A REPORT On Balance of Payment

A REPOTR ON “BALANCE OF PAYMENT”
October 1, 2009
This is to certify that Priyank Shrivastava, student of M.B.E (Master of

Business Economic) at Institute for excellence in higher education, Bhopal
has successfully completed his project on the topic “A REPORT ON
BALANCE OF PAYMENT” under our supervision for the paper titled
“International Economics”
This project report embodies the original work done by

the candidate on the data collection during the field work on actual survey
basis, by the means of questionnaire, a copy of which is attached at the
end of this project.
Mrs. Kalpana Malik (Economic

Department)
October 1, 2009
This project bears the imprints of many a person, who has tooled all the pains
and efforts to help me out, in some or the other way. First of all I would like to
thanks Dr. PRAMILA MAINI (Director, Institute for excellence in higher education,
Bhopal) for granting us the permission for conducting this project. I would like to
express my gratitude to Dr. H.B. Gupta (Head of the Economic Department).
This project would be incomplete without me

expressing gratitude towards all my respondents who help me with the required
information and data, which is the base of my study. I would avail the opportunity
to thank all those, specially the almighty, parents, and friends, who provided me
with their valuable suggestions and help which has a major contribution to my
project. Needless to say I am alone responsible for such blemishes as the report
may have.
Priyank Shrivastava
M.B.E(Final)
Roll No:-9016
October 1, 2009
TABLE OF CONTENTS
Topics
BALANCE OF PAYMENTS
4
BALANCE OF TRADE 6
BALANCE OF CURRENT ACCOUNT 7
THE OFFICIAL SETTLEMENT CONCEPT 9

THE CAPITAL ACCOUNT 10
ACCOMMODATING & AUTONOMOUS CAPITAL FLOWS

11
BALANCE OF INVISIBLE TRADE 13
CAPITAL ACCOUNT CONVERTIBILITY (CAC) 17
IN THE ACCOUNTING SENSE THE BOP ALWAYS BALANCES! 20
DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS 21
A DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR

25
UNDESIRABLE!
OFFICIAL RESERVES ACCOUNT 28

Bibliography 30
Annexure 31
October 1, 2009
A REPORT ON “BALANCE OF
PAYMENTS”
CONCEPT QUESTIONS
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.
The definition given by RBI needs to be clarified further for the following points:
A. Economic Transactions
An economic transaction is an exchange of value, typically an act in which there is transfer of
title to an economic good the rendering of an economic service, or the transfer of title to assets
from one economic agent (individual, business, government, etc) to another. An international
economic transaction evidently involves such transfer of title or rendering of service from
residents of one country
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to another. Such a transfer may be a requited transfer (the transferee gives something of an
economic value to the transferor in return) or an unrequited transfer (a unilateral gift). The
following are the basic types of economic transactions that can be easily identified:
1. Purchase or sale of goods or services with a financial quid pro quo – cash or a promise to
pay. [One real and one financial transfer].
2. Purchase or sale of goods or services in return for goods or services or a barter transaction.
[Two real transfers].
3. An exchange of financial items e.g. – purchase of foreign securities with payment in cash or
by a cheque drawn on a foreign deposit. [Two financial transfers].
4. A unilateral gift in kind [One real transfer].
5. A unilateral financial gift. [One financial transfer].
B. Resident
The term resident is not identical with “citizen” though normally there is a substantial overlap. As
regards individuals, residents are those individuals whose general centre of interest can be said
to rest in the given economy. They consume goods and services; participate in economic
activity within the territory of the country on other than temporary basis. This definition may
turnout to be ambiguous in some cases. The “Balance of Payments Manual” published by the
“International Monetary Fund” provides a set of rules to resolve such ambiguities.
As regards non-individuals, a set of conventions have been evolved. E.g. – government and non
profit bodies serving resident individuals are residents of respective countries, for enterprises,
the rules are somewhat complex, particularly to those concerning unincorporated branches of
foreign multinationals. According to IMF rules these are considered to be residents of countries
in which they operate, although they are not a separate legal entity from the parent located
abroad.
International organisations like the UN, the World Bank, and the IMF are not considered to be
residents of any national economy although their offices are located within the territories of any
number of countries.
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To certain economists, the term BOP seems to be somewhat obscure. Yeager, for example,
draws attention to the word ‘payments’ in the term BOP; this gives a false impression that the
set of BOP accounts records items that involve only payments. The truth is that the BOP
statements records both payments and receipts by a country. It is, as Yeager says, more
appropriate to regard the BOP as a “balance of international transactions” by a country. Similarly
the word ‘balance’ in the term BOP does not imply that a situation of comfortable equilibrium; it
means that it is a balance sheet of receipts and payments having an accounting balance.
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.
The various components of a BOP statement are:
A. Current Account
B. Capital Account
C. IMF
D. SDR Allocation
E. Errors & Omissions
F. Reserves and Monetary Gold
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BALANCE OF TRADE
Balance of trade may be defined as the difference between the value of goods and services sold
to foreigners by the residents and firms of the home country and the value of goods and
services purchased by them from foreigners. In other words, the difference between the value of
goods and services exported and imported by a country is the measure of balance of trade.
If two sums (1) value of exports of goods and services and (2) value of imports of goods and
services are exactly equal to each other, we say that there is balance of trade equilibrium or
balance; if the former exceeds the latter, we say that there is a balance of trade surplus; and if
the later exceeds the former, then we describe the situation as one of balance of trade deficit.
Surplus is regarded as favourable while deficit is regarded as unfavourable.
The above mentioned definition has been given by James. E. Meade – a Nobel Prize British
Economist. However, some economists define balance of trade as a difference between the
value of merchandise (goods) exports and the value of merchandise imports, making it the same
as the ‘Goods Balance” or the “Balance of Merchandise Trade”. There is n doubt that the
balance of merchandise trade is of great significance to exporting countries, but still the BOT as
defined by J. E. Meade has greater significance.
Regardless of which idea is adopted, one thing is certain i.e. that balance of trade is a national
injection and hence it is appropriate to regard an active balance (an excess of credits over
debits) as a desirable state of affairs. Should this then be taken to imply that a passive trade
balance (an excess of debits over credits) is necessarily a sign of undesirable state of affairs in
a country? The answer is “no”. Because, take for example, the case of a developing country,
which might be
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importing vast quantities of capital goods and technology to build a strong agricultural or
industrial base. Such a country in the course of doing that might be forced to experience passive
or adverse balance of trade and such a situation of passive balance of trade cannot be
described as one of undesirable state of affairs. This would therefore again suggest that before
drawing meaningful inferences as to whether passive trade balances of a country are desirable
or undesirable, we must also know the composition of imports which are causing the conditions
of adverse trade balance.
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.
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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.
BASIC BALANCE
The basic balance was regarded as the best indicator of the economy’s position vis- à-vis other
countries in the 1950’s and the 1960’s. 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 don’t 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
October 1, 2009
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.
THE OFFICIAL SETTLEMENT CONCEPT
An alternative approach for indicating, a deficit or surplus in the BOP is to consider the net
monetary transfer that has been made by the monetary authorities is positive or negative, which
is the so called – settlement concept.
If the net transfer is negative (i.e. there is an outflow) then the BOP is said to be in deficit, but if
there is an inflow then it is surplus. The basic premise is that the monetary authorities are the
ultimate financers of any deficit in the balance of payments (or the recipients of any surplus).
These official settlements are thus seemed as the accommodating item, all other being
autonomous.
The monetary authorities may finance a deficit by depleting their reserves of foreign currencies,
by borrowing from the IMF or by borrowing from other foreign monetary authorities. The later
source is of particular importance when other monetary authorities hold the domestic currency
as a part of their own reserves. A country whose currency is used as a reserve currency (such
as the dollars of US) may be able to run a deficit in its balance of payments without either
depleting its own reserves or borrowing from the IMF since the foreign authorities might be
ready to purchase that currency and add it to its own reserves. The settlements approach is
more relevant under a system of pegged exchange rates than when the exchange rates are
floating.
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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
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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 firm’s country, and as a
positive item in the capital account for the other country. That capital outflows appear as a
negative item in a country’s 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 purchaser’s country (and as a positive item
in the accounts of the seller’s country).
The net value of the balances of direct and portfolio investment defines the balance on capital
account.
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
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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
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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.
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
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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.
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).
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
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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 (SDR’s) 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 country’s 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
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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.
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
country’s 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
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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 lending’s but gifts and grants exchanged between government and people in one country
with the governments and peoples in the rest of the world.
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 of
Goods) Goods)
2. Invisible Exports (Sale of Services) 2. Invisible Imports (Purchase of
Services)
a. Transport services sold abroad a. Transport services purchased
from abroad
b. Insurance services sold abroad b. Insurance services purchased
c. Foreign tourist expenditure in c. Tourist expenditure abroad
country
d. Other services sold abroad d. Other services purchased from
abroad
e. Incomes received on loans and e. Income paid on 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 b. Pension payments abroad
from abroad
c. Government grants received c. Government grants abroad.
from abroad
Capital Account Capital Account
3. Foreign long-term investments in the 3. Long-term investments abroad (less
home country (less redemptions and
redemptions and repayments) repayments)
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a. Direct investments in the home a. Direct Investments abroad

country
b. Foreign investments in b. Investments in foreign
domestic securities securities
c. Other investments of foreigners c. Other investments abroad
in the home country
d. Foreign Governments’ loans to d. Government loans to foreign
the home country. countries
4. Foreign short-term investments in 4. Short-term investments abroad.
the home country.
CAPITAL ACCOUNT CONVERTIBILITY (CAC)
While there is no formal definition of Capital Account Convertibility, the committee under the
chairmanship of S.S. Tarapore has recommended a pragmatic working definition of CAC.
Accordingly CAC refers to the freedom to convert local financial assets into foreign financial
assets and vice – a – versa at market determined rates of exchange. It is associated with
changes of ownership in foreign / domestic financial assets and liabilities and embodies the
creation and liquidation of claims on, or by, the rest of the world. CAC is coexistent with
restrictions other than on external payments. It also does not preclude the imposition of
monetary / fiscal measures relating to foreign exchange transactions, which are of prudential
nature.
Following are the prerequisites for CAC:
1. Maintenance of domestic economic stability.

2. Adequate foreign exchange reserves.
3. Restrictions on inessential imports as long as the foreign exchange position is not very
comfortable.
4. Comfortable current account position.
5. An appropriate industrial policy and a conducive investment climate.
6. An outward oriented development strategy and sufficient incentives for export growth.
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DESCRIPTIVE QUESTIONS
DISCUSS THE RELEVANCE / 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
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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 country’s 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.
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
October 1, 2009
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 country’s 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 country’s 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.
DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS
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. A BOP statement
(revised) includes the following sub accounts, as shown in the table below.
Items Credits Debits Net

G. Current Account
October 1, 2009
1. Merchandise
a. Private
b. Government
2. Invisibles
a. Travel
b. Transportation
c. Insurance
d. Investment Income
e. Government (not included elsewhere)
f. Miscellaneous
3. Transfer Payments
a. Official
b. Private
Total Current Account (1+2+3)
H. Capital Account
2. Private
a. Long Term
b. Short Term
3. Banking
4. Official
a. Loans
b. Amortisation
c. Miscellaneous
Total Capital Account (1+2+3)
I. IMF
J. SDR Allocation
K. Capital Account, IMF & SDR Allocation (B+C+D)
L. Total Current Account, Capital Account, IMF & SDR
Allocation (A+E)
M. Errors & Omissions

N. Reserves and Monetary Gold
Current Account
The current account includes all transactions which give rise to or use up national income. The
current account consists of two major items, namely, (a) merchandise export and imports and
(b) invisible imports and exports.
Merchandise exports i.e. sale of goods abroad, are credit entries because all transactions giving
rise to monetary claims on foreigners represent credits. On the other hand, merchandise
imports, i.e. purchase of goods abroad, are debit entries because all transactions giving rise to
foreign money claims on the home country
October 1, 2009
represent debits. Merchandise exports and imports form the most important international
transactions of most of the countries.
Invisible exports i.e. sale of services, are credit entries and invisible imports i.e. purchase of
services are debit entries. Important invisible exports include sale abroad of services like
insurance and transport etc. while important invisible imports are foreign tourist expenditures in
the home country and income received on loans and investment abroad (interests or dividends).
Transfers payments refer to unrequited receipts or unrequited payments which may be in cash
or in kind and are divided into official and private transactions. Private transfer payments cover
such transactions as charitable contributions and remittances to relatives in other countries. The
main component of government transfer payments is economic aid in the form of grants.
Capital Account
The capital account separates the non monetary sector from the monetary one, that is to say,
the trading or ordinary private business element in the economy together with the ordinary
institutions of central or local government, from the central bank and the commercial bank,
which are directly involved in framing or implementing monetary policies. The capital account
consists of long term and short term capital transactions. Capital outflow represents debit and
capital inflow represent credit. For instance, if an American firm invests rupees 100 million in
India, this transaction will be represented as a debit in the US BOP and a credit in the BOP of
India.
Other Accounts
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
October 1, 2009
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 RBI’s
holdings of gold and foreign exchange (in the form of balances with foreign central banks and
investment in foreign government securities) and government’s 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.
HOW WILL YOU IDENTIFY A DEFICIT OR SURPLUS IN BALANCE OF PAYMENTS? /

MEANING OF “DEFICIT” AND “SURPLUS” IN THE BALANCE OF PAYMENTS.
If the balance of payment is a double entry accounting record, then apart from errors and
omissions, it must always balance. Obviously, the terms “deficit” or “surplus” cannot refer to the
entire BOP but must indicate imbalance on a subset of accounts included in the BOP. The
“imbalance” must be interpreted in some sense as an economic disequilibrium.
Since the notion of disequilibrium is usually associated within a situation that calls for policy
intervention of some sort, it is important to decide what is the optimal way of grouping the
various accounts within the BOIP so that an imbalance in one set of accounts will give the
appropriate signals to the policy makers. In the language of an accountant e divide the entire
BOP into a set of accounts “above the line” and another set “below the line.” If the net balance
(credits-debits) is positive above the
October 1, 2009
line we will say that there is a “balance of payments surplus”; if it is negative e will say there is a
“balance of payments deficit.” The net balance below the line should be equal in magnitude and
opposite in sign to the net balance above the line. The items below the line can be said to be a
“compensatory” nature – they “finance” or “settle” the imbalance above the line.
The critical question is how to make this division so that BOP statistics, in particular the deficit
and surplus figures, will be economically meaningful. Suggestions made by economist and
incorporated into the IMF guidelines emphasis the purpose or motive a transaction, as a
criterion to decide whether a transaction should go above or below the line. The principle
distinction between “autonomous” transaction and “accommodating” or compensatory
transactions. 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). The
terms “balance of payments deficit” and “balance of payments surplus” will then be understood
to mean deficit or surplus on all autonomous transactions taken together.
The other measures of identifying a deficit or surplus in the BOP statement are: Deficit or Surplus
in the Current Account and/or Trade Account.
The Basic Balance which shows the relative deficit or surplus in the BOP.
October 1, 2009
A DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR UNDESIRABLE!
The basic balance was regarded as the best indicator of the economy’s position vis- à-vis other
countries in the 1950’s and the 1960’s. 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 country’s 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 country’s
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.
SHORT NOTES
October 1, 2009
BALANCE OF PAYMENTS
(Refer to Concept Questions)
CURRENT ACCOUNT
The current account records exports and imports of goods and services and unilateral transfers.
Exports whether of goods or services are by convention entered as positive items in the
account. Imports accordingly are entered as negative items. Exports are normally calculated
f.o.b i.e. cost from transportation, insurance etc are not included whereas imports are normally
calculated c.i.f. i.e. transportation, insurance cost etc are included.
In many cases the payment for imports and exports will result in transfer of money between the
trading countries. For example a UK firm importing a good from US may settle its debt by
instructing its UK bank to make a payment to the US account of the exporter. This is not
necessarily the case however. If the UK firm holds a bank account in the US, then it may make
payment to the US exporter from that account. In the former case the financial side of the
transaction will appear in the UK BOP account as part of the net change in UK foreign currency
reserves. In the later it will appear as the part of the capital account since the UK firm has
reduced its claims on the US bank.
BOP accounts usually differentiate between trades in goods and trade in services. The balance
of imports and exports of the former is referred to in the UK accounts as the balance of visible
trade in other countries it may be referred to as the balance of merchandise trade, or simply as
the balance of trade. The net balance of
October 1, 2009
exports and imports of services is called the balance of invisible trade in the UK statistics.
Invisible trade is a much more heterogeneous category than is visible trade. It helps in
distinguishing between factor and non-factor services. Trade in the later of which shipping,
banking and insurance services and payments by residents as tourists abroad are usually the
most important, is in economic terms little different from trade in goods. That is, exports and
imports are flows of outputs whose values will be determined by the same variables that would
affect the demand and supply for goods. Factors services, which consist in the main of interest,
profits and dividends, are on the other hand payments for inputs. Exports and imports of such
services will depend in large part on the accumulated stock of past investment in and borrowing
from foreign residents.
Unilateral transfer forms a major part of the current account. It refers to unrequited receipts or
unrequited payments which may be in cash or in kind and are divided into official and private
transactions. 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.
The net value of the balances of visible trade and of invisible trade and of unilateral transfers
defines the balance on current account.
CAPITAL ACCOUNT
(Refer to Concept Questions)

October 1, 2009
OFFICIAL 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 RBI’s holdings of gold and foreign
exchange (in the form of balances with foreign central banks and investment in foreign
government securities) and government’s holding of SDRs.
The change in the reserves account measures a nation’s surplus or deficit on its current and
capital account transactions by netting reserve liabilities from reserve assets. For example, a
surplus will lead to an increase in official holdings of foreign currencies and/or gold; a deficit will
normally cause a reduction in these assets.
For most of the countries, there is a correlation between balance-of-payments deficits and
reserve declines. A drop in reserves will occur, for instance, when a nation sells gold to acquire
foreign currencies that it can use to meet the deficit in the balance of payments.
October 1, 2009
BIBLIOGRAPHY
Balance of Payments
- Paul Madson
International Financial Management
- P G Apte
International Economics
- Lindert
- Francis Chernuliam
- C P Kindelberger
- Geoffrey Reed
- H G Mannur
October 1, 2009
Major Items of India's balance of Payments (April-March, 2008-09)

(In $ million)
April-March April-March
(2008-09) (P) (2007-08) (PR)
Exports 175,184 166,163
Imports 294,587 257,789
Trade Balance -119,403 -91,626
Invisibles, net 89,586 74,592
Current Account Balance -29,817 -17,034
Capital Account* 9,737 109,198
Change in Reserves# (+ 20,080 -92,164
indicates increase;- indicates
decrease)
Including errors & omissions; # On BoP basis excluding valuation; P:
Preliminary, PR: Partially revised. R: revised
SOURCE: Reserve Bank of India Report
INDIA’s cumulative value of exports for the period April- June, 2009 was $ 35432
million (Rs.172762 crore) as against $ 51545 million (Rs.214808 crore) registering
a negative growth of 31.3 percent in Dollar terms and 19.6 percent in Rupee
terms over the same period last year. Again, the cumulative value of imports for
the period April- June, 2009 was $ 50936 million (Rs.248171 crore) as
against
$ 80187 million (Rs.334191 crore) registering a negative growth of36.5 percent
in Dollar terms and 25.7 percent in Rupee terms over the same
period last year.
October 1, 2009
EXPORTS & IMPORTS (April-June, FY 2009-10)
In $ Million In
Rs Crore
Exports including re-exports
2008-09
51545
214808
2009-10
35432
172762
Growth 2009-10/2008-2009 (percent)
-31.3
-19.6
Imports
October 1, 2009
Inflows & Outflows from NRI Deposits and Local Withdrawals

(In $ million)
Inflows Outflows Local

Withdrawals
2006-07 (R) 19914 15593 13208
2007-08 (PR) 29401 29222 18919
April-March 37,089 32,799 20,617
2008-09 (P)
P: Preliminary, PR: Partially revised. R: revised
SOURCE: Reserve Bank of India report, 2008-09
KEY INDICATORS OF INDIA'S BALANCE OF PAYMENTS
2008-09 2007-08 2006-07

Merchandize Trade
Exports ($ on BoP basis) 5.4 28.9 22.6
Growth Rate (percent)
Imports ($ on BoP basis) 14.3 35.2 21.4
Growth Rate (percent)
Crude Oil Prices, Per 82.4 79.5 62.4
Barrel (Indian Basket)
Trade Balance ($ billion) -119.4 -91.6 -61.8
Invisibles
Net Invisibles ($ Billion) 89.6 74.6 52.2
Net Invisibles 75.0 81.4 84.5
Surplus/Trade
Deficit (Percent)
Invisible Receipts/Current 48.1 47.2 47.1
Receipts (Percent)
October 1, 2009
Services Recipts/Current 30.0 28.6 30.3

Receipts (Percent)
Private Transfers/Current 13.7 13.8 12.7
Receipts (Percent)
Current Account
Current Receipts ($ 337.7 314.8 243.4
Billion)
Current Payments ($ 367.6 331.8 253.0
Billion)
Current Account --29.8 -17.0 -9.6
Balance ($ Billion)
Capital Account
Gross Capital Inflows ($ 302.5 433.0 233.3
Billion)
Gross Capital Outflows ($ 293.3 325.0 188.1
Billion)
Net Capital Flows ($ 9.1 108.0 45.2
Billion)
Net FDI/Net Capital 191.3 14.3 17.0
Flows (Percent)
Net Portfolio -153.4 27.4 15.6
Investment/Net capital
Flows (Percent)
Net ECBs/Net capital 89.2 21.0 35.5
Flows (Percent)
Reserves
Import Cover of 10.3 14.4 12.5
Reserves (In months)
Outstanding Reserves as 252.0 309.7 199.2
at end period ($ Billion)
SOURCE: Reserve bank of India Report on Balance of Payment, December 2008
October 1, 2009
India's Merchandize Trade (2003-04 to 2008-09 (April-March)
Year
Exports
Growth (Percent)
Imports
Growth (Percent)
2003-04
63.8
78.1
2004-05
83.5
30.8
111.5
42.7
2005-06
103.1
23.4
October 1, 2009
Gross Capital Inflows and Outflows (In $ Million)
2 2 2006-07 R 2 2 2006
008- 007- 008- 007- -07
09 P 08 09 P 08 R
PR PR
Foreign Direct 36,258 36838 23590 18,762 21437 15897
Investment
Portfolio 128,65 235924 109620 142,68 206368 102560
Investment 1 5
External 5,042 4241 3767 2,404 2127 1992
Assistance
External 15,382 30376 20883 7,224 7743 4780
Commercial
Borrowings
NRI Deposits 37,089 29401 19914 32,799 29222 15593
Banking capital 27,909 26412 17295 35,596 14834 19703
excluding NR
Deposits
Short-term 39,734 48,911 29,992 45,529 31,728 23,380

trade Credits
Rupee Debt 0 0 0 101 121 162
Service
Other Capital 12,391 20904 8230 8,210 11434 4021
TOTAL 302,4 43300 233291 293,3 32501 18808
56 7 10 4 8
R: Revised; P: Preliminary; PR: Partially Revised
SOURCE: Reserve Bank of India Report on Balance of Payment, December
2008
Business Services (In $ Million)

October 1, 2009
2008 2007 2006-07 R 2008 2007 2006-
-09 P -08 -09 P -08 07 R
PR PR
Trade Related 2,008 2233 1325 1,642 2285 1801
Business & 4,847 4433 4476 3,512 3653 3484
Management
Consultancy
Architectural, 1,759 3144 3457 3,106 3173 3025
Engineering &
other Technical
Maintenance of 2,980 2861 2638 3,283 3,496 4,032
Offices
Others 4,657 4100 2648 3,726 4,108 3,522
TOTAL 16,25 1677 14544 15,26 1671 15866
1 1 9 5
R: Revised; P:
Preliminary; PR:
Partially
Revised
SOURCE: Reserve Bank of India Report on Balance of Payment, December
2008

A REPORT On Balance of Payment

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A REPORT On Balance of Payment

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A REPOTR ON “BALANCE OF PAYMENT”

This is to certify that Priyank Shrivastava, student of M.B.E (Master of

This project report embodies the original work done by

Mrs. Kalpana Malik (Economic

This project would be incomplete without me

THE OFFICIAL SETTLEMENT CONCEPT 9

ACCOMMODATING & AUTONOMOUS CAPITAL FLOWS

IN THE ACCOUNTING SENSE THE BOP ALWAYS BALANCES! 20

DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS 21

A DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR

OFFICIAL RESERVES ACCOUNT 28

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

- Reserve Bank of India

The various components of a BOP statement are:

BALANCE OF CURRENT ACCOUNT

THE OFFICIAL SETTLEMENT CONCEPT

THE CAPITAL ACCOUNT

ACCOMMODATING & AUTONOMOUS CAPITAL FLOWS

There is nevertheless a great temptation to assign the labels ‘autonomous’ and

BALANCE OF INVISIBLE TRADE

be positive or negative or zero. A positive sum is regarded as favourable to a country and a

BALANCE OF VISIBLE TRADE

ERRORS AND OMISSIONS

3. Unilateral Transfers 3. Unilateral Transfers

a. Direct investments in the home a. Direct Investments abroad

CAPITAL ACCOUNT CONVERTIBILITY (CAC)

Following are the prerequisites for CAC:

1. Maintenance of domestic economic stability.

DISCUSS THE RELEVANCE / IMPORTANCE OF THE BOP STATEMENTS?

IN THE ACCOUNTING SENSE THE BOP ALWAYS BALANCES!

DETAILED OUTLINE OF THE BOP STATEMENT & SUB ACCOUNTS

Items Credits Debits Net

M. Errors & Omissions

HOW WILL YOU IDENTIFY A DEFICIT OR SURPLUS IN BALANCE OF PAYMENTS? /

in the Current Account and/or Trade Account.

A DEFICIT IN THE BASIC BALANCE IS DESIRABLE OR UNDESIRABLE!

(Refer to Concept Questions)

(Refer to Concept Questions)

OFFICIAL RESERVES ACCOUNT

International Financial Management

Major Items of India's balance of Payments (April-March, 2008-09)

EXPORTS & IMPORTS (April-June, FY 2009-10)

Exports including re-exports

Growth 2009-10/2008-2009 (percent)

Inflows & Outflows from NRI Deposits and Local Withdrawals

Inflows Outflows Local

P: Preliminary, PR: Partially revised. R: revised

SOURCE: Reserve Bank of India report, 2008-09

KEY INDICATORS OF INDIA'S BALANCE OF PAYMENTS

2008-09 2007-08 2006-07

Services Recipts/Current 30.0 28.6 30.3

India's Merchandize Trade (2003-04 to 2008-09 (April-March)

Gross Capital Inflows and Outflows (In $ Million)

Short-term 39,734 48,911 29,992 45,529 31,728 23,380

Business Services (In $ Million)

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