bop(unit 1)
TRANSCRIPT
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Balance of Payments
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Definition
A Balance of Payment (BOP) account is asystematic record of all economic transactions(involving foreign payments) between residentsof a country and the rest of the world carried out
in specific period of time. Provides data for economic analysis
Reveals changes in the composition & magnitudeof foreign trade
Provides indications of future repercussions ofcountrys past trade performances
Reveals the weak and strong points of acountrys foreign trade relations
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Features of BOP
1. Systematic Record
2. Fixed Period of Time
3. Comprehensiveness4. Double Entry System
5. Self-balanced
6. Adjustment of Differences7. All items-Government and Non Government
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Importance of BOP
1. Guide to Economic Conditions and Direction
2. Pictogram of Economic Changes
3. Indicator of Foreign Changes
4. Indicator of Foreign Dependency5. Knowledge of Foreign Investment
6. Indicator of Foreign Trade
7. Helpful in National Planning
8. Determinant of National Economic Policy
9. Helpful for International Financial Organisations
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BOP-Surplus or Deficit
A Surplus in the BOP implies that the demand for the
countrys currency exceeded the supply and that the
government should allow the currency value to increase
in value or intervene and accumulate additional foreign
currency reserves in the Official Reserves Account
A Deficit in the BOP implies an excess supply of the
countrys currency on world markets, and the government
should then either devalue the currency or expend its
official reserves to support its value.
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Sources and Use of Funds
Sources of fund includes
Export of goods & services
Investment & Interest earning
Unilateral Transfer received from Abroad & Loans fromforeigners.
Uses of fund includes
Imports of goods & services
Dividend paid to foreign investors
Transfer payment abroad & loans to foreigners
Increase in reserve assets.
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BALANCE OF
PAYMENTS
Current
Account
Capital
Account
Official Reserve
Account
Foreign
Direct
Investment (FDI)
Unilateral transfers: Gifts, donations & subsidies
Portfolio
Investment
Goods account: Exports & Imports
Services account: Travel, transportation, Insurance etc.
Private
Short-term
Capital Flows
Decrease orincrease in
foreign
exchange
reserves
Investment Income : Interest, Dividends etc.
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CURRENT ACCOUNT All transactions relating to goods, services
and unrequited transfers constitute currentaccount
Flow of items pertaining to specific period
of time Visible items include goods
Invisible items include services
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CAPITAL ACCOUNT All transactions indicating changes in stock
magnitudes concerning capital receipts and
payments constitute capital account
Relates to
- Borrowing
- Capital repayment
- Sale of assets
- Change in stock of gold- Change in reserve of foreign currency
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DIFFERENCE BETWEEN CURRENT
ACCOUNT AND CAPITAL ACCOUNT
CURRENT ACCOUNT CAPITAL ACCOUNT
Indicates flow aspect of
countrys nationaltransactions
Relates to goods ,
services and unrequitedtransfers
Indicates changes in
stock magnitudes
Relates to all transactions
constituting debts andtransfer of ownership
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Balance of Payments DataCredits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
In 2000, the U.S.imported more than itexported, thusrunning a current
account deficit of$444.69 billion.
During the same year,the U.S. attracted net
investment of $444.26billionclearly the restof the world found theU.S. to be a good place
to invest.
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Balance of Payments and the Exchange
Rate
Q
P
As U.S. citizens import, they are supply dollars to the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
Exchange rate $
S
D
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COMPONENTS
OFBALANCE OF PAYMENT
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A. CURRENT ACCOUNT
The Current Account includes all transactions whichgives rise to or use up national income.
The current account has four components:1. Merchandise: Records exports and imports
ofphysical, relocatable merchandise.
EXAMPLE: Export of kiwifruit, brings in acredit, while the import of cars
creates a debit.
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Contd
2. Invisibles or Services: Records transactionsrelating to the provision ofnon-physical items
such as transport, travel and insurance.
3. Income From investments: Records
dividends, royalties and interest payments that
a resident earn on assets held overseas, and also
payments to foreign residents on assets held in
their country.
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Contd
4. Current Transfers: Records transactions relating to theprovision of goods, services, cash or other items of valuebetween residents and non-residents that are intended tobe used for consumption in the short term and for whichthere is no payment.
Payouts on insurance claims
Aid from overseas governments/nations
Pensions received from foreign governments
Money sent from overseas relatives
Gifts from charities in other countries
Work remittances from people working overseas
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B. CAPITAL ACCOUNT & FINANCIAL
ACCOUNT
CAPITAL ACCOUNT: Records capital transfers bothshort term & long term. Capital transfers also involve the
movement of cash or other items of value, but areintended to be for investment rather than consumption.
EXAMPLE: If an American firm investsRs.100 million inIndia, this transaction will be represented as a debit in
the US balance of payments and a credit in the balance
of payments of India.
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FINANCIAL ACCOUNT
FINANCIAL ACCOUNT: Records one countrys financial
transactions with foreign countries, including short-term & long-termmovements of capital.
Three main kinds of flows in the financial accounts:
Direct Investment:Investments in the ownership or control of a business .
Officially it is an investment in at least 10% of the voting capital (or equity)of a company .
Portfolio Investment: which are purchases of company stocks and bonds,
Reserve assets: which are financial assets that can be bought and soldonly by monetary authorities (central banks) & include a countrys officialreserves of foreign exchange.
Other investment: which is a residual category that includes trade credits
& private holdings of foreign currency.
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C. OFFICIAL SETTLEMENTS ACCOUNT
OFFICIAL RESERVES: represent the holdings bythe government or official agencies of the means of
payment that are generally accepted for the
settlement of international claim.
EXAMPLES: FOREX, GOLD
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BALANCE OF PAYMENT ACCOUNTING ENTRIES
ACCOUNT CREDITS DEBITS
Merchandise A. Export of Goods B. Import of Goods
Services C. Export of Services D. Import of Services
Net Investment Income E. Income from foreign
Investments
F. Income paid to foreign
Investors
Net Transfer Income G. Transfers from Overseas
to India
H. Transfers to Overseas by
India
Capital Flows I. Increase in foreigninvestments in India/
Decrease in India
investments overseas
J. Decrease in foreigninvestments in India/
Increase in India
investments overseas
Official Reserve K. Decrease in official
holding of FX & Gold
L. Increase in official
holding of FX & Gold
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Contd
Balance of Trade = (A-B)+ (C-D)
Current Account Balance = (A-B)+ (C-D) +
(E-F)+(G-H)
Capital Account Balance = (I-J)
Official Reserve Balance =(K-L)
Current Account + Capital Account+ OfficialReserve = 0
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Balance Of Payments Adjustments
If part of the balance of payments is in deficit
or surplus for a period of time, mechanisms are
needed to restore equilibrium
Adjustment mechanisms can be:
Automatic - economic processes
Discretionary - government policies
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Automatic Adjustment Under Fixed
Exchange Rates
Key variables
Prices Interest rates
Income
Money
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Price Adjustment - Background
Under the gold standard, each nations currency was
backed by gold and had a fixed price in terms of gold
Imports and exports were paid for in gold
A nations money supply (total amount of gold andgold-backed currency) was directly tied to balance of
payments - whether gold was flowing in or out
overall
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Price Adjustment - Background(Contd)
Balance of payments surplus would expand money
supply; deficit would shrink money supply
By the classical quantity theory of money, increases
in the money supply led directly to an increase in
overall prices (and a shrinking money supply caused
overall prices to fall)
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Price adjustment of the BOP
Deficit nations
Would be losing gold, therefore shrinking their money
supply and causing prices to fall
Lower prices would make their exports more competitiveand lessen demand for imports, restoring equilibrium
Surplus nations
Would be gaining gold, increasing money supply and price
level Higher prices would cut exports and encourage imports
until the surplus was eliminated
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Problems with price adjustment theory
Gold flows are not directly linked to domestic money
supply
Nations are often not at full employment
If economy is not at capacity, less likely that priceswill rise as money supply does
Prices and wages are often not able to fall in the short
run Falling money supply will cut output and
employment rather than prices
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Interest Rate Adjustment
Inflows of gold expand the money supply, causing
short-term interest rates to fall; outflows cause rates
to rise
Investors in surplus nations would send gold abroadin search of higher rates; deficit nations would
receive gold from abroad for investment, restoring
equilibrium
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Income Adjustment
Surplus nations will experience rising nationalincome, leading to an increased demand for imports -partially offsetting the surplus
Deficit nations will experience falling income,leading to a drop in demand for imports - partiallyoffsetting the deficit
Foreign repercussions effect - one countrys deficit is
anothers surplus, so that while income is declining inone country, its exports will increase to the countrywith rising income
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Disadvantages Of Automatic
Mechanisms
Require governments not to intervene
Automatic systems seem desirable when they arebelieved to lead to full employment; when nations
face unemployment and shrinking output, automatic
mechanisms seem inadequate
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Monetary adjustment - background
BOP disequilibrium represents an imbalance between
the supply and demand for money
Demand for money is:
Directly related to income and prices Inversely related to interest rates
Supply of money has two components:
Domestic component - credit created by national
government
International component - foreign exchange reserves
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Monetary Adjustment
Payments deficits are the result of an excess
supply of money at home
Excess supply of money encourages imports,
which results in foreign exchange reserves flowingoverseas and reducing the money supply
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Monetary Adjustment
Excess demand for money leads to a payments
surplus
Excess demand is reflected in higher interest rates
and less spending on imports, encouraging a flowof foreign exchange into the country
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Monetary Adjustment - Implications
Theory focuses on domestic monetary policy as key
to balance of payments
Other policies designed to affect the balance of
payments - tariffs, quotas, devaluation of the currency- are ineffective in the long run according to the
theory
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Policy issues of balance of payment
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BALANCE OF PAYMENTS DEFICIT
An imbalance in a nation's balance of payments in which
payments made by the country exceed payments received by
the country.
Such an unequal flow of currency will reduce the supply of
money in the nation.
A balance of trade deficit is often the source of a balance of
payments deficit, but other payments can turn a balance of
trade deficit into a balance of payments surplus.
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Monetary Measures for Correcting
the BoP
1. Deflation2. Exchange Depreciation
3. Devaluation
4. Exchange Control
Expenditure Changing
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Expenditure Changingpolicy
policy makers need to achieve two goals of macroeconomic
stability, viz. internal and external balances.
Attaining internal and external balances requires two
independen policy tools.
It is a policy to balance a countrys current account by altering
the composition of expenditures on foreign and domestic
goods
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UNEMPLOYMENT DEFICIT
This issue was written at a time when the major source of
deficits was recession.
The President and Congress try to outdo one another on who
can cut the Federal budget deficit the most.
The recent reduction in the deficit is due to the decline in
unemployment.
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The Elasticity Approach
Income of the nation (Y) or receipt from the expenditure on
its final goods and services is Y =C+I+G+X
A = C+I+G+M
Y-A = X-M
Or, B = Y-A, B = current account surplus
Foreign exchange rate through
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Foreign exchange rate throughintervention
The sale of the currency on the exchange market by the fiscal
authority or the monetary authority, in order to influence the
value of the domestic currency.
There are many reasons for the authority to intervene the
foreign exchange market.
When there is an inordinate instability, exchange rate
uncertainty generates extra costs and reduces profits for firms
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BALANCE OF PAYMENTS SURPLUS
An imbalance in a nation's balance of payments in which
payments made by the country are less than payments
received by the country.
Unequal flow of currency will expand the supply of money in
the nation and subsequently cause a decrease in the
exchange rate relative to the currencies of other nations.
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Trend of BOP
CURRENT
ACC
CAPITAL
ACC
ERRORS &
OMMISION
OVERALL
BALANCE
2011 -38.2 51.6 -.01 13.4
2010 -45.9 62 -3 13.1
2009 -29.6 38.9 .3 7
2008 -28.3 35.2 .4 4.9
R F I I BOP I
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Reasons For Increase In BOP In
2011-12
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Capital Flow Increases
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CHANGES IN BOP
1990-91 2011-12
POL IMPORTS 25% OF IMPORTS 25% OF IMPORTS
PHYSICAL TRADE EAST EUROPE US, ASIA
EXTERNAL DEBTRATIO
35% 20%
FISCAL DEFICIT SPIL OVER
EXTERNAL SECTORS
SPIL OVER
EXTERNAL SECTORS
PHYSICAL TRADE HIGH TARRIF, WEAK
INFRASTRUCTURE,
INFLEXIBLE LABOUR,
& OTHER FACTORS
HIGH TARRIF, WEAK
INFRASTRUCTURE,
INFLEXIBLE LABOUR,
& OTHER FACTORS
Current BOP Trends: SWOT Analysis
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Current BOP Trends: SWOT Analysis
Strengths
Equity flows on capital account
Adequate liquidity to defend
currency
Self-adjusting market
determined exchange rate.
Weaknesses
Dependence on POL imports
Physical exports
Ability of domestic investment
to absorb large FC inflows.
Opportunities
Pre-payment of costly debt
Supplement domestic savings
to boost growth rates
Boost infrastructural
investments.
Threats
Instability in US and European
economies.
Rupee depreciation
Fiscal deficit
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Conclusion
WTO Agreements has opened the doors for removal of trade
barriers & Anti-Dumping Duties, leading to expansion of
exports.
Removal of trade barriers in Textile and Agriculture Sector
China's Accession to WTO is poised to challenge Indian
industries.
Improvement in Infrastructural Facilities like Power, Ports,
Rail-Road networks.
Technological Upgrading and Movement along with the Value
Chain.
Crude OIL Bio-fuel & mixing ethanol will reduce export bill.
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Conclusion
Trade Related Intellectual Property System (TRIPs) attempts to
harmonize the intellectual property protection regime.
India has emerged as a significant supplier of certain
knowledge intensive services such as custom software and
other IT enabled services like BPOs and KPOs .
Emerging Patterns of Comparative Advantage in Goods and
Services And the most important Self-sufficiency in military
goods production will lead to substantial reduction in BOP.
Hence we can say that Healthy BOP Scenario in an economyaugurs well for its future growth and its future prospects in
positioning itself in world setup.