A complete BoP account comprises two broad accounts: (a) the current account;

and (b) the capital and financial account.

(a) Current account
The current account measures the flows of goods, services, primary income and
secondary income between residents and non-residents.
The goods and services account records external transactions in goods and
services. The goods account covers principally exports and imports as shown in
merchandise trade statistics, but adjusted for coverage and valuation. For example,
one major adjustment for coverage is the adoption of the change of ownership
principle in the BoP statistical system. Following this principle, goods sent abroad
for processing without a change of ownership are not covered in the goods
account. On the other hand, for goods sold under merchanting, although the goods
involved have never been entered into the economy where the owner resides in,
they are recorded in the goods account of the owners economy given that there has
been a change of ownership of the goods. The goods account values both exports
and imports of goods on the same basis of free on board (f.o.b.) from the economy
of export, thus providing symmetrical valuation. While the goods sent abroad for
processing without a change of ownership are not covered in the goods account of
an economy, the manufacturing services performed on these goods by a processor
in another processing economy are covered in its services account. Other services
cover a wide range of economic activities, including transport, travel, insurance,
financial services, etc.
The primary income account shows the amounts receivable and payable abroad in
return for providing / obtaining use of labour, financial resources or natural
resources to / from non-residents.
The secondary income account records current transfers between residents and
non-residents.
(b) Capital and financial account
The capital account measures external transactions in capital transfers, and the
acquisition and disposal of non-produced, non-financial assets (such as trademarks

and brand names). Examples of capital transfers include forgiveness of debts by

creditors, and cash transfers involving the acquisition or disposal of fixed assets.
The financial account records transactions in financial assets and liabilities
between residents and non-residents. It shows how an economy's external
transactions are financed. Transactions in the financial account are classified by
function (i.e. the purpose of the investment) into direct investment, portfolio
investment, financial derivatives, other investment and reserve assets.
(i) Direct investment
Direct investment refers to external investment in which an investor of an economy
acquires a lasting interest and a significant degree of influence or an effective voice
in the management of an enterprise located in another economy.
(ii) Portfolio investment
Portfolio investment refers to investment in non-resident equity securities and debt
securities (e.g. bonds and notes, money market instruments), other than that
included in direct investment or reserve assets.
(iii) Financial derivatives
Financial derivatives are financial instruments that are linked to a specific financial
instrument or indicator or commodity, and through which specific financial risks
can be traded in financial markets in their own right.
(iv) Other investment
Other investment refers to other financial claims on and liabilities to non-residents
that are not classified as direct investment, portfolio investment, financial
derivatives or reserve assets.
(v) Reserve assets
Reserve assets are external assets that are readily available to and controlled by the
monetary authority of an economy (which refers to the Hong Kong Monetary
Authority in the case of Hong Kong) for meeting balance of payments financing
needs, for intervention in exchange markets to regulate the currency exchange rate
of that economy, and for other related purposes.

Causes of BOP
Crisis in India's BoP caused by several factors. The major causes are:
1. Ever Expanding Trade Gap:
Trade deficit is the result of trade gap, i.e., gap due to a big rise in imports against a
small growth in exports of the country over the years.
As a matter of fact, eighties onwards country's expenditure on imports has risen at
an alarming rates due to the following reasons:
(i) Import Liberalisation:
Due to import liberalisation during the eighties there has been a quantum jump in
imports of capital goods and modern technology. The new economic and trade
policies of 1991 have favoured a further liberalisation of imports.
(ii) Increase in Import Intensity:
The pattern of industrial development and growth of national income during the
seventh plan led to a higher propensity to import. There has been a growth in
import demand for consumer durables.
(iii) Import of Oil:
Petroleum oil and lubricants (POL) has been the single most important item in
India's import bill. During seventies and eighties constituted nearly one-third of
total imports of the country.
(iv) Import of Essential Items:
Due to scarcity created by drought conditions, time to time, the country had to
import essential items such as cereals and edible oils on a large scale.
(v) Rising Prices of Imports:

The country's import bill has been rising due to rising prices of goods in.
international markets. Especially, oil prices have been arbitrarily hiked by the oil
supplying countries.
(vi) Deterioration in the Exchange Rate of Rupee:
The external value of rupee in term of US dollar has continuously depreciated over
the years. Rupee was devalued in 1991. As a result, the country had to pay high
prices of imports in rupee terms.

2. Rising Current Account Deficit:

As a consequence of rising trend in trade deficit, India's currentaccount BoP deficit
has also increased sharply from an average of 1.3 per cent of GDP in the Sixth Plan
to 2.7 per cent of GDP in 1988-89.
The main factor contributing to the rising current account deficit is decline in the
growth of net invisible earnings. The country's earnings from
invisibles declined sharply from Rs. 4311 crores in 1-980-81 to Rs. 1,025 crores in
1989-90. Net invisibles earnings financing only 24 per cent of trade deficit during
the seventh plan as against financing over 60 per cent of trade deficit in the sixth
plan.
Another factor decline is migrants' remittance from abroad. Moreover, the
country's repayment obligation and debt servicing to the IMF and other sources of
external public debt adds to current account BoP deficit.
In 1993-94, that current account deficit came down to $ 0.8 billion from $ 3.6
billion in 1992-93.
3. Deficits on Capital Transactions:
In recent years, there has been the growing deficit on capital account due to
country's rising obligations to meet amortisation payments. The situation is
worsened due to a fall in the availability on concessional aid to finance the deficits
and flattering out a private remittances.

Recently to ease the situation, the government has resorted to external commercial
borrowings, assistance from IMF and MRI deposits, invitation to foreign capital
and encouragement to direct foreign investment.
India's balance of payment position was highly precarious in 1990-91. The country
was caught in a vicious circle of low reserves, low credit rating and poor capacity
to raise resources. The situation was no better in the beginning of 1991-92. To deal
with the problem the government had to compress imports and also to find, sources
of exceptional financing to meet the current account deficit.
Meaning of Disequilibrium in Balance of Payment ?
Though the credit and debit are written balanced in the balance of payment
account, it may not remain balanced always. Very often, debit exceeds credit or the
credit exceeds debit causing an imbalance in the balance of payment account. Such
an imbalance is called the disequilibrium. Disequilibrium may take place either in
the form of deficit or in the form of surplus.
Disequilibrium of Deficit arises when our receipts from the foreigners fall below
our payment to foreigners.
Disequilibrium of Surplus arises when the receipts of the country exceed its
payments.
square Causes of Disequilibrium in Balance of Payment ?
1. Population Growth
Most countries experience an increase in the population and in some like India and
China the population is not only large but increases at a faster rate. To meet their
needs, imports become essential and the quantity of imports may increase as
population increases.
2. Development Programmes
Developing countries which have embarked upon planned development
programmes require to import capital goods, some raw materials which are not
available at home and highly skilled and specialized manpower. Since development

is a continuous process, imports of these items continue for the long time landing
these countries in a balance of payment deficit.
3. Demonstration Effect
When the people in the less developed countries imitate the consumption pattern of
the people in the developed countries, their import will increase. Their export may
remain constant or decline causing disequilibrium in the balance of payments.
4. Natural Factors
Natural calamities such as the failure of rains or the coming floods may easily
cause disequilibrium in the balance of payments by adversely affecting agriculture
and industrial production in the country. The exports may decline while the imports
may go up causing a discrepancy in the country's balance of payments.
5. Cyclical Fluctuations
Business fluctuations introduced by the operations of the trade cycles may also
cause disequilibrium in the country's balance of payments.
6. Inflation
An increase in income and price level owing to rapid economic development in
developing countries, will increase imports and reduce exports causing a deficit in
balance of payments.
7. Poor Marketing Strategies
The superior marketing of the developed countries have increased their surplus.
The poor marketing facilities of the developing countries have pushed them into
huge deficits.
8. Flight Of Capital
Due to speculative reasons, countries may lose foreign exchange or gold stocks
People in developing countries may also shift their capital to developed countries
to safeguard against political uncertainties. These capital movements adversely
affect the balance of payments position.
9. Globalisation

Due to globalisation there has been more liberal and open atmosphere for
international movement of goods, services and capital. Competition has been
increased due to the globalisation of international economic relations. The
emerging new global economic order has brought in certain problems for some
countries which have resulted in the balance of payments disequilibrium.
How to correct the adverse Balance of Payment ?
Solution to correct balance of payment disequilibrium lies in earning moreforeign
exchange through additional exports or reducing imports. Quantitative changes
in exports and imports require policy changes. Such policy measures are in the
form of monetary, fiscal and non-monetary measures
Monetary Measures for Correcting the BoP
The monetary methods for correcting disequilibrium in the balance ofpayment are
as follows :1. Deflation
Deflation means falling prices. Deflation has been used as a measure to
correct deficit disequilibrium. A country faces deficit when its imports exceeds
exports.
Deflation is brought through monetary measures like bank rate policy, open market
operations, etc or through fiscal measures like higher taxation, reduction in public
expenditure, etc. Deflation would make our items cheaper in foreign market
resulting a rise in our exports. At the same time the demands for imports fall due to
higher taxation and reduced income. This would built a favourable atmosphere in
the balance of payment position. However Deflation can be successful when the
exchange rate remains fixed.

2. Exchange Depreciation
Exchange depreciation means decline in the rate of exchange of domestic currency
in terms of foreign currency. This device implies that a country has adopted a
flexible exchange rate policy.

Exchange depreciation will stimulate exports and reduce imports because exports
will become cheaper and imports costlier. Hence, a favourable balance of payments
would emerge to pay off the deficit.
3. Devaluation
Devaluation refers to deliberate attempt made by monetary authorities to bring
down the value of home currency against foreign currency. While depreciation is a
spontaneous fall due to interactions of market forces, devaluation is official act
enforced by the monetary authority. Generally the international monetary fund
advocates the policy of devaluation as a corrective measure of disequilibrium for
the countries facing adverse balance of payment position.
When devaluation is effected, the value of home currency goes down against
foreign currency, After such a change our goods becomes cheap in foreign market.
This is because, after devaluation, dollar is exchanged for more Indian currencies
which push up the demand for exports. At the same time, imports become costlier
as Indians have to pay more currencies to obtain one dollar. Thus demand for
imports is reduced.
Generally devaluation is resorted to where there is serious adverse balance of
payment problem.
4. Exchange Control
It is an extreme step taken by the monetary authority to enjoy complete control
over the exchange dealings. Under such a measure, the central bank directs all
exporters to surrender their foreign exchange to the central authority. Thus it leads
to concentration of exchange reserves in the hands of central authority. At the same
time, the supply of foreign exchange is restricted only for essential goods. It can
only help controlling situation from turning worse. In short it is only a temporary
measure and not permanent remedy.
Non-Monetary Measures for Correcting the BoP
A deficit country along with Monetary measures may adopt the following nonmonetary measures too which will either restrict imports or promote exports.

1. Tariffs
Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices
of imports would increase to the extent of tariff. The increased prices will reduced
the demand for imported goods and at the same time induce domestic producers to
produce more of import substitutes. Non-essential imports can be drastically
reduced by imposing a very high rate of tariff.
2. Quotas
Under the 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 the quota system, the deficit is reduced and the balance of
payments position is improved.
3. Export Promotion
The government can adopt export promotion measures to correct disequilibrium in
the balance of payments. This includes substitutes, tax concessions to exporters,
marketing facilities, credit and incentives to exporters, etc.
The government may also help to promote export through exhibition, trade fairs;
conducting marketing research & by providing the required administrative and
diplomatic help to tap the potential markets.
4. Import Substitution
A country may resort to import substitution to reduce the volume of imports and
make it self-reliant. Fiscal and monetary measures may be adopted to encourage
industries producing import substitutes. Industries which produce import
substitutes require special attention in the form of various concessions, which
include tax concession, technical assistance, subsidies, providing scarce inputs, etc.
Non-monetary methods are more effective than monetary methods and are
normally applicable in correcting an adverse balance of payments.
The causes and consequences of a deficit on the current account of a balance
of payments

A deficit occurs when more money is leaving the country than coming in. This is
when imports of goods and services as well as income and transfer payments
abroad exceed exports and income and transfer payments coming in to the country.
A deficit can arise out of two reasons, one is that the countrys residents are buying
more abroad than overseas residents have spent on the countrys products. This
may be due to a changing exchange rate.
Another cause for a deficit on the trade of goods and services is changes in income.
If people in the UK have an increase in income, they can afford to buy more goods,
some of which may be imports. Similarly, if the US saw a fall in general income
levels, they will buy less products which will decrease imports.
Structural problems can also lead to a deficit in trades in goods and services. This
is where domestic firms are producing poor quality goods and are inefficient. If
this is the case, demand is likely to fall and a deficit will persist.
If there has been a large transfer of income abroad, this will lead to a current
account deficit. A deficit will decrease aggregate demand and lead to a contraction
along aggregate supply. This will lower an economys output, increase
unemployment but reduce the general price level. A rise in the deficit may also
increase international borrowing as well as lead to a fall on the exchange rate.

The causes and consequences of a surplus on the current account of the

balance of payments
A surplus on the other hand is when there is more money entering the country. This
is when the exports and transfers inward exceed the levels of imports and transfers
abroad. This can occur when export revenue exceeds import expenditure and/or
when the country invests successfully abroad and transfers investment income
back home.
The country is likely to have a surplus in the short run when the exchange rate is in
their favour. A reduction in the price of domestic goods attracts foreign customers.
A falling exchange rate also raises the price of imports and this may lead to a
surplus in the current account.

If firms produce high quality products which match consumer demand, then this
will also contribute to the current account surplus.
A surplus however may exist when there is a recession two consecutive quarters
of negative growth. Firms may find difficulty selling products domestically so will
compete vigorously in export markets instead.
A strong inflow of income has the consequence of increasing the money supply.
Banks have more money to lend and this creates a multiplier effect. More
investment from banks can occur which means aggregate demand will increase and
this will have the additional effect of pushing up the exchange rate.
bibliography
Balance of Payments- Paul Madson
International Financial Management- P G Apte
International Economics- Lindert
International Economics- Francis Chernuliam
International Economics- C P Kindelberger
International Economics- Geoffrey Reed
International Economics- H G Mannur

conclusion
You now see that the current account and the capital account are mirror images. A
debit must have a source so for every debit there is a credit. Most important is that
the balance of payments must equal zero if you have recorded your debits and
credits correctly. The Bureau of Economic Analysis collects the balance of
payments data.