06-02-2013, 09:21 AM
BALANCE OF PAYMENTS
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INTRODUCTION
Balance of Payment of a country is one of the important indicators for International trade, which significantly affect the economic policies of a government. As every country strives to a have a favorable balance of payments, the trends in, and the position of, the balance of payments will significantly influence the nature and types of regulation of export and import business in particular.
Balance of Payments is a systematic and summary record of a country’s economic and financial transactions with the rest of the world over a period of time.
(a) Transactions in good and services and income between an economy and the rest of the world,
(b) Changes of ownership and other changes in that country’s monetary gold, SDRs, and claims on and liabilities to the
rest of the world, and
© Unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting.
Balance of Trade and Balance of Payments
The Balance of Trade takes into account only the transactions arising out of the exports and imports of the visible terms; it does not consider the exchange of invisible terms such as the services rendered by shipping, insurance and banking; payment of interest, and dividend; expenditure by tourists, etc. The balance of payments takes into account the exchange of both the visible and invisible terms. Hence, the balance of payments presents a better picture of a country’s economic and financial transactions with the rest of the world than the balance of trade.
Nature of Balance of Payments Accounting
The transactions that fall under Balance of Payments are recorded in the standard double-entry book-keeping form, under which each international transaction undertaken by the country results in a credit entry and a debit entry of equal size, As the international transactions are recored in the double-entry book-keeping form, the balance of payments must always balance, i.e., the total amount of debits must equal the total amount of credits. Somethimes, the balancing item, error and omissions, must be added to balance the balance of payments.
Components of Balance of Payments
Balance of Payments is generally grouped under the following
heads
i) Current Account
ii) Capital Account
iii) Unilateral Payments Account
iv) Official Settlement Account.
Current Account
“The Current Account includes all transactions which give rise to or use up national income.”
The Current Account consists of two major items, namely:
i) Merchandise exports and imports, and
ii) Invisible exports and imports.
Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. On the other hand, merchandise imports, i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits.
Merchandise imports and exports form the most important international transaction of most of the countries.
Invisible exports, i.e., sales of services, are credit entries and invisible imports, i.e. purchases of services, are debit entries.
Important invisible exports include the sale abroad of such services as transport, insurance, etc., foreign tourist expenditure abroad and income paid on loans and investments (by foreigners) in the home country form the important invisible entries on the debit side.
Capital Account
The Capital Account consists of short- terms and long-termcapital transactions A capital outflow represents a debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a debit in the US balance of payments and a credit in the balance of payments of India.
The payment of interest on loans and dividend payments are recorded in the Current Account, since they are really payments for the services of capital. As has already been mentioned above, the interest paid on loans given by foreigners of dividend on foreign investments in the home country are debits for the home country, while, on the other hand, the interest received on loans given abroad and dividends on investments abroad are credits.
Unilateral Transfers Account
Unilateral transfers is another terms for gifts. These unilateral transfers include private remittances, government grants,
disaster relief, etc. Unilateral payments received from abroad are credits and those made
abroad are debits.
Deliberate Measures
This measure is widely employed today.
The various deliberate measures may be broadly grouped into;
(a) Monetary measures
(b) Trade measures;and
© Miscellaneous.
(a) Monetary Measures
The important monetary measures are outlined below; Monetary contraction; the level of aggregate domestic demand,
the domestic price level and the demand for imports and exports may be influenced by a contraction or expansion in
money supply and correct the balance of payments disequilibrium.the measure required is a contraction in money
supply. A contraction in money supply is likely to reduce the purchasing power and thereby the aggregate demand. It is also likely to bring about a fall domestic prices. The fall in the domestic aggregate demand and domestic prices reduces for imports. The fall in the domestic aggregate demand and domestic prices reduces the demand for imports. The fall in
domestic prices is likely to increase exports. Thus, the fall in imports and the rise in exports would help correct the disequilibrium. Devaluation : Devaluation means a reduction in the official rate at which one currency is exchanged for another currency. A country with a fundamental disequilibrium in the balance of payments may devalue its currency in order to stimulate its exports and discourage imports to correct the disequilibrium.
To illustrate, let us take the example of the devaluation of the Indian Rupee in 1966, Just before the devaluation of the
Rupees with effect from 6th June 1966, the exchange rate was $ I= Rs. 4.76. The devaluation of the Rupee by 36.5 per cent changed the exchange rate to $ I = Rs. 7.50. Before the devaluation, the price of an imported commodity, which cost $ I abroad, was Rs. 4.76 (assuming a costless free trade). But after devaluation, the same commodity, which cost $ I abroad, cost Rs. 7.50 when imported. Thus, devaluation makes foreign goods costlier in terms of the domestic currency, and this would discourage imports. On the hand, devaluation makes exports (from the country that has devalued the currency) cheaper in the foreign markets. For example, before the devaluation, a commodity which cost Rs. 4.76 in India could be sold abroad at $ I (assuming a costless free trade); but after devaluation, the landed cost abroad of the same commodity was only $ 0.64. This comparative cheapness of the Indian goods in the foreign markets was expected to stimulate demand for Indian exports.