A Glance at Balance of Payment


By

Kantesha V S
Lecturer
Dept of MBA
T John Institute of Technology
Bangalore-560083
 


Introduction

Balance of payment may be used as an indicator of economic and political stability of any country. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners.

Meaning of Balance of Payment

Balance of Payment of a Country is a systematic accounting record of all economic transactions during a given period of time generally between the residents of the country and residents of foreign countries. It represents an accounting of country's international transactions for a particular period of time. It accounts for transactions by individual, businesses and Government.

Example: Export and Import of goods and services, cross border investments in business, bank account, bonds, stocks and real estate.

Economic Transactions

It refers to transfer of economic value from one economic agent to another. Transfer can be Bilateral or Unilateral. The following are the different types of economic transactions

1. One real and another Financial Transfer
Example: Purchase or Sale of goods and services

2. Two Real Transfers
Example: Barter Transactions

3. Two Financial transfers
Example: Purchase of foreign securities for payment in cash

4. One Real Transfer
Example: A Unilateral Gift in Kind

5. One Financial transfer
Example: A Unilateral Financial Gift

Importance of Balance of Payment

1. It indicates pressure on a country's foreign exchange rate.
2. Changes in BOP signal the imposition or removal of controls over payments of dividends, interest, license fee etc.
3. BOP helps to forecast a country's market potential.
4. Decides a country's monetary policy.

Accounting Principles in BOP

1. BOP statement follows rules of Double Entry System of book keeping that is for every debit entry there is a corresponding credit entry
2. Leaving aside errors and omissions BOP must always balance i.e., total debits = total credits
3. If credits are more than debit then we call it as surplus BOP, if credits are less than debits we call it as deficit BOP and if credit is equal to debit then we call it as balanced BOP.

Components of Balance of Payment

The Current Account

It is basically divided into 3 categories namely, merchandise trade balances, service balances and the balance on unilateral transfers. Entries are recorded at their current value and surplus in current account represents as inflow of funds while a deficit represents an outflow of funds. The balance of merchandise trade refers to balance between exports and imports of goods such as machinery, automobiles etc. Services also called as Invisibles which include interest payments, shipping and insurance fees, tourism, dividends, military expenses etc. Unilateral transfers include gifts and grants from both private and government.

The Capital Account

Capital account consists of foreign investments including direct investments and portfolio investments, loans, banking capital, rupee debt service and other capital. It also includes acquisition of firms, purchase and sale of stocks, establishment of subsidiaries, etc.

The Official Reserve Account

These are government owned assets which represents purchases and sales by central bank of the country. The changes in the official reserve account are necessary to account for the deficit or surplus in the BOP.

Format of Balance of Payment

Particulars

Credit

Debit

Net

A.   CURRENT ACCOUNT
1. Merchandise account
2. Invisibles (a+b+c)
a) Services
b) Transfers
c) Investment Incomes


XXX
XXX
XXX
XXX
XXX


XXX
XXX
XXX
XXX
XXX


XXX
XXX
XXX
XXX
XXX

Total Current Account (1+2)

XXX

XXX

XXX

B.  CAPITAL ACCOUNT
1. Foreign Investments
2. Loans
3. Banking Capital
4. Rupees debt services


XXX
XXX
XXX
XXX


XXX
XXX
XXX
XXX


XXX
XXX
XXX
XXX

Total Capital Account(1+2+3+4)

XXX

XXX

XXX

C.  ERRORS AND OMMISSIONS

XXX

XXX

XXX

Overall Balance

XXX

XXX

XXX

D.  OFFICIAL RESERVE ACCOUNT
Increase/Decrease in foreign exchange reserve


XXX


XXX


XXX


Imbalances in BOP

While the BOP has to balance overall surpluses or deficits on its individual elements can lead to imbalances between countries. In general there is concern over deficits in the current account. Countries with deficits in their current accounts will build up increasing debt and/or see increased foreign ownership of their assets.

Causes of BOP Imbalances

There are conflicting views as to the primary cause of BOP imbalances, with much attention on the US which currently has by far the biggest deficit. The conventional view is that current account factors are the primary cause- these include,

  • The exchange rate
  • The government's fiscal deficit
  • Business competitiveness, and
  • Private behaviour such as the willingness of consumers to go into debt to finance extra consumption.

Equilibrium of BOP

Since the BOP is constructed on the basis of double entry book keeping credit is always equal to debit. If debit on current a/c is greater than credit funds, flow into the country that is recorded on the credit side of the capital account and excess of debit is wiped out. Thus concept of BOP is based on the accounting equilibrium, that is

Current a/c + capital a/c = 0

Disequilibrium of BOP

In economic sense, BOP equilibrium occurs when surplus or deficit is eliminated from the BOPs. But normally, such equilibrium not found. Rather it is disequilibrium in the BOP that is normal phenomenon.

Though several external variables influence the BOP and give rise to disequilibrium, domestic variables like national output and national spending, money supply, exchange rate and interest rate are more significant causative factors.

Different Approaches to the Adjustment of BOP

1. The classical View
2. Elasticity Approach
3. The Keynesian View
4. Absorption Approach
5. Mundell's Approach
6. The new Cambridge School Approach
7. Monetary Approach

Conclusion

The BOP is today proved that it has become an economic barometer as it is base for many countries like India, China, USA, UK, etc in knowing their position in the international market and which also helps many countries to frame suitable financial policies with regard to foreign exchange rate, fund flows between countries.

References:

    • Madhu vij , International Financial Management, Excel publications
    • Jain, Peyard & Yadav , International Financial Management , McMillan publications
    • Sharan V, International Financial Management , Prentice hall of India publications
    • www.wikipedia.com
    • www.rbi.org.in
       


Kantesha V S
Lecturer
Dept of MBA
T John Institute of Technology
Bangalore-560083
 

Source: E-mail March 7, 2012

          

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