BOP

Balance of Payments : 

Balance of Payments

Balance of Payments:: 

Balance of Payments: This term is applicable to nations that transact with other nations of the world. Any nation that transacts with some other nation either receives or pays a consideration. The record of a nation’s transactions in goods and services, and assets with the rest of the world is called its Balance of Payments. It is thus an indicator of the international economic position of the nation. Balance of trade is figure results when merchandise imports are subtracted from exports.

PowerPoint Presentation: 

Higher degree of openness => structure of production and employment, and economic growth, are more likely to be affected by external events The balance of payments provides and indication of how international trade and external events feed back into the macroeconomy This lecture describes how balance of payments accounts are recorded and then explores the link between the balance of payments and the exchange rate

The balance of payments (BOP) accounts : 

The balance of payments (BOP) accounts A country’s balance of payments accounts record its international trading position and its lending and borrowing => records transactions between countries

PowerPoint Presentation: 

Each transaction is classified according to the payment or receipts that it generates Transactions that generate a receipt of a payment from foreigners are a credit item in the accounts with a + sign These represent a supply of foreign exchange ($) and a demand for the local currency Transactions that comprise a payment to foreigners are reported as a debit item with a - sign => These represent demand for foreign exchange ($) and a supply of the local currency

Balance of Payments Accounting: 

What kind of records should be kept? What do you want to find out? The nature of the record changes by what we are trying to find out. Balance of Payments Accounting

Balance of Payments Accounting: 

What kind of things do governments wish to know? What is the international demand for our currency doing to its value? Do we have enough currency reserves, or capacity to pay for our trade? Does our trade promote full employment? And so on. Balance of Payments Accounting

Balance of Payments Accounting: 

Balance of Payments Accounting What kinds of transactions represent the basic focus of balance of payments accounting? All transactions between the citizens of a nation and those of other nations are recorded in the balance of payments for a given period of time.

a) The balance of payments on Current Account: 

a) The balance of payments on Current Account Records transactions arising from trade in goods and services The visible trade balance payments and receipts from the import/export of tangible goods (cars, food, textiles,…) The invisibles trade balance payments and receipts for financial services, shipping and tourism, interest and dividends payments on investments, etc.…

PowerPoint Presentation: 

Trade deficit = government deficit + priv. sector deficit An increase in govt. expenditure ( G ), or a reduction in private saving ( S ) worsens the trade balance (i.e. rises trade deficit)

Recording International Payments: 

Recording International Payments How is information recorded in balance of payments accounting? The basic technique is standard, double-entry accounting, a flow of funds statement that shows changes in assets, liabilities and net worth over time.

Recording International Payments: 

Recording International Payments The balance of payments statement is to inform government authorities of the international position of the country to assist them with monetary-fiscal questions as well as trade and payments policies.

Debits, Credits, and International Payments: 

Debits, Credits, and International Payments What is the meaning of a debit in a balance of payments account? What is a credit? A debit records a transaction increasing assets or reducing liabilities.

Debits, Credits, and International Payments: 

Debits, Credits, and International Payments A debit results from some kind of transaction requiring an immediate out-payment. A debit arises from the purchase of goods, claims, or reserve assets and represents an inflow of value.

Debits, Credits, and International Payments: 

Debits, Credits, and International Payments A credit records a transaction reducing assets or increasing liabilities. It results from some kind of transaction requiring an immediate in-payment. A credit arises from the sale of goods, claims, or reserve assets and represents an outflow of value.

Sources and Uses of Funds: 

Sources and Uses of Funds How does a country derive foreign currencies it needs to conduct its international business? The sources of funds, the supply of foreign exchange, are exports, investment income,

Sources and Uses of Funds: 

Sources and Uses of Funds The sources of funds, the supply of foreign exchange, are transfer payments received, and long-term and short-term borrowing.

Sources and Uses of Funds: 

Sources and Uses of Funds Credit entries reflect the sources, debit entries indicate the uses of foreign exchange.

The Balance of Payments: 

The Balance of Payments The components of the balance of payments: Current account Capital account Official financing National income determination and foreign trade

BALANCE OF PAYMENTS ACCOUNTS : 

BALANCE OF PAYMENTS ACCOUNTS These accounts are to summarize payments a country receives from other nations and payments it must make to other nations. They consist of the following five categories: 1. MERCHANDISE OR TRADE BALANCE: (Exports minus imports )

BALANCE OF PAYMENTS ACCOUNTS : 

BALANCE OF PAYMENTS ACCOUNTS 2. GOODS AND SERVICES BALANCE: (Just add services) 3. NET UNILATERAL TRANSFERS (Gifts) Government transfers to foreigners ( E.g ., Foreign aid or wheat from U.S. stockpiles) Private remittances of wages earned abroad, and Lots of other transfers.

BALANCE OF PAYMENTS ACCOUNTS : 

BALANCE OF PAYMENTS ACCOUNTS To here, we are looking at the CURRENT ACCOUNT BALANCE (Net flows of goods, services and gifts). Again: 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS

Balance of Payments: 

Balance of Payments There is also a set of asset flows referred to as the CAPITAL ACCOUNT BALANCE 4. NET CHANGES IN FOREIGN HOLDINGS OF INDIAN ASSETS Flows of financial assets and similar claims, or Foreign direct and other investments in the INDIA, or “Private capital flows.” (Note that we are talking direct and portfolio investments here).

Balance of Payments: 

Balance of Payments 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION Foreign official holdings of Indian assets, Indian holdings of official reserve (gold and foreign exchange) assets or, “Official asset flows.”

All Together Now: 

All Together Now 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS 4. NET CHANGES IN FOREIGN HOLDINGS OF INDIAN ASSETS 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION

Balance of Payments: 

Balance of Payments THE BALANCE OF PAYMENTS IS, THEREFORE, THE SUM OF THE CURRENT AND CAPITAL ACCOUNT BALANCES.

Services in the Balance of Payments: 

Services in the Balance of Payments Note: *Services include travel and tourism, trade transportation, insurance, education, financial, technical, telecommunications and other business and professional services. In addition there are royalties, payments for capital services besides interest, such as dividends, payments for foreign labor, etc.

Overall Surpluses and Deficits: 

Overall Surpluses and Deficits What is an overall balance of payments surplus? What is an overall deficit? A surplus is when the sum of the current account plus the private capital account is counterbalanced by an accumulation of official net assets, so official reserve assets increase.

Overall Surpluses and Deficits: 

Overall Surpluses and Deficits What is an overall balance of payments surplus? What is an overall deficit? If it is in deficit , the sum is counterbalanced by an accumulation of official net liabilities, so the country sees its official reserve assets decline.

PowerPoint Presentation: 

The current account balance is the difference between domestic saving and domestic investment. If domestic saving falls, the India must borrow from abroad to finance domestic investment…

Exchange Rate:: 

Exchange Rate: Exchange rate , in its most simple connotation, is the rate at which one currency can be exchanged for another. Exchange rates play a crucial role in determining the performance of any economy. They determine the price of imported goods relative to domestic goods and can have significant effects on the level of imports, exports and movement of capital between nations. Two types of exchange rates, i.e., fixed exchange rate and flexible exchange rate.

Flexible Exchange Rate: 

Flexible Exchange Rate Flexible exchange rate is an extreme situation where there is no intervention by Central Bank. The foreign exchange market is busy at all times by changes in exchange rates. A floating exchange rate or flexible exchange rate is a type of exchange rate regime wherein a currency’s value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency.

Fixed Exchange Rate: 

Fixed Exchange Rate Fixed exchange rate system: Under this, exchange rate is officially declared and it is fixed. Only a small deviation from this fixed value is possible. A typical fixed exchange rate system was associated with the Gold standard system of 1880-1914. A fixed exchange rate sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency’s value is matched to the value of another single currency or to a basket of other currencies or to another measure of value, such as gold. A fixed exchange rate is usually used to stabilize the value of a currency, vis-à-vis the currency it is pegged to.

Theories of BOP : 

Theories of BOP 1. Absolute advantage theory 2. Comparative advantage theory 3. Imitation gap theory 4. Hecksher – Ohlin theory 5. International Product life cycle theory

Absolute advantage theory: 

Absolute advantage theory refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Adam Smith first described the principle of absolute advantage in the context of international trade , using labor as the only input.

Ex:: 

Ex:

Comparative advantage theory: 

Comparative advantage theory Absolute Advantage: Where one country can produce goods with fewer resources than another Comparative Advantage: Where one country can produce goods at a lower opportunity cost – it sacrifices less resources in production

Comparative Advantage: 

Comparative Advantage Oil (Barrels) Whisky (Litres) Russia 10 or 5 Scotland 20 or 40 One unit of labour in each country can produce either oil OR whisky. A unit of labour in Russia can produce either 10 barrels of oil per period OR 5 litres of whisky. A unit of labour in Scotland can produce either 20 barrels of oil OR 40 litres of whisky.

Comparative Advantage: 

Comparative Advantage Opportunity Cost = sacrifice/ gain Russia: if it moved 1 unit of labour from whisky to oil it would sacrifice 5 litres of whisky but gain 10 barrels of oil (OC = 5/10 = ½) Moving 1 unit of labour from oil to whisky production would lead to a sacrifice of 10 barrels of oil to gain 5 litres of whisky (OC of whisky is 10/5 = 2) Scotland: if it moved 1 unit of labour from whisky to oil it would sacrifice 40 litres of whisky but gain 20 barrels of oil (OC = 40/20 = 2) Moving 1 unit of labour from oil to whisky production would lead to a sacrifice of 20 barrels of oil to gain 40 litres of whisky (OC of whisky is 20/40 = ½ ) For Scotland the OC of oil is four times higher than that in Russia (2 compared to ½)

Imitation gap theory: 

Imitation gap theory Or Technology gap theory describes an advantage enjoyed by the country that introduces new goods in a market. As a consequence of research activity and entrepreneurship, new goods are produced and the innovating country enjoys a monopoly until the other countries learn to produce these goods: in the meantime they have to import them. Thus, international trade is created for the time necessary to imitate the new goods ( imitation lag ).

Hecksher – Ohlin theory: 

Hecksher – Ohlin theory In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher -Ohlin theory. The Heckscher -Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since those theories focus on the productivity of the production process for a particular good. On the contrary, the Heckscher -Ohlin theory states that a country should specialize production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently.

International Product life cycle theory: 

International Product life cycle theory The product life-cycle theory is an economic theory that was developed by Raymond Vernon in response to the failure of the Heckscher -Ohlin model to explain the observed pattern of international trade . The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. In some situations, the product becomes an item that is imported by its original country of invention. A commonly used example of this is the invention, growth and production of the personal computer (IBM ) with respect to the United States . The model applies to labor-saving and capital-using products that (at least at first) cater to high-income groups.

Disequilibrium in BOP: 

Disequilibrium in BOP Deficit or surplus in BOP account will lead to disequilibrium and this is to be corrected. The causes of this is either economic, social and political.

Measures to correct Disequilibrium in BOP: 

Measures to correct Disequilibrium in BOP 1. Export promotion 2. Devaluation of Rupee 3. Exchange control 4. Depreciation 5.Reducing inflation 6. Import substitution 7. Import restrictions