Open Economy

Balance of Payment
Balance of Payment (BOP)
 BOP is a periodic accounting of international transactions
 Each country having regular economic transactions with
other countries prepares periodically the final accounts of
their foreign receipts and payments of their financial
inflow and outflow arising out of its international
transactions
 BOP is statement of economic transactions of a country
with the rest of the world over a period of time
Purpose of BOP
 It yields necessary information on the strength and
weakness of the country in international economic status
 By analysing the BOP accounts of past years, one can find
the overall gains and losses from the international
economic transactions
 BOP statements give warning signals for future policy
formulation
The BOP Accounts
 Current Account
 Capital Account
Current Account
 Current account items of international transactions are
listed, as suggested by the IMF and currently followed by
India
 All the transactions included in the current account have
their credit and debit counterparts
 The credit shows receivables and debit shows the
payables
 The balance of each item is shown under the net balance
column
 The sum total of net balance give the current account
balance
BOP: Current Account
Current Account
 The items of current account are also classified
 Visible items: export and import of goods, called ‘merchandise
trade’
 Invisible items: all other items
 Balance of Trade
 The ‘net balance’ of the visible trade, that is difference btween
exports (X) and imports (M) of goods
Capital Account
 Short-term capital movements
 Long-term capital movements
 Inflow and outflow of gold and foreign exchange reserves
Short-Term Capital Movements
 Purchase of short-term foreign securities
 Speculative purchase of foreign currency
 Cash balance held by foreigners for security against
uncertainty arising due to wars and political uncertainty
Long-Term Capital Movements
 Direct investment in shares, bonds, real estate or physical
assets like plant, building and equipments, on which the
investor holds a controlling power
 Portfolio investment, including all other stock and bonds,
e.g., government securities, securities of firms which do
not entitle the bolder with a controlling power
 Amortization of capital, i.e., repurchase and resale of
securities sold to the foreigners
 Direct import or export of capital goods fall under the
category of FDI and foreign investment in shares and
securities in called FII (foreign institutional investment)
Gold and Foreign Exchange Reserve
 Maintained as a safeguard against large and prolonged
current account deficits and to stabilize the exchange rate
of the home currency and also to make payments in case
there is payment deficits on current accounts
 The foreign exchange reserve increase or decrease
depending on the net balance of other transactions
Causes and Kinds of BOP Disequilibrium
 Inflation and Fundamental Disequilibrium
 Business Cycle and Cyclical Disequilibrium
 Structural Changes and Structural Disequilibrium
 Short-term Disequilibrium Factors
Inflation and Fundamental Disequilibrium
 Inflation causes deficit in BOP
 Inflation makes imports relatively cheaper and exports
relatively costlier
Business Cycle and Cyclical Disequilibrium
 Business cycle may be confined to a country or to a
group of countries of it may be global as was during the
Great Depression and during the global recession of
2008-09
 Countries with high marginal propensity to import
accumulate large trade deficit during the inflationary
phase of the business cycle, and a moderate deficit or
even a surplus during the depression
 This kind of disequilibrium in BOP is called cyclical
disequilibrium
Structural Changes and Structural
Disequilibrium
 The structural change may be reduction of some widely
used natural resources, change in technology, change in
industrial structure, and change in consumer taste and
preferences
 Such changes affect significantly a country's capacity of
export and propensity to import
 Coal industry in Britain
Short-term Disequilibrium Factors
 Seasonal deficits caused by crop failures
 Rapid growth of population in food-deficient countries
causing import of large quantity of food
 Ambitious development plans necessitating heavy imports
of technological know-how, machinery and equipment
 Demonstration effect of the advanced countries on
developing nations increasing imports in the latter
The Policy Measures
 Expenditure Changing Policies
 Monetary policy
 Fiscal policy
 Expenditure Switching Policy
 Devaluation
 Revaluation
 Monetary approach to manage forex reserves