BALANCE OF

PAYMENTS

1
MEANING
 The balance of payments of a country is a systematic record of
all economic transactions between the residents of the
reporting country and residents of foreign countries during a
given period of time.

 It is a double entry system of record of all economic

transactions between the residents of the country and the rest
of the world carried out in a specific period of time when we
say “a country’s balance of payments” we are referring to the
transactions of its citizens and government.

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BALANCE OF PAYMENT :
DEFINITION

Definition by Reserve Bank of India:

 It presents a classified record of all receipts on account of
goods exported, services rendered and capital received by
residents and payments made by them on account of goods
imported and services received from the capital transferred to
non-residents or foreigners.

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FEATURES OF BALANCE OF PAYMENT
 It is a systematic record of all economic transactions between
one country and the rest of the world.

 It includes all transactions, visible as well as invisible.

 It relates to a period of time. Generally, it is an annual statement.

 It adopts a double-entry book-keeping system. It has two sides:

credit side and debit side.

 Receipts are recorded on the credit side and payments on the

debit side. 5
BALANCE OF TRADE
 It is the difference between a country's imports and its exports.

 Balance of trade is the largest component of a country's balance of

payments.

 Debit items include imports, foreign aid, domestic spending abroad.

 Credit items include exports, foreign spending in the domestic economy.

 When exports are greater than imports then the BOT is favourable and if
imports are greater than exports then it is unfavourable 6
BALANCE OF TRADE V/S BALANCE OF
PAYMENT
 The Balance of Payment takes into account all the
transaction with the rest of the worlds

 The Balance of Trade takes into account all the trade

transaction with the rest of the worlds

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BOP V/S BOT
Balance Of Payments Balance Of Trade

 It is a broad term.  It is a narrow term.

 It includes all transactions related to  It includes only visible items.
visible, invisible and capital  It can be favourable or unfavourable.
transfers.  BoT = Net Earning on Export - Net
 It is always balances itself. payment for Imports.
 BoP = Current Account + Capital  Following are main factors which
Account + Errors and omissions affect BoT
 Following are main factors which a) cost of production
affect BoP
b) availability of raw materials
a)Conditions of foreign lenders.
c) Exchange rate
b)Economic policy of Govt.
d) Prices of goods manufactured at
c) all the factors of BOT home 8
IMPORTANCE OF BALANCE OF
PAYMENTS
 BoP records all the transactions that create demand for and
supply of a foreign currency.
 It judges economic and financial status of a country in the
short-term
 BoP may confirm trend in economy’s international trade and
exchange rate of the currency. This may also indicate change
or reversal in the trend.
 This may indicate policy shift of the monetary authority (RBI)
of the country.
 BoP may confirm trend in economy’s international trade and9
exchange rate of the currency.
THE GENERAL RULE IN BOP
ACCOUNTING
 If a transaction earns foreign currency for the nation, it is a
credit and is recorded as a plus item.

 If a transaction involves spending of foreign currency it is a

debit and is recorded as a negative item.

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THE VARIOUS COMPONENTS OF A BOP
STATEMENT
 Current Account

 Capital Account

 Reserve Account

 Errors & Omissions

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CURRENT ACCOUNT
 BoP on current account is a statement of actual receipts and payments
in short period.

 It includes the value of export and imports of both visible and invisible
goods. There can be either surplus or deficit in current account.

 The current account includes: Export & Import of Goods and/or

services, Interests, Profits, Dividends and Unilateral receipts/payments
from/to abroad.

 BoP on current account refers to the inclusion of three balances of

namely – Merchandise balance, Services balance and Unilateral
Transfer balance
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CAPITAL ACCOUNT
 The capital account records all international transactions that
involve a resident of the country concerned changing either
assets with or liabilities to a resident of another country.
Transactions in the capital account reflect a change in either
assets or liabilities.

 It is difference between the receipts and payments on account

of capital account. It refers to all financial transactions.

 The capital account involves inflows and outflows relating to

investments, short term borrowings/lending, and medium
term to long term borrowing/lending. 13
 There can be surplus or deficit in capital account.

 It includes: Private foreign loan flow, Movement in

banking capital, Official capital transactions

 These are classified into following categories:

 Direct foreign investments
 Portfolio investments
 Other capital flows

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THE RESERVE ACCOUNT
 Reserve Accounts are owned by the central bank of the
country.

 These reserves are in the form of: Gold, foreign currencies like
US Dollar, Japanese Yen, SDR etc.

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ERRORS & OMISSIONS
 Sources of information used to prepare a BoP statement are varied,
namely central bank , institutions linked with external trade such as
Export and Imports (EXIM) bank, and custom authorities etc.

 A perfect coherence among these sources may not be possible. Thus, the
Errors and Omissions serves to bring about an equilibrium between
economic operation and their monetary counterparts.

 The entries under this head relate mainly to leads and lags in reporting of
transactions

 It is a balancing entry and is needed to offset the overstated or

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understated components.
DISEQUILIBRIUM IN THE BALANCE
OF PAYMENTS
 A disequilibrium in the balance of payment means its
condition of Surplus Or deficit

 A Surplus in the BoP occurs when Total Receipts exceeds

Total Payments.
Thus, BoP= CREDIT>DEBIT

 A Deficit in the BoP occurs when Total Payments exceeds

Total Receipts.
Thus, BoP= CREDIT<DEBIT
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CAUSES OF DISEQUILIBRIUM IN THE
BOP
 Some of the major important causes of deficit
(disequilibrium) in balance of payments are:

 Economic Factors
 Political Factors

 Social Factors.

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 ECONOMIC FACTORS
 Developmental activities:
 Developing countries depend on developed nations for supply of
machines, technology and other equipment. This leads to increased
levels of imports, thereby, resulting in a deficit in the BoP account.

 High rate of inflation:

 When there is inflation in the domestic economy, foreign goods become
relatively cheaper as compared to domestic goods. It increases imports
which causes a deficit in the BoP.

 Cyclical fluctuations:
 When the domestic economy is going through a phase of boom, then
domestic production may be unable to satisfy the domestic demand. It
leads to a deficit in BoP, due to increase in imports.

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 Change in Demand:
 Fall in demand for country’s goods in the foreign
markets leads to fall in exports and it adversely
affects the balance of payments.

 Import of Services:
 Underdeveloped countries import services from
developed countries for which, they have to pay huge
amounts of money. It leads to a deficit in the BoP.

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POLITICAL FACTORS
 Political Instability:
 Political instability may lead to large capital outflows and reduce
the inflows of foreign funds, thus, creating disequilibrium in the
BoP.

 Political disturbances:
 Frequent changes in the government, inadequate support to the
government in parliament also discourage inflows of capital. This
leads to a deficit due to higher outflows than inflows.

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SOCIAL FACTORS
 Demonstration Effect:
 When the people of underdeveloped countries come in contact
with those of advanced countries, they start adopting the foreign
pattern of consumption. Due to this reason, their imports increase
and it leads to an adverse balance of payments for
underdeveloped country.

 Change in tastes, preferences, fashion and trends:

 An unfavorable change for the domestic goods leads to a deficit
in the balance of payments.

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MEASURES TO CORRECT
DISEQUILIBRIUM IN THE BOP
 I. Monetary Measures
 a) Monetary Policy
 The monetary policy is concerned with money supply and credit
in the economy. The Central Bank may expand or contract the
money supply in the economy through appropriate measures
which will affect the prices.

 b) Fiscal Policy
 Fiscalpolicy is government's policy on income and expenditure.
Government incurs development and non - development
expenditure. It gets income through taxation and non - tax
sources. Depending upon the situation governments expenditure 23
may be increased or decreased.
 c) Exchange Rate Depreciation:
 By reducing the value of the domestic currency, government
can correct the disequilibrium in the BoP in the economy.
Exchange rate depreciation reduces the value of home
currency in relation to foreign currency. As a result, import
becomes costlier and export become cheaper. It also leads to
inflationary trends in the country.

 d) Deflation:
 Deflation is the reduction in the quantity of money to reduce
prices and incomes. In the domestic market, when the
currency is deflated, there is a decrease in the income of the
people. This puts curb on consumption and government can
increase exports and earn more foreign exchange.

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MEASURES TO CORRECT
DISEQUILIBRIUM IN THE BOP
 II. Non- Monetary measures
 a) Export Promotion:

To control export promotions the country may adopt measures to

stimulate exports like:
 Export duties may be reduced to boost exports
 Cash assistance, subsidies can be given to exporters to increase
exports
 Goods meant for exports can be exempted from all types of taxes.

 b) Import Substitutes:
 Steps may be taken to encourage the production of import substitutes.
This will save foreign exchange in the short run by replacing the use
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of imports by these import substitutes.
 c) Import Control:
 Import may be kept in check through the adoption of a wide variety
of measures like quotas and tariffs.

 Quotas – Under the quota system, the government may fix and
permit the maximum quantity or value of a commodity to be
imported during a given period. By restricting imports through the
quota system, the deficit is reduced and the balance of payments
position is improved.

 Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs

are imposed, the prices of imports would increase to the extent of
tariff. The increased prices will reduce the demand for imported
goods and at the same time promoting domestic producers to
produce more of import substitutes
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INDIA'S BALANCE OF PAYMENT
 A country, like India, which is on the path of
development generally, experiences a deficit balance of
payments situation.

 This is because such a country requires imported

machines, technology and capital equipment's in order to
successfully launch and carry out the programme of
industrialization

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 REASONS FOR POOR PERFORMANCE OF
INDIA’S EXPORT TRADE
 There are Several reasons for India’s Poor performance.

 I. Export Related Problems:

 High Prices :
 As compared to other Asian Countries the prices of Indian goods are
high. Prices are high due to documentation formalities, high
transaction costs & also to make higher profits.

 Poor Quality :
 Many Indian exporters do not give much importance to quality
control, so their products are of poor quality. Due to low quality many
times Indian goods are rejected & sent back to India by foreign 28
buyers.
 Poor Negotiation Skills :
 Indian exporters lack Negotiation Skills due to poor training in
Marketing. They fail to Convince & induce the foreign buyers to
place orders.

 InadequatePromotion :
 For Export Marketing, Promotion is important. Many Indian
Exporters do not give much importance to promotion. A good
number of Indian exporters are not professional in advertising &
Sales promotion. They do not take part in trade fairs & exhibitions.

 Poor follow-up of sales :

 Indian exporters are ineffective in providing after sales-service.
They do not bother to find out the reactions of buyers after sale.
This results in poor performance of India’s export trade.
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 II. General Causes:
 Good Domestic Market:
 Sellers find a ready market for their goods within the country, so
they do not take parts to get orders from overseas markets.

 Number of formalities:
 There are number of documentation & other formalities due to
which the some marketers do not enter the export field. So there is
a need to simplify formalities.

 Problem of Trading Blocs:

 Trading blocs reduce trade barriers on member nations, but they
impose trade barriers on non-members. As India is not a member of
some powerful trading blocs, it has to face some problems.
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 Negative Attitude:
 Some of the overseas buyers have a negative attitude towards
Indian goods. They feel that Indian goods are inferior goods.
Thus there is a need to correct this attitude.

 Poor Infrastructure:
 Indian infrastructure is poor. Indian exporters find it difficult
to get orders & also to deliver them at time.

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MAJOR ITEMS OF INDIA’S
BALANCE OF PAYMENTS

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Q.1. You are required to find out the overall balance, showing clearly all the sub
balances from the following data:
1. UC Corporation of the USA invests in India Rs.3,00,000 to modernize its
Indian Subsidiary.
2. A tourist from Egypt buys souvenirs worth Rs. 3,000 to carry with him. He
also pays hotel and travel bills of Rs. 5,000 to Delhi Tourist Agency.
3. The Indian Subsidiary of UC Corporation remits, as usual, Rs. 5,000 as
Dividends to its parent company in USA.
4. This Indian subsidiary of UC Corporation sells a part of its production in
other Asian Countries for Rs. 1,00,000.
5. The Indian Subsidiary borrows a sum of Rs. 2,00,000 (to be paid back in a
year’s time) from German money market to resolve its urgent liquidity
problem.
6.  

7. An Indian company buys a machine for Rs. 1,00,000 from Japan and 60%
payment is made immediately; the remaining amount is to be paid after 3
years.
8. An Indian subsidiary of French Company borrow Rs. 50,000 from the Indian 33
public to invest in its modernization programme.
Q.2. Prepare a BOP statement for USA from the following data:
1. US exports goods worth $ 5000

2. US import goods worth $ 4000

3. Expenditure of foreign tourist in US $ 2500

4. US makes interest and dividend payments to foreigners $ 2000

5. A US resident working in UK sends a cheque to his wife worth $

500
6. A Bangladesh immigrant working in US remits money to his
account in Dacca $ 1000
7. US telecom invests in India $ 4500

8. Toyota invests in US $ 2000 FDI

9. The US resident buys a German Treasury bond $ 300

10. A Swiss resident buys a US Treasury bond $ 5000

11. A short term loan advanced by Federal bank to a British resident $

4000 34
12. US borrows $ 3800 for short term.
Q.3. The following data is given below. Prepare BOP for India:
1. An exporter sells watches to Russia for Rs. 5,00,000. The exporter accepts Rs. 50,000 in
cash and remaining as a one-year bill of exchange.
2. Mohan, an Indian, goes to Sri Lanka on vacation with Rs. 2,000. He spent Rs. 1,000 on
services received and bought souvenirs for Rs. 900 to bring with him.
3. An Indian company import cloths worth Rs.5000 from Nepal.
4. Karim from Bangladesh immigrates to India with Rs. 1,000.
5. Karim finds a job and sends Rs. 1,500 to his family in Bangladesh.
6. ABC company of India decides to invest Rs. 6,00,000 in Mauritius to establish a business
unit. Half of this investment is made in cash; remaining half is arranged by selling bonds
in France.
7. Profit made by Mauritius subsidiary of the ABC Company is Rs. 20,000, of which 25% is
remitted to the parent company in India.
8. The Government of Sri Lanka issues bonds for Rs. 50,000 with an interest rate of 5%.
Indian buys 20% of these bonds.
9. An exporter, Madan, sells spare parts worth Rs. 25,000 to Colombia and receives
payment on delivery. An US exporter sells to India a process equipment for Rs.15,00,000.
10. The Government of Sri Lanka paid interest of 5% on its bonds.
11. Indian importer paid Rs. 2,500 to an English Shipping company as charges.
12. Karim sold some of his property in Bangladesh for Rs. 5,000. His family members paid35
Rs. 1,000 to Air India for travel and remaining amount, they brought in cash.