CHAPTER – 14. STRUCTURE OF BALANCE OF PAYMENTS & DISEQUILIBRIUM IN BOP

Q. 1: Explain the Structure of Balance of Payments.                           OR

Write note on India’s Balance of Trade.

Ans. A) STRUCTURE OF BALANCE OF PAYMENTS:-The Balance of Payment (BOP) of a country is a systematic account of all economic

transactions between a country and the rest of the world, undertaken during a specific period of time. BOP is the difference between all receipts from foreign countries and all payments to foreign countries. If the receipts exceed payments, then a country is said to have favourable BOP, and vice versa.

According to Charles Kindle Berger "The BOP of a country is a systematic recording of all economic transactions between residents of that country and the rest of the world during a given period of time".

The Balance of payments record is maintained in a standard double - entry book - keeping method. International transactions enter into record as credit or debit. The payments received from foreign countries enter as credit and payments made to other countries as debit. The following table shows the elements of BOP.

BALANCE OF PAYMENTS ACCOUNT

Receipts (Credits) Payments (Debits)

1.    Export of goods. Imports of goods.

Trade Account Balance

2.       Export of services.3.       Interest, profit and dividends         received.4.    Unilateral receipts.

    Import of services.    Interest, profit and dividends paid.

Unilateral payments.

Current Account Balance (1 to 4)

5.    Foreign investments.6.    Short term borrowings.7.    Medium and long term borrowing.

Investments abroad.

Short term lending.

Medium and long term lending.

Capital Account Balance (5 to 7)

8.    Errors and omissions.9.    Change in reserves. (+)

     Errors and omissions.     Change in reserve (-)    

                          Total Reciepts                          =             Total Payments 

              Total payments.

1.             Trade Balance :-

Trade balance is the difference between export and import of goods, usually referred as visible or tangible items. If the exports are more than imports, there will be trade surplus and if imports are more than exports, there will be trade deficit. Developing countries have most of the time suffered a deficit in their balance of payments. The trade balance forms a part of current account. In 2008-09, trade deficit of India was 118.6 US $ billion.2.             Current Account Balance :-

It is the difference between the receipts and payments on account of current account which includes trade balance. The current account includes export of services, interest, profits, dividends and unilateral receipts from abroad and the import of services, profits, interest, dividends and unilateral payments abroad. There can be either surplus or deficit in current account. When debits are more than credits or when payments are more than receipts deficit takes place. Current account surplus will take place when credits are more and debits are less.

Current account balance is very significant. It shows a country's earning and payments in foreign exchange. A surplus balance strengthens the country's international financial position. It could be used for development of the country. A deficit is a problem for any country but it creates a serious situation for developing countries. In 2009-10 India’s current account deficit was 38.4 US $ billion.3.             Capital Account Balance :-

It is the difference between receipts and payments on account of capital account. The transactions under this title involves inflows and outflows relating to investments, short term borrowingsI lending, and medium term to long term borrowings / lending. There can be surplus or deficit in capital account. When credits are more than debits surplus will take place and when debits are more than credits deficit will take place. In 2009-10. India’s capital account surplus was 51.8 US $ billion.4.             Errors and Omissions :-

The double entry book - keeping principle states that for every credit, there is a corresponding debit and therefore, there should be a balance in BOP as well. In reality BOP may not balance, due to errors and omissions. Errors may be due to statistical discrepancies (differences) and omissions may be due to certain transactions may not get recorded. For Eg., remittance by an Indian working abroad to India may not get recorded etc. If the current and capital account shows a surplus of 20,000 $, then the BOP should show an increase of 20,000 $. But, if the statement shows an increase of 22,000 $, then there is an error or omission of 2,000 $ on credit side.5.             Foreign Exchange Reserves :-

The balance of foreign exchange reserve is the combined effect of current and capital account balances. The reserves will increase when:-a)   The surplus capital account is much more than the deficit in current account.b)   The surplus in current account is much more than deficit in capital account.c)   Both the current account and capital account shows a surplus.       In 2009-10 India’s foreign exchange reserves increased by 13.4 US $ billion.

     

 Q.2.  Write note on India’s Balance of TradeANS. A. INDIA’S BALANCE OF TRADE:-

Balance of trade is the difference between exports and imports. India’s Balance of trade is mostly in deficit. This is due to low share off Exports in world market. Imports are high due to petroleum, oil and lubricant products.

INDIA’S BALANCE OF TRADE (US $ Billion)________________ I                 Year       1990-91        2004-05       2009-10

Exports 18.5 85.2 182.2

Imports 27.9 118.9 300.6

Trade Balance -9.4 - 33.7 -118.4

India’s export performance is poor. At present, India’s share off world export trade is 1%. The share of exports of other developing countries is much more than India.B.      REASONS FOR POOR PERFORMANCE OF INDIA’S EXPORT TRADE

There are Several reasons for India’s Poor performance. Some off them are:            I.               Export - Related Problems :-

1.             High Prices :-

As compared to other Asian Countries the price of Indian goods is high. Prices are high due to documentation formalities, high transaction costs & also to make higher profits.2.             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 buyers.3.             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.4.             Inadequate Promotion :-

For Export Marketing, Promotion is important. Many Indian Exporters do not give much importance to promotion. A good no. of Indian exporters are not professional in advertising & Sales promotion. They do not take part in trade fairs & exhibitions.5.             Poor follow-up of sales :-

Indian exporters are ineffective in providing after-sale-service. They do not bother to find out the reactions of buyers after sale. This results in poor performance of India’s export trade.

           II.               General Causes1.             Good Domestic Market

Sellers find a ready market for their goods within the country, so they do not take patns to get orders from overseas markets.

2.             Number of formalities

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

3.             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.

4.             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.

5.             Poor Infrastructure

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

Q. 3 : What are the Types of BOP

Disequilibrium?                                                                       OR    Write note on Types of Disequilibrium in Balance of Payments.

Ans. A. EQUILIBRIUM AND DISEQUILIBRIUM IN BOP :-Balance of payments is the difference between the receipts from and payments to

foreigners by residents of a country. In accounting sense balance of payments, must always balance. Debits must be equal to credits. So, there will be equilibrium in balance of payments.

  Symbolically, B = R - P          Where : - B = Balance of Payments

  R = Receipts from Foreigners

  P = Payments made to Foreigners

When B = Zero, there is said to be equilibrium in balance of payments.

When B is positive there is favourable balance of payments; When &. B is negative there is unfavourable or adverse balance of payments.' When there is a surplus or a deficit in balance of payments there is said : to be disequilibrium in balance of payments. Thus disequilibrium refers to imbalance in balance of payments.

B.       TYPES OF DISEQUILIBRIUM IN BOP

The following are the main types of disequilibrium in the balance of payments:-

1.        Structural Diseguilibrium :-Structural disequilibrium is caused by structural changes in the economy affecting

demand and supply relations in commodity and factor markets. Some of the structural disequilibrium are as follows :-

a.    A shift in demand due to changes in tastes, fashions, income etc. would

decrease or increase the demand for imported goods thereby causing a

disequilibrium in BOP.

b.    If foreign demand for a country's products declines due to new and cheaper substitutes

      abroad, then the country's exports will decline causing a deficit.

c.    Changes in the rate of international capital movements may also cause structural

      disequilibrium.

d.    If supply is affected due to crop failure, shortage of raw-materials, strikes, political instability        etc., then there would be deficit in BOP.

e.    A war or natural calamities also result in structural changes which may affect not only goods

      but also factors of production causing disequilibrium in BOP.

f.     Institutional changes that take place within and outside the country may result in BOP

disequilibrium. For Eg. if a trading block imposes additional import duties on products imported in member countries of the block, then the exports of exporting country would be restricted or reduced. This may worsen the BOP position of exporting country.

2.        Cyclical Disequilibrium :-Economic activities are subject to business cycles, which normally have four phases

Boom or Prosperity, Recession, Depression and Recovery. During boom period, imports may increase considerably due to increase in demand for imported goods. During recession and depression, imports may be reduced due to fall in demand on account of reduced income. During recession exports may increase due to fall in prices. During boom period, a country may face deficit in BOP on account of increased imports.

Cyclical disequilibrium in BOP may occur becausea.  Trade cycles follow different paths and patterns in different countries.b.  Income elasticities of demand for imports in different countries are not identical.

c.  Price elasticities of demand for imports differ in different countries.3.        Short - Run Disequilibrium :-

This disequilibrium occurs for a short period of one or two years. Such BOP disequilibrium is temporary in nature. Short - run disequilibrium arises due to unexpected contingencies like failure of rains or favourable monsoons, strikes, industrial peace or unrest etc. Imports may increase exports or exports may increase imports in a year due to these reasons and causes a temporary disequilibrium exists.

International borrowing or lending for a short - period would cause short - run disequilibrium in balance of payments of a country. Short term disequilibrium can be corrected

through short - term borrowings. If short - run disequilibrium occurs repeatedly it may pave way for long - run disequilibrium.

4.        Long - Run I Secular Disequilibrium :-Long run or fundamental disequilibrium refers to a persistent deficit or a surplus in the

balance of payments of a country. It is also known as secular disequilibrium. The causes of long - term disequilibrium are

a.  Continuous increase in demand for imports due to increasing population.b.  Constant price changes - mostly inflation which affects exports on continuous basis.c.  Decline in demand for exports due to technological improvements in importing countries, and as    such the importing countries depend less on imports.

The long run disequilibrium can be corrected by making constant efforts to increase exports and to reduce imports.

5.        Monetary DiseguilibriumMonetary disequilibrium takes place on account of inflation or deflation. Due to inflation,

prices of products in domestic market rises, which makes exports expensive. Such a situation may affect BOP equilibrium. Inflation also results in increase in money income with people, which in turn may increase  demand for imported goods. As a result imports may turn BOP position in disequilibrium.

6.        Exchange Rate Fluctuations :-A high degree of fluctuation in exchange rate may affect the BOP position. For Eg. if

Indian Rupee gets appreciated against dollar, then Indian exporters will receive lower amounts of foreign exchange, whereas, there will be more outflow of foreign exchange on account of higher imports. Such a situation will adversely affect BOP position. But, if domestic currency depreciates against foreign currency, then the BOP position may have positive impact.

Q. 4 : What are the main causes of BOP Disequilibrium?                          OR                Discuss the causes of disequilibrium in Balance of Payments?    (M.11)Ans. A.  CAUSES OF DISEQUILIBRIUM IN BOP

Any disequilibrium in the balance of payment is the result of imbalance between receipts and payments for imports and exports. Normally, the term disequilibrium is interpreted from a negative angle and therefore, it implies deficit in BOP.

The disequilibrium in BOP is caused due to various factors. Some of them areI. Import - Related Causes             The rise in imports has been the most important factor responsible for large BOP deficits. The causes of rapid expansion of imports are :-

1.             Population Growth            Population Growth may increase the demand for imported goods such as food items and non food items, to meet their growing needs. Thus, increase in imports may lead to BOP disequilibrium.

2.             Development Programme            Increase in development programmes by developing countries may require import of capital goods, raw materials and technology. As development is a continuous process, imports of these items continue for a long time landing the developing countries in BOP deficit.

3.             Imports Of Essential Items            Countries which do not have enough supply of essential items like Crude oil or Capital equipments are required to import them. Again due to natural calamities government may resort to heavy imports, which adversely affect the BOP position.

4.             Reduction Of Import Duties            When import duties are reduced, imports becomes cheaper as such imports increases. This increases the deficit in BOP position.

5.             Inflation            Inflation in domestic markets may increase the demand for imported goods, provided the imported goods are available at lower prices than in domestic markets.

6.             Demonstration Effect            An increase in income coupled with awareness of higher living standard of foreigners, induce people at home to imitate the foreigners. Thus, when people become victims of demonstration effect, their propensity to import increases.

II. Export  Related Causes :-Even though export earnings have increased but they have not been sufficient enough to

meet the rising imports. Exports may reduce without a corresponding decline in imports. Following are the causes for decrease in exports1.             Increase In Population :-            Goods which were earlier exported may be consumed by rising population. This reduces the export earnings of the country leading to BOP disequilibrium.2.             Inflation :-

When there is inflation in domestic market, prices of export goods increases. This reduces the demand of export goods which in turn results in trade deficit.3.             Appreciation Of Currency :-

Appreciation of domestic currency against foreign currencies results in lower foreign exchange to exporters. This demotivates the exporters.4.             Discovery Of Substitutes :-

With technological development new substitutes have come up. Like plastic for rubber, synthetic fibre for cotton etc. This may reduce the demand for raw material requirement.5.             Technological Development :-

Technological Development in importing countries may reduce their imports. This can be possible when they start manufacturing goods which they were exporting earlier. This will have an adverse effect on exporting countries.6.             Protectionist Trade Policy :-

Protectionist trade policy of importing country would encourage domestic producers by giving them incentives, whereas, the imports would be discouraged by imposing high duties. This will affect exports.

III. Other Causes :-1.             Flight of Capital

Due to speculative reasons, countries may lose foreign exchange or gold stocks. Investors may also withdraw their investments, which in turn puts pressure on foreign exchange reserves.2.             Globalisation

Globalisation and the rules of WTO have brought a liberal and open environment in global trade. It has positive as well as negative effects on imports, exports and investments. Poor countries are unable to cope up with this new environment. Ultimately they become loser and their BOP is adversely affected.3.             Cyclical Transmission

International trade is also affected by Business cycles. Recession or depression in one or more developed countries may affect the rest of the world. The negative effects of trade cycle (low income, low demand, etc.) are transmitted from one country to another. For eg. The current financial crisis in U.S.A. is affecting the rest of the world.4.             Structural Adjustments

Many countries in recent years are undergoing structural changes. Their economies are being liberalised. As a result, investment, income and other variables are changing resulting in changes in exports and imports.   5.             Political factors

The existence of political instability may result in disrupting the productive apparatus of the country causing a decline in exports and increase in imports. Likewise, payment of war expenses may also serious affect disequilibrium in the country’s BOP. Thus political factors may also produce serious disequilibrium in the country’s BOPs.

Q. 5 : Explain the different measures to correct disequilibrium in BOP.                                  OR              Examine the measures taken by government to overcome the BOP crisis.                 OR

       What are the measures to be undertaken to correct BOP disequilibrium.

Ans. A. MEASURES TO CORRECT DISEQUILIBRIUM IN BOP :-Any disequilibrium (deficit or surplus) in balance of payments is bad for normal internal

economic operations and international economic relations. A deficit is more harmful for a country’s economic growth, thus it must be corrected sooner than later. The measures to correct disequilibrium can be broadly divided into four groups

MEASURES

  

              Monetary                      Fiscal                     Exchange Rate                    Non-monetary    Policy                         Policy                        Policy                                    Policy

      I.               Monetary Measures :-1)        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.A.            Inflation :-

If in the country there is inflation, the Central Bank through its monetary policy will make an attempt to reduce inflation. The Central Bank will adopt tight monetary policy. Money supply will be controlled by increase in Bank Rate, Cash Reserve Ratio, Statutory Ratio etc.

The monetary policy measures may reduce money supply, and encourage people to save more, which would reduce inflation. If inflation is reduced, the prices of domestic market will decrease and also that of export goods. In foreign markets there will be more demand for export goods, which would correct BOP disequilibrium.B.            Deflation :-            During deflation the Central Bank of the country may adopt easy monetary policy. It will try to increase money supply and credit in the economy, which would increase investment.  More investment leads to more production. Surplus can be exported, which in turn may improve BOP position.           

2)        Fiscal Policy            Fiscal policy 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 may be increased or decreased.a)         Inflation            During inflation the government may adopt easy fiscal policy. The tax rates for corporate sector may be reduced, which would encourage more production and distribution including exports. Increased exports will bring more foreign exchange there by making the BOP position favourable.b)         Deflation            During deflation the government would adopt restrictive fiscal policy.It may impose additional taxes on consumers or may introduce tax saving schemes. This may reduce the consumption of citizens, which in turn may enable more export surplus.

To restrict imports the government may also impose additional tariffs or customs duties which may improve the BOP position.

3)        Exchange Rate PolicyForeign exchange rate in the market may directly or indirectly be influenced by the

Government.a)       Devaluation

When foreign exchange problem is faced by the country, the government tries to reduce imports and .increase exports. This is done through devaluation of domestic currency. Under devaluation, the- government makes a deliberate effort to reduce the value of home country. If devaluation is carried out, then the exports will become cheaper and imports costlier. This is turn will help to reduce imports and increase exports.

b)       DepreciationDepreciation like devaluation lowers the value of domestic currency or increases the

value of foreign currency. Depreciation of a country's currency takes place in free or competitive foreign exchange market due to market forces. Depreciation and devaluation have the same effect on exchange rate. If there is high demand for foreign currency than its supply, it will appreciate and vice versa. However, in several countries the system of managed flexibility is followed. If there is more demand for foreign exchange, the central bank will release the foreign currency in the market from its reserves so as to reduce the appreciation of foreign currency. If there is less demand for foreign exchange, it will purchase the foreign currency from market so as to reduce the depreciation of foreign country and appreciation of domestic currency.

Due to devaluation and depreciation of domestic currency, the exports become cheaper and imports become expensive. This helps to increase exports.

I)               Non-Monetary / General Measures :            A deficit country along with monetary measures may adopt the following non-monetary measures too, which will either restrict imports or promote exports.1)             Tariffs :-

Tariffs refer to duties on imports to restrict imports. Tariff is a fiscal device which may be used to correct an adverse balance of payments. The imposition of import duties will raise the prices of imports. This will lead to a reduction in demand for imports thereby improving the balance of payments position.2)             Quotas :-

Under 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 quota system, the deficit is reduced and the balance of payments position is improved.3)             Export Promotion :-

The government may introduce a number of export promotion measures to encourage exporters to export more so as to earn valuable foreign exchange, which in turn would improve BOP Situation. Some of the incentives are Subsidies, Tax Concessions, Grants, Octroi refund, Excise exemption, Duty Drawback, Marketing facilities etc.4)             Import Substitution

Governments, especially, that of the developing countries may encourage import substitution so as to restrict imports and save valuable foreign exchange. The government may encourage domestic producers to produce goods which were earlier imported. The domestic producers may be given several incentives such as Tax holiday, Cash Subsidy, Assistance in Research & Development, Providing technical assistance, Providing Scarce inputs etc.A.       CONCLUSION :-

From the above measures it is clear that more exports with import substitution based on economic strength of the country are the real effective solutions to correct the disequilibrium in the balance of payments.

CHAPTER 15  -  EMERGING TRENDS IN INDIA’S BOP POSITION SINCE 1991Q.1: Explain the emerging trends in India’s BOP position since 1991.                                 OR          Examine the structure of BOP in India since 1991.                                           OR          Examine the changes in current account and capital account balance of          India’s BOP since 1991.

Ans. A) INDIA’S BOP SINCE 1991:-

The Balance of Payments of a country is a systematic record of all transactions between

the residents of a country and the rest of the world carried out in a specific period of time.

In 1990-91 India was facing BOP crisis. India faced huge trade deficit of 9.4 US $ billion and the net invisibles were also negative. This was mainly due to rise in imports of petroleum products. BOP situation improved since 1993-94. In 2009-10, BOP position showed increase in foreign exchange reserves of over 9.5 US $ Billion.

INDIA’S BOP POSITION (US $ BILLION)

Items 1990-91 2000-01 2009-10

1.       Exports2.        Imports

3.       Trade Balance4.        Invisibles (net)

5.       Current Account Balance6.       Capital Account Balance7.       Reserves Use (- increase)

18.527.9-9.4-0.3- 9.78.4

+ 1.3

45.457.9-12.59.8

- 2.78.5-5.8

182.2 300.6-118.4 80.0

-38.451.8-13.4

Source: - Economic Survey 2005-06 & 2010-11

                        Note :-  Reserves (+ Sign) indicates use of reserves.              Reserves (- Sign) indicates reserves have increased.

Let us Explain :-

1)        Trade Balance :-Trade balance is a difference between export earnings and import payments. In India,

trade deficit is mostly negative. In 1990-91, trade deficit was over 9 US $ billion which increased to over 118.4 US $ billion in 2009-10. There was negative growth in exports, due to recession in world markets on account of sub-prime crisis of USA.

2)        Invisibles (net) :-

The net invisibles include the difference between receipts and payments on account of Non-factor services (insurance, transport, travel etc.), Income (Interest, profit, dividend), private transfers and official transfers. In 1990-91, the net invisibles were negative to the extent of about 0.3 US $ billion. In 2009-10, the net invisibles were positive to the extent of over 80 US $ billion.

3)        Current Account Balance :-

It is the difference between the receipts and payments on current account which includes trade balance. In India the current account balance is mostly negative due to huge trade deficit. In 1990-91, the current account deficit was 9.7 US $ billion, which increased to 38.4 US $ billion in 2009-10.

4)        Capital Account Balance :-

It is the difference between the receipts and payments on capital account. In India, the capital account always showed a surplus mainly due to inflow of foreign investments in India and net borrowings. In 1990-91, the capital account showed a surplus of 8.4 US $ billion, which increased to about 52 US $ billion in 2009-10.

5)        Foreign Exchange Reserves :-

A negative foreign exchange reserve position shows a weak economy and a positive balance shows comfortable position of the country. In 1990-91, the foreign exchange reserves were reduced by 1.3 US $ billion. In 2009-10, the foreign exchange reserves increased by 13.4 US $ billion.

Q. 2: Explain the reasons for satisfactory performance of BOP since 1991.

Ans. A) REASONS FOR SATISFACTORY PERFORMANCE OF BOP SINCE 1991:-

The Balance of Payment situation started improving since 1991 except for the years 1995-96 and 2008-09. As on 31st March, 2009 foreign exchange reserves were 252 US $ billion. It further increased to 279 US $ billion oh 31st March 2010. The reasons for satisfactory performance of BOP are as follows :-

1)        Increase In FDI In India :-

The policies of liberalisation and privatisation have been instrumental in attracting huge foreign investment. At present FDI is allowed even upto 100% in certain sectors. In 1990-91, the net FDI in India was about 0.1 US $ billion, which increased to 18.8 US $ billion in 2009-10. This has improved the net foreign investment in India.

2)        Increase In Portfolio Investment

Portfolio investment includes investment by FIls in the Indian stock markets. In     1990-91, portfolio investment was nil. In 2007-08 it was 27.4 US $ billion. Again in 2008-09 portfolio investment was negative as withdrawls were more due to collapse of stock markets World wide in 2008-09. However, in 2009-10, the net portfolio investments again picked up at 32.4 billion.

3)        Increase In External Commercial Borrowings

External commercial borrowings have been an important source of funds for the government. Over the years the net external commercial borrowings have increased. In 1990-91, they were about 2.2 US $ billion, which increased to 7.9 US $ billion in 2008-09, but it reduced to US $ 2.8 in 2009-10.

4)        Increase In Private Transfers

Private transfers include inward remittances from Indian workers working abroad, personal gifts received from abroad, donations received from abroad by religious / charitable trusts etc. Private transfers were about 2.1 US $ billion in 1990-91. It increased to 12.8 US $ billion in 2000-01. Which further increased to 44.6 US $ billion.

5)        Increase In Service Exports

At present, India ranks 9th in the world for overall services exports and 2nd in the world for computer and information services exports. In 2000-01 India’s services exports have increased from 16.3 US $ billion to 96 US $ billion in 2009-10.

The invisibles (net) on BOP account have increased over the years due to increase in services exports. In 1990-91, the net invisibles were negative to the extent of 0.3 US $ billion, which increased to 80 US $ billion in 2009-10.

The private transfers along with services exports have increased the net invisibles on BOP account.

6)        Non Resident Deposits

The non-resident deposits add to the capital account of BOP. In 1990-91, non-resident deposits (net) were 1.5 US $ billion, which increased to 2.9 US $ billion in 2009-10. The various schemes of incentives announced by Indian government helped in attracting huge deposits from non-resident Indians.

Q.3 : What are the measures to be taken to maintain the BOP problem?               OR

            Discuss the various measures to solve the problem of balance of payment.

Ans.  A. MEASURES / SOLUTION OF BALANCE OF PAYMENTS PROBLEMSome of the important measures for maintaining / Improving balance of payments in

order are as follows:-

1)        Foreign Assistance

During the earlier period of planning India received substantial amounts of foreign assistance from a number of countries like USA, UK, France, Germany, and also from international institutions like IMF World Bank and IDA. Such assistance was in concessional terms. In 1991, when we faced BOP crisis India approached IMF and received substantial amount of loan. However, the role of foreign assistance in financing deficits in balance of payments has declined in recent years.

2)        Foreign Investment   :-

India attracts substantial amount of Foreign exchange both in form of Foreign Direct Investment (FDI) and portfolio Investment. Government has been announcing numerous concession and incentives to attract foreign investment. However Foreign investment is not an unmixed blessing. Huge payments in terms of royalty and dividends are required to be made every year in foreign exchange. Therefore, it is necessary to ensure that all investments are productively employed.

Either FDI should be directed to export industries or it should be directed in building up of infrastructure. Thus FDI can continue to serve as a reliable source of assistance in future also. Portfolio investment is made mainly on the basis of short run returns and hence they may not be treated as a reliable source.

3)        External Commercial Borrowings :-

This is a high cost method of financing deficits as external commercial borrowings can generally be obtained at high rates of interest. Care must be taken to see that such loans are raised for projects which have direct impact on increasing our exports or reducing imports.

4)        Non - Resident Deposits :-

Non - Resident deposits are also obtained at high rates of interest. Such deposits are highly volatile in nature as, their main objective is to maximise returns. If conditions are unfavourable, they can withdraw their funds from the country. Thus, both foreign institutional investors and non-residents are fair weather friends. We cannot rely upon them at times of crisis.

5)        Earnings From Invisibles :-

Earnings from invisibles have played an important role in reducing the current account deficit in balance of payments all through 1990’s. It v covered the entire trade deficit in the year 2001-02. The prospects of invisibles in future looks bright for India.

6)        Merchandise Trade :-

The lasting solution to BOP problem lies in our policy to promote exports. All possible efforts should be taken to increase exports. Reduction in import would be very difficult in India, under the regime of liberalised import policies. The best policy is to promote exports with the help of well formulated strategy. Thus promotion of exports must be the most important plank of our trade strategy.

Equibrilium

The balance of international payment is a statement that takes into account the debits and credits of a country on international account during a calendar year. When a country has unfavourable or adverse balance of payments, it is regarded as herald of disaster because the country by having deficit in her balance of payments either decreases her balances abroad or increases her foreign debits. When it has favourable credit balance, it, is considered that the country is heading towards prosperity because by having surpluses, it either increases her foreign credits or reduces her foreign debits.There is no doubt that a study of country’s balance of payment reveals much information about its economic position and development of the country. But when we are to see that a country is heading towards financial bankruptcy or higher standard of living, we are to examine the balance of payments of many years of that country. A persistent deficit in thebalance of payments on current account certainly leads to economic and financial bankruptcy. A.continued favourable balance on current account is also disadvantageous because it creates difficulties for other countries. The credit country may utilize her surplus in advancing short or long term loans to the debtor country. But if it gives no opportunity to the debtor country to repay the loan by exporting more, then how can the loans he realized? The hard earned surplus of the credit country will then one day be turned into gifts and this may create political difficulties for the creditor country. We have seen, thus, that a country should neither have unfavourable nor favourable balance of payment on current account in perpetuity. It must

obtain equilibrium in her balance of payments over a reasOnable ,period of time.

From this it may not be concluded that a country should balance her account every year with every country with which it has trade relations. A country may have favorablebalance of payment with one country and unfavorable with another but in the long run it must balance her account. The total liabilities and total assets of all nations related to one currency block must balance over a reasonable period of time.

Causes of DiseqUilibrium in the Balance of Payment:Balance of international payment is a summary account of total debits and credits of a country during a year. It includes both visible and invisible trading terms, i.e., merchandize imported and exported, interest on dividend received and paid, payments and receipts of transport services, commission, insurance, brokerage, etc., received and paid money lent abroad or borrowed, movement of gold, etc., etc. Disequilibrium in the balance, of payments can arise due to persistently one sided movement of one or more than onetrading ‘terms. If, for instance, the total value of goods exported exceeds the total value ofthe goods imported over a given period and this surplus is not offset by the debit balanceon invisible item, the country will have favorable balance of payments. Disequilibrium in the balance arises when exports of a country fall short of imports,because of decrease in production at home, due to stiffer competition abroad or of an appreciation in the currency or fall of purchasing power of the buyers in the foreign market When the imports remain unaffected or increase, then the country will also face deficit in her balance on Invisible items, the country will have disequilibrium in her balance of payments. Disequilibrium in -her balance of payments can also arise over a given period due to excessive imports not equalized by exports of invisible items and if it is not offset by credit balance on visible items, the country will face disequilibrium in her balance of payments.

Correction Of Disequilibrium In The Balance Of PaymentsWe have stated earlier that a country must obtain equilibrium in her balance of paymentscorrecting methods for disequilibrium with other countries in the long run. When thebalance of payments is favourable, it can be looked at with satisfaction from her point ofview because the surplus will be invested abroad in securities. But if a country has deficitbalance in perpetuity, it must be rectified by taking necessary steps.The days of the gold standard are gone when the balance was corrected automatically under gold standard. An active or passive. balance accompanied by an inflow or outflow of gold was normally supposed to result in an expansion or contraction. of the domestic money supply, and this expansion or contraction was expected to bring about a rise or fall in the level of domestic coats and prices tending in the former case to stimulate imports and discourage exports or in the latter, to discourage imports and stimulate exports. Gold flow, changes in the quantity of money, and changes in relative price levels, thus appeared as the principal factor in the mechanism of adjustment. But, now a days when every country is on inconvertible standard, steps are to be taken to correct the adverse – balanceof payments.The main methods adopted to cover a deficit in balance of payments ()of a country are as follows:

(i)      Rectifying the Balance of Trade: One of the major items which can adversely affect the balance of payments Of a country is the excess of imports over exports. In case of a deficit in the balance of payments, a country must try to stimulate exports or discourage imports or do both. The exports can be encouraged by bringingOown the level of costs in the country, or by granting bounties or by giving concessions to industrialists and expbrters. Imports can be restricted either by adopting quota system or by imposing duties or by reducing people’s disposable income or by higher taxation or by a reduced government expenditure or by total prohibitions, etc.(ii)    Deflation: Deflation is another important weapon which is used to correct the unfavourable balance of payments. The currency authority may

try to lower the prices by reducing the quantity of money in circulation. If the country succeeds in bringing down the prices, it then becomes a good market to buy from and a bad market to sell in Exports are encouraged, and impdrts fall and thus the deficit gap is greatly reduced. This method when adopted is full of dangers. If by contracting supply of money, the prices are lowered, the rigid costs may not be brought down. Labour may oppose the reduction in the wages. This can lead to depression and unemployment in the country which may prdve very dangerous.(iii)  Devaluation: Devaluation is a remedy which is applied only in times of extreme crisis to correct the adverse balance of payments. Devaluation means the lowering of theexchange rate. This method like devaluation is adopted to cheapen exports and make imports dearer, Devaluation, thus, raises exports and lowers imports. England devalued the value of pound from 4.03 dollars to 2.80 dollars, i.e. by 30% in September, 1949 to correct disequilibrium in her balance of payments. Pakistan first devalued its currency in 1955. The advantage with this method is that there is no need to reduce the money wages and the object is achieved. The disadvantage is that it shakes the people’s confidence in home currency.

(iv)   Exchange Control: Exchange control is a very effective and useful method forcorrecting adverse balance of payments. Under this system, the government enforces a complete monopoly of buying and selling of foreign exchange in the foreign exchange market. The exporters are required to surrender their foreign exchange at fixed rates to the central bank. The central bank then rations out this foreign exchange among the licensed importers of essential commodities only When imports are restricted to the available foreign exchange, the problem of adverse balance of payments is then greatly solved.(v)    International Monetary Fund: Deficit in the balance of payments can also be covered by obtaining assistance from International Monetary Fund. The IMF, which began its operation in March, 1941, helps member countries in maintaining equilibrium in thebalance of payments. The International Monetary Fund has proved very helpful in promoting exchange stability and facilitating the settlement of international transactions

The Balance or PaymentsHere, we would like to make a sharp distinction between balance of international trade andbalance of international payments as they are often confused by the readers. By balance of International trade we mean, statement that takes into account the total value of exportsand imports of visible commodities of a country during a year. By visible commodities is meant the commodities which when exported or imported are recorded to the tradeaccounts at the ports. Balance of payments, on the other hand, is a statistical statement ofincome and expenditure both of the visible and invisible items of trade on international account during a calendar year.Invisible items are those items which are not shown in the trade accounts a the time of their imports. Under this heading comes all the receipts and payments made for the international services such as banking, shipping, insurance, educational, travel, etc., etc. When the total value of visible exports is in excess to total value to visible imports during a year. the country is said to have favorable or positive balance of trade. Conversely, when the total value of the good imported exceeds the total value of goods exported, the country is said to have unfavorable balance of trade. The Mercantilism believed that a favorablebalance of trade indicates that country is heading towards prosperity while unfavorablebalance of trade is a sign of approaching national disaster; When exports are greater thanimports, they say, gold is brought into the country and the national wealth is increased. When imports exceed exports, gold is taken out of the country and this leads to reduction in national wealth. The importance of service transactions andother invisible items was under estimated by them. The modern economists, however, differ with this view. They are of the opinion that a country’s prosperity or adversity is not judged by its favourable or unfavourable balance of trade but by its favourable or unfavourable balance of payment England, for instance with the exception of 1958 had an adverse balance of trade since 1890 but its national wealth during these long years was increasing at a very fast rate. It was because of this fact that its debt balance of visible trade was offset by its

credit balance on invisible trade. We, conclude, therefore, that a favourable balance of trade is not an index of the economic prosperity or poverty of the country. It is the balance of payments which serves as a better guide to its economic position. If a country has persistently unfavourable balance of payments, it can be safely taken as a sign of approaching national disaster. Temporarily, a country may have favorable or unfavorable balance of payments but in the long run, it must balance its payments, otherwise, it will be inviting troubles.

Presentation of international balance of paymentsThe total balance of international payments is customarily divided into two sections: (1) the balance of international payments on current account, and (2), the balance ofinternational payments on capital account. The movement of gold coins and bullion is sometimes shown separately in the third section.The Balance of International Payments on Current Account:The balance of payment, as we know, is built up in terms of credit and debit entries. On the side of credit account, the amount which a country has to receive from the other country is shown, while on the debt side of the account, the payment which has to be made to other countries is entered. In the balance of payment on current account only those items are entered which do not create a new item or cancel a previously existing capital claim.The main credit Items in the balance on current account are as follow:1. Value of merchandize exports.

2. Payments received from foreigners for rendering banking insurance and shipping services.3. Travel expenditure of the foreign tourists in the country.

4. Expenditure of foreign students.

5. Remittances of money by the nationals of the country living in other countries,

6. Income on investment (interest and dividend. etc.), from abroad.

7. Charity contributions made to the institutions by the foreigners.

8 Miscellaneous government transactions such • as sale as of diplomatic representatives, repatriation, military and payments, etc., etc.

The main debit items in the balance of payments on the current account are:1. Value on merchandise imports.Payments made to the foreigners for rendering banking and insurance and shipping services for the country.

1. Travel expenditure of country’s tourists in other countries.2. Payments made to country’s students studying abroad,3. Remittance by immigrants to their home countries. 6 Interest and

dividend payments by the foreigners to their countries.7. Donations sent to other countries.

8. Miscellaneous government transactions such as salaries of diplomatic representatives, repatriation, military aid payments. etc., etc to other countries

II. The Balance of International Payments on Capital Account:

The balance of international payments on capital account is split up into two parts. (1) thebalance of payment on long term capital account and (2) the balance of payment on short term capital account. In the balance of international payment on long term capital account, we include the net private and government long term loans and net long term foreign investment. The short term capital account is composed of (1) private or government short term loans and (2) net investment in short term debts.The movement of capital from one country to another takes place due to three reasons: Firstly, when country has to make investment abroad.

Secondly, when it has to advance loans to another country. Thirdly, when the capital has to he shifted due to safety reasons. The movement of capital from one country to another has a seriousrepercussion on the international payments on current account. When, the capital is shifted to another country, a payment is to be made. Therefore, it is a debit entry and when we borrow from abroad, we receive payment, therefore it is credit entry. If we have

a favourable balance on current account, it may be offset by a debit account balance oncapital account.

Gold Movements: Gold is sometimes an important balancing item. If the deficit on.

international account exists, it is covered by shipping gold from one country to another. U.S.A. received large quantity of gold from. other countries in the 1930′s.