Chapter 12 Balance of payments

Meaning of Balance of Payments

Balance of payments is an accounting statement that provide a systematic record to all the
economic transaction, between resident of a country and the rest of the world, in a given
period.

Economic Transaction
1. Visible Items
These include all types of physical goods which are imported and exported as they are
made of some matter that can be seen, touched, measured.
2. Invisible Items
Invisible items of trade refer to all types of services like shipping, banking, etc…these
are called invisible goods as they cannot be felt, seen, and measured
3. Unilateral Items or transfer
Unilateral transfer includes gifts, remittance, etc. since this transaction do not involve
any claims for repayments.
4. Capital transfer
Capital transfer relates to capital receipts (through borrowings or sale of assets) and
capital payments (through capital repayments or purchase of assets)

Structure of Balance of Payments

1. Credit side:
All inflow or sources of foreign exchange are recorded
2. Debit side
All outflow or uses of foreign exchange are recorded on the debit side.
1. Balanced bop
2. Surplus bop
3. Deficit bop
Pehle baat krte hai hum

1. Balance Bop
 Bop is balance when receipt of foreign exchange is equal to payments of foreign
exchange.
2. Surplus BOP
BOP is surplus when receipt of foreign exchange is more than payments of foreign
exchange.
3. Deficit BOP
BOP is deficit when the receipt of foreign exchange is less than payments of foreign
exchange.

Meaning of balance of trade

Balance of trade refers to difference between the amount of export and import of visible item.
BALANCE OF TRADE = EXPORT OF GOODS - IMPORTS OF GOODS

Components of balance of payments

1. Current account
Current account refers to an account which record all the transaction relating to
exports and import of goods and services and unilateral transfer during a given period.
Components of current accounts
(i) Export and Import of Goods
(i) Export and Import of Goods (Merchandise Transactions or Visible Trade):
A major part of transactions in foreign trade is in the form of export and import of goods
(visible items). Payment for import of goods is written on the negative side (debit items) and
receipt from exports is shown on the positive side (credit items). Balance of these visible
exports and imports is known as balance of trade (or trade balance).

(ii) Export and Import of Services

Export and Import of Services (Invisible Trade): It includes a large variety of non-factor
services (known as invisible items) sold and purchased by the residents of a country, to and
from the rest of the world. Payments are either received or made to the other countries for use
of these services. Services are generally of three kinds: (a) Shipping, (b) Banking, and (c)
Insurance. Payments for these services are recorded on the negative side and receipts on the
positive side.

(iii) Unilateral or Unrequited Transfers to and from abroad (One sided Transactions):
Unilateral or Unrequited Transfers to and from abroad (One sided Transactions): Unilateral
transfers include gifts, donations, personal remittances and other ‘oneway’ transactions.
These refer to those receipts and payments, which take place without any service in return.
Receipt of unilateral transfers from rest of the world is shown on the credit side and unilateral
transfers to rest of the world on the debit side.

(iv) Income receipts and payments to and from abroad

Income receipts and payments to and from abroad: It includes investment income in the form
of interest, rent and profits.

Balance on current account

In the current account receipt from export of goods services and unilateral receipt are entered
as credit or positive item and payments for import of goods services and unilateral payments
are entered as debit or negative items. The net value of credit and debit balance referred as
balance on current account.
Surplus in the current account arises when Credit items are more than debit items.
Deficit in current account arises when debit items are more than Credit items
[Link] account
Capital account of balance of payment record all the transaction between the resident of a
country and rest of the world, which cause a change in the assets or liability of the resident of
the country or its government.

[Link] Transaction - When private sector company receive or give short term or long
term loan is known as private transactions. In which loan received will come under credit side
and repayment or interest on loan come under debit side.
[Link] Transaction – Government of country also take short term and long term loans
from international institutions like World bank, IMF tec. Reason could be anything , but it is
affecting assets and liabilities.
[Link] Direct Investment- A foreign direct investment (FDI) is an investment made by a
firm or individual in one country into business interests located in another country.
Generally, FDI takes place when an investor establishes foreign business operations or
acquires foreign business assets in a foreign company.
[Link] to and from abroad - a. investment by the rest of the world in shares of Indian
companies, real estate in India etc.…. such investment from abroad is recorded on the
positive (credit) side as they bring in foreign exchange.
b. investment by Indian resident in shares of foreign companies, real estate abroad,
etc…...such investment to abroad are recorded on the negative (debit) side as they lead to
outflow of foreign exchange...
Balance on capital account
In the capital account receipt of foreign exchange like loan from abroad, sale of assets, shares
of foreign countries etc. are entered as credit or positive item and Payments of foreign
exchange like repayment of loans, purchase of assets or shares in foreign countries etc. are
entered as debit or negative items. The net value of credit and debit balance referred as
balance on capital account.
Surplus in the capital account arises when Credit items are more than debit items.
Deficit in capital account arises when debit items are more than Credit items.

Difference between Autonomous and Accommodating items

1. Autonomous item
Autonomous items: refers to that international economic transaction, which take place
due to some economic motive such as profit maximization.
1. These items are also known as above line item
2. Autonomous transactions are independent of the state of BOP accounts.
2. Accommodating items

Accommodating items refer to the transaction that are undertaken to cover deficit or surplus
in autonomous transaction i.e. such transaction is determined by net consequences of
autonomous transaction…
1. These items are also known as below the line item.
2. Accommodating transaction take place only on capital account.

Deficit in Balance of payment

1. Fall in demand for country’s goods in the foreign markets leads to fall in exports and
it adversely affects the balance of payments.
2. High inflation- When there is inflation in the domestic economy, foreign goods
become relatively cheaper as compared to domestic goods. It increases imports which
causes a deficit in the BOP.
[Link] of services-
Underdeveloped countries import services from developed countries for which, they must pay
huge amounts of money. It leads to a deficit in the BOP.

[Link] Process-
Developing countries depend on developed nations for supply of machines, technology, and
other equipment. This leads to increased levels of imports, thereby, resulting in a deficit in the
BOP account.

[Link] fluctuations-
When the domestic economy is going through a phase of boom, then domestic production
may be unable to satisfy the domestic demand. It leads to a deficit in BOP, due to increase in
imports.

Political Factors
[Link] instability –
Political instability may lead to large capital outflows and reduce the inflows of foreign
funds, thus, creating disequilibrium in the BOP.

[Link] disturbance-
Frequent changes in the government, inadequate support to the government in parliament also
discourage inflows of capital. This leads to a deficit due to higher outflows than inflows.
Social Factors
[Link] in taste and preferences-
An unfavourable change for the domestic goods leads to a deficit in the balance of payments.

[Link] effect-
When the people of developed countries come in contact with those of advanced countries,
they start adopting the foreign pattern of consumption. Due to this reason, their imports
increase and it leads to an adverse balance of payments for underdeveloped country.

Difference between Balance of Trade Vs Balance of Payments

BASIS FOR
COMPARISON BALANCE OF TRADE BALANCE OF PAYMENT

Meaning Balance of Trade is a statement that Balance of Payment is a statement that

captures the country's export and keeps track of all economic transactions
import of goods with the remaining done by the country with the remaining
world. world.

Records Transactions related to goods only. Transactions related to both goods and
services are recorded.

Capital Transfers Are not included in the Balance of Are included in Balance of Payment.
Trade.

Which is better? It gives a partial view of the country's It gives a clear view of the economic
economic status. position of the country.

Result It can be Favorable, Unfavorable or Both the receipts and payment sides
balanced. tallies.

Component It is a component of Current Account Current Account and Capital Account.

of Balance of Payment.