Balance of payments structure..

BALANCE OF PAYMENTS

Balance of Payment (BOP) of a country is a systematic record of all economic transactions, between the residents of the country and the rest of the world in a given period of time, generally one year. 

Residents: Persons are residents of a country in which they normally reside.

Economic Transactions: It is an exchange or transfer of value. This transfer/exchange can take the form of goods or services, or it can take form of the donations, gifts or reparations, which are called unilateral transfers.

Systematic record: Records prepared by classifying all items as per their nature, are systematic records.

Balance of Payments in Account Form

Balance of Payment Account
RECEIPTS		PAYMENTS
Current Account		Current Account
1	Visible Trade: Export of Goods & Merchandise	1	Visible Trade: Import of Goods & Merchandise
2	Invisible Trade: Export of Services	2	Invisible Trade: Import of Services
3	Unilateral Transfers	3	Unilateral Transfers
Capital Account		Capital Account
4	Medium/Long Term Capital Receipts	4	Medium/Long Term Capital Payments
5	Movement in Reserves	5	Movement in Reserves
Total		Total

Transactions inside the balance of payments can be classified in two broad categories: transactions on the capital account, and those on the current account.

The current account: The current account is a record of all transactions relating to trade in goods and services, net interest and dividend payments and any transfers in the form of foreign aid. Therefore, the three component of the current account are:

1.     The trade balance: This is the difference between the exports and imports of goods and services. The excess of exports over imports is called the trade surplus, and likewise if the imports exceed exports, there is a trade deficit. Often, a distinction is made between goods and services by calling them visible and invisible trade. The trade balance is the most significant element of the current account. Often, a ‘worsening balance of payments’ refers to an increase in the trade deficit.

2. Net foreign income: Income is earned by residents on assets held abroad and likewise foreigners earn income on the domestic assets. Net foreign income is the difference of the two.

3.  Unilateral transfers include transfers such as foreign aid that are made without consideration.

The capital account
The capital account is a record of all transactions that represent flow of money for investment and international loans. It is different from the current account in that it does not include settlements for current transactions. To illustrate with an example, while the purchase of a machinery would feature in the current account, its financing with an international loan would be an entry in the capital account. Investments by foreigners in our stock markets, raising of capital by Indian companies in markets abroad, foreign direct investments in Indian industry are all inflows on the capital account. Similarly, extinguishments of debt by settlement represents an outflow on the capital account.

Long and short-term capital flows

A very important characteristic of the capital account is the nature of the capital flow, i.e. whether it is short term or long term in nature. When a punter puts money in India’s stock markets hoping to make a quick gain, it will be regarded as a short-term capital flow. Similarly, when an investor eyeing high Indian interest rates deposits money with an Indian bank, it too is a short-term capital flow. On the other hand, when a large international financial investor lends long-term money to an Indian company so that it can buy plant and machinery, it is an example of long term, also called ‘stable’ capital flows. The difference is crucial because only long term capital flows can make any significant impact on the economy. Short term capital flows can be quite destabilising, for instance as they were in the recent South Asian crisis when all the ‘hot’ money was pulled out at the first signals of trouble and eventually led to the melt down.

The current account and the capital account are complementary to each other. The net total of the two decides the net increase or decrease in the country’s forex reserves. For the past many years, the Indian economy has witnessed a steady worsening of the current account deficit, but large capital inflows in the form of foreign direct investment and portfolio investment and taken together, the reserves have been building up. A deficit in the current account is not necessarily a negative indicator, so long as the deficit is used to augment productive capacity. This can take the form of investments in infrastructure that make economic expansion possible and increase the capacity of the country to export in the future. At the same time, a surplus in the current account does not necessarily imply prosperity, for instance Russia has a large current account surplus from its export of commodities and arms, which is offset by large-scale capital flight and therefore a deficit on the capital account.

Balance of Payments- Book Keeping
Balance of Payments is an application of Double entry book keeping i.e. debits and credits always balance and Balance of Payment is always in balance (equilibrium). Left side of Balance of Payment A/c shows all the ways in which the country can acquire foreign currency. Right side shows how foreign currency is spent. 

Balance of Payments -Disequilibrium
A Balance of Payment Account comprises of Autonomous and Induced transactions Autonomous transactions are real trade transactions, pertaining to exports and imports of goods and services, that are undertaken for their own sake, under profit or utility motive.

Any imbalance (debit or credit) in the value of autonomous transactions has to be counter balanced by a corresponding change (increase/decrease) in foreign exchange reserves or short term capital movement which is referred to as induced or accommodating transaction (which is not undertaken for its own sake, but which emerges on account of imbalance in the current account). Thus in the process of equalizing the Balance of Payment Account, induced or accommodating transactions take place in the capital account. Such induced transactions often involve short-term capital movement in the form of lending or borrowing, addition or subtraction in foreign exchange reserves of the country etc.

Causes of Disequilibrium in BoP
Since the balance of payments deficit refers to the excess of autonomous payments over the autonomous receipts, the causes of the deficit in the balance of payments are essentially those which cause the payments to rise faster than the receipts, Among these many causes, the major one is the deficit in the balance of trade i.e. excess of imports over exports of goods. This may, in turn be caused by mounting domestic requirements of imported goods (such as machinery and equipment for development), slow growth in exports, high inflation in the home economy.

India’s Balance of Payments
Strong capital flows led by a renewal in portfolio inflows resulted in an overall balance of payments (BoP) surplus for the fourth successive year. This enabled an increase in foreign exchange reserves by US $ 5,546 million during the year to US$38,036 million by end-March 2000.

India's Balance of Payments

BoP Projection for fiscal 2000-01

CATEGORY	1999-2000	2000-2001
Merchandise Trade	-17	-22
Invisibles	12.9	15.50
Current Account Balance	-4.1	-6.5
Foreign Investment	5.1	2
External Assistance	0.9	1
Commercial Borrowing	0.7	-1
Bank Capital	2.7	3
Rupee Debt Service and Others	0.8	1
Total Capital Account	10.2	6
Overall balance of payments	6.1	-0.5

Source: RBI data, CFO India estimates

Wise management of the country’s external sector is vital to well being of the people of India. Faced with a very small domestic market with limited purchasing power, exports alone can provide the engine of growth that can pull large masses of the population out of poverty. While liberalization and freedom from exchange control are laudable objectives, these cannot be achieved unless other liberalization measures sustainably improve the productivity of Indian industry to global standards. Premature liberalization of the forex markets may lead to huge capital flights accompanied by loss of domestic and international confidence in the economy and ultimate pauperisation of an already impoverished populace. Since excessive control and government intervention can also have equally disastrous consequences, our regulatory authorities will need to tread a very fine line between control and the need to globalise. A constantly shifting balance will need to be struck between the interest of the nation, the needs of the economy, and international pressures such as that from the WTO.