOP
(ii) Business cycle in terms of recession and depression causes less export and more import and thus deficit in BOP
(iii) High rate of inflation compelling large scale imports of essential goods.This drives the economy towards deficit balance.
(iv) Change in cost structure of trading partners due to technological and managerial innovation , new sources of supply reduces cost and encourage export and result in surplus BOP disequilibrium

(2) POLITICAL FACTORS

(i) Political instability can cause less foreign capital inflow in form of direct and portfolio investment in the country
(ii) Populism policies of the govt. like import duty cut at times of election can cause huge import

(3) SOCIAL FACTORS

(i) Change in taste and preference across different parts of the world causes change in pattern in Demand .A favourable change might create surplus and a unfavourable change would generate deficit.
(ii) Cross- Broader tension sometimes force the countries to shift to expensive source of import and drive the country to deficit disequilibrium.