Balance of Payments

• BOP is a systematic record of all international

economic transactions of the country during a
given period, usually a year
• BOP accounting of any country uses a double
entry system of recording accounts with the
rest of the world
• Thus the BOP account is divided into
transactions giving rise to payments (or debit)
and receipts (or credit)
• All international transactions that result in
payments in India (receipts to India) for
instance, increase India’s stock of foreign
currencies and may be recorded as credit (or
plus) entries in India’s BOPs.
• Conversely, all payments by India (receipts to
foreigners) deplete India’s stock of foreign
currencies and may be recorded as debit (or
minus) entries in the BOPs account.
 Importance of BOP
• A BOPs account is complied to measure the
gross deficits or surpluses with the rest of the
world.
• However, it has become increasingly
important in recent years as it has been
devised to describe in a concise fashion the
state of international economic relationship of
the country as a guide to its monetary, fiscal,
exchange and other policies
• Inform the government authorities about the
in international economic position of the
country
• Assist policy policymakers in reaching
decisions on monetary and fiscal policies and
foreign trade and foreign exchange
phenomena
• The BOP analysis shows whether a country is
paying its way internationally, whether it is paying
for its imports and other payments transactions by
exporting goods or receiving donations
• Thus whether a country is borrowing or lending
money, whether its currency and foreign exchange
resources are becoming weaker or stronger and
how effective are the monetary policies, can be
studied from the BOP statement of the country
 STRUCTURE OF BOPs
• The current account (real transactions)
• The capital account (financial transactions)
• Real transactions – exports, imports – income
creating transactions
• Financial transactions – involves only the
transfer of money or currency
 Current account
• Merchandise or trade account – only
transactions relating to goods are entered, i.e.
all goods exported and imported are recorded
in trade account
• Invisible account – consists of gifts or charities
account (transfer payments), banking and
insurance charges, interest on loans, transport
charges, etc.
• IMF included the following items as invisible
transactions:
• International transportation of goods,
including warehousing while in transit and
other transit expenses
• Travel for reasons of business, education,
health
• Insurance premiums and payments to loans
• Donations, migrant remittances,
 Capital account
• capital transactions include the sale and
purchase of assets like properties.
• Furthermore, the capital account also includes
the flow of taxes, sales and purchases of fixed
assets for a migrant moving in or out of the
country.
• The three major elements of the capital
account are investments, foreign exchange
reserves, and loans and borrowings.
• Balance of Payment is classified into as:
• 1. Favourable Balance of Payments: Excess of goods and
services exported plus capital transferred to abroad over
the goods and services imported and capital transfers
from abroad is known as favourable balance of
payments
• 2. Unfavorable balance of payments: An imbalance in a
nation's balance of payments in which payments made
by the country exceed payments received by the
country. This is also termed a balance of payments
deficit.
 Disequilibrium in BOP
• A disequilibrium in the BOP of a country may
be either a deficit or surplus
• If credit receipts exceeds debit payments
there is a surplus in the bop and the
disequilibrium is said to be favourable
• If debit payments exceed credit payments
then there is a deficit in the BOP and the
disequilibrium is said to be unfavourable or
adverse
 Causes
• Temporary Changes – caused by random
variations in trade, seasonal fluctuations, effects
of weather on agricultural production, etc.
• Fundamental disequilibrium – persistent and
long-term BOP disequilibrium of a country. It is
chronic according to IMF. It is caused by a.
changes in consumer tastes within the country
or abroad which reduce country’s exports and
increase its imports, b. continuous fall in
• Country’s foreign exchange reserves due to
supply inelasticities of exports and excessive
demand for foreign goods and services c.
excessive capital outflows due to massive
imports of capital goods, raw materials,
essential consumer goods, d. low competitive
strength in world markets which adversely
affects exports e. inflationary pressures within
country which make exports dearer
• Structural changes – a. technological changes
in methods of production b. import
restrictions of all kinds c. deficit in BOP arises
when a country suffers from deficiency of
resources d. changes in the supply of long-
term capital flows
• Changes in exchange rates – in the form of
overvaluation or devaluation of foreign
currency lead to BOP disequilibrium.
• When the value of currency is higher in
relation to other currencies, it is overvalued.
This makes foreign goods cheaper and exports
dearer in foreign countries. Undervaluation
encourages exports, reducing imports
• Cyclical fluctuations – Depression – volumes of
exports and imports fall, fall in exports is more
due to fall in production; Boom – exports and
imports increase
• Changes in National Income – if NI increases, will
lead to increase in imports and so deficit in BOP.
• Price changes – if there is inflation, prices of
exports increase, exports fall, imports increase
• Stage of economic development – if a country is
developing, it will have a deficit in BOP, because it
imports raw materials, machinery, etc and export
primary products. The country has to pay more
for costly imports and get less for cheap exports
• Capital movements – borrowings and lendings
or movements of capital by countries also
result in disequilibrium in BOP. A country
which gives loans and grants on a large scale
to other countries has a deficit in BOP on
capital account. If it is also importing more, it
will have a chronic deficit.
• Political conditions – political instability in a
country creates uncertainty among foreign
investors which leads to outflow of capital and
retards its inflow. Disequilibrium in BOP also
occurs in event of war or fear of war with
some other country