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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 policy measures of direct action.

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• 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 consumption or national income.

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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 Credit Debit Net balance

1 Merchandise Export Import -

2 Foreign travel

Transportation

Insurance

Investment

Govt sales and purchase of goods and services

Miscellaneous

Earning

Earning

Receipts

Dividend

Receipt

Receipt

Payments

Payments

Payments

Dividend

Payment

Payment

-

-

-

-

-

-

Current account balance

- - Surplus (+)

Deficit (-)

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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 in balance.

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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.

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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 exportable surplus

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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 position.

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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.