Balance of Payments and its Components, Study notes of Financial Management

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BALANCE OF PAYMENT (BOP)

A country has to deal with other countries in

respect of the following

1. Visible items which include all types of physical

goods exported and imported.

2. Invisible items which include all those services whose

export and import are not visible. e.g. transport

services, medical services etc.

3. Capital transfers which are concerned with capital

receipts and capital payment.

BALANCE OF PAYMENT : DEFINITION

• 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 them on account of goods imported and services received from the capital transferred to non-residents or foreigners. - Reserve Bank of India

FEATURES OF BOP

• It is a systematic record of all economic transactions between one country and the rest of the world.
• It includes all transactions, visible as well as invisible.
• It relates to a period of time. Generally, it is an annual statement.
• It adopts a double-entry book-keeping system. It has two sides: credit side and debit side. Receipts are recorded on the credit side and payments on the debit side.

BALANCE OF TRADE V/S BALANCE OF PAYMENT

• The Balance of Payment takes into account all the transaction with the rest of the worlds
• The Balance of Trade takes into account all the trade transaction with the rest of the worlds

BALANCE OF TRADE V/S BALANCE OF PAYMENT

BOP BOT 1 It is a broad term. It is a narrow term. 2 It includes all transactions related to visible, invisible and capital transfers. It includes only visible items. 3 It is always balances itself. It can be favourable or unfavourable. 4 BOP = Current Account + Capital Account + or - Balancing item (Errors and omissions) BOT = Net Earning on Export - Net payment for imports. 5 Following are main factors which affect BOP a)Conditions of foreign lenders. b)Economic policy of Govt. c) all the factors of BOT Following are main factors which affect BOT a) cost of production b) availability of raw materials c) Exchange rate d) Prices of goods manufactured at home

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.

THE VARIOUS COMPONENTS OF A BOP

STATEMENT

1. Current Account
2. Capital Account
3. Reserve Account
4. Errors & Omissions

TYPES OF BALANCES

• Trade Balance Merchandise: exports - imports of goods
• Services: exports - imports of services Income Balance Net investment income: net income receipts from assets Net international compensation to employees: net compensation of Employees Net Unilateral Transfers Gifts from foreign countries minus gifts to foreign countries

CAPITAL ACCOUNT BALANCE

• 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.
• It is difference between the receipts and payments on account of capital account. It refers to all financial transactions.
• The capital account involves inflows and outflows relating to investments, short term borrowings/lending, and medium term to long term borrowing/lending.

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 repurchase (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 monetary authorities of two different countries.

ERRORS & OMISSIONS

• The entries under this head relate mainly to leads and lags in reporting of transactions
• It is of a balancing entry and is needed to offset the overstated or understated components.

CAUSES OF DISEQUILIBRIUM IN THE BOP

• Cyclical fluctuations
• Short fall in the exports
• Economic Development
• Rapid increase in population
• Structural Changes
• Natural Calamites
• International Capital Movements

MEASURES TO CORRECT DISEQUILIBRIUM IN

THE BOP

1. Monetary Measures : a) Monetary Policy The monetary policy is concerned with money supply and credit in the economy. The Central Bank may expand or contract the money supply in the economy through appropriate measures which will affect the prices. b) Fiscal Policy Fiscal policy is government's policy on income and expenditure. Government incurs development and non - development expenditure,. It gets income through taxation and non
   • tax sources. Depending upon the situation governments expenditure may be increased or decreased.