Balance of Payments (BoP) – An Understanding


The balance of payments (BoP) record the transactions in goods, services and assets between residents of a country with the rest of the world for a specified time period typically a year. The Reserve Bank of India (RBI) is responsible for compilation and dissemination of BoP data. BoP is broadly consistent with the guidelines contained in the BoP Manual of the International Monetary Fund.
Balance of payment (BoP) comprises of current account, capital account, errors and omissions and changes in foreign exchange reserves. Under current account of the BoP, transactions are classified into merchandise (exports and imports) and invisibles. Invisible transactions are further classified into three categories, namely (a) Services-travel, transportation, insurance, Government not included elsewhere (GNIE) and miscellaneous (such as, communication, construction, financial, software, news agency, royalties, management and business services); (b) Income; and (c) Transfers (grants, gifts, remittances, ets.) which do not have any quid pro quo.
There are two main accounts in the BoP – the current account and the capital account.

Current Account
The current account records exports and imports in goods and services and transfer payments.. The third item gives the trade balance which is obtained by subtracting imports of goods from the exports of goods. When exports exceed imports, there is a trade surplus and when imports exceed exports there is a trade deficit.
The data on merchandise trade are available from two sources namely; (a) from the Directorate General of Commercial Intelligence and Statistics (DGCI&S) on customs basis; and (b) from RBI on payments (which includes both receipts and payments) basis. The Daily Trade Return (DTR) is the primary source of recording exports data at DGCI&S, while RBI relies mainly on the R-return furnished by Authorised Dealers (Ads) to compile the exports and imports data. The data on merchandise exports in BoP are compiled on the basis of information available from the DGCI&S, after adjusting for time and exchange rate differences. The merchandise export data is recorded on free on board (F.O.B.) basis. It may be noted that export of software in physical form is captured by DGCI&S.
 Trade in services denoted as invisible trade (because they are not seen to cross national borders) includes both factor income (net income from compensation of employees and net investment income, the latter equals, the interest, profits and dividends on our assets abroad minus the income foreigners earn on assets they own in India) and net non-factor income (shipping, banking, insurance, tourism, software services, etc.). Transfer payments are receipts which the residents of a country receive ‘for free’, without having to make any present or future payments in return. They consist of remittances, gifts and grants. They could be official or private. The balance of exports and imports of goods is referred to as the trade balance. Adding trade in services and net transfers to the trade balance, we get the current account balance . If this figure had been a positive number, there would have been a current account surplus.

Capital Account
The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc. We note that any transaction resulting in a payment to foreigners is entered as a debit and is given a negative sign. Any transaction resulting in a receipt from foreigners is entered as a credit and is given a positive sign.
Under the Capital Account, capital inflows can be classified by instrument (debt or equity) and maturity (short or longterm). The main components of the capital account include foreign investment, loans and banking capital. Foreign investment, comprising Foreign Direct Investment (FDI) and Portfolio Investment consisting of Foreign Institutional Investors (FIIs) investment, American Depository Receipts/Global Depository Receipts (ADRs/GDRs) represents non-debt liabilities, while loans (external assistance, external commercial borrowings and trade credit) and banking capital, including non-resident Indian (NRI) deposits are debt liabilities.
 BoP Surplus and Deficit
 The essence of international payments is that just like an individual who spends more than her income must finance the difference by selling assets or by borrowing, a country that has a deficit in its current account (spending more abroad than it receives from sales to the rest of the world) must finance it by selling assets or by borrowing abroad. Thus, any current account deficit is of necessity financed by a net capital inflow. Alternatively, the country could engage in official reserve transactions, running down its reserves of foreign exchange, in the case of a deficit by selling foreign currency in the foreign exchange market. The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus). The basic premise is that the monetary authorities are the ultimate financiers of any deficit in the balance of payments (or the recipients of any surplus). The balance of payments deficit or surplus is obtained after adding the current and capital account balances.
A country is said to be in balance of payments equilibrium when the sum of its current account and its non-reserve capital account equals zero, so that the current account balance is financed entirely by international lending without reserve movements. We note that the official reserve transactions are more relevant under a regime of pegged exchange rates than when exchange rates are floating.
Autonomous and Accommodating Transactions
 International economic transactions are called autonomous when transactions are made independently of the state of the BoP (for instance due to profit motive). These items are called ‘above the line’ items in the BoP. The balance of payments is said to be in surplus (deficit) if autonomous receipts are greater (less) than autonomous payments. Accommodating transactions (termed ‘below the line’ items), on the other hand, are determined by the net consequences of the autonomous items, that is, whether the BoP is in surplus or deficit. The official reserve transactions are seen as the accommodating item in the BoP (all others being autonomous).
 Errors and Omissions
Errors and Ommissions constitute the third element in the BoP (apart from the current and capital accounts) which is the ‘balancing item’ reflecting our inability to record all international transactions accurately.
Terms Related to BoP
 Invisibles Travel Credit ― This item represents foreign tourist’s expenditure during their stay in India, expenditure incurred by resident travelers abroad and on the debit side it covers exchange sold for private and official travel.
Transportation covers receipts and payments on account of international transportation services.
Insurance comprises receipts and payments relating to all type of insurance services as well as reinsurance.
Investment Income
Receipts include interest earned on the investments of RBI and on holdings of SDRs, and payments include interest and commitment charges on foreign loans, on purchases from the IMF and those on cumulative allocation of SDRs.
Government not included elsewhere
The item includes receipts and payments on account of maintenance of embassies and diplomatic missions and offices of international institutions as well as receipts and payments on government account not included elsewhere.
This item covers, receipts and payments in respect of all other services such as communication services, construction services, software services, technical know-how, royalties etc.
 Transfers of payments
It (official, private) represent receipts and payments without a quid pro quo. Official transfer receipts represent.

Friday, 02nd Oct 2015, 11:54:57 AM

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