1. BALANCE OF
PAYMENT
When we say “a country’s
balance of payments” we are
referring to the transactions of
its citizens and government.

2. Group Members
 Karan Desai - 33
 Vaibhav Aggarwal - 51
 George Joseph - 57
 Dhruval Karia - 72

3. BALANCE OF PAYMENT:
 The balance of payments of a country is a
systematic record of all economic transactions
between the residents of a country and the rest
of the world. It presents a classified record of all
receipts on account of goods exported, services
rendered and capital received by residents and
payments made by theme on account of goods
imported and services received from the capital
transferred to non-residents or foreigners.
- Reserve
Bank of India

4. IMPORTANCE OF THE BALANCE
OF PAYMENTS
 BOP records all the transactions that create
demand for and supply of a currency. This
indicates demand-supply equation of the
currency. This can drive changes in exchange
rate of the currency with other currencies.
 BOP may confirm trend in economy’s
international trade and exchange rate of the
currency. This may also indicate change or
reversal in the trend.
 This may indicate policy shift of the monetary
authority (RBI) of the country.

5.  BOP may confirm trend in economy’s
international trade and exchange rate of
the currency. This may also indicate
change or reversal in the trend.
 This may indicate policy shift of the
monetary authority (RBI) of the country.

6. The General Rule in BOP
Accounting
 a) If a transaction earns foreign currency
for the nation, it is a credit and is recorded
as a plus item.
 b) If a transaction involves spending of
foreign currency it is a debit and is
recorded as a negative item.

7. The various components of a
BOP statement
 A. Current Account
 B. Capital Account
 C. IMF
 D. SDR Allocation
 E. Errors & Omissions
 F. Reserves and Monetary Gold

8. Current Account
 BOP on current account refers to the
inclusion of three balances of namely –
Merchandise balance, Services balance
and Unilateral Transfer balance. In other
words it reflects the net flow of goods,
services and unilateral transfers (gifts).
The net value of the balances of visible
trade and of invisible trade and of
unilateral transfers defines the balance on
current account.

9. Capital Account
 The capital account records all
international transactions that involve a
resident of the country concerned
changing either his assets with or his
liabilities to a resident of another country.
Transactions in the capital account reflect
a change in a stock – either assets or
liabilities.

10. The Reserve Account
 Three accounts: IMF, SDR, & Reserve and
Monetary Gold are collectively called as The
Reserve Account.
 The IMF account contains purchases (credits)
and re-purchase (debits) from International
Monetary Fund. Special Drawing Rights (SDRs)
are a reserve asset created by IMF and
allocated from time to time to member countries.
It can be used to settle international payments
between monitary authorities of two different
countries.

11. Errors and Omission.
 This is a balancing item so that total
credits & debits of the three accounts must
equal in accordance with principle of
double entry book keeping so that balance
of payments always balances in the
accounting sense

12. National Income Account and
BOP
 Y = C + I + G + CA
 Y = GDP
 C = consumption
 G = government spending
 CA = current account balance
This is called National Income Identity

13. Current Account
 CA = X – M = net export of goods and
services
X = export; M = import
 Strictly speaking CA = X – M +UT but, for
a while, we ignore UT = unilateral transfer
 In a closed economy, we do not have CA.
(because X = M = 0)

14. National Income Account
 Consumption
= spending by households, including consumer
spending on durable goods
 Investment
= Business sector’s adding to the physical stock
of capital, including inventories. (individual
household’s purchases of stocks, bonds or real
estates are not included)
 Government purchases
= spending by federal, state, or local
governments

15. Current account balance
 (Domestic spending on goods and
services produced domestically)
=C+I+G–M
 (Foreign spending on goods and services
produced domestically)
=X

16. Current account balance
(cont’d)
 CA = X – M
 When X > M or CA > 0, we say current
account surplus.
 When X < M or CA < 0, we say current
account deficit.
 CA = Y – (C + I + G) = Y – A
where A = domestic absorption

17. Current account balance
(cont’d)
 A country with current account deficit is
buying more from foreigners than it sells
to them
⇒It has to increase net foreign debts.
∆CA = ∆net foreign wealth
 US has been a net debtor since 1985.
In 1998, debt = $5.5 trillion

18. Saving and Investment
 Let S = national saving = Y – C – G.
 Then
S = I + CA
(In a closed economy S = I)
where
I = domestic investment = capital stock
accumulation
CA = foreign wealth acquisition = net foreign
investment
 An open economy can increase investment by
borrowing abroad.

19. Saving
 S = SP + SG
where SP = Yd – C = Y – T – C
SG = T – G
SP = private saving; SG = government saving;
Yd = disposable income; T = net tax.
 Then SP = (C + I + G + CA) – T – C
= I + CA + (G - T)
where G – T = government budget deficit.
 So CA = SP – I – (G – T)
A large gov’t budget deficit leads to a large current
account deficit.

20. Balance of Payment Accounts
 Double-entry bookkeeping
each entry is recorded twice.
 A debit entry ⇐ a payment to foreigners
 A credit entry ⇐ a receipt from foreigners

21. Current Account (CA)
the record of commodity and services transaction
 A. Exports (credit)
 B. Imports (debit)
 1. Merchandise: commodity transaction
 2. Services: travel, tourism, royalties, transportation
costs, insurance premiums.
 3. Income
 Income receipts on US assets abroad (credit)
 Income payments on foreign assets in US (debit)
 Direct investment receipts and payments
 Interest, dividends.

22. Current Account (cont’d)
 C. Unilateral Transfers (debit)
 US foreign aid, gifts, retirement pensions, interest
payments to foreigners on their US gov’t debt,
workers’ remittances.
 CA > 0: current account surplus
⇒ the country is a net lender to the rest of world
 CA < 0: current account deficit
⇒ the country is a net borrower from the rest of
world

23. Capital Account (KA)
the record of financial assets transaction
 A. US assets abroad
 1. US official reserve assets (Gold, SDR, reserve in
IMF, foreign currencies)
 2. US gov’t assets
 3. US private assets (direct investment, foreign
securities)
 B. Foreign assets in US
 1. Foreign official assets in US (US gov’t securities,
…)
 2. Other foreign assets in US (direct investment, US
treasury securities)

24. Example (a)
 An American buys a share of German
stock, paying by writing a $10,000 check
on his account with a Swiss Bank.
 Debit: US asset held abroad $10,000
 Credit: US asset held abroad $10,000.
For Germany
 Credit: Foreign asset held in Germany
 Debit: German asset held abroad

25. Example (b)
 An American buys a share of German
stock, paying the seller with a $10,000
check on an American bank.
 Debit: US asset held abroad $10,000
 Credit: Foreign asset held in US $10,000

26. Example (c)
 The French government carries out an
official foreign exchange intervention in
which it uses dollars held in an American
bank to buy French currency from its
citizens.
 Debit: Foreign asset held in US $1 million
 Credit: Foreign asset held in US $1 million
(US official reserve asset)

27. Official Reserve Assets
 Official reserve assets:
 purchase or sale of foreign assets held by the central
bank
 Official international reserves: gold, SDR, foreign
currencies, etc.
 (current account) + (non-reserve capital
account) + (statistical discrepancy)
= Balance of Payment (official settlement)

28. Balance of Payment
 Balance of Payment (official settlement)
= current account deficit needed to be
covered by the central bank’s official
reserve transactions.
 BOP deficit ⇒ the country is running down
its official reserves.

29. TRENDS IN INDIA’S BALANCE
OF PAYMENTS
 A country, like India, which is on the path
of development generally, experiences a
deficit balance of payments situation.
 This is because such a country requires
imported machines, technology and
capital equipments in order to successfully
launch and carry out the programme of
industrialization

30. FIRST PLAN
 During the first plan period, the balance of
payments was affected by the Korean War
boom, American recession of 1953 and
favorable monsoon at home which helped
to boost agricultural and industrial
production.
 balance of payment during the first plan
was only Rs. 42 crores.

31. SECOND PLAN
 An important feature of the second plan
period was the heavy deficit in the balance
of trade which aggregated to Rs. 2339
crores.
 The foreign exchange reserves sharply
declined and the country was left with no
choice but to think of ways and means to
restrict imports and expand exports.

32. THIRD PLAN
 The balance of current account was
unfavorable during the third plan .
 The serious adverse balance of payments
which started with the second plan
continued relentlessly during the third and
annual plans.
 Heavy amount had to be paid by India in
the form of interest payments on loans

33. FOURTH PLAN
 One of the objectives of the fourth plan
was self-reliance – i.e., import substitution
of certain critical commodities on the one
side and export promotion so as to match
the rising import bill, on the other
 Accordingly the government managed to
restrict imports and succeeded in
expanding exports.

34. FIFTH PLAN
 During the whole of the Fifth Plan India
experienced a surplus balance of payments due
to a sharp increase in the exports surplus on
account of invisibles.
 From 1979-80 onwards, India started
experiencing very adverse balance of payments.
 India had to meet this colossal deficit in the
current account through withdrawals and
borrowings from IMF .

35. SIXTH PLAN
 The Sixth plan characterize the balance of
payments position acute.
 The annual average current account
deficit was of the order of rs.2600 crores
during the Sixth Plan.
 During the Sixth Plan, the trade deficit was
3.3 per cent of GDP and current account
deficit was 1.4 per cent of GDP.

36. SEVENTH PLAN
 Exports performance substantially improved in
the Seventh Plan with average volume growth
exceeding 7 per cent.
 The share of net invisible earnings in financing
trade deficit declines from 63 per cent during the
Sixth Plan to 29.5 per cent during the Seventh
Plan.
 The average current account deficit as a per
cenr of GDP increased to 2.4 per cent in the
Seventh Plan.

37. DEVELOPMENT SINCE 1993-2010
 In the year 1993-94, India saw a
remarkable turnaround from a foreign-
exchange constrained control regime to a
more open, market driven by liberalized
economy.
 During the last three years export
earnings, on average, accounted for
nearly 90 per cent of the value of imports

38.  Exports recorded a growth of 20 per cent
in dollar terms. The surplus on the
invisible account doubled.
 Foreign currency reserves which were just
$1205 million in 990 reached the level of
$19386 million in 1994.
 The economy thus moved to a more
stable and sustainable balance of
payments position.

41. India's Foreign Trade: 2005-06
(In US$ million)
(April, 2005-Oct. 2006)
Exports
2004-05 42200.62
2005-06 51516.87
Y-O-Y Growth 22.08
Imports
2004-05 56381.09
2005-06 75032.08
Y-O-Y Growth 33.08
Trade Balance
2004-05 -14180.47
2005-06 -23515.21
Source: Federal Ministry of Commerce, Govt. of India

42. India's Balance of Payments(2001-05)
US $ million
Items 2004-05 (P) 2003-04 2002-03 2001-02 2000-01 1990-91
Trade Balance -38,130 -15,454 -10,690 -11574 -12460 -9437
Invisibles, net 31,699 26,015 17,035 17,035 9,794 -243
Current
Account -6,431 10,561 6,345 6,345 2,666 -9,680
Balance
Capital
32,175 20,542 10,840 10,840 8,840 7,056
Account
Overall
26159 31,421 16,985 16,985 5,868 -2,492
Balance
Foreign -26,159 -31,421 -16,985 -16,985 -5,842 1,278
Exchange
Reserve
Increase
(+)/Decrease
(-)
Source: Reserve Bank of India Annual report (2004-05)

43. India's Foreign Trade (2004-05)
(In US $ million)
April, 2004-March, 2005
EXPORTS
2003-2004* 63978.78
2004-2005 79593.59
% Growth 24.41
IMPORTS
2003-2004* 78250.86
2004-2005 106121.18
% Growth 35.62
TRADE BALANCE
2003-04* -14272.08
2004-05 -26527.59
Source: Federal Ministry of Commerce, Government of India
* Final figures as given by DGCI&S