BCom Balance of Payment Notes Study Material
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BCom Balance of Payment Notes Study Material
In the present era, there is no economy in the world that can be labeled as a completely closed economy. Generally in the worldwide scenario, all countries are open to some degree and allow their residents to purchase imported goods, travel abroad, and sell their services to foreigners. Some countries even permit them to purchase shares and debentures issued abroad. Similarly, corporations and traders are also permitted to purchase imported inputs and finished goods and even raise funds from abroad. Likewise, foreigners are allowed to supply their goods and services and invest in domestic companies. (BCom Balance of Payment Notes Study Material)
All such types of transactions, reflecting international transactions in goods and services, movements of factors of production such as labor, capital, and entrepreneurship, and transfer of knowledge and technology, of a country with the rest of the world are recorded in the balance of payment statement in a double entry book-keeping system. (BCom Balance of Payment Notes Study Material)
MEANING OF BALANCE OF PAYMENTS
It is a systematic pattern to record all trade and capital inflows to and outflows from a country in the balance of payment statement. Thus, the balance of payment (BOP) is a systematic record of a country’s all economic transactions with the rest of the world during a given period of time.
“The balance of payments of a country is a systematic record of all economic transactions completed between its resident and the resident of the world during a given period of time usually a year.” – Walter Krause
“A systematic record of all economic transactions between the resident of the reporting country and of foreign countries during a given period of time.” — Kindle Berger
According to Benham, “Balance of payment of a country is a record of the monetary transactions over a period with the rest of the world.”
The balance of payment statement consists of two sides, the credit side and the debit side. Receipts of a payment from a foreign country are recorded as a credit transaction, which takes a positive (+) or no sign. Transactions on the credit side of the BOP are sources of foreign exchange. On the contrary, a payment to a foreign country is recorded as a debit item with a negative (-) sign.
These transactions result in an outflow of foreign exchange and reduce the external purchasing power of a country. The transactions on the debit side of the BOP represent the uses of foreign exchange. This statement is widely used in evaluating a country’s relative strength in global markets.
Balance of Payment (BOP) on Current Account = Exports of Visible and Invisible Item – Imports of Visible and Invisible Item
Invisible items: Kinds of services like Transport, Banking Insurance services of experts, etc.
Here, invisible items are kinds of services like transport, banking, insurance, service of experts, etc.
BALANCE OF TRADE
Balance of trade is a narrower concept. It refers only to visible items like materials (such as Machines, Cloth, Sugar, etc.) that can be physically seen counted, measured, and weighted and which are to be recorded at the custom barriers. These are visible items.
BOT is the process of proper recording of visible items in respect to measuring the values of the difference between exports and imports of goods.
Balance of trade (BOT) = Export of Visible Goods – Import of Visible Goods
FEATURES OF BALANCE OF PAYMENT
The main features of the balance of payments are as follows:
(i) It is a proper record of all economic transactions between the residents of one country to other countries of the world.
(ii) The given period of time is one year.
(iii) It comprises mainly three types of transactions i.e., visible, invisible, and capital transfers.
(iv) All receipts and payments are recorded in a double-entry system.
(v) There are chances of positive and negative balances.
(vi) These are provisions for necessary adjustments.
CONSTITUENTS OF THE BALANCE OF PAYMENT STATEMENTS
The BOP statement is divided into three subheads Current Account, Capital Account, and Official Settlement Account. These are explained below:
(i) Current Account
All the transactions relating to trade in goods and services, all the receipts, and unilateral transfers in a given period of time, that do not result in the creation of an asset or liability, are recorded in the Current Account of the BOP Statement. On the basis of different categories of transactions the account is other divided into two categories:
(a) Trade Account: The transactions related to visible and physical goods of export and import are recorded in the Trade Account of the BOP. These Transactions are recorded at the market value of the goods from the point of exit i.e., sea, airport, or land border.
(b) Invisible Items: These transactions are not included any physical transfer of goods. This account consists of all the receipts and payments emerging from export and imports of services, investment income, and unilateral transfer from private entities and the government. For example, service transactions-banking, insurance, shipping, consultancy, etc: foreign travel, investment income; transfer payments. (BCom Balance of Payment Notes Study Material)
(ii) Capital Account
All the transactions with the rest of the world that result in the formation of assets or liabilities are recorded in the capital account of the BOP. Hence, loans and investments in shares and debentures, which either create a liability or an asset, are recorded as capital account transactions.
The capital account transactions are recorded in the following form:
(a) Short-term Capital Transaction: Transactions in foreign assets and liabilities of maturity period ranging between three months and less than one year are short-term capital transactions. (BCom Balance of Payment Notes Study Material)
(b) Long-term Capital Transaction: Transactions in foreign assets and liabilities with a maturity of one year or more are long-term capital transactions. These consist of foreign direct investments, portfolio investments, international loans, and repayment of loans.
(iii) Official Settlement Account
The official settlement account or official reserve account records the changes in official reserve assets held by the monetary authority i.e., Central Bank.
As a regulator, Central Bank maintains a stock of reserve assets, also known as the foreign exchange reserves or forex reserves, in terms of foreign currency, Gold, and Special Drawing Rights (SDRs). (BCom Balance of Payment Notes Study Material)
The transactions on the official settlement account are not independent of the size or other items in the balance of payments. These transactions are accommodating in nature and performed to balance the deficit or surplus emerging on account of the current and/or capital account of the balance. (BCom Balance of Payment Notes Study Material)
When India became independent on Aug. 15, 1947, it had a very comfortable ‘Sterling Balance’ of Rs. 1,733 Crore. This was the result of a sizeable surplus on the balance of trade with the UK, during the second world war period when the U.K. had made large-scale purchasing from India to meet its war requirements. The foreign exchange position of the country was, thus quite satisfactory.
However, these reserves were spent soon after independence on imports of food products, raw materials, and finished goods because of huge demand and shortage in food production, with larger imports foreign exchange reserves started declining and reached the bottom of Rs. 250 crores in 1964-65. (BCom Balance of Payment Notes Study Material)
With the introduction of planning in India, the balance of payments position of the country has been recording considerable changes corresponding with the continuous changes in its import and export. The following table shows the balance of payments trends during the planning periods:
The First Plan Period (1951-56)
Under this planning period, the trade deficit was 542 crore, but there was a surplus in net invisible to the extent of 500 crores. Accordingly, the adverse balance of payment was only 42 crore. It was quite satisfactory. (BCom Balance of Payment Notes Study Material)
The Second Plan Period (1956-61)
During this planning period, the deficit in the balance of trade was to turn 2,339 crores and the surplus of Invisibles and donations from other countries totaled 614 crores. Ultimately the unfavorable balance of payment position during this period was to the order of 1,725 crores.
Third Plan Period (1961-65)
During this planning period, the country has faced a Current Account deficit in its balance of payments to the extent of 1,951 crores which was financed by loans from foreign countries under various schemes. (BCom Balance of Payment Notes Study Material)
The causes of this adverse balance were mainly -(i) Imports were expanding faster to overcome the domestic shortages in areas of defense and infrastructural development. (ii) Exports were extremely sluggish and failed to match imports.
Annual Plans (1966-69)
During this period, the deficit of the balance of payment on the current account was 2,015 crore. The main reason for this deficit was the heavy imports of foodgrains to overcome famine conditions and the internal shortage of foodgrains. The secondary reason was inadequate exports due to economic recession also made in this period. (BCom Balance of Payment Notes Study Material)
The Fourth Plan Period (1969-74)
During the fourth planning period, the balance of payments became favorable for the first time since independence. During this planning period Govt. has taken corrective measures such as export promotions and import substitution to reduce deficits in the balance of payments. Moreover, the trade deficit during the fourth plan was 1,564 crore and the surplus in net invisible amounted to 1,664 crores. So, the plan ended with a surplus of 100 crores in its balance of payments. (BCom Balance of Payment Notes Study Material)
The Fifth Plan Period (1974-78)
During this planning period, the value of imports was rapidly rising due to a hike in oil prices, but there was a reduction in the deficit of the balance of trade due to a rise in exports through promotional measures and restrictions on imports as depromotional measures. Although, the gains in the balance of payments rose to 3,082 crores. It was a huge surplus. For the first time since independence, India was in a comfortable position in its external account. (BCom Balance of Payment Notes Study Material)
The Sixth Plan Period (1980-85)
During this planning period, India started experiencing an adverse balance of payments from 1979-80 onwards as against the surplus balance of payments experienced by the country during the fifth plan period. (BCom Balance of Payment Notes Study Material)
During this planning period, apart from external assistance, India had to meet this huge deficit in the Current Account through withdrawals of SDRs and borrowing from IMF under the extended credit arrangements. The deficit during the sixth plan period amounted to 11,384 crores despite positive Invisibles of 19,072 crores because the trade deficit during this period was 30,456 crore.
The Seventh Plan Period (1985-90)
During the seventh plan, the balance of payment position was highly adverse. was a serious concern because it has reached 38,313 (Deficit) in 1990. For the first time during the last 40 years, net Invisibles became negative to the turn of 435 crores in 1990-91.
The Eighth Five Year Plan (1992-97)
The eighth plan was to commence in 1990. But due to some reasons launched in 1992. During this planning period, the trade deficit had been by a record level of 62,429 crores in 1996-97 from that of 12,764 crores in 1992-93. Under this plan, there is a crisis in foreign exchange. Thus, the deficit has reached 59,832 crores on the Current Accounts of the BOP. (BCom Balance of Payment Notes Study Material)
There were various reasons for this rise in deficit:
(i) Increase in imports of capital goods by 34%.
(ii) 27% increase in the import of petrol.
(iii) Crisis of foreign exchange.
(iv) Decline in the exchange rate of the rupee.
(v) There was a 22% increase in the imports of essential raw materials required for the production of capital goods.
The Ninth Plan Period (1997-2000)
During this planning period, the current account deficit reached a record level of 20.885 crores in 1997-98. In 1998-99 it declined to 16,788 crores and in 1999-2000, it again increased to 20,331 crores. In the years 2000-01, the current account deficit declined to 11,431 crores. In the last year of this plan (2001-02) balance of payments on current accounts was in surplus at 6,719 crores.
After analysis of the Table, it is revealed that there have been significant improvements in the structure of India’s Balance of Payment and the strength of the external sector since the economic crisis of June 1991. (BCom Balance of Payment Notes Study Material)
The Tenth Plan Period (2002-07)
The tenth five-year plan (2002-07) is being prepared against a backdrop of high expectations arising from some aspects of the recent performance. In the first year of the tenth plan (2002-03), the balance of payments on the current account was in surplus at 19,987 crores. In the year 2003-04, the balance of payments on the current account was in surplus at 63,983. But during 2004-05, there was a huge trade deficit of the order of 12,174 crores on account of a huge increase in our imports. In the year 2006-07, the balance of payments on the current account was in deficit of 45,343 crores. (BCom Balance of Payment Notes Study Material)
The Eleventh Plan Period (2007-12)
In the first year of the eleventh five-year plan, i.e. in the year 2008-09, the balance of payments on the current account was in deficit of 68.914 crores. In the years 2008-09, also a balance of payments on current account was in deficit it 1,27,631 crore.
In the next year also, this balance is expected to be negative because the growth rate has drastically come down due to Global Slow down. However, the current account deficit despite lower trade deficits increased to 1,79,700 crore in 2009-10 mainly due to a lower net Invisibles surplus.
The Twelfth Plan Period (2012-2017)
Under this planning period in 2012-13, the current account deficit reached 4,79,610 but in 2013-14 it was only 1,87,750. It was lower than 2012-13.
BALANCE OF PAYMENTS CRISIS
In India, a deficit of the balance of payments has been rising continuously from 1980-81. For instance, in 1980-81, the balance of payments on current accounts was adverse to the tune of 2,212 crores and it rose in 1990-91 to 17,367 crore. The current account deficit averaged 2.4% of GDP during the period from 1980-81 to 1990-91. Withdrawal of non-resident deposits also adversely affected the foreign exchange. The Gulf crisis of 1990, led to an unprecedented crisis in the balance of payments. The immediate impact was the rise in the oil import bill.
The remittances from Indian workers in the gulf area also declined. All this resulted in an unprecedented rise in the balance of the payment deficit. The foreign exchange reserves declined to the lowest level. Forex reserves were less than even 1 billion US dollars in 1991. In order to meet the payment of essential imports, the government was forced to pledge the gold reserve of RBI to the U.K.
There was no other alternative before the government but to take loans from international financial institutions. These institutions granted loans on the condition that economic reforms in the form of liberalization, privatization, and globalization are to be immediately implemented. This resulted in the emergence of new economic reforms. As a result, now our overall balance of payment is in surplus.
CAUSES OF UNFAVOURABLE BALANCE OF PAYMENTS (CURRENT ACCOUNT)/UNFAVOURABLE BALANCE OF TRADE
Various causes of disequilibrium in the balance of Payments are as follows:
(i) Import of Machinery: Since independence, the import of machines has increased on two scores: (a) During world war II, machines in Indian Industries were overworked. Consequently, there was large-scale depreciation and wear and tear of machines. In order to replace the same, a large number of new machines were imported. (b) Industrialisation of the country in the wake of five-year plans also necessitated the import of machines worth crores of rupees. This turned India’s balance of payments unfavorable.
(ii) Import of War Equipments: In order to defend itself against China and Pakistan, a large amount of war equipment was imported by India. These imports also caused disequilibrium in the balance of payments. (BCom Balance of Payment Notes Study Material)
(iii) More Demand for Consumption Goods: In the post-war period, demand not only for foreign goods but also for Indian goods went up. Previously, a large number of oilseeds, tea, iron ores, etc. used to be exported out of India. Now because of the increase in population, their demand within the country has gone up. 30, export of these goods has gone down very much.
(iv) Price Disequilibrium: There has been a wide difference in the domestic prices of goods and the prices of goods in foreign countries. Due to inflation and backward technology domestic prices have increased more than the increased prices of foreign goods. This has led to an increase in imports and a decrease in exports. (BCom Balance of Payment Notes Study Material)
(v) Foreign Competition: India mainly exported jute, tea and text now foreign competition in these goods is growing, Bangladesh is India’s jute exports and Sri Lanka and Indonesia export tea, and Korea and China export cloth. This has also adversely affected our exports.
(vi) Increase in Consumption and Prices of Crude oil: The value of imports has gone up on account of a constant hike in the price and more consumption of crude oil. In 1973, the price of crude oil was 2 US dollars per barrel. It has gone up to 147 US dollars per barrel in July 2008. In May 2009, the price of crude oil has reduced to US 57 per barrel due to a global slowdown in demand.
In May 2010, the price of crude oil was US 88 per barrel. In 1970-71, petroleum products worth 136 crores were imported. In the years 2008-09, the imports of petroleum products further rose to 4,19,946 crore. (BCom Balance of Payment Notes Study Material)
(vii) Payment of Interest on Foreign Debts: Foreign debts Contracted in India amounted to approximately 11,42,618 crore till 2008-09. The interest of these loans for the year 2008-09 approximated 50,275 crores. This huge internet burden also caused disequilibrium in a BOP.
(viii) Less Growth in Exports: Despite various export promotion schemes our exports are still less than our imports. Moreover, the growth rate of exports is less than the growth rate of imports. In the year 2008-09, although the growth rate in exports was 28.9 percent still is less than the growth rate of imports. (BCom Balance of Payment Notes Study Material)
In the same year, the growth rate of imports was 35.4 percent. Due to the economic slowdown, in the years 2008-09 growth rate in exports come down to 13.6 percent, and the growth rate in imports has also reduced to 20.7 percent. The growth rate in exports in 2009-10 was negative (-) 20.3% and the imports growth rate was also negative (-) 23.6%. (BCom Balance of Payment Notes Study Material)
(ix) Gulf War: In 1991, the Gulf war also had an adverse effect on India’s BOP. On the one hand, the price of petrol increased and on the other hand, foreign remittances by Indians working in the gulf area, viz., Kuwait, Iraq, etc. to India altogether stopped. It rendered the imports expensive and reduced the foreign remittances. (BCom Balance of Payment Notes Study Material)
(x) Population Explosion: Rapid growth of population in countries like India increases imports and decreases the capacity for exports. Moreover, whatever is produced extra for export purposes, the same is consumed within the country. This leads to an adverse BOP position.
(xi) Other Causes: Poor quality of industrial production, Backward technology, Natural factors, Political factors, etc are other factors that are responsible for adverse Balance of Payments. (BCom Balance of Payment Notes Study Material)
MEASURES/SUGGESTIONS TO CORRECT DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS
Following specific measures are suggested to correct disequilibrium in the balance of payments:
(i) Promotion of Exports: Promotion of exports is the best measure to correct an adverse balance of payments. For this, all taxes on export goods be withdrawn, and export industries should be provided with new materials and transport facilities at reduced prices so that prices of these goods remain low. These industries should be provided credit facilities at liberal rates and goods be designed to the tastes of foreign consumers. (BCom Balance of Payment Notes Study Material)
(ii) Increase in Production: To cut down imports and encourage exports, it is essential that agricultural, industrial, and mineral production be increased. Jute manufactured products, tea, and coffee are of great importance among exports from India. Efforts have been made to increase the production of these products in five-year plans. Raw materials should be made available to export industries at international prices. The production capacity of cement, fertilizers, iron and steel, sugar, etc. should be utilized fully.
(iii) Trade Agreements: More trade agreements should be done with foreign countries to promote our foreign trade and exports. As a member of WTO, India is having trade relations with other 152 members of WTO.
(iv) Encouragement to Foreign Investment: Foreign Industries and MNCs are encouraged to invest their capital in India. Special facilities are provided to attract foreign capital. It leads to an inflow of foreign capital. It also leads to an inflow of foreign exchange in the country. It also increases production to export goods and thus exports are encouraged. (BCom Balance of Payment Notes Study Material)
(v) Attraction to Foreign Tourists: Government should spend a lot of money to develop picnic spots and resorts in different parts of the country. A large amount of foreign exchange can be earned from foreign tourists. (BCom Balance of Payment Notes Study Material)
(vi) Devaluation of Indian Currency: Lowering the value of the domestic currency in terms of foreign currencies is called devaluation. The exchange rate of the currency may be reduced by the Government. Foreign goods will become costly and local goods will become cheap. Imports will be cut down and exports will be pushed up. (BCom Balance of Payment Notes Study Material)
(vii) Restriction on Non-essential Imports: Another important measure of correcting adverse BOP is a restriction on imports of such goods as luxury goods, industrial goods, non-domestic and FMCG products, etc. (BCom Balance of Payment Notes Study Material)
(viii) Import Substitution: Import substitution helps to correct an adverse BOP. It means total or partial replacements of imported products with domestic products. Its main objective is to reduce imports and become a self-dependent economy.
BCom Balance of Payment Notes Study Material