BALANCE OF PAYMENTS

SYSTEMATIC RECORDS OF ALL ECONOMIC TRANSACTIONS

 BETWEEN RESIDENTS OF A COUNTRY

AND RESIDENTS OF OTHER

COUNTRIES(REST OF THE WORLD)

 CARRIED OUT IS A SPECIFIC PERIOD OF

TIME

 BALANCE OF PAYMENTS INCLUDE

BALANCE OF TRADE

BALANCE OF TRADE IS THE DIFFERENCE

BETWEEN MERCHANDISE IMPORTS AND EXPORTS(VISIBLE)

 BALANCE OF PAYMENTS INCLUDE BOTH

VISIBLE AND NON VISIBLE ITEMS

THE INVISIBLE ITEMS

BANKING

INSURANCE
TRANSPORT SERVICES SERVICES RENDERED AND CAPITAL

RECEIVED

THE PRINCIPLE
IT IS BASED ON STANDARD DOUBLE ENTRY

SYSTEM
EVERY ENTRY IS ENTERED TWICE

ONCE AS A CREDIT ITEM

ONCE AS A DEBIT ITEM

 THE PURCHASING POWER OF A COUNTRY IS

INCREASED
IT IS A CREDIT ENTRY IT REPRESENTS SOURCE OF FOREIGN

EXCHANGE

EXAMPLES OF SOURCE OF FOREIGN EXCHANGE

EXPORT OF GOODS OR MERCHANDISE

EXPORTS
EXPORT OF SERVICES LIKE TRAVEL,

INSURANCE, ETC. OR INVISIBLES

A CAPITAL INFLOW INTO THE COUNTRY

(BORROWING ABROAD)
A DECREASE IN FOREIGN EXCHANGE

RESERVES AND GOLD RESERVES OF THE MONETARY AUTHORITY

 THE EXTERNAL PURCHASING POWER OF

THE COUNTRY IS REDUCED

IT IS RECORDED AS A DEBIT ENTRY IT REPRESENTS THE USE OF (APPLICATION

OF FOREIGN EXCHANGE)

EXAMPLES OF USE OF FORREIGN EXCHANGE

MERCHANDISE IMPORTS AND INVISIBLE

IMPORTS
A CAPITAL OUTFLOW OR LENDING ABROAD

INCREASE IN FOREIGN EXCHANGE

RESERVES AND GOLD RESERVES OF THE MONETARY AUTHORITY

 IN PRINCIPLE OF BALANCE OF PAYMENTS

ALWAYS SHOULD BALANCE BY OFFSETTING CREDITS AND DEBIT ENTRIES

 THERE ARE FOUR MAIN SECTIONS IN A

BALANCE OF PAYMENTS ACCOUNT A. CURRENT ACCOUNT B. CAPITAL ACCOUNT C. ERRORS AND OMISSIONS D. MONETARY MOVEMENTS

 ACCORDING TO THE PRINCIPLE OF

BALANCE
SURPLUS IN CURRENT ACCOUNT SHOULD ALWAYS BE MATCHED BY DEFICIT

IN CAPITAL ACCOUNT

 DEFICIT IN CURRENT ACCOUNT IS

ALWAYS MATCHED BY A SURPLUS IN CAPITAL ACCOUNT

DISCREPANCIES DUE TO EXCHANGE

RATE DIFFERENTIAL ALWAYS DO OCCUR THEY ARE TAKEN AS ERRORS AND OMISSIONS AND BALANCE OF PAYMENTS ARE BALANCED

 Balance of payments is analogous to a frims

income statement
Deficits are equal to corporate losses These losses can be financed by selling bonds

or new equity or by divesting assets

 If there is a net outflow from a firm or country due

to acquiring new productive capital, this might not be unhealthy

Unfortunately the balance of account does not

distinguish imports of capital goods from import of consumption goods.

summary
The balance of payments account is a record of

the flow of payments between residents of one country and the rest of the world in a given period

 Entries in the account that give rise to a demand

for the countrys currency such as exports and asset sales are identified by a plus sign
Entries giving a rise toa supply of the countrys

currency are identified by a minus sign

 Balance of payments can be considered as a

record of the supply of and demand for a countrys currency

Components

credit debit net A. Current account 1. merchandise a. Exports b. Imports 2. invisibles (a+b+c) a. services i. travel ii. Transportation iii. Insurance iv. maintenance funds (embassy) v. Misc. (payment to foreign tech) TOTAL CURRENT ACCOUNT(1+2)

o credit debit net

B. CAPITAL ACCOUNT

1. FOREIGN INVESTMNET (A+B) A. In India i. direct ii. Portfolio B. Abroad

 2. LOANS (A+B+C) A. EXTERNAL ASSISTANCE I. By India 2. to india B. commercial borrowings i. By India ii. To India C. Short term to india

 3. bank capital (a+b)

a Commercial banks i. assets ii. Liabilities iii. Non-resident deposits b others 4. rupee debt service 5. other capital Total Capital account(1+2+3+4+5)

 C. errors and omissions D. overall balance(A+B+C) E. Monetary Movements (i+ii)

i. IMF ii. FOREIGN EXCHANGE RESERVES (increase or decrease)

 Transfers (official and private) Official transfers which are of debit nature revenue contribution by government to international institutions or any transfer of gifts by government to

non residents

 Private transfers

Cash remittance by non resident indians Redemption of NRE account

Capital account
Foreign investment

Loans
Banking capital rupee debt service Other capital

 Any increase in financial assets are debits

Any decrease in financial assets are credits

Any increase in financial liabilities are credits Any decrease in financial liabilities are debits

 Foreign direct investment Any investment made by foreign residents in

the acquisition of physical assets in India Foreign residents can be individuals, companies, financial institutions, foreign government It is inflow of foreign capital. It is a credit item in BOP statement

 Foreign Portfolio Investment When a foreign portfolio investor directly

purchases financial assets in the Indian securities market it is termed as Foreign Portfolio Investment

 Loans In the BOP, disbursements received by Indian resident entities are credit items while

repayments and loans made By Indians are debit items

 Bank capital covers changes in assets and

liabilities of commercial banks

An increase in assets i. e. decrease in

liabilities is a debit item

A decrease in assets i.e. increase in liabilities

is a credit item

 Rupee debt service is the cost of meeting interest

payments and regular contractual repayments of principal of a loan along with any administration charges in rupees by India.

 Monetary movements (a) transactions with IMF drawings from IMF are credit items repayments to IMF are debit items (b) foreign exchange reserves (RBI) RBI holdings of gold and foreign currency

assets

drawings are debits additions are credits

Case: FDI and the Irish miracle BALANCE OF PAYMENTS

FDI in Ireland grew from $164m (1985) to $24b

(2000) By 2000 two-thirds of Irelands top exporters were MNEs Reasons for Irelands success
Member of EU (access to EU markets) Highly educated workforce Good infrastructure

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Pragmatic nationalism
FDI has benefits and costs
Allow FDI if benefits outweigh costs

Block FDI that harms indigenous industry

Court FDI that is in national interest

Tax breaks Subsidies

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Benefits of FDI to host countries

Resource-transfer effects
Capital Technology Management

Employment effect
Direct indirect

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Benefits of FDI to host countries

Balance-of-payments effect.

Current account-surplus/deficit Capital account Increases competition and spurs economic growth

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Resource-transfer effects

Capital Technology
Management

Employment effects
Brings jobs that otherwise would not be created
Direct: Hiring host-country citizens Indirect:

Jobs created by local suppliers

Jobs created by increased spending by

employees of the multi-national enterprise

Questions remain on whether net jobs gained

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Balance-of-payments effects
Host country benefits from initial capital inflow when

MNC establishes business

Host country records current account debit on

repatriated earnings of MNC

Host country benefits if FDI substitutes for imports of

goods and services Host country benefits when MNC uses its foreign subsidiary to export to other countries

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Balance of payment accounts

Current account deficit occurs when imports are

greater than exports Current account surplus occurs when exports are greater than imports Capital account records transactions that involve the purchase or sale of assets

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Effect on competition and economic growth

Increased
productivity growth product and process innovation greater economic growth

FDI can
Increase market competition Lower prices Create greater consumer choice Stimulate capital investments

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Home country FDI benefits

Improves balance of payments for inward flow of

foreign earnings Creates a demand for exports. Export demand can create jobs Increased knowledge from operating in a foreign environment Benefits the consumer through lower prices Frees up employees and resources for higher value activities

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Costs of FDI to host countries

Can drive out local competitors or prevent their

development Profits brought home hurts (debit) a hosts capital account Parts imported for assembly hurt trade balance Can affect sovereignty and national defense

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Home country problems with FDI

Negative effect on Balance of Payments
Initial capital outflow MNC uses foreign subsidiary to sell back to home

market MNC uses foreign subsidiary as a substitute for direct exports

Potential loss of jobs

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Balance of payments and India in the current context

During April to October 2005, Indias total trade

grew by 27% with imports rising faster than exports, resulting in a widening of the trade deficit While on an average, exports grew by 21%, imports increased at faster pace 33%

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 At present the burgeoning trade deficit does not

seem to be a cause for concern for policy makers. Since, net of oil imports, there is a small surplus of around $ one billion in the trading account

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 Other imports especially, raw materials, are

growing at a healthy rate which is indicative of growing domestic manufacturing output

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