BoP

BoP

1. Current Account

   •   The current account records all international economic transactions relating to export and import of goods, services, unilateral transfers and international incomes.   
   • Receipts (Credit)
     • Export of Goods
       • Includes all physical goods exported and imported. Export of goods is shown on the credit side in BoP because the exporter earns foreign currency (inflow).
     • Invisible Items
       • Items which are neither tangible, nor physical and cannot be seen are called Invisible items. 
       • Export of Services
         • Includes various non-factor services sold to and  purchased by the residents of a country from the rest of the world.  Export of services comprises payments received from shipping services, banking and insurance services, foreign tourism etc. which enable a country to acquire foreign exchange and hence are put on the credit side (inflow). 
       • Income Receipts
         •  are classified into investment income and compensation of employees. Investment income earned by residents from investments abroad, e.g. interest, dividend, profits on foreign loans and investments provide foreign exchange to the country and hence listed on the credit side of BoP (inflows). Compensation ofemployees include wages and salaries received by residents from non-residents,which involves receipt of foreign currency and hence listed on the credit side(inflow). 
       • Unilateral Transfer Receipts
         • includes both private and government receipts and payments which take place without any current service (no quid pro quo) in return in the current period.  Examples- gifts, donations to residents from abroad, cash remittances by people from abroad to their families, indemnity payments are transfer receipts shown as items on the credit side of BoP (inflows). 
   • Payments (Debit)
     • Import of Goods
       • Includes all physical goods exported and imported. Import of goods is shown on the debit side in BoP because importers pay in foreign currency (outflow). 
     • Invisible Items
       • Items which are neither tangible, nor physical and cannot be seen are called Invisible items. 
       • Import of Services
         • Includes various non-factor services sold to and purchased by the residents of a country from the rest of the world.  Import of services comprises payments made by residents to foreigners for similar services in foreign exchange and hence are put on the credit side (outflow).
       • Unilateral Transfer Payments
         • includes both private and government receipts and payments which take place without any current service (no quid pro quo) in return in the current period. Similar payments made from the country in question to other countries are transfer payments shown as items in the debit side of BoP. 
       • Income Payments
         • are classified into investment income and compensation of employees. Investment income earned by residents from investments abroad. Payments for similar items by residents of a country to foreign countries involve payments in foreign currency and hence listed on the debit side. . Similar payments made by residents to non-residents which involve foreign currency payments are listed on the debit side (outflow). 
         • are classified into investment income and compensation of employees. Investment income earned by residents from investments abroad. Payments for similar items by residents of a country to foreign countries involve payments in foreign currency and hence listed on the debit side. . Similar payments made by residents to non-residents which involve foreign currency payments are listed on the debit side (outflow). 

2. Capital Account

   • Capital Account Transactions show change in stock magnitude. They refer to Capital receipts and payments (international movements of long-term and short-term capital)  
   • Credit
     • Capital Receipts (Credit Items-Import of Capital, includes capital inflows, item 5)   §  Government, corporations, individuals of a particular country may take loans from the government, corporations, individuals of foreign countries or from international financial institutions §  Government, corporations, individual residents may receive payments from abroad as repayment for a loan they might have lent abroad §  Foreigners might acquire assets in the form of land, houses, factories (plants) shares, etc. in the country whose BoP is of concern to us §  Changes in a country’s stock of gold or reserve of foreign currency    
   • Debit
     •    Capital Payments (Debit Items-Export of Capital, includes capital outflows, item 10) §  Government, corporations, individuals of a particular country may give loans to the government, corporations, individuals of foreign countries §  Government, corporations, individual residents may make payments abroad as repayment for a loan they might have borrowed from abroad §  Residents in the country whose BoP is of concern to us might acquire assets in the form of land, houses, factories (plants) shares, etc. in foreign countries     
   • Direct Foreign Investment
     •    1.     Investment undertaken in firms of other countries either by setting up a firm or by acquisition of an existing firm. If resident Indians undertake direct investments in foreign firms, it involves Capital Payments on the debit side of BoP (outflow). If foreigners undertake direct investments in Indian firms, it involves Capital Receipts on the credit side of BoP (inflow)   
   • Portfolio Investments
     •    1.     consists of purchase of shares in foreign companies and bonds issued by foreign governments. If resident Indians undertake such portfolio investments abroad, it involves payment in foreign currency and is listed under Capital Payments on the debit side of BoP (outflow). If foreigners undertake such portfolio investments in Indian companies/Government, it involves receipt of foreign exchange and is listed under Capital Receipts on the credit side of BoP (inflow).   

3. Balance of Current Account

   •    Balance of Current Account=Balance of Trade+Balance of Invisibles+Balance of Transfers ·      Balance of current account is made up of visibles (Balance of Trade), invisibles (Balance of services), Balance of transfers ·      It shows the difference between export and import of goods and services, net of income receipts and income payments and net of unilateral transfers ·      Since transfers are relatively an unimportant item, balance of current account is made up of mainly trade balance and invisible balance ·      Balance of current account shows the flow aspect of a country’s economic transactions and the items included respond quickly to change in exchange rate ·      Balance of Current Account may be in surplus or deficit. It need not be equal (in equilibrium)   

4. Balance of Trade

   •    Balance of Trade=Export of goods-Import of goods ·      Shows the balance of imports and exports of visible goods in a given year. ·      It is the difference between value of goods exported and the value of goods imported during a year (balance of rows 1 and 6 of Table of components of BoP). ·      If the value of exports of a country is more than its imports, it has a surplus or favourable balance of trade. ·      If the value of imports is more than its exports, it has a deficit or unfavourable balance of trade.   

5. Balance of Capital Account

   •    ·      Refers to the balance of capital transfers-borrowing and lending from abroad, capital repayments (inflow and outflow), sale of assets (import of capital) and purchase of assets (export of capital), gold and foreign exchange from other countries. (balance of rows 5 and 10 of Table of components of BoP). ·      Shows the balance of inflow and outflow of capital   
   • Autonomous Capital Flows
     • Are ordinary capital flows due to normal economic considerations, like earning profits, dividends, interest, other income by international investment and lending.   
   • Accommodating Capital Flows
     •  Accommodating Capital flows are made to bring the balance of payments in equilibrium Example- If there is a deficit in the current account it will have to be settled by an accommodating capital inflow, to bring the balance of payments in equilibrium ·      A deficit in the current account must be settled by a net surplus in the capital account. Example- Foreign currency necessary to finance imports must be met by drawing from the government’s reserves of foreign exchange and gold or by borrowings from abroad ·      Similarly, a surplus in current account must be matched by a deficit in the capital account. ·      Hence balance of payments will be brought in equilibrium, as balance of current account and balance of capital account are inter-related   

6. Disequilibrium

   •    ·      The BoP is normally in disequilbrium, which may be either as a surplus (favourable) or as a deficit (unfavourable) ·      Autonomous receipts < Autonomous Payments = BoP in deficit ·      Autonomous receipts > Autonomous Payments = BoP in surplus ·      A surplus in BoP is a favourable situation, hence not a problem ·      A deficit in the BoP is an adverse situation for the economy   
   • Causes
     • Fall in Foreign Demand
       •    ·      Changes in tastes, fashion, preferences of foreign consumers or comparatively lower prices of products from other countries ·      Fall in foreign income due to recession in those countries ·      This leads to decrease in exports, making BoP unfavourable   
     • Inflationary Pressure in the Economy
       •    ·      A high rate of inflation, makes imports relatively cheaper and encourages imports. ·      It also makes exports less competitive in the foreign markets and reduces exports. ·      This may increase imports and reduce exports, making BoP unfavourable.   
     • Political Factors
       •    ·      Firstly, political turmoil and instability have adverse effects on a country’s BoP.  Example- many African countries, Afghanistan, etc. ·      Secondly, Economic Sanctions imposed by UNO and developed countries adversely affect BoP. Example- Economic sanctions against Iraq, Libya etc. by U.S.A. and others   
     • Developmental Expenditure
       •    ·      Developing countries have to import machines, technical know-how, raw materials etc. from developed nations, during the initial stages of economic development. ·      However, they cannot increase exports to finance imports. ·      Such developmental efforts, lead to adverse BoP and this deficit in the BoP is called structural deficit   
     • Decrease in Supply
       •    ·      Example- agricultural production may fall due to failure of crops, industrial production may fall due to labour strike, shortage of raw materials, power, etc. leading to fall in domestic supply. ·      This may increase imports to overcome the shortfall in domestic supply and also reduce exports. ·      This makes Bop unfavourable.   
     • Population Pressure
       •    ·      Increasing population in developing nations creates increased demand for various consumer goods which cannot always be met out of domestic production and goods produced for exports have to be used to fulfill the domestic demand. ·      This leads to a fall in export surplus and a fall in export earnings, leading to adverse BoP   
     • Demonstration Effect
       •    ·      People of underdeveloped countries imitate the consumption pattern of the developed nations, like high-end luxury cars and other consumer durables. ·      This necessitates increase in imports of such goods, leading to adverse BoP      
     • Appreciation in the Exchange Rate
       •    ·      Appreciation in the Exchange Rate increases the external value of the currency. ·      This makes exports expensive and imports cheaper. ·      Hence imports may increase and exports fall, leading to adverse BoP   
     • Increased Debt Burden
       •    ·      In developing countries, large foreign portfolio investments create the burden of large interest payments in foreign currency which is unfavourable to BoP   
     • Increase in Cost Structure of Export Industries
       •    ·      maybe due to higher wages, higher prices of raw materials and cost of production or higher rate of inflation. ·      This reduces the competitiveness of the exports in the world markets and brings down the volume of exports. ·      This makes BoP unfavourable.   
   • Measures
     • Exchange Control
       •    ·      The exchange control policy is implemented through the central bank. ·      The government may direct exporters to sell their foreign exchange earnings to the central bank and all importers to obtain foreign exchange requirements from the central bank. ·      Foreign exchange may be rationed out among import licence-holders for specified commodities. ·      Government tries to control the deficit in BoP by limiting selling of foreign exchange for payments and imports as far as possible, to the extent of export earnings. ·      However, such exchange controls give rise to black marketing in foreign exchange.   
     • Export Promotion
       •    ·      Reduction in export duties ·      Cash assistance and subsidies to exporters ·      Various facilities like quality control, provision of market information, arranging exhibitions in foreign countries to promote exports ·      Tax exemption for exports as an incentive to exporters ·      Providing tax benefits, finances, raw materials at concessional rates to exporters to reduce cost of production of exports and make them more competitive in foreign markets ·      Encourage foreign tourism by providing good hotels, transport facilities, etc. and earn foreign exchange ·      However it is not easy to increase exports, as exports depend not only on domestic conditions but also on demand conditions in the foreign countries over which the home country has no control.   
     • Import Control
       •    ·      Import control measures are import quotas and tariffs. ·      Quotas apply quantitative restrictions and control the volume of imports. Example- Government may decide that 90% of last year’s volume of imports maybe allowed this year. ·      Government may increase import duties and tariffs to increase the prices of imported goods and bring down imports. ·      Import quotas are more effective as they are a direct measure to bring down imports, while import tariffs are less effective as they are an indirect measure   
     • Devaluation
       •    ·      A Government can devalue its currency to wipe out deficit in BoP. ·      It makes imports expensive to domestic consumers and exports cheaper in foreign countries. ·      If elasticity of demand and supply of imports and exports is high, this leads to a fall in imports and a rise in exports. This reduces deficit in BoP   
     • Depreciation
       •    ·      Depreciation of the country’s currency will wipe out deficits in the BoP. ·      Depreciation means fall in price of domestic currency. ·      Example- If US $1 was ₹ 60 earlier but now exchanges for ₹ 65, Indians have to pay more rupees to buy $1. This means Indian Rupee has depreciated against US Dollar. ·      Depreciation of domestic currency makes imports costlier as import prices rise and imports fall. But, exports become cheaper as export prices fall and exports rise. ·      Government (through the central bank) pursues appropriate exchange rate policy to achieve external balance in BoP   
     • Production of Import Substitutes
       •    ·      Encouragement of production of import substitutes, enables replacement of imports by import substitutes. ·      This will save foreign exchange in the short-run. ·      In the long-run, these industries with adequate incentives, may also become export-earners, which would have a positive impact on the BoP     
     • Monetary Policy
       •    ·      is a powerful instrument to correct disequilibrium in BoP ·      A tight monetary policy, reduces the availability of volume of credit (by selling securities in open market operations, raising CRR and SLR) and also raises interest rates (raising bank rate, Repo rate). ·      Due to this, producers borrow less and undertake less investment. ·      This controls overall expenditure in the economy and reduces/wipes out the deficit in BoP.   
     • Capital Import
       •    ·      In the short-run a deficit in BoP can be corrected by importing Capital , i.e. capital borrowings from foreign countries ( world Bank, IMF, foreign governments, market borrowings from individuals.    ·      As a temporary short-term measure, a country can also attract short-run private capital by raising interest rates and offering tax concessions to foreign investors.   
       • Special Drawing Rights (SDR) – Ø India and a few other countries can use SDR facility with IMF to meet the deficit in BoP. Ø It is an international reserve created by IMF in 1969. Ø It supplements the existing official reserves of member-countries. Ø SDRs are made up of a basket of major foreign currencies like US Dollars, Pound, Euro, Yen. Ø SDR facility is not a currency. It is a potential claim on the freely usable currencies of IMF member-countries. Ø SDRs are allocated by IMF to member countries. SDRs are used only among governments and IMF for BoP settlements. 
     • Fiscal Policy
       •    ·      A restrictive (tight) fiscal policy is a powerful tool to reduce the total expenditure in the economy and reduce/wipe out the deficit in BoP. ·      A tight fiscal policy takes measures to increase taxes and decrease government expenditure. ·      Increase in direct taxes reduces the disposable income in the hands of people and results in decrease in consumption and thereby reduction in imports. ·      Decrease in Government Expenditure also reduces the demand for imported goods. ·      Decrease in transfer payments like old- age pensions which are mostly given to aged people in the low-income groups, etc. immediately reduces consumption as the pensioners allocate most of this pension for consumption purpose. ·      Overall decrease in consumption and investment through fiscal tools of increase in taxes and reduction in government expenditure, leads to fall in income, output and thereby fall in imports, reducing the deficit in BoP. ·      Fiscal Policy tools have more efficacy in correcting deficit in BoP than monetary policy.