Balance of Payments

Macro Economics

Reasons to Study International Trade

1. Due to globalization – we are moving towards a single global economy which have powerful economic influences on other economics through Trade Relations .

2. If U.S Economy grows or goes into recession affects the other economies.

3. If the industrial countries shift to fiscal stimulus or stringency makes a differences to U.S economy.

Balance of Payments

Balance of Payments:BOP is a systematic record of economic

transactions of the residents of a country with rest of the world during a given period of time.

Thus, the aim is to present an account of all receipts and payments on account of goods exported & goods imported by the residents of a country.

Balance of Trade

Balance of Trade: refers to the difference in value of imports & exports of commodities only.

◘ If imports & exports are exactly equal we have balanced trade.

◘ If value of exports exceeds value of imports we have favourable balance of trade.

◘ If value of imports exceeds value of exports, the country is said to have deficit or adverse balance of trade.

Balance of Payments Accounts

A country’s balance of payments accounts keep track of both its payments to and its receipts from foreigners.

Every international transaction automatically enters the balance of payments twice: once as a credit (+) and once as a debit (-).

Balance of Payments Accounts

Three types of international transactions are recorded in the balance of payments: Exports or imports of goods or services in

the current account Purchases or sales of financial assets in

the financial account Transfers of wealth between countries in

the capital account.

Balance of Payments Accounts The Current Account: The current account records trade in goods and services, as well

as transfer payments. It is divided into : Merchandise trade

Exports or imports of goods

Services Payments for legal assistance, tourists’ expenditures, and

shipping fees, royalty payments and interest payments.

Income International interest and dividend payments and the

earnings of domestically owned firms operating abroad Net Transfer PaymentsRemittances, gifts and grants

Balance of Payments Accounts The Capital AccountTrade balance simply records trade in goods, adding

trade in services and net transfer to the trade balance, we arrive at the current account balance

The Financial Account It measures the difference between sales of

assets to foreigners and purchases of assets located abroad. Financial inflow (capital inflow)

A loan from the foreigners with a promise that they will be repaid

Financial outflow (capital outflow) A transaction involving the purchase of an asset from

foreigners

Balance of Payments Accounts The simple rule for BOP accounting is that

any transaction that gives to a payment by a country’s resident is a deficit item in that country’s BOP eg gifts to foreign, a purchase of land in Spain, or a deposits in foreign banks.

Eg of surplus items would be sales of goods abroad, payments from foreign, pensions from abroad received by Indian residents, foreign purchases of Indian assets .

Capital Account The capital and financial account is that

balance of payments account in which all cross-border transactions involving financial assets are listed. This includes transactions between foreign and domestic residents, and foreign and domestic governments. All purchases or sales of assets, including:

Direct investment Securities (debt) Bank claims and liabilities Official reserves transactions When Indian citizens buy foreign securities or

when foreigners buy Indian securities, they are listed here as outflows and inflows, respectively.

Account Overview (Level 2)Current Account

Merchandise tradeexportsimportsTrade Balance

Servicesmilitary trans. (net)other services, netService Balance

Balance on goods & servicesInvestment income, net

Unilateral transfersUS government grantsUS govt pensions, and other transfersPrivate remittances and other transfersAll transfers, net

Balance on current account

Capital Account

Changes in US assets abroad, netother US govt assetsUS private assetsAll changes, net

Changes in foreign assets in the US,

net foreign private assetsAll changes, net

Changes in holdings of official international reserves, net

Statistical discrepancy

Balance on capital account

Current Account Surplus and Deficit

A current account surplus means exports of goods and services, investment income and transfers exceed imports and outflows.

A current account deficit means imports of goods and services, and outflows are greater than exports and inflows; must be financed by borrowing (capital account inflows).

Current Account Surplus and Deficit

Deficit in current account is financed by selling assets or borrowings abroad. This implies that the country should have a capital account surplus.

In short a current account deficit should be financed by an offsetting capital inflow.

BOP Surplus and Deficit (Continued)

In terms of the supply and demand of a nation’s currency, there is: A balance of payments surplus if quantity

demanded for a currency exceeds quantity supplied, putting upward pressure on the value of the nation’s currency.

A balance of payments deficit if quantity supplied of a currency exceeds quantity demanded, putting downward pressure on the value of the nation’s currency.

Exchange Rates

Exchange Rate is the price of a foreign currency in terms of a Domestic currency .

The market in which currencies are exchanged traded or converted is called “Foreign Exchange Market “

Floating or Flexible Exchange Rate

Since exchange rate is a price, its determination can be explained through demand for and supply of currencies. The system of exchange in which the value of a currency is allowed to adjust freely or to float as determined by demand for and supply of foreign exchange is called a flexible exchange system.

Fixed or Pegged Exchange Rate

If the exchange rate instead of being determined by demand for and supply of foreign exchange is fixed by the government, it is called the fixed exchange rate system, which prevailed under the Bretton Wood System , where exchange rates were pegged at a certain rate .

Appreciation of Currency

Appreciation of a currency is the increase in its value in terms of another foreign currency. For eg if the value of rupee interns of Us dollar increases from Rs 45.50to Rs 44 to a dollar, Indian rupee is said to appreciate. This indicates strengthening of the rupee.

Depreciation of Currency

If the value of Indian rupee interms of US dollars falls, say from Rs45.5 to Rs 46 to a dollar, the Indian rupee is said to depreciate which shows weakening of Indian rupee.

Devaluation and Revaluation of a Currency Devaluation is a reduction in the value of a

currency with respect to other monetary units. In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. In contrast, (currency) depreciation is used for the unofficial decrease in the exchange rate in a floating exchange rate system. The opposite of devaluation is called revaluation

Devaluation and Revaluation of a Currency

Revaluation This term is specially used as revaluation of a currency, where it means a rise of currency to the relation with a foreign currency in a fixed exchange rate. In floating exchange rate correct term would be appreciation.

Currency Convertibility By convertibility of a currency we mean

currency of a country can be freely converted into foreign exchange at market determined rate of exchange, that is, exchange rate as determined by demand for and supply of a currency. For eg, convertibility of rupee means that those who have foreign exchange ( eg US dollars, Pound Sterling etc ) can get them converted in rupee and vice-versa at the market determined exchange rate

Current Account and Capital Account Convertibility

A current may be convertible on current account (i.e exports, imports of visible and invisible items )

By Capital Account convertibility we mean that in respect t of capital flows, i.e flows of portfolio capital, direct investment flows, flows of borrowed funds and dividends and interest payable on them.

Current Account and Capital Account Convertibility

By convertibility of rupee on capital account means those who bring in foreign exchange for purchasing stocks, bonds in the Indian stock market, or for direct investment in power projects, highways, steel plant etc. can get them freely converted into rupees converted into us dollar.

The End

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