B. Bop - Final

International Finance
1.Introduction:
BALANCE OF PAYMENTS
The balance of payments of a country is a systematic record of all

economic transactions between the residents of a country and the rest of the
world. It presents a classified record of all receipts on account of goods exported,
services rendered and capital received by residents and payments made by
theme on account of goods imported and services received from the capital
transferred to non-residents or foreigners.
- Reserve Bank of India
The above definition can be summed up as following: - Balance of

Payments is the summary of all the transactions between the residents of one
country and rest of the world for a given period of time, usually one year.
Like other accounts, the BOP records each transaction as either a plus or a
minus. The general rule in BOP accounting is the following:-
a) If a transaction earns foreign currency for the nation, it is a credit and is

recorded as a plus item.
b) If a transaction involves spending of foreign currency it is a debit and is
recorded as a negative item.
The BOP is a double entry accounting statement based on rules of debit

and credit similar to those of business accounting & book-keeping, since it
records both transactions and the money flows associated with those
transactions. Also in case of statistical discrepancy the difference amount is
adjusted with errors and omissions account and thus in accounting sense the BOP
statement always balances.
Balance of Payment is a standard double entry accounting record to capture all

transactions of an economy with the Rest of the World.
It is a statistical statement showing:
a. Transactions in goods and services between an economy and rest of the

world.
b. Changes of ownership and changes in countrys monetary, gold, SDRs, claims

and liabilities to the rest of the world.
c. Unrequited transfers and counterpart entries that are needed to balance, in

the accounting sense.
2. The BOP Components

The various components of a BOP statement are:
A. Current Account
B. Capital Account
C. IMF
D. SDR Allocation
E. Reserves and Monetary Gold
F. Errors and omissions
Components of Balance of Payments

Items Credit Debit Net

I] Current Account
1. Merchandise:
-Private
-Government
2. Non-Monetary Gold Movement
3. Invisibles
Total Current Account (1+2+3)
II] Capital Account
1. Private:
-Long Term
-Short Term
2. Banking
3. Official
-Loans
-Amortization
-Miscellaneous
Total Capital Account (1+2+3)
*Basic Balance
III] Reserves Account
1. IMF
2. SDR Allocation
3. Reserves and Monetary Gold
IV] Errors and Omissions

A. Structure of Current Account

1] Merchandise (Trade of Visible items)
-Private
-Government
2] Non Monetary Gold Movement
3] Invisibles
- Trade in services
- Investment income
- Government not classified elsewhere
- Transfer Payments
- Unilateral Payments
Total Current Account (1+2+3)
Balance Of Current Account
BOP on current account refers to the inclusion of three balances of namely

Merchandise balance, Services balance and Unilateral Transfer balance.
In other words it reflects the net flow of goods, services and unilateral transfers
(gifts). The net value of the balances of visible trade and of invisible trade and of
unilateral transfers defines the balance on current account.
BOP on current account is also referred to as Net Foreign Investment

because the sum represents the contribution of Foreign Trade to GNP.
Thus the BOP on current account includes imports and exports of

merchandise (trade balances), military transactions and service transactions
(invisibles). The service account includes investment income (interests and
dividends), tourism, financial charges (banking and insurances) and
transportation expenses (shipping and air travel). Unilateral transfers include
pensions, remittances and other transfers for which no specific services are
rendered.
It is also worth remembering that BOP on current account covers all the
receipts on account of earnings (or opposed to borrowings) and all the payments
arising out of spending (as opposed to lending). There is no reverse flow entailed
in the BOP on current account transactions.
Identify a deficit or a surplus in Current account.

Cr > Dr = surplus and visa versa
Balance Of Visible Trade
Balance of visible trade is also known as balance of merchandise trade,

and it covers all transactions related to movable goods where the ownership of
goods changes from residents to non-residents (exports) and from non-residents
to residents (imports). The valuation should be on F.O.B basis so that
international freight and insurance are treated as distinct services and not
merged with the value of goods themselves. Exports valued on F.O.B basis are
the credit entries. Data for these items are obtained from the various forms that
the exporters have fill and submit to the designated authorities. Imports valued
at C.I.F are the debit entries. Valuation at C.I.F. though inappropriate, is a forced
choice due to data inadequacies. The difference between the total of debits and
credits appears in the Net column. This is the Balance of Visible Trade.
In visible trade if the receipts from exports of goods happen to be equal to

the payments for the imports of goods, we describe the situation as one of zero
goods balance. Otherwise there would be either a positive or negative goods
balance, depending on whether we have receipts exceeding payments (positive)
or payments exceeding receipts (negative).
Balance Of Trade
The difference between the value of goods and services exported and
imported by a country is the measure of balance of trade.
Non monetary gold movements:
Traditionally gold is treated as both a commodity and a financial asset.

The quantum of gold that is held by monetary authority as a part of International
reserves is classified as financial asset. All the other gold that is with residents is
commodity. While this commodity gold is traded by residents and non-residents,
it is recorded in this account which is a part of the Current Account. It is simply
import/ export transaction of gold by any one other than monetary authority. In
India Monetary authority is RBI.
Monetisation and Demonetisation of Gold: it may be observed that

:Reserves and Monetary Gold part of Balance of Payments accounts for
monetary gold. Monetary authority might sometimes acquire gold from residents
to increase gold that forms part of international reserves. In this process
commodity category gets transferred to financial asset category. Hence it is a
debit to reserve account.
Non-Monetary Gold movements current account. This process is called as

Monetiasation of Gold. If it is reverse process i.e. monetary authority sells gold,
debiting Non Monetary Gold Movement and crediting Reserves it is called
Demonetisation of Gold.
Balance Of Invisible Trade
Just as a country exports goods and imports goods a country also exports
and imports what are called as services (invisibles). The service account records
all the service exported and imported by a country in a year. Unlike goods which
are tangible or visible services are intangible. Accordingly services transactions
are regarded as invisible items in the BOP. They are invisible in the sense that
service receipts and payments are not recorded at the port of entry or exit as in
the case with the merchandise imports and exports receipts. Except for this there
is no meaningful difference between goods and services receipts and payments.
Both constitute earning and spending of foreign exchange. Goods and services
accounts together constitute the largest and economically the most significant
components in the BOP of any country.
The service transactions take various forms. They basically include 1)

transportation, banking, and insurance receipts and payments from and to the
foreign countries, 2) tourism, travel services and tourist purchases of goods and
services received from foreign visitors to home country and paid out in foreign
countries by home country citizens, 3) expenses of students studying abroad and
receipts from foreign students studying in the home country, 4) expenses of
diplomatic and military personnel stationed overseas as well as the receipts from
similar personnel who are stationed in the home country and 5) interest, profits,
dividends and royalties received from foreign countries and paid out to foreign
countries. These items are generally termed as investment income or receipts
and payments arising out of what are called as capital services. Balance of
Invisible Trade is a sum of all invisible service receipts and payments in which
the sum could be positive or negative or zero. A positive sum is regarded as
favourable to a country and a negative sum is considered as unfavourable. The
terms are descriptive as well as prescriptive.
Unilateral Transfers
Unilateral transfers or unrequited receipts, are receipts which the

residents of a country receive for free, without having to make any present or
future payments in return. Receipts from abroad are entered as positive items,
payments abroad as negative items. Thus the unilateral transfer account includes
all gifts, grants and reparation receipts and payments to foreign countries.
Unilateral transfer consist of two types of transfers:
(a) government transfers (b) private transfers.
Foreign economic aid or assistance and foreign military aid or assistance

received by the home countrys government (or given by the home government
to foreign governments) constitutes government to government transfers. The
United States foreign aid to India, for BOP 9but a debit item in the US BOP).
These are government to government donations or gifts. There no well worked
out theory to explain the behaviour of this account because these flows depend
upon political and institutional factors. The government donations (or aid or
assistance) given to government of other countries is mixed bag given for either
economic or political or humanitarian reasons. Private transfers, on the other
hand, are funds received from or remitted to foreign countries on person to
person basis. A Malaysian settled in the United States remitting $100 a month to
his aged parents in Malaysia is a unilateral transfer inflow item in the Malaysian
BOP. An American pensioner who is settled after retirement in say Italy and who
is receiving monthly pension from America is also a private unilateral transfer
causing a debit flow in the American BOP but a credit flow in the Italian BOP.
Countries that attract retired people from other nations may therefore expect to
receive an influx of foreign receipts in the form of pension payments. And
countries which render foreign economic assistance on a massive scale can
expect huge deficits in their unilateral transfer account. Unilateral transfer
receipts and payments are also called unrequited transfers because as the name
itself suggests the flow is only in one direction with no automatic reverse flow in
the other direction. There is no repayment obligation attached to these transfers
because they are not borrowings and lendings but gifts and grants exchanged
between government and people in one country with the governments and
peoples in the rest of the world.
B. Structure of capital a/c
CAPITAL A/c
PRIVATE SECTOR BANKING SECTOR OFFICIAL SECTOR

CAPITAL FLOWS CAPITAL FLOWS CAPITAL FLOWS
- LONG TERM
-SHORT TERM
The Capital Account
The capital account records all international transactions that involve a

resident of the country concerned changing either his assets with or his
liabilities to a resident of another country. Transactions in the capital account
reflect a change in a stock either assets or liabilities.
It is often useful to make distinctions between various forms of capital

account transactions. The basic distinctions are between private and official
transactions, between portfolio and direct investment and by the term of the
investment (i.e. short or long term). The distinction between private and official
transaction is fairly transparent, and need not concern us too much, except for
noting that the bulk of foreign investment is private.
Direct investment is the act of purchasing an asset and the same time acquiring
control of it (other than the ability to re-sell it). The acquisition of a firm resident
in one country by a firm resident in another is an example of such a transaction,
as is the transfer of funds from the parent company in order that the subsidiary
company may itself acquire assets in its own country. Such business transactions
form the major part of private direct investment in other countries, multinational
corporations being especially important. There are of course some examples of

such transactions by individuals, the most obvious being the purchase of the
second home in another country.
Portfolio investment by contrast is the acquisition of an asset that does not

give the purchaser control. An obvious example is the purchase of shares in a
foreign company or of bonds issued by a foreign government. Loans made to
foreign firms or governments come into the same broad category. Such portfolio
investment is often distinguished by the period of the loan (short, medium or long
are conventional distinctions, although in many cases only the short and long
categories are used). The distinction between short term and long term
investment is often confusing, but usually relates to the specification of the asset
rather than to the length of time of which it is held. For example, a firm or
individual that holds a bank account with another country and increases its
balance in that account will be engaging in short term investment, even if its
intention is to keep that money in that account for many years. On the other
hand, an individual buying a long term government bond in another country will
be making a long term investment, even if that bond has only one month to go
before the maturity. Portfolio investments may also be identified as either private
or official, according to the sector from which they originate.
The purchase of an asset in another country, whether it is direct or

portfolio investment, would appear as a negative item in the capital account for
the purchasing firms country, and as a positive item in the capital account for the
other country. That capital outflows appear as a negative item in a countrys
balance of payments, and capital inflows as positive items, often causes
confusions. One way of avoiding this is to consider that direction in which the
payment would go (if made directly).
The purchase of a foreign asset would then involve the transfer of money to the
foreign country, as would the purchase of an (imported) good, and so must
appear as a negative item in the balance of payments of the purchasers
country (and as a positive item in the accounts of the sellers country).
The net value of the balances of direct and portfolio investment defines the
balance on capital account.
Identify a deficit or a surplus in Capital account.

Cr > Dr = surplus and visa versa
The capital account consists of financial transactions that lead to changes

in foreign assets and liabilities of the economy. Increase in assets (decrease in
liabilities) is debit. Decrease in assets (increase in liabilities) is credit. It means
capital inflow is credit and capital outflow is debit.
The transactions are grouped by the institutional sector (banking,

government and private) and by term to maturity of the original claim.
1. Private Sector Capital Flows: This consists of loans received by private entities
(other than banks) in India from non-residents, investment by foreigners in
shares of Indian companies, repayment of loans to residents by non-
residents, repatriation of Indian investments abroad i.e. capital inflows, on
credit side. The capital outflows are recorded on the debit side such as
investment by residents in shares abroad, investment by residents in foreign
properties and assets, repatriation of foreign investments in India,
disbursement of loans to non-residents. Short-term capital flows pertain to
claims with maturities upto a year, rest are long term capital flows.
2. Banking Capital: This covers changes in assets and liabilities of commercial

banks. This includes government banks, private banks as well as co-operative
banks that are authorized to deal in foreign exchange. Assets are the balances
held by foreign branches of Indian banks in India. Increase in assets is debit
and Increase in liabilities is credit. Decrease in assets is credit and decrease in
liabilities is debit.
3. Official Capital Flows: This includes transactions of Government of India (GOI)

and RBI that affect foreign financial assets and liabilities of Government of
India. In case of RBI, official reserve assets are excluded as they are covered
under Reserves and Monetary Gold. Even transactions of GOI with
International Monetary Fund are excluded and recorded separately.
The net balance between the debit and credit entries under the private
sector capital flows, Banking sector capital flows, Official sector capital flows
taken together is Capital account. If credits exceed debits, it is a surplus and
if debits exceed credits it is a deficit.
Accommodating & Autonomous Capital Flows

Economists have often found it useful to distinguish between autonomous

and accommodating capital flows in the BOP. Transactions are said to
Autonomous if their value is determined independently of the BOP.
Accommodating capital flows on the other hand are determined by the
net consequences of the autonomous items. An autonomous transaction is
one undertaken for its own sake in response to the given configuration of prices,
exchange rates, interest rates etc, usually in order to realise a profit or reduced
costs. It does not take into account the situation elsewhere in the BOP. An
accommodating transaction on the other hand is undertaken with the motive of
settling the imbalance arising out of other transactions. An alternative
nomenclature is that capital flows are above the line (autonomous) or below the
line (accommodating). Obviously the sum of the accommodating and
autonomous items must be zero, since all entries in the BOP account must come
under one of the two headings. Whether the BOP is in surplus or deficit depends
on the balance of the autonomous items. The BOP is said to be in surplus if
autonomous receipts are greater than the autonomous payments and in deficit if
vice a versa.
Essentially the distinction between both the capital flow lies in the motives
underlying a transaction, which are almost impossible to determine. We cannot
attach the labels to particular groups of items in the BOP accounts without giving
the matter some thought. For example a short term capital movement could be a
reaction to difference in interest rates between two countries. If those interest
rates are largely determined by influences other than the BOP, then such a
transaction should be labelled as autonomous. Other short term capital
movements may occur as a part of the financing of a transaction that is itself
autonomous (say, the export of some good), and as such should be classified as
accommodating.
There is nevertheless a great temptation to assign the labels autonomous

and accommodating to groups of item in the BOP. i.e. to assume, that the great
majority of trade in goods and of long term capital movements are autonomous,
and that most short term capital movements are accommodating, so that we
shall not go far wrong by assigning those labels to the various components of the
BOP accounts. Whether that is a reasonable approximation to the truth may
depend in part on the policy regime that is in operation. For example what is an
autonomous item under a system of fixed exchange rates and limited capital
mobility may not be autonomous when the exchange rates are floating and
capital may move freely between countries.
Basic Balance
The basic balance was regarded as the best indicator of the economys position
vis--vis other countries in the 1950s and the 1960s. It is defined as the sum of
the BOP on current account and the net balance on long term capital, which were
considered as the most stable elements in the balance of payments. A worsening
of the basic balance [an increase in a deficit or a reduction in a surplus or even a
move from the surplus to deficit] was seen as an indication of deterioration in the
[relative] state of the economy.
The short term capital account balance is not included in the basic balance. This is
perhaps for two main reasons:
a) Short term capital movements unlike long term capital movements are
relatively volatile and unpredictable. They move in and out of the country in a
period of less than a year or even sooner than that. It would therefore be
improper to treat short term capital movements on the same footing as
current account BOP transactions which are extremely durable in nature. Long
term capital flows are relatively more durable and therefore they qualify to be
treated along side the current account transactions to constitute basic
balance.
b) In many cases, countries dont have a separate short term capital

account as they constitute a part of the Errors and Omissions Account.
A deficit on the basic balance could come about in various ways, which are
not mutually equivalent. E.g. suppose that the basic balance is in deficit because
a current account deficit is accompanied by a deficit on the long term capital
account. The long term capital outflow will, in the future, generate profits,
dividends and interest payments which will improve the current account and so,
ceteris paribus, will reduce or perhaps reduce the deficit. On the other hand, a
basic balance surplus consisting of a deficit on current account that is more than
covered by long term borrowings from abroad may lead to problems in future,
when profits, dividends etc are paid to foreign investors.
BASIC BALANCE- total of the credit column of both current A/c and capital
A/c and the totals of the debits of both these accounts.
CR DR
Inflows outflows
(A) Current A/C xxx xxx
(B) Capital A/C xxx xxx

(A+B)Basic balance xx xxx
(C) Reserves xx xxx basic A/C surplus
BOP bal xx xx basic A/C deficit
C. D. E. The IMF SDR & RESERVES AND MONETARY GOLD A/C.

,
Reserves Account
Official reserve account forms a special feature of the capital account. This
account records the changes in the part of the reserves of other countries that is
held in the country concerned. These reserves are held in three forms: in
foreign currency, usually but not always the US dollars, as gold, and as
Special Deposit Receipts (SDRs) borrowed from the IMF. Note that the
reserves do not have to be held by the country. Indeed most of the countries hold
a proportion of the reserves in accounts with foreign central banks.
The IMF account contains purchases (credits) and repurchases (debits)

from the IMF. SDRs Special Drawing Rights are a reserve asset created by the
IMF and allocated from time to time to member countries. Within certain
limitations it can be used to settle international payments between monetary
authorities of member countries. An allocation is a credit while retirement is a
debit. The Reserve and Monetary Gold account records increases (debits) and
decreases (credits) in reserve assets. Reserve assets consist of RBIs holdings of
gold and foreign exchange (in the form of balances with foreign central banks and
investment in foreign government securities) and governments holding of SDRs.
Errors and Omissions is a statistical residue. Errors and omissions (or the
balancing item) reflect the difficulties involved in recording accurately, if at all, a

wide variety of transactions that occur within a given period of (usually 12
months). It is used to balance the statement because in practice it is not possible
to have complete and accurate data for reported items and because these cannot,
therefore, ordinarily have equal entries for debits and credits.
F. ERRORS AND OMISSIONS
Errors and omissions is a statistical residue. It is used to balance the

statement because in practice it is not possible to have complete and accurate
data for reported items and because these cannot, therefore, ordinarily have
equal entries for debits and credits. The entry for net errors and omissions often
reflects unreported flows of private capital, although the conclusions that can be
drawn from them vary a great deal from country to country, and even in the
same country from time to time, depending on the reliability of the reported
information. Developing countries, in particular, usually experience great difficulty
in providing reliable information.
Errors and omissions (or the balancing item) reflect the difficulties
involved in recording accurately, if at all, a wide variety of transactions that occur
within a given period of (usually 12 months). In some cases there is such large
number of transactions that a sample is taken rather than recording each
transaction, with the inevitable errors that occur when samples are used. In
others problems may arise when one or other of the parts of a transaction takes
more than one year: for example wit a large export contract covering several
years some payment may be received by the exporter before any deliveries are
made, but the last payment will not made until the contract has been completed.
Dishonesty may also play a part, as when goods are smuggled, in which case the
merchandise side of the transaction is unreported although payment will be made
somehow and will be reflected somewhere in the accounts. Similarly the desire to
avoid taxes may lead to under-reporting of some items in order to reduce tax
liabilities.
Finally, there are changes in the reserves of the country whose balance of
payments we are considering, and changes in that part of the reserves of other
countries that is held in the country concerned. Reserves are held in three forms:
in foreign currency, usually but always the US dollar, as gold, and as Special
Deposit Receipts (SDRs) borrowed from the IMF. Note that reserves do not have
to be held within the country. Indeed most countries hold a proportion of their
reserves in accounts with foreign central banks.
The changes in the countrys reserves must of course reflect the net value
of all the other recorded items in the balance of payments. These changes will of
course be recorded accurately, and it is the discrepancy between the changes in
reserves and the net value of the other record items that allows us to identify the
errors and omissions.
Illustrate the items which fall under capital account and current account
with examples.
CREDITS DEBITS
Current Account Current Account
1. Merchandise Exports (Sale of 1. Merchandise Imports (purchase
Goods) of Goods)
2. Invisible Exports (Sale of 2. Invisible Imports (Purchase of
Services) Services)
a. Transport services sold a. Transport services
abroad purchased from abroad
b. Insurance services sold b. Insurance services
abroad purchased
c. Foreign tourist c. Tourist expenditure
expenditure in country abroad
d. Other services sold d. Other services purchased
abroad from abroad
e. Incomes received on e. Income paid on loans and
loans and investments abroad. investments in the home
country.
3. Unilateral Transfers 3. Unilateral Transfers
a. Private remittances received a. Private remittances abroad
from abroad
b. Pension payments received from b. Pension payments abroad
abroad
c. Government grants received c. Gov
from abroad ernment grants abroad.
Capital Account Capital Account
3. Foreign long-term investments 3. Long-term investments abroad
in the home country (less (less redemptions and repayments)
redemptions and repayments)
a. Direct investments in the a. Direct Investments
home country abroad
b. Foreign investments in b. Investments in foreign
domestic securities securities
c. Other investments of c. Other investments
foreigners in the home country abroad
d. Foreign Governments d. Government loans to
loans to the home country. foreign countries
4. Foreign short-term 4. Short-term investments
investments in the home country. abroad.
3. The Importance of the BOP Statements

BOP statistics are regularly compiled, published and are continuously
monitored by companies, banks and government agencies. A set of BOP accounts
is useful in the same way as a motion picture camera. The accounts do not tell us
what is good or bad, nor do they tell us what is causing what. But they do let us
see what is happening so that we can reach our own conclusions. Below are 3
instances where the information provided by BOP accounting is very necessary:
1. Judging the stability of a floating exchange rate system is easier with BOP
as the record of exchanges that take place between nations help track the
accumulation of currencies in the hands of those individuals more willing to
hold on to them.
2. Judging the stability of a fixed exchange rate system is also easier with
the same record of international exchange. These exchanges again show the
extent to which a currency is accumulating in foreign hands, raising questions
about the ease of defending the fixed exchange rate in a future crisis.
3. To spot whether it is becoming more difficult for debtor counties to repay
foreign creditors, one needs a set of accounts that shows the accumulation of
debts, the repayment of interest and principal and the countries ability to earn
foreign exchange for future repayment. A set of BOP accounts supplies this
information. This point is further elaborated below.
The BOP statement contains useful information for financial decision

makers. In the short run, BOP deficit or surpluses may have an immediate impact
on the exchange rate. Basically, BOP records all transactions that create demand
for and supply of a currency. When exchange rates are market determined, BOP
figures indicate excess demand or supply for the currency and the possible impact
on the exchange rate. Taken in conjunction with recent past data, they may
conform or indicate a reversal of perceived trends. They also signal a policy shift
on the part of the monetary authorities of the country unilaterally or in concert
with its trading partners. For instance, a country facing a current account deficit
may raise interest to attract short term capital inflows to prevent depreciation of
its currency. Countries suffering from chronic deficits may find their credit ratings
being downgraded because the markets interpret the data as evidence that the
country may have difficulties its debt.
BOP accounts are intimately with the overall saving investment balance in
a countrys national accounts. Continuing deficits or surpluses may lead to fiscal
and monetary actions designed to correct the imbalance which in turn will affect
exchange rates and interest rates in the country. In nutshell corporate finance
managers must monitor the BOP data being put out by government agencies on a
regular basis because they have both short term and long term implications for a
host of economic and financial variables affecting the fortunes of the company.
4. Imp questions:
1. IN THE ACCOUNTING SENSE THE BOP ALWAYS BALANCES!
The BOP is a double entry accounting statement based on rules of debit and
credit similar to those of business accounting & book-keeping, since it records
both transactions and the money flows associated with those transactions. For
instance, exports (like sales of a business) are credits, and imports (like the
purchases of a business) are debits. As in business accounting the BOP records
increases in assets (direct investment abroad) and decreases in liabilities
(repayment of debt) as debits, and decreases in assets (sale of foreign securities)
and increases in liabilities (the utilisation of foreign goods) as credits. An
elementary rule that may assist in understanding these conventions is that in
such transactions it is the movement of a document, not of the money that is
recorded. An investment made abroad involves the import of a documentary
acknowledgement of the investment, it is therefore a debit. The BOP has one
important category that has no counter part or at least no significant counter part
in business accounting, i.e. international gifts and grants and other so called
transfer payments.
In general credits may be conceived as receipts and debits as payments. However

this is not always possible. In particular the change in a countrys international
reserves in gold and foreign exchange is treated as a debit if it is an increase and
a credit if it is a decrease. The procedure is to offset changes in reserves against
changes in the other items in the table so that the grand total is always zero,
(except for errors and omissions).
A transaction entering the BOP usually has two aspects and invariably gives rise
to two entries, one a debit and the other a credit. Often the two aspects fall in
different categories. For instance, an export against cash payment may result in
an increase in the exporting countrys official foreign exchange holdings. Such a
transaction is entered in the BOP as a credit for exports and as a debit for the
capital account. Both aspects of a transaction may sometimes be appropriate to
the same account. For instance the purchase of a foreign security may have as its
counter part reduction in official foreign exchange holdings.
Thus it is clear that if we record all the entries in BOP in a proper way, debits and
credits will always be equal. So that in accounting sense the BOP will be in
balance.
In accounting sense BOP always balances. A
Double entry accounting record to capture all transactions

Current A/C deficit are matched with capital A/C surplus and
visa versa
Reserves A/c
DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR UNDESIRABLE!
The basic balance was regarded as the best indicator of the economys
position vis--vis other countries in the 1950s and the 1960s. It is defined as the
sum of the BOP on current account and the net balance on long term capital,
which were considered as the most stable elements in the balance of payments.
A worsening of the basic balance [an increase in a deficit or a reduction in a

surplus or even a move from the surplus to deficit] is seen as an indication of
deterioration in the [relative] state of the economy. Thus it is very much evident
that a deficit in the basic balance is a clear indicator of worsening of the state of
the countrys BOP position, and thus can be said to be undesirable at the very
outset.
However, on further thoughts, a deficit in the basic balance can also be

understood to be desirable. This can be explained as follows: A deficit on the
basic balance could come about in various ways, which are not mutually
equivalent. E.g. suppose that the basic balance is in deficit because a current
account deficit is accompanied by a deficit on the long term capital account. This
deficit in long term capital account could be clearly observed in a developing
countrys which might be investing heavily on capital goods for advancement on
the agricultural and industrial fields. This long term capital outflow will, in the
future, generate profits, dividends and interest payments which will improve the
current account and so, ceteris paribus, will reduce or perhaps reduce the deficit.
Thus a deficit in basic balance can be desirable as well as undesirable, as it

clearly depends upon what is leading to a deficit in the long term capital account.
Numericals
1. The following balance of payments information is available for a particular
economy:
Decline in foreign exchange reserves 500

Long term Capital Inflow (net) 600
Merchandise Exports 2,000
Merchandise Imports 1,500
Export of Services 3,000
Import of Services 2,500
Calculate short-term capital account.
Solution:
From the above data balance in the current account is determined as follows
Particulars Credit Debit

(Inflow) (Outflow)
Merchandise Exports 2,000 -
Merchandise Imports - 1,500
Export of Services 3,000 -
Import of Services - 2,500
Total 5,000 4,000
Therefore, Credit Debit = 5,000 - 4,000 = 1,000
Hence there is surplus on current account by Rs. 1,000/-
Now,
Change in foreign = Balance in Current + Balance in short term +

Balance in long term
Reserves Account capital account
Capital Account
Surplus is denoted by + sign while deficit by - sign
Therefore solving by above formula we get,
-500 = 1000 + Balance in short term capital account + 600

-500 = 1600 + Balance in short term capital account
Therefore balance in short term capital account = -500-1600 = -2100
Hence short term capital account has net outflow or deficit of Rs. 2100/-.
2. The following data pertains to the balance of payment for India for the
year 2000
Particulars Rs. in crores

Government loans from abroad 30
Government loans to abroad 60
Direct investment abroad 58
FDI in the country 191
Foreign short term loans investments in the country 60
Short-term loans and investments abroad 451
Private remittances abroad (Transfer of Payments) 85
Private remittances from abroad 211
Calculate the balance on capital account in the balance of payments accounts of

India
Solution:
Capital Account

(Inflow) (Outflow)
Government loans from abroad 30 -
Government loans to abroad - 60
Direct investment abroad - 58
FDI in the country 191 -
Foreign short term loans investments in the 60 -
country
Short-term loans and investments abroad - 451
Total 281 569
Therefore, Credit Debit = 281 569 = -288
Hence there is deficit on current account = 288
(Note: Private Remittances have not been included as they are the part of current
account of balance of payment)
3. The following balance of payments data are available for an economy:
Increase in foreign exchange reserves 450

Short term Capital Outflow (net) 1,200
Merchandise Exports 2,000
Merchandise Imports 1,500
Export of Services 2,700
Import of Services 2,200
Determine the long-term capital account
Solution:
The balance in current is a follows:

(Inflow) (Outflow)
Total 4,700 3,700
Therefore, Credit Debit = 4700 - 3700 = 1,000
Hence there is surplus on current account by Rs. 1000/-
Since,

Capital Account
450 = 1000 + (-1200) + Balance in long term capital account
Therefore balance in long term capital account = 450 1,000 + 1,200
= 650 = long term net inflow of

capital
4. Following details have been extracted from the balance of payments

statements of Fairland for the year 2000-2001
Transactions on Capital Account
FDI in Fairland 201

Short-term loans given by Fairland 80
Government loans given by Fairland 40
Government loans received by Fairland 23
Direct investment abroad (made by Fairland) 58
Short-term loans raised by Fairland 68
It is also noticed that the balance of foreign exchange reserves as at the end of
2000-01 is exactly equal to the balance as at the beginning of 1999-2000.
Calculate the deficit on Current Account.
Solution:

(Inflow) (Outflow)
FDI in Fairland 201 -
Short-term loans given by Fairland - 80
Government loans given by Fairland - 40
Government loans received by Fairland 23 -
Direct investment abroad (made by - 58
Fairland)
Short-term loans raised by Fairland 68 -
Total 292 178
Therefore, Credit Debit = 292 - 178 = 114
Hence there is surplus on current account = 114
In other words, theres a deficit on current account: (-) 114
(Since there is no change in foreign exchange reserves, surplus on capital

account must have been equal to the deficit on current account)
5. You are given the following balance of payments data for the country X for
the calendar year 2000.
Particulars Millions of country

Xs currency unit
Merchandise imports 18,191
Merchandise exports 17,277
Exports of services including travel and 15,972
transportation
Imports of services including travel and 12,464
transportation
Earnings on loans and investments from abroad 429
Earnings of loans and investments in X by 1,054
foreigners
Private remittances to abroad (transfers) 85
Private remittances from abroad (transfers) 124
Direct investments abroad 26
FDI in X 134
Short term loans and investments abroad 288
Foreign short-term loans and investments in X 42
From the data given above, prepare a balance of payments (BoP) statement and
answer the following questions:
What is the trade balance on merchandise account?
What is the balance on current account?
What is the balance on long-term capital account?
What will be the entry against the items change in country Xs official
foreign exchange reserves in the BoP? Does this entry represent an
increase or decrease in the stock of foreign exchange reserves?

Solution:
Balance of Payments of country X for the year 2001

(All amounts in millions of country Xs currency unit)

(Inflow) (Outflow)
Current Account
Merchandise exports 17,277 -
Merchandise imports - 18,191
Exports of services including travel and 15,972 -

transportation
Imports of services including travel and - 12,464

transportation
Earnings on loans and investments from 429 -

abroad
- 1,054
Earnings of loans and investments in X
by foreigners
124 -
Private remittances from abroad
(transfers) - 85
Private remittances to abroad

(transfers)
Total 33,802 31,794

Capital Account
FDI in X 134
Short term loans and investments 288

abroad
42
Foreign short-term loans and
investments in X
Total 194 355
1. Trade Balance on Merchandise Account = Export Import
= 17,277 18,191
= - 914
2. Balance on current account = 33,802 31,794
= 2,008
3. Balance on long term capital account = (18 + 34) (41 + 26)
= 152 67
= 85
4. Balance on Current Account = 2,008
Balance on Capital Account = 194 355
= -161
5. Overall Balance = Balance on Current + Balance

on Capital
Account
Account
= 2,008 + ( 161)
= 1,847
Therefore, change in country Xs official foreign exchange reserves = 1,847

millions.
Since the overall balance is favourable, this entry represents an increase in

the stock of foreign exchange reserves.
6. The following data pertains to the balance of payments for a country for
the year 2001.

Direct investment abroad 60
Foreign direct investments in the country 193
Foreign short-term loans investments in the 65
country
Short-term loans and investments abroad 456
Private remittance to abroad (transfers) 78
Calculate the balance on capital account in the balance of payments account

of the country.
Solution:
Capital Account

(Inflow) (Outflow)
Government loans from abroad 35 -
Government loans to abroad - 65
Direct investment abroad - 60
FDI in the country 193 -
Foreign short term loans investments in the 65 -
country
Short-term loans and investments abroad - 456
Total 293 581
Therefore, Credit Debit = 293 581 = -288
Hence there is deficit in capital account = 288
(Note: Private Remittances have not been included as they are the part of current
account of balance of payment and we have been asked to calculate the balance
on capital account)
7. The following balance of payments data are available for an economy:
Increase in foreign exchange reserves 500

Short-term capital outflow (net) 1,000
Export of services 3,000
Import of services 1,500
Determine the long-term capital account.
Solution:
The balance in current is a follows:

(Inflow) (Outflow)
Total 4,800 3,200
Therefore, Credit Debit = 4,800 3,200 = 1,600
Hence there is surplus on current account by Rs. 1,600/-
Since,

Capital Account
500 = 1,600 + (-1,000) + Balance in long term capital account
Therefore balance in long term capital account = 500 1,600 + 1,000
= -100
Hence, long term net outflow of capital is 100
8. Following details have been extracted form the Balance of statement of 'x'
for the year 2000-2001
1. Foreign Direct Investment (In 'x') 180

2. Short term loans given by 'x' 60
3. Government loans given by 'x' 36
4. Government loans received by 'x' 8
5. Direct Investment abroad (made by 'x') 82
6. Short term loans raised by 'x' 100
It is also noticed that the balance of foreign exchange reserves as at the end
of 2000-01 is exactly equal to the balance as at the beginning of 2000-01.
Calculate deficit on Current Account.
Solution:

(Inflow) (Outflow)
Foreign Direct Investment (In 'x') 180 -
Short term loans given by 'x' - 60
Government loans given by 'x' - 36
Government loans received by 'x' 8 -
Direct Investment abroad (made by 'x') - 82
Short term loans raised by 'x' 100 -
Total 288 178
Hence there is surplus on current account = 110
In other words, theres a deficit on current account: (-) 100
(Since there is no change in foreign exchange reserves, surplus on capital

account must have been equal to the deficit on current account)
9. The following balance of payments information is available for an

economy.
1. Decline in foreign exchange reserves 300

2. Long-term capital inflow (net) 600
3. Merchandise exports 2,000
4. Merchandise imports 1,500
5. Export of services 3,000
6. Import of services 2,500
Calculate the short-term capital account.
Solution:
From the above data balance in the current account is determined as follows

(Inflow) (Outflow)
Total 5,000 4,000
Hence there is surplus on current account by Rs. 1000/-
Now,

Capital Account
Surplus is denoted by + sign while deficit by - sign
-300 = 1000 + Balance in short term capital account + 600

-300 = 1600 + Balance in short term capital account
Therefore balance in short term capital account = -300-1,600 = -1,900
Hence short term capital account has net outflow or deficit of Rs. 1,900/-.
10.You are given the following balance of payments data for country X f6r the
calendar year 2001.
(Millions of country Xs currency unit)
Particulars Amount
Exports of services including travel and 15,972
transportation
Imports of services including travel and 12,464
transportation
Earnings of loans and investments from abroad 429
Earnings of loans and investments in X by 1,054
foreigners
Private remittances to abroad (transfers) 85
FDI in X 126
Short term loans and investments abroad 288
Foreign short-term loans and investments in X 42
From the data given above, prepare a balance of payments (BOP) statement and
answer the following questions
1. What is the trade balance on merchandise account?
2. What is the balance on current account?
3. What is the balance on the long-term capital account?
4. What will be the entry against the item 'change in country X's official
foreign exchange reserves' in the BOP? Does this entry represent an
increase or decrease in the stock of foreign exchange reserves?
Solution:
Balance of Payments of country X for the year 2001

(All amounts in millions of country Xs currency unit)

(Inflow) (Outflow)
Current Account
Merchandise exports 17,484 -
Merchandise imports - 18,499
Exports of services including travel and 15,972 -

transportation
Imports of services including travel and - 12,464

transportation
Earnings on loans and investments from 429 -

abroad
- 1,054
Earnings of loans and investments in X
by foreigners
124 -
Private remittances from abroad
(transfers) - 85
Private remittances to abroad

(transfers)
Total 34,009 32,102

Capital Account
Government loans from abroad

20
FDI in X
126
Short term loans and investments 288
abroad
Foreign short-term loans and 42

investments in X
Total 188 359
1. Trade Balance on Merchandise Account = Export Import

= 17,484 18,499
= - 1015
2. Balance on current account = 34,009 32,102
= 1,907
3. Balance on long term capital account = (20 + 126) (43 + 28)
= 146 71
= 75
4. Balance on Current Account = 1,907
Balance on Capital Account = 188 - 359
= -171
11.Overall Balance = Balance on Current + Balance

on Capital
Account
Account
= 1,907 + ( 171)
= 1,736
Therefore, change in country Xs official foreign exchange reserves = 1,736
millions.
Since the overall balance is favourable, this entry represents an increase in
the stock of foreign exchange reserves.
You are required to find out the overall balance, showing clearly all the
sub-balances from the following data.
(1) UC Corporation of the USA invests in India Rs. 3, 00,000 to modernize its
Indians subsidiary.
(2) A tourist from Egypt buys souvenirs worth Rs. 3,000 to carry with him. He
also pays hotel and travel bills of Rs. 5,000 to Delhi Tourist Agency.
(3) The Indian subsidiary of UC Corporation remits, as usual, Rs. 5,000 as

dividends to the parent company in the USA.
(4) The Indian subsidiary of UC Corporation sells a part of its production in

other Asians countries for Rs. 1, 00,000.
(5) The Indian subsidiary borrows a sum of Rs. 2, 00,000 (to be paid back in a
years time) from German money market to resolve its urgent liquidity
problem.
(6) The Indian company buys a machine for Rs. 1, 00,000 from Japan and
60% payment is made immediately; the remaining amount is to be paid
after 3 years.
(7) An Indian subsidiary of French Company borrows Rs. 50,000 from the
Indian public to invest in its modernization programme.
Solution:
Sr.no Sources Uses Nature

1 3,00,000 Direct Foreign Investment.
2 a. 3,000 Goods exported.
b. 5,000 Services (invisible) rendered.

3 5,000 Dividend paid.
4 1,00,000 Goods exported.
5 2,,00,000 Short-Term borrowing.
6 a. 1,00,000 Equipments imported.
b. 40,000 Increase in claim on India.

6,48,000 1,05,000
BOP Statement
A. Current Account
Goods Accounts
Exports: Rs. 1, 03,000 (+)
Imports: Rs. 1, 00,000 (-)
Balance: Rs. 3,000 (+)
Invisible Accounts
Payments Received: Rs. 5,000(+)
Payments Made : Rs. 5,000(-)
Balance : NIL
Current Account Balance: Rs. 3,000 (+)
B. Capital Account
Foreign Direct Investment
Inflow : Rs. 3, 00,000 (+)
Outflow: Rs. NIL
Balance: Rs. 3, 00,000 (+)
Portfolio Investment
Inflow : Rs. 40,000 (+)
Outflow: Rs. NIL
Balance: Rs. 40,000 (+)
Long-Term Capital Account: Rs. 3, 40,000 (+)

(Foreign Direct Investment + Portfolio Investment)
Short-term borrowings
Inflow : Rs. 2,00,000 (+)
Outflow: Nil
Balance: Rs. 2,00,000 (+)
Capital Account Balance: Rs. 5, 40,000 (+)
Overall Balance: Rs. 5, 43,000 (+)

There is a net surplus of Rs 5, 43,000 in the balance of payments. This means,
there will be an increase of reserves by this amount.
Note: The transaction No.7 did not enter into the BOP Statement since this
transaction does not involve any foreign country. The entire transaction has taken
place in Indian rupees within India.
Case Study:
Prepare a BOP statement for France from the following data:
1. France export goods worth FFrs. 5000.
2. France import goods worth FFrs. 4000.
3. Expenditure of foreign tourist in France; FFrs. 2500.
4. France makes interest and dividend payments to foreigners; FFrs. 2000.
5. A France working in USA sends a cheque to his wife in Paris worth FFrs.
500.
6. A American Immigrant working in France remits money to his account in

LA; FFrs. 1000
7. France Telecom invest in India; FFrs.4500.
8. IBM invests in France; FFrs.2000.
9. A France resident buys a German Treasury bond; FFrs.300.
10. A Swiss resident buys a France Treasury bond; FFrs.5000.
11. France borrows FFrs. 3800 for short-term.
12. A short-term loan advanced by BNP to a British resident; FFrs. 4000.
Solution:
1 5,000 Exports
2 4,000 Imports
3 2,500 Exports
4 2,000 Imports
5 500 Unilateral transfer
6 1,000 Unilateral transfer
7 4,500 FDI
8 2,000 FDI
9 300 Portfolio investment
10 5,000 Portfolio investment

11 ---------- ------------ --------
12 3,800 Short-term
borrowings
18,800 11,800
BOP Statement:
A. Current Account
Goods Accounts
Exports: Rs. 7,500 (+)
Imports: Rs. 6,000 (-)
Balance: Rs.1, 500 (+)
Invisible Accounts
Payments Received: Rs. 500 (+)
Balance : Rs. 500 (-)
B. Capital Account

Inflow : Rs. 2,000 (+)
Outflow: Rs. 4,500 (-)
Balance: Rs. 1,500 (-)
Inflow : Rs. 5,000 (+)
Outflow: Rs. 300 (-)
Long-Term Capital Account: Rs. 3,200 (+)

Inflow : Rs. 3800 (+)
Outflow: Nil
Capital Account Balance: Rs. 7,000 (+)
Overall Balance: Rs. 8,000 (+)
There is a net surplus of Rs 8,000 in the balance of payments. This means, there
will be an increase of reserves by this amount.
Note: The transaction No11 did not enter into the BOP Statement since this
transaction does not involve any foreign country. The entire transaction has taken
place in France currency within France.
Prepare a BoP statement for France from the following data:
1. France imports goods worth FFr 4,000.
2. Expenditure of foreign tourists in France FFr 2,500.
3. France makes interest and dividend payments to Foreigners FFr 2,000.
4. A French working in USA sends a cheque to his wife worth FFr 500.
5. A Bangladeshi immigrant working in France remits money to his account in
Dhaka FFr 1,000.
6. France Telecom invests in India FFr 4,500.
7. IBM invests in France FFrs 2,000.
8. A French resident buys a German treasury bond FFr 300.
9. A Swiss resident buys a French treasury bond worth FFr 5,000.

Balance of Payments Account for France
(Amounts in FFr)
Credit (Inflow of Debit (Outflow

Funds) of Funds)
Current Account Balance
Import of Goods 4,000

2,500
Exports of goods (Purchase made by
foreign tourist)
Payment of Interests and dividends 2,000

500
Cash remittance by French working
in U.S (Unilateral Transfer of
Payments)
5,000 1,000
Transfer of Payments (by
Bangladeshi immigrant working in
France)
Investment Income
8,000 7,000
Total (1)
Capital Account Balance
Foreign investments by France in 4,500

India
2,000
Foreign Direct Investment (FDI) in
France by IBM
300
Investment Abroad
Total (2) 2,000 4,800
Total Balance (1+ 2) 10,000 11,800
Therefore Balance of Payment = Credit Debit = 10,000 11,800
= - 1800
Hence there is deficit in balance of payment of France by 1800 FFr which is
unfavourable.
Prepare a BOP statement for France from the following data:
1. France export goods worth FFrs. 5000.
2. France import goods worth FFrs. 4000.
3. Expenditure of foreign tourist in France; FFrs. 2500.
4. France makes interest and dividend payments to foreigners; FFrs. 2000.
5. A France working in USA sends a cheque to his wife in Paris worth FFrs.
500.
6. A American Immigrant working in France remits money to his account in
LA; FFrs. 1000
7. France Telecom invest in India; FFrs.4500.
8. IBM invests in France; FFrs.2000.
9. A France resident buys a German Treasury bond; FFrs.300.
10. A Swiss resident buys a France Treasury bond; FFrs.5000.
11. France borrows FFrs. 3800 for short-term.
12. A short-term loan advanced by BNP to a British resident; FFr. 4000.

Solution:
1 5,000 Exports
2 4,000 Imports
3 2,500 Exports
4 2,000 Imports
5 500 Unilateral transfer
6 1,000 Unilateral transfer
7 4,500 FDI
8 2,000 FDI
9 300 Portfolio investment
10 5,000 Portfolio investment
11 ---------- ------------ --------
12 3,800 Short-term
borrowings
18,800 11,800
BOP Statement:
C. Current Account
Goods Accounts
Exports: Rs. 7,500 (+)
Imports: Rs. 6,000 (-)
Balance: Rs.1,500 (+)
Invisible Accounts
Payments Received: Rs. 500 (+)
Balance : Rs. 500 (-)
B. Capital Account

Inflow : Rs. 2,000 (+)
Outflow : Rs. 4,500 (-)
Balance : Rs. 1,500 (-)
Inflow : Rs. 5,000 (+)
Outflow : Rs. 300 (-)
Balance : Rs. 4,700 (+)
Long-Term Capital Account: Rs. 3,200 (+)

Inflow : Rs., 3800 (+)
Outflow : Nil
Balance : Rs. 3,800 (+)
Capital Account Balance: Rs. 7,000 (+)
Overall Balance : Rs. 8,000 (+)
There is a net surplus of Rs 8,000 in the balance of payments. This means, there
will be an increase of reserves by this amount.
Note: The transaction No11 did not enter into the BOP Statement since this transaction
does not involve any foreign country. The entire transaction has taken place in France
currency within France.

B. Bop - Final

Uploaded by

Copyright:

Available Formats

You might also like

B. Bop - Final

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

B. Bop - Final

Uploaded by

Copyright:

Available Formats

International Finance

The balance of payments of a country is a systematic record of all

The above definition can be summed up as following: - Balance of

a) If a transaction earns foreign currency for the nation, it is a credit and is

The BOP is a double entry accounting statement based on rules of debit

Balance of Payment is a standard double entry accounting record to capture all

It is a statistical statement showing:

a. Transactions in goods and services between an economy and rest of the

b. Changes of ownership and changes in countrys monetary, gold, SDRs, claims

c. Unrequited transfers and counterpart entries that are needed to balance, in

2. The BOP Components

E. Reserves and Monetary Gold

F. Errors and omissions

Components of Balance of Payments

Items Credit Debit Net

Total Current Account (1+2+3)

II] Capital Account

Total Capital Account (1+2+3)

III] Reserves Account

3. Reserves and Monetary Gold

IV] Errors and Omissions

A. Structure of Current Account

2] Non Monetary Gold Movement

Total Current Account (1+2+3)

Balance Of Current Account

BOP on current account refers to the inclusion of three balances of namely

BOP on current account is also referred to as Net Foreign Investment

Thus the BOP on current account includes imports and exports of

Identify a deficit or a surplus in Current account.

Balance Of Visible Trade

Balance of visible trade is also known as balance of merchandise trade,

In visible trade if the receipts from exports of goods happen to be equal to

Non monetary gold movements:

Traditionally gold is treated as both a commodity and a financial asset.

Monetisation and Demonetisation of Gold: it may be observed that

Non-Monetary Gold movements current account. This process is called as

Balance Of Invisible Trade

The service transactions take various forms. They basically include 1)

Unilateral transfers or unrequited receipts, are receipts which the

Foreign economic aid or assistance and foreign military aid or assistance

B. Structure of capital a/c

PRIVATE SECTOR BANKING SECTOR OFFICIAL SECTOR

The Capital Account

The capital account records all international transactions that involve a

It is often useful to make distinctions between various forms of capital

corporations being especially important. There are of course some examples of

Portfolio investment by contrast is the acquisition of an asset that does not

The purchase of an asset in another country, whether it is direct or

Identify a deficit or a surplus in Capital account.

The capital account consists of financial transactions that lead to changes

The transactions are grouped by the institutional sector (banking,

2. Banking Capital: This covers changes in assets and liabilities of commercial

3. Official Capital Flows: This includes transactions of Government of India (GOI)

Accommodating & Autonomous Capital Flows

Economists have often found it useful to distinguish between autonomous

There is nevertheless a great temptation to assign the labels autonomous

b) In many cases, countries dont have a separate short term capital