BALANCE OF BALANCE OF PAYMENTPAYMENT

When we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.

Group MembersGroup Members

Karan Desai - 33Karan Desai - 33

Vaibhav Aggarwal - 51Vaibhav Aggarwal - 51

George Joseph - 57George Joseph - 57

Dhruval Karia - 72Dhruval Karia - 72

BALANCE OF PAYMENTBALANCE OF PAYMENT::

The balance of payments of a country is a The balance of payments of a country is a systematic record of all systematic record of all economic transactionseconomic transactions between the between the residentsresidents of a country and the of a country and the rest of the world. It presents a classified rest of the world. It presents a classified record of all receipts on account of goods record of all receipts on account of goods exported, services rendered and capital exported, services rendered and capital received by residents and payments made by received by residents and payments made by theme on account of goods imported and theme on account of goods imported and services received from the capital transferred services received from the capital transferred to non-residents or foreigners.to non-residents or foreigners.

- - Reserve Bank of Reserve Bank of IndiaIndia

IMPORTANCE OF THE BALANCE IMPORTANCE OF THE BALANCE OF PAYMENTSOF PAYMENTS

BOP records all the transactions that BOP records all the transactions that create demand for and supply of a create demand for and supply of a currency. This indicates demand-supply currency. This indicates demand-supply equation of the currency. This can drive equation of the currency. This can drive changes in exchange rate of the currency changes in exchange rate of the currency with other currencies.with other currencies.

BOP may confirm trend in economy’s BOP may confirm trend in economy’s international trade and exchange rate of international trade and exchange rate of the currency. This may also indicate the currency. This may also indicate change or reversal in the trend.change or reversal in the trend.

This may indicate policy shift of the This may indicate policy shift of the monetary authority (RBI) of the country.monetary authority (RBI) of the country.

BOP may confirm trend in BOP may confirm trend in economy’s international trade and economy’s international trade and exchange rate of the currency. This exchange rate of the currency. This may also indicate change or may also indicate change or reversal in the trend.reversal in the trend.

This may indicate policy shift of the This may indicate policy shift of the monetary authority (RBI) of the monetary authority (RBI) of the country.country.

The General Rule in BOP The General Rule in BOP Accounting Accounting

a) If a transaction earns foreign a) If a transaction earns foreign currency for the nation, it is a credit currency for the nation, it is a credit and is recorded as a plus item.and is recorded as a plus item.

b)  If a transaction involves spending b)  If a transaction involves spending of foreign currency it is a debit and is of foreign currency it is a debit and is recorded as a negative item.recorded as a negative item.

The various components of a The various components of a BOP statementBOP statement

A.   Current AccountA.   Current Account B.   Capital AccountB.   Capital Account C.   IMFC.   IMF D.   SDR AllocationD.   SDR Allocation E.   Errors & OmissionsE.   Errors & Omissions F.   Reserves and Monetary GoldF.   Reserves and Monetary Gold

Current AccountCurrent Account

BOP on current account refers to the BOP on current account refers to the inclusion of three balances of namely – inclusion of three balances of namely – Merchandise balance, Services balance Merchandise balance, Services balance and Unilateral Transfer balance. In and Unilateral Transfer balance. In other words it reflects the net flow of other words it reflects the net flow of goods, services and unilateral transfers goods, services and unilateral transfers (gifts). The net value of the balances of (gifts). The net value of the balances of visible trade and of invisible trade and visible trade and of invisible trade and of unilateral transfers defines the of unilateral transfers defines the balance on current account.balance on current account.

Capital AccountCapital Account

The capital account records all The capital account records all international transactions that international transactions that involve a resident of the country involve a resident of the country concerned changing either his assets concerned changing either his assets with or his liabilities to a resident of with or his liabilities to a resident of another country. Transactions in the another country. Transactions in the capital account reflect a change in a capital account reflect a change in a stock – either assets or liabilities.stock – either assets or liabilities.

The Reserve AccountThe Reserve Account

Three accounts: IMF, SDR, & Reserve and Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Monetary Gold are collectively called as The Reserve Account.Reserve Account.

The IMF account contains purchases The IMF account contains purchases (credits) and re-purchase (debits) from (credits) and re-purchase (debits) from International Monetary Fund. Special International Monetary Fund. Special Drawing Rights (SDRs) are a reserve asset Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to created by IMF and allocated from time to time to member countries. It can be used to time to member countries. It can be used to settle international payments between settle international payments between monitary authorities of two different monitary authorities of two different countries. countries.

Errors and Omission.Errors and Omission.

This is a balancing item so that total This is a balancing item so that total credits & debits of the three accounts credits & debits of the three accounts must equal in accordance with must equal in accordance with principle of double entry book principle of double entry book keeping so that balance of payments keeping so that balance of payments always balances in the accounting always balances in the accounting sensesense

National Income Account and National Income Account and BOPBOP

Y = C + I + G + CAY = C + I + G + CA Y = GDPY = GDP C = consumptionC = consumption G = government spendingG = government spending CA = CA = current account balancecurrent account balance

This is called This is called National Income IdentityNational Income Identity

Current AccountCurrent Account

CA = X – M = CA = X – M = net export of goods andnet export of goods and

servicesservicesX = export; M = importX = export; M = import

Strictly speaking CA = X – M +UT but, Strictly speaking CA = X – M +UT but, for a while, we ignore UT = for a while, we ignore UT = unilateral unilateral transfertransfer

In a In a closed economyclosed economy, we do not have , we do not have CA. (because X = M = 0)CA. (because X = M = 0)

National Income AccountNational Income Account

Consumption Consumption = spending by households, including = spending by households, including

consumer spending on durable goodsconsumer spending on durable goods InvestmentInvestment = Business sector’s adding to the = Business sector’s adding to the physicalphysical

stock of capital, including inventories. stock of capital, including inventories. (individual household’s purchases of stocks, (individual household’s purchases of stocks, bonds or real estates are bonds or real estates are notnot included) included)

Government purchasesGovernment purchases = spending by federal, state, or local = spending by federal, state, or local

governmentsgovernments

Current account balance Current account balance

((Domestic spendingDomestic spending on goods and on goods and services produced domestically)services produced domestically)

= = C + I + G – MC + I + G – M ((Foreign spendingForeign spending on goods and on goods and

services produced domestically)services produced domestically)

= = XX

Current account balance Current account balance (cont’d)(cont’d)

CA = X – MCA = X – M When X > M or CA > 0, we say When X > M or CA > 0, we say

current account surpluscurrent account surplus.. When X < M or CA < 0, we say When X < M or CA < 0, we say

current account deficitcurrent account deficit.. CA = Y – (C + I + G) = Y – ACA = Y – (C + I + G) = Y – A

where A = where A = domestic absorptiondomestic absorption

Current account balance Current account balance (cont’d)(cont’d)

A country with A country with current account current account deficitdeficit is is buying more from buying more from foreigners than it sells to themforeigners than it sells to them

It has to increase It has to increase net foreign debtsnet foreign debts..

CA = CA = net foreign wealthnet foreign wealth US has been US has been a net debtora net debtor since since

1985.1985.

In 1998, debt = $5.5 trillionIn 1998, debt = $5.5 trillion

Saving and InvestmentSaving and Investment

Let S = national saving = Y – C – G.Let S = national saving = Y – C – G. Then Then

S = I + CAS = I + CA(In a closed economy (In a closed economy S = IS = I))

where where I = domestic investment = I = domestic investment = capital stock capital stock accumulationaccumulationCA = CA = foreign wealth acquisitionforeign wealth acquisition = net foreign = net foreign investmentinvestment

An open economy can increase investment by An open economy can increase investment by borrowing abroadborrowing abroad..

SavingSaving S = SS = SPP + S + SGG

where Swhere SPP = Y = Ydd – C = Y – T – C – C = Y – T – C SSGG = T – G = T – G

SSPP = private saving; S = private saving; SGG = government saving; = government saving;

YYdd = disposable income; T = net tax. = disposable income; T = net tax. Then SThen SPP = (C + I + G + CA) – T – C = (C + I + G + CA) – T – C = I + CA + (G - T) = I + CA + (G - T)

where G – T = government budget deficit.where G – T = government budget deficit. So CA = SSo CA = SPP – I – (G – T) – I – (G – T)A large gov’t budget deficit leads to a large A large gov’t budget deficit leads to a large

current account deficit.current account deficit.

Balance of Payment AccountsBalance of Payment Accounts

Double-entry bookkeepingDouble-entry bookkeeping

each entry is recorded twice.each entry is recorded twice. A A debitdebit entry entry a payment to a payment to

foreignersforeigners A A creditcredit entry entry a receipt from a receipt from

foreignersforeigners

Current Account (CA)Current Account (CA)the record of commodity and services transactionthe record of commodity and services transaction

A. A. ExportsExports (credit) (credit) B. B. ImportsImports (debit) (debit)

1. 1. MerchandiseMerchandise: commodity transaction: commodity transaction 2. 2. ServicesServices: travel, tourism, royalties, : travel, tourism, royalties,

transportation costs, insurance premiums.transportation costs, insurance premiums. 3. 3. IncomeIncome

Income receipts on US assets abroad (credit)Income receipts on US assets abroad (credit) Income payments on foreign assets in US (debit)Income payments on foreign assets in US (debit) Direct investment receipts and paymentsDirect investment receipts and payments Interest, dividends.Interest, dividends.

Current Account (cont’d)Current Account (cont’d)

C. C. Unilateral TransfersUnilateral Transfers (debit) (debit) US foreign aid, gifts, retirement pensions, US foreign aid, gifts, retirement pensions,

interest payments to foreigners on their US interest payments to foreigners on their US gov’t debt, workers’ remittances.gov’t debt, workers’ remittances.

CA > 0: CA > 0: current account surpluscurrent account surplus the country is a the country is a net lendernet lender to the rest of to the rest of worldworld

CA < 0: CA < 0: current account deficitcurrent account deficit the country is a the country is a net borrowernet borrower from the from the rest of worldrest of world

Capital Account (KA)Capital Account (KA)the record of financial assets transactionthe record of financial assets transaction

A. US assets abroadA. US assets abroad 1. US official reserve assets (Gold, SDR, 1. US official reserve assets (Gold, SDR,

reserve in IMF, foreign currencies)reserve in IMF, foreign currencies) 2. US gov’t assets2. US gov’t assets 3. US private assets (direct investment, foreign 3. US private assets (direct investment, foreign

securities)securities) B. Foreign assets in USB. Foreign assets in US

1. Foreign official assets in US (US gov’t 1. Foreign official assets in US (US gov’t securities, …)securities, …)

2. Other foreign assets in US (direct 2. Other foreign assets in US (direct investment, US treasury securities)investment, US treasury securities)

Example (a)Example (a)

An American buys a share of An American buys a share of German stock, paying by writing a German stock, paying by writing a $10,000 check on his account with a $10,000 check on his account with a Swiss Bank. Swiss Bank. Debit: US asset held abroad $10,000Debit: US asset held abroad $10,000 Credit: US asset held abroad $10,000.Credit: US asset held abroad $10,000.

For GermanyFor Germany Credit: Foreign asset held in GermanyCredit: Foreign asset held in Germany Debit: German asset held abroadDebit: German asset held abroad

Example (b)Example (b)

An American buys a share of German An American buys a share of German stock, paying the seller with a stock, paying the seller with a $10,000 check on an American bank.$10,000 check on an American bank. Debit: US asset held abroad Debit: US asset held abroad

$10,000$10,000 Credit: Foreign asset held in US $10,000Credit: Foreign asset held in US $10,000

Example (c)Example (c)

The French government carries out an The French government carries out an official foreign exchange intervention official foreign exchange intervention in which it uses dollars held in an in which it uses dollars held in an American bank to buy French currency American bank to buy French currency from its citizens.from its citizens. Debit: Foreign asset held in US $1 millionDebit: Foreign asset held in US $1 million Credit: Foreign asset held in US $1 millionCredit: Foreign asset held in US $1 million

(US official reserve asset)(US official reserve asset)

Official Reserve AssetsOfficial Reserve Assets

Official reserve assets: Official reserve assets: purchase or sale of purchase or sale of foreign assetsforeign assets held by the held by the

central bankcentral bank Official international reservesOfficial international reserves: gold, SDR, : gold, SDR,

foreign currencies, etc.foreign currencies, etc. (current account) + (non-reserve capital (current account) + (non-reserve capital

account) + (statistical discrepancy) account) + (statistical discrepancy)

= Balance of Payment= Balance of Payment ( (official settlementofficial settlement) )

Balance of PaymentBalance of Payment

Balance of PaymentBalance of Payment ( (official official settlementsettlement) )

= current account deficit needed to = current account deficit needed to be covered by the central bank’s be covered by the central bank’s official reserve transactions.official reserve transactions.

BOP deficitBOP deficit the country is the country is running running downdown its official reserves. its official reserves.

TRENDS IN INDIA’S BALANCE TRENDS IN INDIA’S BALANCE OF PAYMENTSOF PAYMENTS

A country, like India, which is on the A country, like India, which is on the path of development generally, path of development generally, experiences a deficit balance of experiences a deficit balance of payments situation.payments situation.

This is because such a country This is because such a country requires imported machines, requires imported machines, technology and capital equipments in technology and capital equipments in order to successfully launch and carry order to successfully launch and carry out the programme of industrialization out the programme of industrialization

FIRST PLANFIRST PLAN

During the first plan period, the During the first plan period, the balance of payments was affected by balance of payments was affected by the Korean War boom, American the Korean War boom, American recession of 1953 and favorable recession of 1953 and favorable monsoon at home which helped to monsoon at home which helped to boost agricultural and industrial boost agricultural and industrial production.production.

balance of payment during the first balance of payment during the first plan was only Rs. 42 crores. plan was only Rs. 42 crores.

SECOND PLAN SECOND PLAN

An important feature of the second An important feature of the second plan period was the heavy deficit in plan period was the heavy deficit in the balance of trade which the balance of trade which aggregated to Rs. 2339 crores. aggregated to Rs. 2339 crores.

The foreign exchange reserves The foreign exchange reserves sharply declined and the country was sharply declined and the country was left with no choice but to think of left with no choice but to think of ways and means to restrict imports ways and means to restrict imports and expand exports. and expand exports.

THIRD PLANTHIRD PLAN

The balance of current account was The balance of current account was unfavorable during the third plan .unfavorable during the third plan .

The serious adverse balance of The serious adverse balance of payments which started with the payments which started with the second plan continued relentlessly second plan continued relentlessly during the third and annual plans.during the third and annual plans.

Heavy amount had to be paid by Heavy amount had to be paid by India in the form of interest India in the form of interest payments on loans payments on loans

FOURTH PLANFOURTH PLAN

One of the objectives of the fourth One of the objectives of the fourth plan was self-reliance – i.e., import plan was self-reliance – i.e., import substitution of certain critical substitution of certain critical commodities on the one side and commodities on the one side and export promotion so as to match the export promotion so as to match the rising import bill, on the other rising import bill, on the other

Accordingly the government Accordingly the government managed to restrict imports and managed to restrict imports and succeeded in expanding exports. succeeded in expanding exports.

FIFTH PLANFIFTH PLAN

During the whole of the Fifth Plan India During the whole of the Fifth Plan India experienced a surplus balance of experienced a surplus balance of payments due to a sharp increase in the payments due to a sharp increase in the exports surplus on account of invisibles.exports surplus on account of invisibles.

From 1979-80 onwards, India started From 1979-80 onwards, India started experiencing very adverse balance of experiencing very adverse balance of payments. payments.

India had to meet this colossal deficit in India had to meet this colossal deficit in the current account through withdrawals the current account through withdrawals and borrowings from IMF .and borrowings from IMF .

SIXTH PLANSIXTH PLAN

The Sixth plan characterize the The Sixth plan characterize the balance of payments position acute. balance of payments position acute.

The annual average current account The annual average current account deficit was of the order of rs.2600 deficit was of the order of rs.2600 crores during the Sixth Plan.crores during the Sixth Plan.

During the Sixth Plan, the trade During the Sixth Plan, the trade deficit was 3.3 per cent of GDP and deficit was 3.3 per cent of GDP and current account deficit was 1.4 per current account deficit was 1.4 per cent of GDP. cent of GDP.

SEVENTH PLANSEVENTH PLAN

Exports performance substantially Exports performance substantially improved in the Seventh Plan with average improved in the Seventh Plan with average volume growth exceeding 7 per cent. volume growth exceeding 7 per cent.

The share of net invisible earnings in The share of net invisible earnings in financing trade deficit declines from 63 per financing trade deficit declines from 63 per cent during the Sixth Plan to 29.5 per cent cent during the Sixth Plan to 29.5 per cent during the Seventh Plan. during the Seventh Plan.

The average current account deficit as a The average current account deficit as a per cenr of GDP increased to 2.4 per cent per cenr of GDP increased to 2.4 per cent in the Seventh Plan.  in the Seventh Plan. 

DEVELOPMENT SINCE 1993-2010DEVELOPMENT SINCE 1993-2010

In the year 1993-94, India saw a In the year 1993-94, India saw a remarkable turnaround from a remarkable turnaround from a foreign-exchange constrained control foreign-exchange constrained control regime to a more open, market regime to a more open, market driven by liberalized economy.driven by liberalized economy.

During the last three years export During the last three years export earnings, on average, accounted for earnings, on average, accounted for nearly 90 per cent of the value of nearly 90 per cent of the value of imports imports

Exports recorded a growth of 20 per Exports recorded a growth of 20 per cent in dollar terms. The surplus on cent in dollar terms. The surplus on the invisible account doubled.the invisible account doubled.

Foreign currency reserves which Foreign currency reserves which were just $1205 million in 990 were just $1205 million in 990 reached the level of $19386 million reached the level of $19386 million in 1994.in 1994.

The economy thus moved to a more The economy thus moved to a more stable and sustainable balance of stable and sustainable balance of payments position.payments position.

India's Foreign Trade: 2005-06 (In US$ million)

(April, 2005-Oct. 2006)

Exports

2004-05 42200.62

2005-06 51516.87

Y-O-Y Growth 22.08

Imports

2004-05 56381.09

2005-06 75032.08

Y-O-Y Growth 33.08

Trade Balance

2004-05 -14180.47

2005-06 -23515.21

Source: Federal Ministry of Commerce, Govt. of India

India's Balance of Payments(2001-05)India's Balance of Payments(2001-05)US $ millionUS $ million

Items 2004-05 (P) 2003-04 2002-03 2001-02 2000-01 1990-91

Trade Balance -38,130 -15,454 -10,690 -11574 -12460 -9437

Invisibles, net 31,699 26,015 17,035 17,035 9,794 -243

Current Account Balance

-6,431 10,561 6,345 6,345 2,666 -9,680

Capital Account 32,175 20,542 10,840 10,840 8,840 7,056

Overall Balance 26159 31,421 16,985 16,985 5,868 -2,492

Foreign Exchange ReserveIncrease (+)/Decrease (-)

-26,159 -31,421 -16,985 -16,985 -5,842 1,278

 

Source: Reserve Bank of India Annual report (2004-05)

India's Foreign Trade (2004-05)India's Foreign Trade (2004-05)(In US $ million)(In US $ million)

  April, 2004-March, 2005

EXPORTS

2003-2004* 63978.78

2004-2005 79593.59

% Growth 24.41

IMPORTS

2003-2004* 78250.86

2004-2005 106121.18

% Growth 35.62

TRADE BALANCE

2003-04* -14272.08

2004-05 -26527.59

Source: Federal  Ministry  of  Commerce,  Government  of  India* Final figures as given by DGCI&S