Balance of Payments

Dr. Raj AgrawalDr. Raj Agrawal

Part IBalance of Payments

Accounting

What kind of records should What kind of records should be kept?be kept?

What do you want to find What do you want to find out?out?

The nature of the record The nature of the record changes by what we are changes by what we are trying to find out. trying to find out.

Balance of Payments AccountingBalance of Payments Accounting

What kind of things do What kind of things do governments wish to know?governments wish to know?

What is the international What is the international demand for our currency demand for our currency doing to its value?doing to its value?

Do we have enough currency Do we have enough currency reserves, or capacity to pay reserves, or capacity to pay for our trade? for our trade?

Does our trade promote full Does our trade promote full employment? And so on.employment? And so on.

Balance of Payments AccountingBalance of Payments Accounting

Balance of Payments AccountingBalance of Payments Accounting

What kinds of transactions represent the basic What kinds of transactions represent the basic focus of balance of payments accounting?focus of balance of payments accounting?

All transactions between the citizens of a All transactions between the citizens of a nation and those of other nations are recorded nation and those of other nations are recorded in the balance of payments for a given period in the balance of payments for a given period of time. of time.

Recording International PaymentsRecording International Payments

How is information recorded in balance of How is information recorded in balance of payments accounting?payments accounting?

The basic technique is standard, double-entry The basic technique is standard, double-entry accounting, accounting,

a flow of funds statement that shows changes in a flow of funds statement that shows changes in assets, liabilities and net worth over time.assets, liabilities and net worth over time.

Recording International PaymentsRecording International Payments

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

Sources and Uses of FundsSources and Uses of Funds How does a country derive foreign currencies How does a country derive foreign currencies

it needs to conduct its international business?it needs to conduct its international business?

The The sources of funds, the supply of foreign sources of funds, the supply of foreign exchangeexchange, are , are

exports, exports, investment income, investment income,

Sources and Uses of FundsSources and Uses of Funds The The sources of funds, the supply of foreign sources of funds, the supply of foreign

exchangeexchange, are , are

transfer payments received, transfer payments received, and long-term and short-term borrowing.and long-term and short-term borrowing.

Part IIPart IIThe Balance of Payments The Balance of Payments

AccountsAccounts

BALANCE OF PAYMENTS BALANCE OF PAYMENTS ACCOUNTSACCOUNTS

These accounts are to summarize payments a These accounts are to summarize payments a country receives from other nations and payments country receives from other nations and payments it must make to other nations. it must make to other nations.

They consist of the following five categories:They consist of the following five categories:

1. MERCHANDISE OR TRADE BALANCE: 1. MERCHANDISE OR TRADE BALANCE: (Exports minus imports )(Exports minus imports )

BALANCE OF PAYMENTS BALANCE OF PAYMENTS ACCOUNTSACCOUNTS

2. GOODS AND SERVICES BALANCE: 2. GOODS AND SERVICES BALANCE: (Just add services)(Just add services)

3. NET UNILATERAL TRANSFERS3. NET UNILATERAL TRANSFERS (Gifts)(Gifts)

Indian government transfers to foreignersIndian government transfers to foreigners ((E.gE.g., Foreign aid or wheat from Indian stockpiles)., Foreign aid or wheat from Indian stockpiles) Private remittances of wages earned abroad, and Private remittances of wages earned abroad, and Lots of other transfers.Lots of other transfers.

BALANCE OF PAYMENTS BALANCE OF PAYMENTS ACCOUNTSACCOUNTS

To here, we are looking at the To here, we are looking at the CURRENT ACCOUNT BALANCECURRENT ACCOUNT BALANCE

(Net flows of goods, services and gifts).(Net flows of goods, services and gifts).

Again:Again:1. MERCHANDISE OR TRADE BALANCE: 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS 3. NET UNILATERAL TRANSFERS

Balance of PaymentsBalance of Payments

There is also a set of asset flows referred to as the There is also a set of asset flows referred to as the CAPITAL ACCOUNT BALANCE CAPITAL ACCOUNT BALANCE

4. NET CHANGES IN FOREIGN HOLDINGS OF Indian ASSETS

Flows of financial assets and similar claims, or Flows of financial assets and similar claims, or Foreign direct and other investments in India., orForeign direct and other investments in India., or““Private capital flows.”Private capital flows.”

(Note that we are talking direct and portfolio investments (Note that we are talking direct and portfolio investments here).here).

Balance of PaymentsBalance of Payments

5. NET OFFICIAL INTERNATIONAL 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTIONRESERVE TRANSACTION

Foreign official holdings of Indian assets,Foreign official holdings of Indian assets, Indian holdings of official reserve (gold and Indian holdings of official reserve (gold and

foreign exchange) assets foreign exchange) assets or, “Official asset flows.”or, “Official asset flows.”

All Together NowAll Together Now1. MERCHANDISE OR TRADE BALANCE: 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS 3. NET UNILATERAL TRANSFERS 4.4. NET CHANGES IN FOREIGN HOLDINGS

OF INDIAN ASSETS5. NET OFFICIAL INTERNATIONAL 5. NET OFFICIAL INTERNATIONAL

RESERVE TRANSACTIONRESERVE TRANSACTION

Balance of PaymentsBalance of Payments THE BALANCE OF THE BALANCE OF

PAYMENTS IS, PAYMENTS IS, THEREFORE, THE THEREFORE, THE SUM OF THE SUM OF THE CURRENT AND CURRENT AND CAPITAL ACCOUNT CAPITAL ACCOUNT BALANCES.BALANCES.

Services in the Balance of PaymentsServices in the Balance of Payments

Note:Note:*Services include travel and *Services include travel and tourism, trade transportation, tourism, trade transportation, insurance, education, financial, insurance, education, financial, technical, telecommunications technical, telecommunications and other business and and other business and professional services. professional services.

In addition there are royalties, In addition there are royalties, payments for capital services payments for capital services besides interest, such as besides interest, such as dividends, payments for foreign dividends, payments for foreign labor, etc.labor, etc.

Overall Surpluses and DeficitsOverall Surpluses and Deficits What is an overall balance of payments What is an overall balance of payments

surplus? What is an overall deficit?surplus? What is an overall deficit?

A surplus is when the sum of the current A surplus is when the sum of the current account plus the private capital account is account plus the private capital account is counterbalanced by an accumulation of official counterbalanced by an accumulation of official net assets, so official reserve assets increase. net assets, so official reserve assets increase.

Overall Surpluses and DeficitsOverall Surpluses and Deficits What is an overall balance of payments What is an overall balance of payments

surplus? What is an overall deficit?surplus? What is an overall deficit? If it is in deficit , the sum is counterbalanced If it is in deficit , the sum is counterbalanced

by an accumulation of official net liabilities, so by an accumulation of official net liabilities, so the country sees its official reserve assets the country sees its official reserve assets decline.decline.

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

Indian foreign indebtedness is not necessarily Indian foreign indebtedness is not necessarily bad if foreign funds are used towards bad if foreign funds are used towards investment. investment.

Repayment of the debt is potentially a problem Repayment of the debt is potentially a problem if foreign funds are used to purchase if foreign funds are used to purchase consumption goods since future generations consumption goods since future generations will bear the burden of debt. will bear the burden of debt.