Balance of

Payments

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BoP is an account of the international transactions of a country, and shows how the country is faring in trade, attracting capital from abroad, and the effect of that on its foreign exchange reserves.

Current Account

The current account shows you the trade position of the country.

It shows you the merchandise imports and exports, and then the invisibles part of it is also trade but it’s that part of trade where there is no physical good exported or imported.

In India’s case, the transfers and grants part of the invisibles is quite big relative to other countries because of the large Indian diasporas.

Capital Account

Where current account shows you trade, capital account can be thought of as the investments part of the international transactions.

This is further broken out into equity and debt investment and the FII money and FDI money is part of the equity investments while the external commercial borrowings, money deposited in banks by NRIs and trade credits are debt investments.

Change in Forex Reserves

The difference between the Current account and the Capital account is reflected in the change in the Forex reserves.

For example, in 2010 – 11 – India’s Current Account Deficit was $45.9 billion but the Capital Account Surplus was $62.0 billion and this resulted in increase in Foreign Exchange Reserves of $13.1 billion.

This doesn’t exactly total up due to the effect of Errors and Omissions.

Link between Internal and External Indicators

X-M Current Account DeficitY IncomeC ConsumptionI InvestmentG Government ExpenditureT-G Fiscal deficitSP-Ip Private Saving-investment Gap

C Rangarajan

X-M = Y-(C+I+G) = (T-G)+(SP-Ip)

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.

BOP Adjustment Theory

Current Account DeficitOccurs when a country's total imports of

goods, services and transfers is greater than the country's total export of goods, services and transfers. This situation makes a country a net debtor to the rest of the world

CURRENT ACCOUNT DEFICIT TREND

CAD has hit a historic high of 6.7 per cent in the December quarter of the fiscal 2012-13 due to highly subsidised fuel and the voracious appetite for gold

Possible explanations for the rise in CADEXCESS DEMAND EXCHANGE RATES (Rs 44 in July 2011 to Rs 54-55 levels)CAPITAL FLOWS

(higher capital flows lead to higher CADs but  just when the CAD widened in 2011, there were capital outflows that made it difficult to finance the CAD)

EXTERNAL SHOCKS(supply shocks that have sustained high

inflation over 2007-13, alongside lower growth) POLICY ACTION

( freer import competition without building export capacity, leading to import growth exceeding that of exports)

Indian CAD is countercyclical. That is, it rises when output falls and not when demand rises. GDP growth has fallen to sub-six per cent levels and industry is actually faced with a problem of excess capacity

Global scenario

Global scenario

Current price corrections Gold import bill will go down by $8 billion

because of the price effect A fall of $10 per barrel of crude oil will help

lower the net import oil bill by $9 billion Also WPI may fall to 5.6%

source: Nomura

Measures taken by GoI• Measures to address supply-side constraints

• Cabinet Committee of Investments has cleared $14 billion of projects in oil & gas, coal road and power sector

• Increased customs duty on gold

Actions which needs to be taken:

1.Dissuade investment in gold.2.Reduce dependency on oil.3.Open the market.4.Promote exports.5.Reduce subsidies.6.Reduce unplanned expenditure in five

year plans.7.Transparency in governance.8.Austerity measures

ReferencesIndian Economy – Mishra and PuriEconomics – Samuelson and Nordhauswww.commerce.nic.inwww.rbi.orgwww.mrunal.orgwww.anilagashe.blogspot.comThe Economic TimesHindu Business Line