Unit 5 Balance of Payments

Chapter-2
Balance of Payments
Unit - 5

Introduction
• The Balance of Payment (BOP) accounts are
an important aspect of the study of
macroeconomy.
• Macroeconomic phenomena cannot be
confined with a particular economy. Open
economies react sharply to events that are
occurring in ROW sector.
• In order to record the overseas transactions
of a country, the BOP accounts are
maintained and they constitute an important
part of national income accounts.

Meaning of Balance of Payments
● The balance of payments of the country is an
accounting statement that provides a
systematic record of all economic transactions
between the residents of a country and the
rest of the world in a given period of time.
● In other words, BOP is the difference
between inflow of foreign exchange and
outflow of foreign exchange on account of
economic transactions.
● It reflects the international economic
position of a country in a given period.

1. Visible items (Flow of Goods) – Visible
items include all types of physical goods
exported and imported. These are visible
in the sense that they can be touched and
seen.
2. Invisible items (Flow of services) –
Invisible items include all types of
services such as shipping, banking,
insurance etc. These are invisible in the
sense that they cannot be touched or
see.
Economic Transactions in BOP

3. Unilateral Transfers – It refers to one
sided receipts or one sided payments. For
example -donations, remittances etc.
4. Capital transfers – Capital transfers are
related to capital receipts, e.g., borrowings or
sale of assets and capital payments, e.g.,
repayments of loans or purchase of assets.
Economic
Transactions in BOP
Visible
Items
Invisible
Items
Unilateral
Transfers
Capital
Transfers

Meaning of Balance of Payment
Accounting
• The transactions are recorded in the
balance of payments account in the double
entry book keeping system.
• Each international transaction undertaken
by the country will result in a credit entry
and debit entry of equal amount.
• Debit side is the payment side and credit
side is the receipts side.

• Payments received from ROW are called
credits.
• Payments made to ROW are called debits.
• As international transactions are recorded
in double entry accounting, the BOP
accounting must be always balanced, that
is, total amount of debits must be equal to
total amounts of credits.
• The balancing item “errors and omissions”
must be included to ‘balance’ the BOP
account.
• If BOP account is still not balanced then
accommodating transactions are
undertaken to balance the BOP account.

Components of Balance of Payments
Components of BOP
Current
A/c
Capital
A/c
Does not affect
assets or
liabilities status.
Affects the
assets or
liabilities status.
Visible
Items
Invisible
Items
Unilateral
Transfers
Official
Transactions
Unofficial
Transactions
FDI
Portfolio
Investment
Change in
Forex
Reserve

Meaning and Components of
Current Account
• Current account of BOP records all those
transactions between the residents of a
country and the rest of the world, which do
not cause a change in the assets or liabilities
of the residents of the country or its
government.
• Current account contains the receipts and
payments relating to all the transactions of
visible items, invisible items and unilateral
transfers.

(i) Visible Items (Exports and Imports of Goods)
• This category includes all exports and imports
of physical goods.
• All exports of goods are recorded as positive (+)
items as they create inflow of foreign money and
are recorded on the credit side.
• All imports of visible items (goods) are recorded
as negative (-) items as these cause the flow of
foreign exchange out of the country and are
recorded on the debit side.
• The difference between export and import of
goods is termed as balance of visible items,
merchandise trade or simply balance of trade
(BOT).

(ii) Invisible Items (Exports and Imports of
Services)
• It includes a large variety of non- factor
services (like shipping, banking, insurance,
interest, dividend, tourism etc.) sold to and
purchased by the residents of a country to and
from rest of the world.
• Exports of services are recorded as positive (+)
items. Receipts are put on the credit side.
• Imports of services are recorded as negative (-)
items. Payments are put on the debit side.
• Balance occurring on account of exports and
imports of services is recorded as balance of
invisible trade.

(iii) Unilateral Transfers (Unrequited Receipts
and Payments)
• Unilateral transfers refer to these receipts
and payments which take place without any
services in return these are one side or one
way transactions.
• These include gifts, remittances, indemnities
aid etc. to and from foreign.
• Receipts of unilateral transfers are recorded
as positive (+) items and put on the credit
side.
• Payments of unilateral transfers are recorded
as negative (-) items and put on the debit side.
• Balance of receipts and payments of unilateral
transfers is balance of unilateral transfers.

Balance on Current Account
• Receipts from exports of goods, services and
unilateral receipts are recorded as credits (+)
items as they represent inflow of foreign
exchange.
• Payments for imports of goods services and
unilateral payments are entered as debit (-)
items as they represent outflow of foreign
exchange.
• The net value of these credits and debits is
the balance on current account.

• Surplus on current account (when credit items
are more than debit items) implies net inflow
of foreign exchange.
• Deficit on current account (when debit items
are more than credit items) implies net outflow
• Surplus or deficit of current account is
adjusted through capital account.
Debit Side (Negative Items) Credit Side (Positive Items)
1. Import of Goods
2. Import of Services
3. Unilateral Payments
* Surplus on Current A/c
(Balancing Figure)
1. Export of Goods
2. Export of Services
3. Unilateral Receipts
* Deficit on Current A/c
(Balancing Figure)

Meaning and Components of
Capital Account
• Capital Account of BOP records all those
transactions between the residents of a
country and the rest of the world, which
cause a change (increase or decrease) in the
assets or liability status of the residents of
a country or its government.
• Capital account is related to assets and
liabilities of financial nature.

1. Official Transactions
• These are those transaction which affect
assets and liability status of the government
of a country.
For example, Indian Government borrows money
from IMF, World Bank or from any other
country to finance the deficit in the balance of
payments.
• Receipts of such loans are recorded on the
positive (credit) side.
• Repayments of loans by the governments are
recorded on the negative (debit) side.

(ii) Non- Official/ Private Transactions
• These are those transactions which affect
assets and liabilities of non-government
entities or private sector.
For example, private sector of the country
receives short-term and long-term foreign loans.
• Receipts of such loans are recorded on the
positive (credit) side.
• Repayments of loans by the governments are
recorded on the negative (debit) side.
Receipts of Loans – Inflow of Foreign Exchange – Credit Side (+)
Repayments of Loans – Outflow of Foreign Exchange – Debit Side (-)

(iii) Foreign Direct Investment (FDI)
• It refers to purchase of an asset in rest of
the world which gives full control to the buyer
over the asset.
For example, acquisition of a foreign firm by
ITC limited.
• Purchase of assets abroad is recorded on the
negative (debit) side.
• Sale of assets abroad is recorded on positive
(credit) side of BOP.
Sale of Assets – Inflow of Foreign Exchange – Credit Side (+)
Purchase of Assets – Outflow of Foreign Exchange – Debit Side (-)

(iv) Portfolio Investment
• It refers to purchase of assets in abroad
which does not give full control over the
asset.
• For example, purchase of shares or bonds of a
foreign firm by TATA industry.
• Purchase of assets abroad is recorded on the
negative (debit) side.
• Sale of assets abroad is recorded on positive
(credit) side of BOP.
Sale of Assets – Inflow of Foreign Exchange – Credit Side (+)
Purchase of Assets – Outflow of Foreign Exchange – Debit Side (-)

(v) Change in foreign exchange reserves
• Foreign exchange reserves are the financial
assets of a country held in the central bank.
• When addition to these reserves is made, it
implies negative item and entered in the debit
side of BOP.
• Any withdrawal from these reserves is
recorded on the positive (credit) side of BOP.
Increase in Forex Reserves – Outflow of Forex– Debit Side (-)
Decrease in Forex Reserves – Inflow of Forex– Credit Side (+)

Balance on Capital Account
• The transactions which lead to inflow of
foreign exchange, are recorded on the credit
side (positive items).
• The transactions which lead to outflow of
foreign exchange, are recorded on the debit
side (negative items).
• Surplus on capital account (when credit items
are more than debit items) implies net inflow
• Deficit on capital account (when debit items
are more than credit items) implies net
outflow of foreign exchange.

Note: Current account is that part of BOP account which
shows all payments made or received in respect of goods
and services including payments of interest on past
lending and borrowing .Capital account is that part of BOP
account which shows all payments made or received by
the way of setting old debts or creating new debts.

Difference between Current Account
and Capital Account
Basis Current Account Capital Account
1. Meaning
2. Compon-
ents
3. Lending
&
Borrowing
4. Concept
It records all such
transactions between the
residents of a country and
the rest of the world, which
do not cause a change in the
assets or liabilities of the
residents of the country or
its government.
Visible items, invisible items
and unilateral transfers.
It includes interest on past
lending and borrowing.
It is a flow concept as it is
measured over a period of
time.
It records all such transactions
between the residents of a
country and rest of the world
which cause a change in the
assets or liability status of the
residents of a country or its
government.
Official transactions, unofficial
transactions, FDI, portfolio
investments, official reserve.
It records all payments made or
received by way of settling old
debts or creating new debts.
It is stock concept as it is
measured at a point of time.

Meaning of Autonomous and Accommodating
Items
(A) Autonomous Items in BOP
• These are those international economic
transactions which are done for some economic
motive or economic considerations such as profit
maximization.
• These transactions are independent of the state of
the country's BOP.
• Autonomous transactions take place on both,current
and capital account.
• These items are generally called ‘above the line
items’ in BOP.
• Deficit or Surplus in BOP depends upon the balance
of autonomous items.

(B) Accommodating Items in BOP
• These are those transactions which are
undertaken to cover the deficit or surplus in
balance of payments.
• These are conditioned by BOP status of the
country. These are not related to those
transactions which are determined by profit
maximization.
• Accommodating transactions take place on capital
account only.
• These items are also called ‘below the line items’.
• Government financing, official settlements are
used as accommodating items to keep the BOP
identity.

• The official settlement approach is based on
the assumption that monetary authority or the
central bank of the country is the ultimate
finances of any deficit in the BOP or the
ultimate recipient of any surplus.

Types of Balance of Payments
Equilibrium in
BOP
Disequilibrium
in BOP
Surplus
BOP
Deficit
BOP

Types of Balance of Payments
Equilibrium in BOP
• It occurs when the
net balance of all
receipts and
payments is zero.
• In other words,
when the total of
debit side is equal to
total of credit side
in BOP.
Disequilibrium in BOP
• It occurs when the
net balance of all
receipts and payments
is not zero.
• In other words, when
the total of debit side
does not match with
the total of credit
side in BOP.

Disequilibrium in BOP
Disequilibrium in BOP is a state of either
surplus (favorable) BOP status or deficit
(unfavorable or adverse) BOP status.
(i) Surplus BOP – When the payments (debit) of
the country are less than its receipts (credit),
the BOP is said to be surplus BOP. In other
words, when inflow of foreign exchange is more
than its outflow, BOP is in surplus.
Credits
Debits

(ii) Deficit BOP – When the payments (debit)
of the country are more than its receipts
(credit), the BOP is said to be deficit BOP. In
other words, when outflow of foreign exchange
is more than its inflow, BOP is in deficit.
• A surplus in the BOP generally does not create
much of a problem. However the deficit BOP
often creates difficult problem for the
economy.
Debits
Credits

Meaning of Balance of Trade
(BOT)
• Balance of Trade is the difference
between the value of exports and imports
of visible items (goods) only.
BOT = Exports of visible items (goods)-
Imports of visible items (goods)
• Balance of trade is just a part of the BOP
account.
• It is also termed as balance of visible
items of BOP or merchandise trade.

(i) Surplus in BOT
• If a country exports more goods than it
imports.
• It has a favorable or surplus in the BOT.
(Exports > Imports)

(ii) Deficit in BOT
• If a country imports more goods than it
exports.
• It has an unfavorable or deficit in the
BOT. (Imports > Exports)

Basis Balance of Trade Balance of Payments
1. Meaning
2. Items
3. Capital
Transaction
4. Scope
5. Nature
of Record
Balance of trade is the
difference between the
money value of exports and
imports of goods or Balance
of visible items of BOP.
Visible items.
Does not record transactions
of capital nature.
Narrow concept as it is a part
of current account of BOP.
It is an incomplete record of
economic transactions with
ROW.
The Balance of payments of the
country is a systematic record
of all transaction between the
residents of the country and
the rest of the world in a given
period of time.
Visible, invisible items,
unilateral and capital receipts.
Records transactions of capital
nature.
Broad concept as it includes
BOT.
It is a complete record of
economic transactions with
ROW.

Balance of Payment Always
Balances
• The BOP always balances in the accounting
sense according to the principle of
accounting.
• BOP accounts are prepared on the basis of
double entry system of book- keeping under
which receipts (credit side) are always equal
to payments (debit side).
• As a result accounts are always in balance.
• The Balance of current account need not be
equal but can show surplus or deficit.

• Deficit or surplus in current account is
balanced by an equal amount of surplus or
deficit in capital account.
• If there is a deficit in current account of a
country, it is offset by a matching surplus in
the capital account by borrowings from abroad
or with drawing out of its gold and foreign
exchange reserves.
• On the other hand, if there is a surplus in
current account, it is offset by a matching
deficit in the capital account.
• So, surplus or deficit of current account is
accommodated by capital account. Therefore
BOP is always in equilibrium or balance.

An Extra Mile
I. Causes for Disequilibrium in the BOP
(Deficit BOP)
(i) Developmental Activities
(ii) High rate of inflation
(iii) Trade Cycles
(iv) Change in Cost Structure of Trading
Partners
(v) Development of Import Substitutes
(vi) Political Instability
(vii) Policies of the Government

II. Measures to Correct Disequilibrium
in BOP
(i) Export Promotion
(ii) Depreciation of Domestic Currency
(iii) Import Control
(iv) Exchange Control
(v) Devaluation of Domestic currency
(vi) Reducing Inflation

Presented by –
Ritvik Tolumbia
CS, CWA, M.Com (ABST), M.A (Eco), B.Ed
Author & Faculty of Commerce

Unit 5 Balance of Payments

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Unit 5 Balance of Payments

Similar to Unit 5 Balance of Payments (20)

More from Ritvik Tolumbia

More from Ritvik Tolumbia (14)

Recently uploaded

Recently uploaded (20)

Unit 5 Balance of Payments