The Balance of Payments Account of a country shows, on its credit side, the different items for which it has received payment and the amount of such payments. These are called the credit items. On the debit side the Account shows the items for which the country had paid to foreigners and the amount of such payments.
They are the Debit Items. If the total of the debit items and the total of the credit items are equal in value, the country’s international payments are balanced. In other words, if the entries are done in a proper way debits and credits will always be in balance, so that in an accounting sense the BOP will always be in balance.
Each debit has a corresponding credit entry. If the credit items are larger, so that there is a net balance due to it, the country is said to have a Favourable Balance.
If the debit items are larger, so that there is a net balance due to foreigners, the country is said to have an Unfavourable Balance. The terms ‘favourable’ and ‘unfavourable’ are misleading but have the sanction of long usage.
The Balance of Payment (BOP) statement is divided into two major accounts.
(i) Current Account and
(it) Capital Account.
Transaction relating to goods, services and income constitute the current account, while those relating to claims and liabilities of a financial nature, which go to finance the deficit on current account or to absorb its surplus, form the capital account. The sum of these current and capital account transactions together constitute the basic Balance of Payments.
Balance of Current Account = [Export of goods + export of services + unrequited receipts] – [Imports of goods + Imports of services + unrequited payments] – unrequited receipts include gifts and indemnities etc. from foreigners while unrequited payments are gifts and indemnities to foreigners.
Only in the year 1976-77 to 1979-80, India had a small current account surplus of 0.6% of GDP otherwise there is generally a deficit.
Balance of Capital Account = Capital Receipts – Capital Payments
Capital receipts include borrowings from, capital repayments by or sale of assets to foreigners. Capital payment includes lending to, capital repayments to or purchase of assets from foreigners.
Balance of Payment (BOP) = Balance of Current Account + Balance of Capital Account.
The Balance of Payment is sometimes also presented in three divisions as follows:
I. Current Account:
(a) Visible trade relating to imports and exports.
(b) Invisible items, viz, receipts and payments for such services as shipping.
(c) Unilateral transfers such as donations.
II. Capital Account:
(a) Short term movement of capital made by instruments of less than one year’s maturity, both private and government.
(b) Long term movement of capital, both private and governmental.
III. Official Reserve Assets Accounts:
(a) Gold stock.
(b) Holding of its convertible foreign currencies.
(c) Special Drawing Rights.
The official Reserve Assets Accounts consists of gold stock, holdings of its convertible foreign currencies, and Special Drawing Rights (SDRs). This account is the balancing item with respect to current and capital account transactions.
The account will see a decline in terms of foreign exchange reserves, i.e., a net outflow of foreign exchange, whenever total disbursements on the current and capital accounts exceed total receipts. Thus, the balance of current account plus the balance on capital account must always be offset by the balance on official reserve asset account.
The Balance of a Payment can either have deficit or surplus. A deficit means that the country is importing more than exports and if this continues for a number of years, it may have adverse impact on the country’s foreign exchange reserves and its international position. The deficit can be overcome by an emphasis on export promotion and also by devaluation of the country’s currencies.
In November 2000, to promote exports, Special Economic Zones (SEZs) were set up based on the Chinese SEZ model, with a view to provide an internationally competitive and hassal-free environment for export production.
Devaluation leads to increase in exports as the goods and services of that country become cheaper in terms of the foreign currency and the deficit in Balance of Payment can thus be overcome. Excess devaluation may also lead to inflation and to rise in cost of essential imports.
Tariffs and quotas are used by countries to restrict imports and thus overcome Balance of Payment problems. Quotas are quantitative restrictions (QRs) on imports of certain commodities and no imports beyond a certain quantity are allowed. In India QRs have been phased out from April 1, 2001.
The countries still using QRs are Pakistan, Sri Lanka, Bangladesh and Tunisia. Tariffs are custom duties paid by goods entering the country and this increases the final price of the imported goods and reduces their demand. Peak rate of customs duty has been decreased from 35% to 30% in 2002-03 budgets.
It is to be remembered that Structural Adjustment Loan [SAL] was a programme launched by World Bank in 1980, in which lending to the less developed countries was linked formally to the implementation of policy reforms, aimed at elimination of quantitative restrictions, reduction of tariffs and export promotion.
To rectify Balance of Payment problem the country can improve the balance on their capital account by encouraging more private foreign investment and seeking more public foreign assistance. In this context one should remember the role of Foreign Direct Investment [FDI].
Foreign Direct Investments are those foreign investments which are involved in directly productive activities and infrastructure. The foreign investor has a share in the management and he may also provide managerial and technical assistance.
Foreign Institutional Investments [FII], on the other hand, are foreign investments which are mainly of financial nature and move from one country to another in search of profits.
The Foreign Investment Promotion Board (FIPB) was set up in 1991 in the PM’s office to provide a single window clearance to invite and facilitate investments in India by international companies. In 1996 it became part of the Industry Ministry and later it was shifted to the Finance Ministry and it is chaired by the Finance Secretary.
Finally, a country can also seek to modify the detrimental impact of chronic Balance of Payments deficits by expanding their stocks of official monetary reserves. Generally, under the workings of the international monetary system, countries with deficits in their balance of payments are required to pay for these deficits by drawing down on their official reserves comprising gold, U.S. dollars and SDRs.
The SDR owe its origin to the phenomenal growth in the volume and value of world trade. The remarkable expansion of international trade necessitated new international assets to supplement the limited stock of gold and dollars. Consequently, in 1970 the International Monetary Fund (IMF) was given the authority to create $ 10 billion of these SDRs. These new international assets perform many of the function of gold and dollars in settling balance of payments account.