bop

Balance of Payment: 

Balance of Payment - By Vidushi Sharma

Introduction :-: 

Balance of Payment is also called as Balance of international trade. It is a systematic and summary record of country’s economic and financial transactions with the rest of the world , over a period of time. BOP statements is a device for recording all the economic transactions within a given period between the residents of 1 country and the rest of the world. It include international transactions- transfer of assets and liability, creation of claims or receipts and payment of funds. Introduction :-

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According to IMF BOP is a statistical statement for a given period showing: Transaction in goods & services & income between a country and the rest of the world. Changes of ownership and other changes in country’s assets and liabilities with the rest of the world. Unrequited transfers and counterpart entries that are needed to balance as per the accounting rules.

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BOP uses a double entry system of recording accounts with the rest of the world. BOP account is divided into ‘payments’ (debit) and ‘receipts’ (Credit) All the international transactions that result in payment in a country is recorded as credit entries payments made by a country is recorded as the debit entries in BOP.

Structure of BOP :-: 

Various entries of BOP can be grouped under following heads :- Current Account Capital Account Unilateral Payments Account Official Reserves Asset Account Structure of BOP :-

1.Current Account :-: 

It includes all the transactions which give rise to or use up national capital. It mainly consist of 2 items :- Merchandise exports and imports Invisible exports and imports Merchandise export is the sale of goods abroad. These are credit entries. On the other hand merchandise imports are the purchase of goods from abroad. These are debit entries. Invisible exports are the sale of services and are credit entries. 1.Current Account :-

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While invisible imports are the purchase of services and are debit entries. Some invisible exports are sale abroad of services like transport, insurance, foreign tourists expenditure in home country and income received on loans and investment abroad. Some invisible imports are purchase of services like transport, insurance, tourists expenditure abroad and income paid on loans and investment (by foreigners) in home country. E.g. Software exports have emerged as a very important invisible item of India’s current account.

2. Capital Account :-: 

The capital account consist of short term and long term capital transactions. Capital outflow represents debit and capital inflow represents credit. For E.g. American firm invests Rs 100 million in India, this transaction will be represented as debit in US Balance of Payment and credit in the Balance of Payment of India. Though loans and investment are capital transactions but the interest on loan and dividend earned on investment are Current account transactions. 2. Capital Account :-

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Capital account can be sub-divided into :- Private capital account International institutional capital account Specie account Government capital account

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(a) Private capital account :- It consist of balances held by corporate bodies or commercial banks. It consist of both short term and long term transactions. Long term transactions can be both direct and indirect in nature. Direct investment is real investment in industries – infrastructure Indirect or portfolio investment is financial investment in holding of existing assets.

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(b) International institutional capital account :- It consist of assistance from short and long term capital supplying agencies like BIS (bank for international settlement), World Bank, International Finance Corporation etc. (c) Specie Account :- It records the movements (inflow and outflow) of gold.

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(d) Government Capital Account :- It consist of all governmental capital transactions in the form of grants and loans (both short term and long term)

3. Unilateral Transfer Account :-: 

It is the term used for gifts. It also includes private remittances, government grants, reparations and disaster relief. Unilateral payments those received from abroad are credits and those made abroad are debits. 4. Official Reserves Account :- It represents the holdings by government or official agencies which are accepted for the settlement of international claims 3. Unilateral Transfer Account :-

Importance of Balance of Payment: 

It measures gross deficit or surpluses with the rest of the world. It describes the state of international economic relation of a country. It is a guide for monetary, fiscal, exchange and other policies. It offers a control tool for both analyzing and directing a country’s international economic position It measures the influence of foreign trade on national income. Importance of Balance of Payment

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Difference between Balance of Payment and Balance of Trade :- Balance of trade takes into account only transactions of exports and imports of visible items. It does not include invisible items such as services rendered by shipping, insurance and banking payment of interest, dividend or expenditure by tourist. Balance of Payment takes into account the exchange of both visible and invisible items and the capital account. Balance of trade is a small part of Balance of Payment Balance of Payment is a broader concept.

Disequilibrium of BOP: 

BOP is in equilibrium when demand for Foreign exchange is exactly equivalent to supply of it. It is said to be in disequilibrium when it shows either ‘surplus’ or ‘deficit’. Deficit : When demand for foreign exchange exceeds its supply Surplus : When supply for foreign exchange exceeds its demand Disequilibrium of BOP

Causes of Disequilibrium :-: 

Economic Factors :- Development Disequilibrium : Large scale development expenditure leads to large imports of capital goods, machinery etc. Development also leads to increase purchasing power & aggregate demand resulting into larger imports. Above factors lead to more imports than exports & thus deficit arises in balance of payment. Causes of Disequilibrium :-

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b) Cyclical disequilibrium : Cyclical fluctuations is one of the reasons for BOP disequilibrium. Depression always bring about shrinkage in world trade. A country experiencing depression reduces its imports and exports drastically. On the other hand a country in boom condition have much more imports than its exports.

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c) Secular disequilibrium: Sometimes BOP disequilibrium is because of slow & long lasting trends in economy. Ex:- In developed countries disposable income & aggregate demand is generally very high. Also production cost is high because of higher wages leading to higher domestic prices. Thus high demand & high prices leads to higher imports.

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d) Structural disequilibrium: Structural changes also causes disequilibrium like: Development of alternative sources of supply. Development of better substitute. Exhaustion of productive resources. Changes in transport route and cause.

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2) Political factors: Political instability causes large capital outflows and inadequate domestic investment and production. changes in world trade policies and war are some other political factors leading to BOP disequilibrium. 3) Social factors: Some social factors like change in taste & preference leads to BOP disequilibrium.

Correction of BOP Disequilibrium:: 

Correction of BOP Disequilibrium:

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Every country tries to remove or reduce BOP deficit. Various measures for correcting BOP disequilibrium can be divided into 2 categories: Automatic measures Deliberate measures

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I.Automatic Measures: This theory says that if market forces of demand and supply are allowed to have free play, than with time equilibrium will be automatically restored . E.g. if there is a deficit in BOP then the demand for foreign exchange exceeds its supply this leads to increase in exchange rate. This means external value of domestic currency decreases. This increases the exports and in imports is seen BOP equilibrium is established.

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II. Deliberate Measures :- These corrective measures are deliberately taken to restore equilibrium. These measures can be divided into 3 groups:- Monetary measures Trade Measures Miscellaneous

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Monetary Measures :- Monetary Contraction :- Demand for export and import is influenced by contraction or expansion of money supply in the economy. In case of BOP deficit if money supply is reduced then the purchasing power and demand for imported product automatically comes down. Also fall in domestic prices increases exports. All these factors lead to correction in BOP.

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b) Devaluation :- It means reduction of official rate at which one currency is exchanged for another. A country with disequilibrium in BOP will devalue its currency to encourage exports and decrease imports.. Devaluation makes export cheaper and imports expensive c) Exchange Control :- Under it govt. or Central bank assumes complete control over the foreign exchange reserves and earnings of country. Exporters are required to surrender foreign exchange to the Central Bank. Govt. also have a control over imports.

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ii) Trade Measures :- It include measures to encourage exports and to reduce imports :- a) Export Promotions : exports are encouraged by removing export duties, providing export subsidies, monetary, physical and institutional incentives b) Import Control : imports are controlled by imposing import duties, import quotas, licensing & prohibiting exports for some products.

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iii) Miscellaneous Measures :- Measures like obtaining foreign loans. Encouraging foreign investment in home country Development of tourism to attract foreign tourists

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Thank You !!!!