India’s Balance of Payment’s
Balance of Payment Account
Bop is the oldest and the most important statistical statement for any country. In a nutshell BOP of a country is “a systematic record of all economic transactions between the residents of one country with the residents of the other country in a financial year”.
Economic Transactions include all the foreign receipts and payments made by a country during a given financial year.
The Foreign receipts include all the earnings and borrowings by a country from the other countries.
Source of Earnings (Inflows) | Source of Borrowings (Inflows) |
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The accumulation of foreign receipts (net of payments) over the years becomes Foreign Exchange Reserves of a Country.
The Payments include all the spending and lending by a country from the countries of the rest of the World.
Spending’s (Outflows) | Lending’s (Outflows) |
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All the foreign receipts are financial inflows, and all the foreign payments are financial outflows in a given year.
The Balance of Payments Accounts of any Country includes Six Major accounts which are as follows:
- Goods Account
- Services Account
- Unilateral Transfer Account
- Long-term Capital Account
- Short-term Capital Account
- International Liquidity Account.
The six major accounts are clubbed together into two most important accounts.
Goods Account versus Services Account
Goods Account | Services Account |
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Unilateral Transfer Account
- The account includes gifts, grants, remittances received from foreign countries and paid to foreign countries.
- Unilateral transfers are of two types:
Private Transfer | Government Transfer |
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Why are they called Unilateral Transfers?
Unilateral receipts and payments are also called ‘Unrequited Transfers’. They are called so because the flow of transfer is unidirectional or in one direction. There is no liability for an automatic reverse flow or repayment obligation in other direction since they are not lending’s and borrowings. These items are simply gifts, and grants exchanged between governments and people of one country with that of others.
Long Term Capital Account versus Short Term Capital Account
Long Term Capital Account | Short Term Capital Account |
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Note for Student Box: Is FDI necessarily Good for Host Economies?
When a Japanese MNC invests in India, India receives a capital inflow in the form of long term capital (FDI). It has a favourable effect on our BOP account. But when the Japanese MNC in India, starts repatriating profits/ sending profits back to their home countries(Japan), there will be a capital outflow from India to Japan.
The outflow will be recorded in our Services part of Current account as outflow of Income. India, therefore will experience a temporary surplus in its Capital account. But when MNCs starts to send out profits in their home countries, India will experience a permanent outflow from its current account.
The understanding of this treatment effect of FDI is very important, since it is always assumed that FDI inflow is good for a host country economy.
Note: I will return to the topic in much detail when I discuss Current account deficit part.
International Liquidity Account
International Liquidity Account simply records net changes in Foreign Exchange Reserves. Following table represents an example of how International liquidity account works.
Case 1) BOP Surplus: When Receipts are Greater than Payments in a BOP Account
Major Accounts | Receipts(Credits) | Payments(Debits) | ||
A. Goods Account | 2000 | 1000 | ||
B. Services Account | 1000 | 500 | ||
C. Unilateral Transfers | 200 | 100 | ||
D. Long-Term Capital Account | 1500 | 500 | ||
E. Errors and Omissions/Short Term Capital Account | 200 | 300 | ||
F. International Liquidity Account | 2500 | (G-(A+B+C+D+E+F) | ||
G. Balance of Payments | 4900 | 4900 |
- Total Receipts are 4900 Million, and Total Payments are 2400 Million.
- There is a BOP Surplus of 2500 Million.
The surplus of 2500 Million will enter into International Liquidity Account as payment item. The economic logic of 2500 Million entering as the debit item is:
- The sum represents accumulation of foreign exchange reserves of 2500 Million; or
- Purchase of Gold or other currencies by surplus country in order to increase their Foreign Exchange Reserves; or
- The surplus country might lend 2500 Million to other countries.
In all the above cases, the amount is spent on either buying gold, other country currencies or lending. Hence treated as payments.
Case 2) BOP Deficit: When Payments are Greater than Receipts in a BOP Account
Major Accounts | Receipts(Credits) | Payments(Debits) | ||
A. Goods Account | 1000 | 2000 | ||
B. Services Account | 500 | 1000 | ||
C. Unilateral Transfers | 100 | 200 | ||
D. Long Term Capital Account | 500 | 1500 | ||
E. Errors and Omissions/Short Term Capital Account | 300 | 200 | ||
F. International Liquidity Account | 2500 | (G-(A+B+C+D+E+F) | ||
G. Balance of Payments | 4900 | 4900 |
- Total Receipts are 2400 Million, and Total Payments are 4900 Million.
- There is a BOP Deficit of 2500 Million.
- The important point to ask is how a country will finance its deficit of 2500 Million?
- The sum will be spent by drain of past accumulated foreign exchange reserves of 2500 Million; or
- Sale of Gold or other currencies held as foreign exchange reserves by deficit country; or
- The deficit country might borrow 2500 Million from other countries.
In all the above cases, the amount is financed by either selling gold, other country currencies or borrowings. Hence treated as receipts. In this case, a deficit country is receiving a payment to finance its deficit, Hence receipts. Whereas, in a surplus case, a surplus country is siphoning off its surplus amount to invest in Gold or Other currencies, Hence payments.
By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University
So nicely explained thanks a lot