Balance of Payments

Balance of Payments

Notes

The Balance of Payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world during a period (usually a year or quarter). It is kept on a double-entry basis, so in accounting terms it always balances; surpluses and deficits refer to its sub-accounts.

Components

• Current account: trade in goods (merchandise), services, primary income (investment income, wages) and secondary income (transfers such as remittances).
• Capital account: capital transfers and non-produced assets (small).
• Financial account: FDI, FPI, external borrowing (ECBs), banking capital, trade credit and changes in reserve assets.
• Errors and omissions: a balancing item for unrecorded flows.
• Overall balance = Current account + Capital and financial account (excluding reserves). A deficit is financed by drawing down foreign exchange reserves or borrowing (including from the IMF); a surplus adds to reserves.

Autonomous vs accommodating items: autonomous items (trade, FDI) occur for their own reasons; accommodating items (reserve changes) adjust to balance the account.

Causes of disequilibrium: cyclical changes, structural changes (such as heavy oil dependence), price changes, a mis-valued exchange rate, and capital flight.

Corrective measures: export promotion and import substitution, currency depreciation or devaluation, tariffs and quotas, borrowing, tighter monetary and fiscal policy.

India

• The 1991 crisis was a BoP crisis: the current account deficit was about 3% of GDP, reserves fell to around US$1.2 billion (less than three weeks of imports), after the Gulf War oil shock.
• Today India has a merchandise trade deficit offset by a large services surplus and remittances, so the current account deficit (CAD) is usually below 2% of GDP (about 0.6-1% in recent years); capital inflows (FDI and FPI) finance it. The RBI compiles the BoP quarterly (IMF BPM6 format).

Key Points

• BoP: record of all transactions with the rest of the world; always balances in accounting terms.
• Components: current account, capital account, financial account, errors and omissions.
• A deficit is financed from reserves or borrowing.
• 1991: a BoP crisis; reserves about US$1.2 billion.
• India's CAD is financed by capital inflows; services and remittances help.

MCQs

Q1. Which of the following is part of the current account? (a) FDI (b) Remittances (c) External commercial borrowings (d) Change in reserves Ans: (b). Remittances are secondary income.

Q2. A BoP deficit is financed by: (a) Drawing down forex reserves or borrowing (b) Printing money only (c) Lowering imports automatically (d) Increasing CRR Ans: (a).

Q3. India's 1991 crisis was primarily a: (a) Banking crisis (b) Balance of payments crisis (c) Currency boom (d) Trade surplus Ans: (b).