Balance Of Payments (BoP)
BoP record the transactions in goods, services and assets between residents of a country with the rest of the world. There are two main accounts in the BoP – the current account and the capital account.
- The current account records exports and imports in goods and services and transfer payments.
- Trade in services denoted as invisible trade (because they are not seen to cross national borders) includes both factor income (payment for inputs-investment income, that is, the interest, profits and dividends on our assets abroad minus the income foreigners earn on assets they own in India) and 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.
- The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc.
- 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.
- Errors and Omissions 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.
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.
Table (given at the end this article) shows that there has been a trade deficit throughout the period and an invisible surplus except for 1990-91. The current account deficit (which has been observed for 24 years from 1977-78) had started shrinking and turned into surplus from 2001-02. The surplus continued till 2003-04, but turned into a deficit in 2004-05. The large trade deficit could not be bridged by the invisible surplus.
In April-September 2005-06, the current account deficit of US$13 billion was financed by a capital inflow of US$19.5 billion, the extra capital inflow of US$ 6.5 billion being added to our stock of foreign exchange.
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).
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.
Note : 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).
Bibliography : NCERT – Introductory Macroeconomics