BALANCE OF PAYMENTS
BALANCE
OF PAYMENTS DEFINED
The balance of payments of a country is a systematic record of all economic transactions between of one country and resident of foreign countries during a given period of time.
It is important to note three things in the definition of balance of payment:
1. Balance of payments refers to systematic record of all economic transactions of one country with other countries. Economic transactions refer to flow of economic goods, services and the assets. Normally, an economic transaction involves a payment and receipt of money in exchange of these flows. Thus, balance of payments is a record of all receipt and all payments of our country with other countries refers to “Double Entry Book Keeping System”.
2. Economic transactions reflected in the balance of payments are between of a country and residents of other countries. The term residents of country mean the normal residents of the reporting country. It is comprehensive account.
3. Business of payment is a flow concept is a flow concept as it refers to a certain time period usually a calendar year.
COMPONENTS
OF BALANCE OF PAYMENTS
The items included in the balance of payments are called components of balance of payments. Each transaction in the balance of payments, such as export of import of goods, is recorded and classified according to the payments and receipts that would arise from it. Payments made by a country residents to foreigners are called debits and receipt from the foreigners are termed as credits.
Any item that enables a country to acquire foreign currency is recorded as a credit items and any item that gives rise to use or spending of foreign currency is recorded as debit item in the balance of payments.
Various items in the balance of payments are generally categorized into two main groups as below:
1. Current Account: The current account records transaction relating to export and import goods, services, unilateral transfers and international incomes. Thus, the balance on current account is the value of exports minus the value of imports , adjusted for international incomes and net transfers.
2. Capital Account: The capital account records all international economic transaction relating in change in assets both financial and physical. It is a record of short-term and long-term capital transaction, both private officials.
COMPONENTS
OF BALANCE OF PAYMENTS
|
CREDIT |
DEBIT |
|
Current |
Account |
|
Visible
trade |
|
|
1. Export of goods |
2. Import of goods |
|
Invisible
trade |
|
|
3. Export of services |
6. import of services |
|
4. Unilateral transfer receipt (gifts, indemnities from foreigners). |
7. Unilateral transfer payments( gifts, indemnities to foreigners). |
|
5. Income receipts. |
8. income payments |
|
Capital |
Account |
|
1. Foreign investment from foreigners. |
4. 4. Investment in foreign countries and loans to foreigners. |
|
2. Capital, repayment by foreigners. |
5. Capital repayments to foreigners. |
|
3. Sale of gold and assets to foreigners. |
6. Purchases of gold and assets from foreigners. |
The current account transactions are classified into broad categories as explained below:
1. Export and import of goods or Merchandise: This category includes all types of physical goods exported an imported. A country can acquire foreign currency by exporting goods( row 1. This appears as a credit item in the Indian balance of payments because hereby this exporter earns foreign currency. Row (6) shows that import of goods appears on the debit side because when we pay for imports, foreign currency would be used. Thus, rows(1) and (6) describe the country’s visible trade.
Visible trade comprises of goods, such as cars, aluminum, tea, iron ore etc. which are tangible, have physical from and we can see when they cross the boundaries of a country.
2. Invisible Items: These are the items which are not tangible and cannot be seen. Hence, they are known as invisible.
These invisible items are classified into three groups. (i) services (ii) unilateral and (iii) income.
i.) Services: It includes a large variety of non-factor services sold to and purchased by the residents of a country from rest of the world flow (2) shows the receipt of the country from the sale of services to foreigners during the given period. Export of services comprises of shipping services, banking and insurance, tourism services etc. Payments received for these services are put on the credit side. In the same way / rows (7) covers payments which residents of the country in question make to foreigners for similar services, i.e. shipping, banking, tourism, insurance and payments the resident have to make as tourist abroad. They are items on the debit side.
ii.) Unilateral transfer: Unilateral transfers are those receipts and payments which take plae without any service in return in the current period. It includes transfers both at private and official (government) level. The items in row (3) are called unilateral transfer. These are the receipts which the residents of a country receive “for free”, without any payment in return. Example of this kind of receipts are gift, donations, grants, indemnities etc. which residents receive from foreigners- from relatives, friends and governments of other countries. Cash remittances by the people settled in other countries to their families is also a transfer receipt. These are the items on the credit side. In the same way, rows (8) comprises payments which the country in question makes as gif, assistance, aid, indemnities, etc, to other countries and they appear on the debit side.
iii.) Incomes: Incomes are classified into investment income and compensation of employees investment income comprises of interest, dividends, profit, etc., which residents of a country earn from investment made abroad. Compensation of employees includes wages and salaries etc. received by residents of a country, from non-residents. These earning are entered on the credit side (row 4) since a country is able to acquire foreign exchange thereby.
iv.) In this way, rows (9) covers payments which residents of the country in question make to non- residents for labour services in the form of wages, salaries, etc. Similarly, payments for capital services like interest and dividends on foreign capital made by the resident of the country to the foreign country are items on the debit side.
Thus, capital account of India records the capital inflows from other countries (foreign investment in India) and outflow in other countries (Indian Investment abroad).
Items (1), (2), (3), (4), (6) and (7),(8),(9) comprise all the payments and receipts made for the current period of time. They are flow items and are all expressed over a period of time. These are transaction in the current account.
CAPITAL ACCOUNT TRANSACTION
Capital account transactions are different from current account transactions. They would change in stock change in stock magnitude. They refer to capital receipt and payments. These relate to movements of long-term and short-term capital.
When the residents of a country want to borrow from abroad, we say they are importing capital. They would acquire foreign currency, and it will be entered as credit item in (5). On the other hand, when the residents of a country want to invest abroad, we say that they are exporting capital. In order to do this they need to obtain foreign currency. They are demanders of foreign currency. This transaction is therefore, debit item in the balance of payments account under row (10).
Capital movement may be divided in several ways:
1. First, the government; corporation or individual of the country in question may take loans from government, corporation and individual of foreign countries or from the international financial instructions.
2. Second, foreigners might acquire assets in the currency such as land, house plants, shares, etc.
3. Third, Government Corporation or individual residents may receive sums from abroad in repayment for a loan that it might be abroad.
4. Fourth, changes in a country’s stock of gold or reserve of foreign currency are also included here. All these transaction will be entered as credit item in row (5).
If residents of the country acquire foreign assets in the form of land abroad or foreign shares or of the government, corporation or individual were to give loans to residents other countries or if the loans taken earlier were to be repaid, all the transaction will be entered as debit items in row (10).These capital movements are classified into two categories viz. Direct and Portfolio Investment, Direct foreign investment refers to investment undertaken in the firms belonging to other countries by acquiring control over them.
For example residents of a foreign country may undertake investment in India either by setting up a plant or either by setting up a plant or through acquisition of an Indian firm. Similarly, Indians may invest in the foreign firms.
Portfolio investment, on the other hand, is the form of investment under which companies and residents of a country purchase shares in foreign companies or buy bonds issued by foreign governments.
It also includes foreign purchases of shares (stock) issued by firms and of bonds of the government of this country.
The Reserve Bank of India (RBI) gives a detailed classified of various items in the capital account. The main component of capital account is as follows:
1. Foreign Investment: It consists of direct and portfolio investment from abroad in Indian companies, in Indian branches of foreign companies, in real estate, etc. by non-residents on the ‘credit ‘side. Likewise. Direct and portfolio investment made by Indian residents abroad appears on the ‘debit’ side.
2. Loans: Borrowing by private individuals, non-financial institutions, government etc. from abroad and loan repayment by foreigners are included under ‘credit’ item. All lending by private individual, non-financial institutions, government, etc., to abroad and repayment of foreign loans are included under ‘debit’ item.
3. Banking Capital: Banking capital refers to the capital transaction in the form of foreign exchange and investment in foreign currency and securities by the foreign branches of Indian commercial banks.
4. Rupee Debt Service: Some borrowing by India (mostly government) is done in rupee terms. Such loans are repaid through exports of goods and services. Servicing of this debt involves flow of foreign exchange.
5. Monetary Movement: RBI overcomes disequilibrium in the balance of payments by what it terms as monetary movements. Monetary movements consist of (i) purchase and repurchase from IMF (ii) changes in foreign exchange reserves.
i.) Purchase and repurchases from IMF: Purchase from IMF means purchasing foreign currency from IMF by making payments in rupee. It is sort of loan from IMF because the country is under obligation to buy back its own currency in exchange for foreign exchange. When it buys back its currency by making payment in foreign exchange, it is called repurchase.
ii.) Changes in foreign exchange reserves: RBI holds foreign exchange reserve consisting of foreign currency gold and SDR (Special Drawing Rights) with IMF. SDR is a sortexchange international currency issued by IMF. If the country has deficit in the balance of payments, the deficit can be met by withdrawing from the foreign exchange reserve. A withdrawal from this reserve is recorded as a ‘credit’ item in the balance of payment because it causes in flow of foreign exchange into the country. An increase in the foreign exchange reserves, on the other hand, is recorded as a ‘debit’ item because it would cause outflow of foreign exchange reserves.
DISTINGUISH BETWEEN CURRENT ACCOUNT & CAPITAL ACCOUNT OF BOP
|
CURRENT
ACCOUNT |
CAPITAL
ACCOUNT |
|
· The current account deals with payments for currently produced goods and services. It also includes interest earned or paid on claims, and transfer payments as well. |
· The capital account on the other hand, deals with payments of debts and claims. |
|
· The current account of the balance of payments has a direct influence on the level of income of a country. For instance, when India sells its currency produced goods and services to foreign countries the producers of these goods get income, in other words, current account receipts (credit items) have the effects of increasing the flow of income in the country. On the other hand, when India import goods and services from foreign countries and pays for them, money which would have been used to demand goods and service within the country flows out to foreign countries. Hence, current payments (debit items) to foreigners involve reduction of the flow of income within the country and constitute a leakage. Thus current account of the balance of payments has direct influence on the level of income in a country. |
· The capital account, however, does not have such a direct effect on the level of income. It influences the volume of assets which a country. |
|
· Current account includes all items of a flow nature; hence current account is a flow concept. |
· Capital account includes all items expressing changes in stocks, hence it is a stock concept. |
METHOD TO CORRECT DISEQUILIBRIUM IN BOP
1.) Depreciation: Depreciation of a country’s currency will wipe out deficit in B.O.P. Depreciation means rise in the price of foreign exchange or fall in the price of domestic currency. This will make exports changes and imports costlier and hence, rectify the deficit disequilibrium in B.O.P.
2.) Devaluation: Devaluation means a deliberate reduction in the domestic value of a country’s currency in terms of foreign exchange by the govt. Devaluation and depreciation implies the same things. The only difference is that devaluation takes place under fixed exchange rate by the govt., whereas, depreciation takes place under floating exchange rate system. Devaluation cheapens exports and makes imports expensive, thereby rectifying the disequilibrium in B.O.P.
3.) Import Control: Import can be restricted by adopting quotes and tariffs. Quotes restrict quantity of import; tariffs raise the price of imports thereby making them costlier. This reduces the demand for imported goods and BOP disequilibrium is rectified.
4.) Export Promotion: The govt. can adopt several measure to boost exports:
a.) Reduces export duties to encourage exports.
b.) Cash assistance and subsidies can be given to exporters to stimulate exports.
c.) Various facilities like quality control, provision of market information and arranging exhibition of exportable in foreign countries can be provided to promote exports.
d.) Goods meant for exports can be exempted from various duties to make them cheap. Export industries should be provided with finances and raw materials, so that cost of production goes down and goods become cheaper in the international market.
e.) Journalism should be encouraged by providing hotels transport in order to earn foreign exchange.
All this can reduce BOP disequilibrium.
5.) Exchange Control: Exchange control is controlling the outflow of foreign exchange from the country. This can be done in the following ways:
a.) The govt. can direct the exporters to sell their foreign exchange earnings to the central bank and importer to buy the foreign exchange from central bank.
b.) Foreign exchange is given out only to those importers who have to import absolute in disequilibrium from abroad.
6.) Production of import substitutes: Steps should be taken to encourage the production of import substitute in the market. This will save foreign exchange and remove BOP deficit
7.) Capital Import: Deficit in BOP can also be cleared by borrowing capital (loans) from foreign govt., financial institutions like IMF, World Bank etc. A country can raise etc. A country can raise capital from abroad by increasing domestic interest rate and giving tax concessions to remove deficit in BOP.
8.) Monetary Policy: A tight monetary policy can be used to remove deficit in BOP. The central bank can reduce credit creation by raising bank rate, cash reserve ratio etc. AN increase in interest rates can decrease credit and lead to fall in investment expenditure. This will reduce income and demand for imports thereby leading to a rectification in BOP.
CAUSES OF DISEQUILIBRIUM IN BOP
1.) Fall in foreign demand: when demand for a country’s goods fall in the foreign market due to changes in tastes, fashion of foreign consumers or fall in their income, exports of the country iin question decline leading to a disequilibrium in BOP.
If products of he other countries are relatively cheaper than the foreigners are inclined towards those goods and the country in question faces an advance BOP e.g. with the invention of ‘Sal’ by ‘Indonesia’ the demand for our jute product went do ………. The global market, causing all decline in our jute exports………………….
2.) Inflationary Pressures in the economy: Generally, developing countries like India have adverse BOP due to domestic inflation. This encourages imports which are relatively cheaper and exports decline in the foreign markets due to their high prices.
3.) Development Expenditure: Developing countries have to depend on the developed countries of the world for machinery, technical know-how, raw materials etc. in the initial stages of countries development. This increases their import bills and their exports are pretty low to finance the imports, which causes an advance BOP for the country in question.
4.) Increase in cost structure industries: When the cost of production of the export industries of a country increase that the sale ability of the export goods in the foreign markets go down leading to a decline in the export earnings of the country in question which causes a deficit in its BOP.
5.) Appreciation in the Rate of Exchange: Rate of exchange is the rate at which a country’s currency is exchanged with a foreign currency in the global market. Appreciation in the rate of exchange is the rate of exchange is the rise in the external value of the currency. This raises imports as they become cheaper and lowers exports are they are expensive thereby causing a deficit in BOP.
Earlier 1 $ < Rs. 40 and now 1 $ = Rs. 30.
6.) Decrease in Supplier: Agriculture production may decline due to advance weather condition. Industrial production may decline due to labour problem, strikes, lockout, shortage of raw material etc. As a result export fall and import rise in overcome the scarcity at home, causing a deficit in BOP.
7.) Demonstration Effect: People of understand country generally try to initiate the consumption pattern, style etc. of the developed nations which leads to large increase of import of consumer durables thereby causing a deficit in its BOP.
8.) Increased Debt Burden: In order to bring about development, the developing countries are trying to speed up the process of development by attracting large no. of portfolio investment which has created the burden of debt as interest has to be paid out. This has created an advance BOP condition.
9.) Population Pressure: A rapid increase in population in the country has increased the demand for consumer goods which has lowered the export surplus leading to a decline in export earning and causing a deficit in BOP.
exchange. exchange from the country to the foreign exchange reserve.
No comments:
Post a Comment