India’s Balance of Payments: Current Account, Capital Account, Goods and Services Account

India’s Balance of Payment’s

Balance of Payment Account

Bop is the oldest and the most important statistical statement for any country. In a nutshell BOP of a country is “a systematic record of all economic transactions between the residents of one country with the residents of the other country in a financial year”.

Economic Transactions include all the foreign receipts and payments made by a country during a given financial year.

The Foreign receipts include all the earnings and borrowings by a country from the other countries.

Source of Earnings (Inflows) Source of Borrowings (Inflows)
  • Merchandise Exports
  • Services Exports
  • Interest, Profits, Dividends and Royalties received from Foreign countries.
  • Gifts, Grants and Aids received from Foreign Countries.
  • Private Transfers such as Remittances.

 

  • Foreign Direct Investments
  • Foreign Portfolio Investments
  • Government Loans from Foreign Governments.
  • Short Term deposits by NRIs and Foreigners.

The accumulation of foreign receipts (net of payments) over the years becomes Foreign Exchange Reserves of a Country.

The Payments include all the spending and lending by a country from the countries of the rest of the World.

Spending’s (Outflows) Lending’s (Outflows)
  • Merchandise Imports
  • Services Imports
  • Interests, Profits, Dividends and Royalties paid to foreign countries
  • Gifts, Grants and Aids given to foreign countries
  • Remittances paid.
  • Outward Foreign Direct Investment by Indian Firms
  • Outward Foreign Portfolio Investment by Indian Citizens
  • Indian Governments Lending’s/Loans to Foreign Governments
  • Short Term Deposits by country residents into foreign countries.

All the foreign receipts are financial inflows, and all the foreign payments are financial outflows in a given year.

The Balance of Payments Accounts of any Country includes Six Major accounts which are as follows:

  • Goods Account
  • Services Account
  • Unilateral Transfer Account
  • Long-term Capital Account
  • Short-term Capital Account
  • International Liquidity Account.

The six major accounts are clubbed together into two most important accounts.

Goods Account versus Services Account

Goods Account Services Account
  • It includes the value of Merchandise Exports and Merchandise Imports
  • They are called ‘Visible items’ in the BOP account.
  • If Export of Goods= Import of Goods. We call it ‘Goods Balance’.
  • Positive Goods Balance= Export of Goods> Import of Goods.
  • Negative Goods Balance= Export of Goods< Import of Goods.
  • The services account records all the services exported and imported by a country in a year.
  • Unlike goods which are tangible or visible, services are intangible. Hence are called ‘invisible items in the BOP.
  • The services transactions include:
  • Transportation, Banking and Insurance.
  • Tourism, Travel and Tourist purchases of domestic goods and services.
  • Foreign Students studying in Host countries and Domestic Students studying in Foreign.
  • Expenses of Diplomatic personnel stationed overseas as well as income from diplomatic personnel who are stationed in host countries.
  • Investment Income: Interests, Profits, Dividends and Royalties received from foreign countries and paid out to foreign countries.

Unilateral Transfer Account

  • The account includes gifts, grants, remittances received from foreign countries and paid to foreign countries.
  • Unilateral transfers are of two types:
Private Transfer Government Transfer
  • Private Transfers are person to person transfers.
  • These are money/funds received from or paid to a citizen of one country to a citizen of another country.
  • Example: An Indian (Keralite) working in UAE remitting Rs 15000 to his aged parents in Kerala, India.
  • Foreign economic aid and Foreign military aid by one country government to another country government constitute Government to Government transfer.
  • Example: The United States Military Aid to Pakistan is a Government transfer constituting a receipt/Credit item in Pakistan’s BOP (But a payment/debit item from USA’s BOP).

Why are they called Unilateral Transfers?

Unilateral receipts and payments are also called ‘Unrequited Transfers’. They are called so because the flow of transfer is unidirectional or in one direction. There is no liability for an automatic reverse flow or repayment obligation in other direction since they are not lending’s and borrowings. These items are simply gifts, and grants exchanged between governments and people of one country with that of others.

Long Term Capital Account versus Short Term Capital Account

Long Term Capital Account Short Term Capital Account
  • It includes the amount of Capital that has moved in or out of the country in a year.
  • The Capital that has moved in or out for a period of one or year or more is called Long term capital movement.
  • The Long-term capital account includes the following:
  • Foreign Direct Investment: Investments done by home country citizens and firms in foreign countries and by foreigners in the host country. These movements are induced by different rate of profits between the home and foreign country.
  • Foreign Portfolio Investment: Investments done by home country citizens and firms in stock markets (shares and securities) or debt markets (Bonds) of Foreign countries and by Foreigners in host countries shares and securities. These movements are induced by differences in interest rates, returns or dividends on capital between home and a foreign country.
  • Government Loans: Loan given by the home country government to foreign country government and Foreign country government to home country government.
  • The Capital that moves in or out of a country for a period of less than one-year short-term capital movement.
  • Bank deposits and other short-term payments and credit arrangements fall under this category.
  • These short-term payments are sometimes included under the term ‘Errors and Omissions’ in BOP account.

Note for Student Box: Is FDI necessarily Good for Host Economies?

When a Japanese MNC invests in India, India receives a capital inflow in the form of long term capital (FDI). It has a favourable effect on our BOP account. But when the Japanese MNC in India, starts repatriating profits/ sending profits back to their home countries(Japan), there will be a capital outflow from India to Japan.

The outflow will be recorded in our Services part of Current account as outflow of Income. India, therefore will experience a temporary surplus in its Capital account. But when MNCs starts to send out profits in their home countries, India will experience a permanent outflow from its current account.

The understanding of this treatment effect of FDI is very important, since it is always assumed that FDI inflow is good for a host country economy.

Note: I will return to the topic in much detail when I discuss Current account deficit part.

International Liquidity Account

International Liquidity Account simply records net changes in Foreign Exchange Reserves. Following table represents an example of how International liquidity account works.

Case 1) BOP Surplus: When Receipts are Greater than Payments in a BOP Account

Major Accounts Receipts(Credits) Payments(Debits)
A. Goods Account 2000 1000
B. Services Account 1000 500
C. Unilateral Transfers 200 100
D. Long-Term Capital Account 1500 500
E. Errors and Omissions/Short Term Capital Account 200 300
F. International Liquidity Account 2500 (G-(A+B+C+D+E+F)
G. Balance of Payments 4900 4900
  • Total Receipts are 4900 Million, and Total Payments are 2400 Million.
  • There is a BOP Surplus of 2500 Million.

The surplus of 2500 Million will enter into International Liquidity Account as payment item. The economic logic of 2500 Million entering as the debit item is:

  1. The sum represents accumulation of foreign exchange reserves of 2500 Million; or
  2. Purchase of Gold or other currencies by surplus country in order to increase their Foreign Exchange Reserves; or
  3. The surplus country might lend 2500 Million to other countries.

In all the above cases, the amount is spent on either buying gold, other country currencies or lending. Hence treated as payments.

Case 2) BOP Deficit: When Payments are Greater than Receipts in a BOP Account

Major Accounts Receipts(Credits) Payments(Debits)
A. Goods Account 1000 2000
B. Services Account 500 1000
C. Unilateral Transfers 100 200
D. Long Term Capital Account 500 1500
E. Errors and Omissions/Short Term Capital Account 300 200
F. International Liquidity Account 2500 (G-(A+B+C+D+E+F)
G. Balance of Payments 4900 4900
  • Total Receipts are 2400 Million, and Total Payments are 4900 Million.
  • There is a BOP Deficit of 2500 Million.
  • The important point to ask is how a country will finance its deficit of 2500 Million?
  1. The sum will be spent by drain of past accumulated foreign exchange reserves of 2500 Million; or
  2. Sale of Gold or other currencies held as foreign exchange reserves by deficit country; or
  3. The deficit country might borrow 2500 Million from other countries.

In all the above cases, the amount is financed by either selling gold, other country currencies or borrowings. Hence treated as receipts. In this case, a deficit country is receiving a payment to finance its deficit, Hence receipts. Whereas, in a surplus case, a surplus country is siphoning off its surplus amount to invest in Gold or Other currencies, Hence payments.

 

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

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