Economic Environment of Business_5

Balance of Payments

•It is a systematic record of all economic transactions that take place between the residents of the reporting country and the rest of the world (ROW) during a specific period of time.
•Double entry book keeping system
•All transactions that involve a transfer of title or ownership
•Nationals of the reporting country : individuals, business organisations, government departments etc
•Generally one year



The structure of BOP Accounts


•Current Account : current transactions involving import and export of goods and services
•Capital Account : Capital transactions resulting in increase or decrease in county’s total stock of capital
•Official Settlement Account :Changes in Foreign Exchange reserves and reserves of monetary gold held by monetary authorities



Current Account


•Export and Import of merchandise / visibles / goods
•Export and Import of invisibles / services
•Incomes on investments – interest and dividends paid and received
•Unilateral transfers – gifts and charities

Invisible transactions
•Travel on account of business, education , health
•Insurance premium and payments of claims
•Incomes from services like advertising, commissions, pensions, patent fees, royalties, membership fees, subscription to periodicals etc



Capital Account


•Long term capital movements :
–direct investment in shares or bonds, real estate, physical assets like plant, building, equipment etc
–Portfolio investments in government securities or securities of firms
–Amortisation of capital

•Short term capital movements:
–Purchase of short term securities such as treasury bills, commercial bills etc
–Speculative purchases of foreign currencies
–Cash balances held by foreigners



Official Settlement Account


•Gold and Foreign Exchange Reserves
–To impart stability to the exchange rate
–To enable payments of dues
•Assistance provided by international financial institutions like the IMF, World Bank etc



Balance of Trade


•Difference between the value of import and export of merchandise or visible items
•Exports > imports : Favourable Balance of Trade
•Exports < Imports : Adverse Balance of Trade


Balance on Current Account


Balance of Trade + Balance on Services + Net income on Investment + Net Unilateral Transactions
•A deficit on Current Account implies that the reporting country is a net debtor i.e. it owes money to the rest of the world.



Balance on Capital Account


Net long term borrowings + Net short term borrowings -------------------------------------------------------- + Net change in the Foreign Exchange Reserves + Net change in the stock of monetary gold + Errors and omissions



Overall Balance


Balance on Current Account + Balance on Capital Account
•Balance of Payments always balances
–Double entry accounting system
–Any adverse balance on current account is made good by a surplus on current account and vice-versa
–This is the accounting point of view



The Economic Point of View


There are two types of transactions
– Autonomous Transactions : these are genuine transactions of current or capital nature. They are guided by long term considerations and are intended at optimisation of returns
–Accommodating Transactions : these are short term adjustments, induced transactions



Basic Balance


Basic Balance
= Balance on Autonomous Transactions
= Balance on Current Account
+ Net long term capital movements



BOP Equilibrium


Balance of payments is said to be in Equilibrium when the Basic Balance is zero.
i.e.
Balance on Current Account
+ Net long term capital movements = 0



Disequilibrium in BOP


•The BOP is said to be in disequilibrium when a country’s autonomous payments are not equal to the autonomous receipts
•Disequilibrium in BOP implies a non-zero basic Balance



Causes of Disequilibrium in BOP


•Huge Amounts of Developmental Expenditure
–Population growth
–Import of technology
–Imports for price stabilisation
•Business cycles
•Changes in demand for exports
–Primary goods market is not very attractive
•Heavy External Borrowings leading to increasing debt servicing



•Inflation
–More imports and less exports
•Flight of capital
–Capital account convertibility
–Speculative movement of capital
•International demonstration effect
•Non-tariff barriers
–Countervailing duties in the name of ‘Social clause’
–Child labour content



Measures to correct Disequilibrium


1.Monetary measures
1.Deflation
2.Depreciation
3.Devaluation
4.Exchange control
•Non-monetary measures
•Export promotion measures
•Import control measures