Download balance of payment

EXTERNAL SECTOR
MODULE 1
BALANCE OF PAYMENT
External sector deals with export and import of goods and services, and financial
capital between nations. The countries export goods and services over which it has
advantage over other countries and import goods and services in which it lacks
advantage over others.
CURRENT
ACCOUNT
BALANCE OF PAYMENT
Trade Account
RECEIPTS
Export
PAYMENTS
Import
1. Non-factor services
2. Investment Income
3. Transfers
Invisibles
Account
CAPITAL
ACCOUNT
1. Foreign Investment
2. External Assistance
3. External Commercial
Borrowings (ECBs)
4. NRI deposits
5. Other flows
Current Account Balance = Trade Balance + Invisibles Balance
Goods & Services Balance = Trade Balance + Non-Factor Services Balance
BoP Balance = Current Account Balance + Capital Account Balance
BALANCE OF PAYMENT
The balance of payment of a country is a systematic record of all its economic
transactions with the outside world in a given year. The term ‘all transaction’ means
transaction of government as well as private. It is a double entry book keeping. It
means the incoming receipts are credited and outgoing transactions are debited.
1. EXPORT
Export means the receipts against export of merchandise goods to other
countries. The export receipts of services are not included here.
2. IMPORT
Import means the payment for import of merchandise goods from other
countries. The payments for import of services are not included here.
3. TRADE BALANCE
The balance of trade is difference between export receipts and import payments.
Trade balance = Export – Import
4. INVISIBLES (NET)
The head of invisibles record the receipts and payments regarding services exports
and imports and other current account payments viz.,
(a) Non-factor services
(b) Income
(c) Private Transfers
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(a) NON-FACTOR SERVICES
Non-factor services refer to all invisible receipts or payments not attributable
to conventional factor of production, i.e., labour (remittance from overseas
migrants). Thus Non-factor services mean the export and import of services
alone. The non-factor services includes Group of Services viz., Travel,
Transportation, Insurance, Government Not Included Elsewhere (GNIE) and
Miscellaneous Services, which encompass communication services,
construction services, financial services, software services, news agency
services, royalties, management services and business services etc. The
software services comprise information technology (IT) and IT-enabled
services (ITES).
(b) INCOME
Income includes transactions regarding income from investments in the form
of dividends, profit and interest from loans. The investment income outflows
are called servicing (repayment) of debt (loan) and non-debt liabilities
(investment)
(c) PRIVATE TRANSFERS
Private transfers include grants, gifts, remittances, etc., which do not have
any quid pro quo. Among the private transfers, the remittances is the major
source.
Remittance is directly earned by labour which is a factor of production and
incomes like dividend, profit and interest are earned by capital which is also a
factor of production. So the income from both these heads is called factor
income services.
5. GOODS AND SERVICES BALANCE
It is the sum of trade balance and non-factor services
Goods and services balance = Trade balance + Non-factor services.
6. CURRENT ACCOUNT BALANCE
Current account balance is the sum of trade balance and net invisibles.
Current account balance = Trade balance + Net invisibles.
If the current account balance is positive, it is said to be surplus which means
favourable current account balance. If the current account balance is negative, it
is said to be deficit which means unfavorable current account balance.
7. EXTERNAL ASSISTANCE (NET)
External assistance means the transaction of official (government) bilateral and
multilateral loans. The bilateral loans are loan transactions between two countries.
Multilateral loans are official loan transactions between a country and multilateral
bodies like World Bank, IMF and Asian Development Bank etc.
8. COMMERCIAL BORROWINGS (NET)
Commercial borrowings means loan transaction by commercial enterprises. It is
also called as External Commercial Borrowing (ECB).
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9. NON-RESIDENT DEPOSITS
The deposit received from non-resident Indians come under this head. At present,
there are three, types of NRI Deposit Schemes. They are:
(a) Foreign Currency Non-Resident (Banks)-FCNR (B)
(b) Non Resident External Rupee Accounts NR (E) RA
(c) Non Resident Ordinary Rupee Account (NRO)
(a) FOREIGN CURRENCY NON-RESIDENT (BANKS) – FCNR (B)
These deposits are held in the following foreign currencies, US $, Pound
Sterling, Euro, Japanese Yen, Austalian $ and Canadian $. Only term deposits of
one to three years maturity is allowed. The interest rates are pegged to LIBOR/
SWAP of corresponding maturities.
(b) NON-RESIDENT EXTERNAL RUPEE ACCOUNT NR (E) RA
These deposits are held in Indian Rupee. Term deposits with maturity of one to
three years as well as saving deposits are allowed under this scheme. Its
interest rate is also pegged to LIBOR / SWAP rate.
(c) NON-RESIDENT ORDINARY RUPEE ACCOUNT (NRO)
It is the account held by Indians ordinarily living abroad. An Indian who was
Indian resident but migrated abroad can shift his account to this category. It is
held in Indian Rupee. NRO accounts can be opened as current, savings,
recurring or fixed deposit accounts.
10. FOREIGN INVESTMENTS
There are two types of foreign investments. One is foreign direct investment and
another is portfolio investment. Portfolio investment is also called as rentier
investment.
(a) FOREIGN DIRECT INVESTMENT (FDI)
Foreign Direct Investment refers to direct bulk investment in a domestic
company by a foreign individual or company. The foreign direct investors have
control over company’s management and day to day affairs of company which
is possible by enough voting rights in his hand due to bulk investment.
(b) PORTFOLIO (OR) RENTIER INVESTMENT
Portfolio investment refers to investment minimally in various financial
instruments like shares, debentures of a company. The portfolio investor cannot
have any control over company management.
11. OTHER FLOWS
Other flows include, delayed export receipts, leads and lags in export receipts
(the difference between the customs data and the banking channel data), funds
held abroad, and other capital transactions not included elsewhere such as flows
arising from cross-border financial derivative and commodity hedging
transactions, and sale of intangible assets such as patents, copyrights,
trademarks etc., and errors and omissions.
The difference between the customs data and the banking channel data arises
because banking channels data relies on foreign exchange release/ receipt returns
which are actual cash outgo and cover all flow and customs data are based on
bills of entries (import document field with the customs), which might remain
somewhat incomplete for a number of reasons in the short run. Defence imports
are not reflected in the customs data.
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12. CAPITAL ACCOUNT TOTAL
Capital Account total (net) = External Assistance (net) + Commercial Borrowings
(net) + Non-resident deposits(net) + Foreign investments (net) + Other flows (net).
If the capital account balance is positive, it is said to be surplus. Surplus capital
account balance means favorable capital account balance. If the capital account
balance is negative, its said to be deficit. Deficit capital account balance means
unfavorable capital account balance.
13. RESERVES
Reserve means foreign exchange reserve. The sum of current and capital
account balance is the balance of payment.
Balance of payment = current account balance + capital account balance
The balance is added to foreign exchange reserve if the balance of payment is in
surplus. The balance is deducted if the balance of payment is in deficit. It means
payment is made out of old balance (foreign exchange reserve.)
SERVICE EXPORTS
Currently, India is ranked eighth in service exports with exports of $154 billion, but
this accounts for just 3.2 per cent of the world total. Although this is double the share of
merchandise exports (which has a 1.7 per cent share of world trade in goods), the
potential exists to substantially enhance this. While some of the larger sectors, such as
travel and tourism, IT and telecom and, to an extent, healthcare, have managed to
grow, the potential in fields like media and entertainment, scientific research and
development, logistics, education, professional services, space and even
government services, remain largely untapped. India’s Election Commission, for
instance, has robust technology and systems for conducting elections, which can find
ready takers in other democracies. There is significant scope to grow exports of such
services, especially in the Saarc region, as well as South-East and Central Asia, and
Africa, where they are either underprovided or largely missing.
While the recent trade policy has made a beginning, more can be done, especially to
push Mode 2 (consumption abroad) and Mode 3 (commercial presence abroad)
exports. Industry will also have to get its act together. Services trade is dogged by nontariff barriers which are accentuated by a ‘tit-for-tat’ mentality in many of the
autonomous governing self-regulatory bodies of professions such as accountancy, law
and medicine. Indian lawyers can consult, but not sign anything in Singapore, for
instance; that country does not recognise Indian qualifications because India refuses to
recognise theirs! This is where an overarching policy guideline from the Centre can
help, paving the way for quicker mutual recognition of standards, processes and
qualifications, which will enable India’s services talents to compete better globally.
Above all, policymakers will also have to recognise that globalisation has rendered the
‘made-here-sold-there’ approach redundant, and focus on improving India’s presence
in global value chains.
GOVERNMENT MUST WORK HARDER TO COUNTER DECLINE IN EXPORTS
The Reserve Bank of India has released data for India's balance of payments in the
third quarter of 2015-16. The current account deficit, or CAD, narrowed to $7.1 billion
in that period, which amounts to 1.3 per cent of gross domestic product or GDP. The
CAD for the equivalent quarter of 2014-15 was $7.7 billion, or 1.7 per cent of GDP. The
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trade deficit, at $34 billion, was $4.6 billion less than in the equivalent quarter of 201415 and $3.4 billion less than in the second quarter of the current financial year. A
cursory examination of these numbers would suggest that India's external sector is
strong, and there is no cause for worry. This conclusion would also fit with the intuition
that India, as a major commodities importer, would in general benefit from the long
downturn in the global prices of commodities.
However, a closer look at the numbers suggests that any such confidence might be
misplaced. In fact, there are three significant weaknesses in India's external account.
The most obvious is the weakness in exports. Exports of goods brought in $64.9
billion in Q3, 2015-16, down by $15.2 billion from the equivalent quarter in the previous
year. This is not entirely due to lower fuel prices. Exports of petroleum, oil and
lubricants fell in value by only $7.6 billion. In other words, exactly half of the decline in
exports was due to non-oil goods. The continuing weakness in India's non-oil exports
is problematic, as it is happening in a time in which many peer countries are growing
their exports, such as Bangladesh and Vietnam. The structural changes needed to
render Indian exports competitive are clearly not yet in place.
The other specific sector causing concern is remittances from overseas Indians. The
country received remittances from overseas Indians totalling $14.8 billion during
October-December, 2015. This was the lowest in 18 quarters. In the corresponding
months of the previous year, remittances had been $15.97 billion; in the previous
quarter of 2015, remittances had been $15.9 billion. It is likely that weaker oil prices
have hit the incomes of Indians in the Gulf states. This, again, moderates the positive
effect that low fuel prices have had on the CAD. And then there is the deceleration in
services exports, particularly software exports and business services exports,
which together account for more than half of services exports. In software exports,
growth is barely positive; in business services exports, there is a decline. This again
indicates that the commodity downturn should not lead to complacency about India's
balance of payments situation. It is true that, currently, low fuel prices and a sharp
increase in foreign direct investment mean that the situation appears comfortable.
But both these variables cannot be controlled by policy. If they reverse, then the
comfort on this account goes away. The government must work harder to counter the
decline in exports of both goods and services.
PREVIOUS YEARS’ QUESTIONS (PRELIMS)
1.
2.
With reference to Balance of payments, which of the following constitutes / constitute
the Current Account?
(2014)
1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights
Select the correct answer using the code given below.
(a) 1 only
(b) 2 and 3
(c) 1 and 3
(d) 1, 2 and 4
Which of the following constitute Capital Account?
(2013)
1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment
Select the correct answer using the codes given below:
(a) 1, 2 and 3 only (b) 1, 2 and 4 only (c) 2, 3 and 4 only (d) 1, 3 and 4
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3.
4.
5.
6.
The balance of payments of a country is a systematic records of
(2013)
(a) all import and export transactions of a country during a given period of time,
normally a year
(b) goods exported from a country during a year
(c) economic transaction between the government of one country to another
(d) capital movements from one country to another
In terms of economy, the visit by foreign nationals to witness the XIX Common
Wealth Games in India amounted to
(2011)
(a) Export
(b) Import
(c) Production
(d) Consumption
Consider the following actions which the Government can take:
(2011)
1. Devaluing the domestic currency.
2. Reduction in the export subsidy.
3. Adopting suitable policies which attract greater FDI and more funds from FΙΙs.
Which of the above action/actions can help in reducing the current account
deficit?
(a) 1 and 2
(b) 2 and 3
(c) 3 only
(d) 1 and 3
Assertion (A): ‘Balance of Payments’ represents a better picture of a country’s
economic transactions with the rest of the world than the ‘Balance of Trade’.
Reason (R): ‘Balance of Payments’ takes into account the exchange of both visible
and invisible items whereas ‘Balance of Trade’ does not.
(2006)
PREVIOUS YEARS’ QUESTIONS (MAINS)
1. Explain the term Balance on Current Account.
(2007)
2. What are non-factor services in India’s balance of payments?
(2006)
3. Why did India have a surplus in current account balance in 2001-02 after a gap
of 24 years?
(2003)
4. Differentiate between Trade and Balance of payments.
(1996)
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