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Dr. Kavita Srivastava

Department of Management

ITS, Ghaziabad

Balance of Payments

Disequilibrium & Adjustments

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Meaning

Countries having economic transactions with other countries

prepare periodically their final accounts :

ywith a view of taking stock of their foreign receipts andpayments

and

y also of their assets and liabilities that arise out of

international transactionsThis account is known as Balance of Payments (BOP)

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Definition

A systematic record of all economic transactions of a

country with the rest of the world during a period of time, usually a year.


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Key terms

y A systematic accounting refers to the double entry book

keeping system where both sides of transactions debit and

credit are recorded.

y

Economic transactions include all such transactions thatinvolve the transfer of title or ownership of goods, services,

money and assets

y Residents means the nationals of the reporting country


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Purpose

y To take the stock of country·s foreign receipts and payment

obligations and of assets and liability arising out of

international economic transactions

y

Provides necessary information on strength and weakness of the country in international economic relations

y It can be ascertained whether composition and direction of

international trade has improved or not.

y

Warning signal for future policy formulation


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Balance of Payments accounts

y Economic transactions between a country and the rest of the

world are grouped under two broads categories:

y Current transactions : includes export and import of goods

and services, visible and invisible trade, unrequited receiptsand payments also known as the transfer payments.

y Capital transactions: includes inflows and outflows of capital

including foreign investments and gold and foreign exchange

reserves.y Thus in accordance with the two kinds of transactions, BOP

accounts is divided into Current & Capital accounts


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Current AccountTransactions Credit Debit Net Balance

(+) or (-)

Merchandise Exports Imports

Foreign Travel Receipts Payments

Transportation ( Shipping)* Receipts Payments

Insurance Premium Receipts Payments

Banking Receipts Payments

Investment Income Receipts Payments

Government (Purchase & Sale of Goods & Service)

Receipts Payments

Miscellaneous** Receipts Payments

CurrentAccount Balance : Surplus/ Deficit

*Added to IMF List,** Includes motion picture royalties, telephone and telegraph services,

fees for copy rights and consultancy ,etc.1/10/20107 Dr. Kavita Srivastava

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Capital Account

Broad items of capital account are the following:

y Short Term Capital Movements

y Long term Capital Movementsy Inflow and outflow of Gold and foreign exchange reserves


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Short term capital movements

y Purchase of short term securities, for example, treasury bills,

commercial bills

y Speculative purchase of foreign currency

yCash balance held by the foreigners for such reasons as war,political uncertainty


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Long Term Capital Movements

y Direct investment in shares, bonds, real estate or physical

assets like plant, building and equipment in which the

investor holds a controlling power

y

Portfolio investment, including all other stocks & bonds, e.g.government securities, securities of firms which do not

entitle the holder with a controlling power

y Repurchase and resale of securities sold to the foreigners.

y

Direct import and export of capital goods fall under foreigndirect investment


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Gold and foreign exchange reserves

y These are maintained to stabilize the exchange rate of the

home country and to make payments in case there is payment

deficits on current accounts

y

The foreign exchange reserves increase or decreasedepending on the net balances of other transactions

Ex port of capital is a debit item as it causes outflow of

foreign exch

ange and import of capital is credit item asit causes the inflow of foreign exchange


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Disequilibrium in the BOP

y If total receipts from the foreign countries exceeds the total

payments there is surplus in the BOP accounts

y If the total payments exceeds the total receipts then there is

deficit in the BOP.


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Causes of Disequilibrium

Inflation and fundamental disequilibrium

y Inflation makes imports relatively cheaper and exports

costlier.

yImports increase and exports decline

y This kind of disequilibrium is known as fundamental

disequilibrium as gap between imports and exports

incereases


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Business cycle and cyclical

disequilibrium

y Business cycle may be confined to a country or a group of

countries or it may be global as great depression

yIf business cycle is global in nature most of the countries faceeither inflation or deflation simultaneously.

y Since countries differ in income and size, the exports and

imports are effected in varying degrees.


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y Some countries have trade surplus other might face problem

of trade deficit

yCountries with high marginal propensity to import,accumulate large trade deficits during the inflationary phase

of the business cycle, and a moderate deficit or even a surplus

during depression

y

This kind of disequilibrium is called cyclical disequilibrium


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Structural Changes and Structural

disequilibrium

y Structural changes may be caused by depletion of somewidely used natural resources, change in technology, changein industrial structure and change in consumers taste andpreferences.

y Such changes affect significantly a country·s capacity toexport and propensity to import

y Gradual exhaustion of coal in Great Britain resulted in anincrease in the cost of production in spite of technological

improvements in coal mining.y This coupled with labour problems, converted Great Britain

from Coal exporter to coal importing nation.


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Short term disequilibrium

y Seasonal deficit caused by crop failures, as in case of India in

the mid 1970s

y Rapid growth of population in food deficient countries

leading to the rise in food importsy Heavy imports due to development plans


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Measures to correct the disequilibrium

Monetary policy:

y A contractionary monetary policy reduces the supply of money.

y A decrease in money supply increases the rate of interest.

y Increase in the rate of interest reduces investment.

y A fall in investment reduces the level of income and hencethe level of imports

y Reduction of imports reduces the trade deficits and therefore

the BOP deficit

y Increase in the interest rate results in short-term capitalinflow which too reduces the BOP deficit.


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Fiscal Policy

y Expansionary fiscal policy including increased government

expenditure , tax rebate increases the aggregate demand

increases the aggregate demand

y

Quota restrictionsy Imposing duties

y Protectionist policy for the infant industry


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Devaluation:

y Lowering the external value of the currency in the

international market

y

Exports become cheapery Increase in exports lowers the deficit in the balance of

payments of the country concerned.

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Other Measures

y Promotion of tourism

y International organizations can even help in correction of

balance of payments deficits.

1/10/2010


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Thank You

1/10/2010


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