Components of Balance of payment of India Upsc

Balance of payments

Table of Contents

6.1 THE BALANCE OF PAYMENTS

The balance of payments (BoP) records the transactions in goods, services, and assets between residents of a country with the rest of the world for a specified time period, typically a year.
There are two main accounts in the BoP: the current account and the capital account.
According to the new accounting standards specified by the International Monetary Fund (IMF) in the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6), the balance of payments has been divided into three accounts: the current account, the financial account, and the capital account.
India has made the change to these new accounting standards, but the Reserve Bank of India continues to publish data according to the old classification.

6.1.1 Current Account

Current Account is the record of trade in goods and services and transfer payments.
Trade in goods includes exports and imports of goods.
Trade in services includes factor income and non-factor income transactions.
Transfer payments are receipts that residents of a country get for ‘free’, without having to provide any goods or services in return, consisting of gifts, remittances, and grants, which could be given by the government or by private citizens living abroad.
Buying foreign goods is expenditure from our country and becomes income of that foreign country; hence, imports decrease domestic demand for goods and services in our country.
Selling foreign goods (exports) brings income to our country and adds to aggregate domestic demand for goods and services.

Balance on Current Account

Current Account is in balance when receipts on the current account are equal to payments on the current account:
- Current Account Surplus: Receipts $>$ Payments; indicates the nation is a lender to other countries.
- Balanced Current Account: Receipts $=$ Payments.
- Current Account Deficit: Receipts $<$ Payments; indicates the nation is a borrower from other countries.
Balance on Current Account has two components:
- Balance of Trade or Trade Balance (BOT): The difference between the value of exports and value of imports of goods of a country in a given period of time.
  - Export of goods is entered as a credit item in BOT, whereas import of goods is entered as a debit item in BOT.
  - BOT is in balance when exports of goods are equal to imports of goods.
  - Surplus BOT (Trade surplus) arises if a country exports more goods than it imports.
  - Deficit BOT (Trade deficit) arises if a country imports more goods than it exports.
- Balance on Invisibles (Net Invisibles): The difference between the value of exports and value of imports of invisibles of a country in a given period of time.
  - Invisibles include services, transfers, and flows of income that take place between different countries.
  - Services trade includes factor income (net international earnings on factors of production like labour, land, and capital) and non-factor income (net sale of service products like shipping, banking, tourism, software services, etc.).

6.1.2 Capital Account

Capital Account records all international transactions of assets.
An asset is any one of the forms in which wealth can be held (e.g., money, stocks, bonds, Government debt, etc.).
Purchase of assets is a debit item on the capital account (e.g., an Indian buying a UK car company, as foreign exchange flows out of India).
Sale of assets is a credit item on the capital account (e.g., sale of shares of an Indian company to a Chinese customer).
Components of the Capital Account include:
- Investments:
  - Direct Investment: Foreign Direct Investment (FDI), equity capital, reinvested earnings, and other direct capital flows.
  - Portfolio Investment: Foreign Institutional Investments (FII), offshore funds.
- External Borrowings: External commercial borrowings, short-term debt.
- External Assistance: Government aid, inter-governmental loans, multilateral and bilateral loans.

Balance on Capital Account

Capital account is in balance when capital inflows (receipt of loans from abroad, sale of assets or shares in foreign companies) are equal to capital outflows (repayment of loans, purchase of assets or shares in foreign countries).
Surplus in the capital account arises when capital inflows are greater than capital outflows.
Deficit in the capital account arises when capital inflows are lesser than capital outflows.

6.1.3 Balance of Payments Surplus and Deficit

A country running a current account deficit (spending more than it receives from sales to the rest of the world) must finance it by selling assets or borrowing abroad; thus, any current account deficit must be financed by a capital account surplus (net capital inflow).
When a country is in balance of payments equilibrium, the current account deficit is financed entirely by international lending without any reserve movements:
$$\text{Current account} + \text{Capital account} \equiv 0$$
Alternatively, a country can use foreign exchange reserves to balance a deficit in its balance of payments; the reserve bank sells foreign exchange during a deficit (called official reserve sale).
The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus).
Monetary authorities are the ultimate financiers of any deficit in the balance of payments (or recipients of any surplus).
Official reserve transactions are more relevant under a fixed exchange rate regime than under floating exchange rates.
Balance of payments classifications:
- BoP Deficit: Overall Balance $< 0$, Reserve Change $> 0$.
- Balanced BoP: Overall Balance $= 0$, Reserve Change $= 0$.
- BoP Surplus: Overall Balance $> 0$, Reserve Change $< 0$.

Autonomous and Accommodating Transactions

Autonomous Transactions: International economic transactions made due to reasons other than bridging the gap in the balance of payments (independent of the state of BoP), such as to earn profit.
- Termed ‘above the line’ items in the BoP.
- The balance of payments is in surplus (deficit) if autonomous receipts are greater (less) than autonomous payments.
Accommodating Transactions: Determined by the gap in the balance of payments (whether there is a surplus or deficit) and by the net consequences of autonomous transactions.
- Termed ‘below the line’ items.
- Official reserve transactions are the accommodating items in the BoP (all others being autonomous).

Errors and Omissions

A third element of the BoP (alongside current and capital accounts) to account for difficulties in recording all international transactions accurately.

Box 6.1

Explains that while standard presentations divide transactions into current and capital accounts, the IMF’s sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) establishes three accounts: current account, financial account, and capital account.
Under this updated classification, almost all transactions arising from trade in financial assets (such as bonds and equity shares) are placed in the financial account.
The Reserve Bank of India also modified its BoP structure accordingly, though it continues to publish data using the older two-account classification (detailed in the Balance of Payments Manual for India, RBI, September 2010).

Table 6.1: Balance of Payments for India (in million USD)

Illustrates a sample balanced BoP where a trade deficit and current account deficit are offset by a capital account surplus:
1. Exports (of goods only): $150$
2. Imports (of goods only): $240$
3. Trade Balance $[2 – 1]$: $-90$
4. (Net) Invisibles $[4a + 4b + 4c]$: $52$
  - a. Non-factor Services: $30$
  - b. Income: $-10$
  - c. Transfers: $32$
5. Current Account Balance $[3 + 4]$: $-38$
6. Capital Account Balance $[6a + 6b + 6c + 6d + 6e + 6f]$: $41.15$
  - a. External Assistance (net): $0.15$
  - b. External Commercial Borrowings (net): $2$
  - c. Short-term Debt: $10$
  - d. Banking Capital (net): $15$ (of which Non-resident Deposits (net): $9$)
  - e. Foreign Investments (net) $[6eA + 6eB]$: $19$ (FDI (net): $13$, Portfolio (net): $6$)
  - f. Other Flows (net): $-5$
7. Errors and Omissions: $3.15$
8. Overall Balance $[5 + 6 + 7]$: $0$
9. Reserves Change: $0$

Reference Ncert Document

https://ncert.nic.in/textbook/pdf/leec106.pdf

Author: Pravin Babu R

I've done a Master of Engineering in Computer Science and B.Tech in Information Technology . Worked in a private IT company for 5 years. Currently preparing for the Civil Services Exam. My hobby is blogging in different Niches, especially technologies. View all posts by Pravin Babu R

Balance of payment of India Ncert Upsc Notes