Economicsm2 Balance Of Payments

BALANCE OF PAYMENTS Refer Dewett Page nos 444/449 Uni. Text 113/122

Balance of Payments • Balance of Trade • A comparison of total imports and exports of a country is its balance of trade. • The balance of trade is regarded as favorable or active or positive when the value of exported goods exceeds that of imported goods. It is unfavorable or adverse or negative when imports exceed the value of exports.

Favorable/Unfavorable • These terms are only technical and favorable balance may not really the favorable and make the country rich. • For a long time, under British regime. India had a favorable balance of trade, still India was poor. Britain had an unfavorable balance, but she has always been prosperous. So it is not the balance of trade, but balance of payments which shows light on the economic condition of the country.

Balance of Payments. • Balance of trade includes only the visible items in foreign trade. They are material goods exported and imported. Only these are entered in the port registers maintained by custom authorities. • But there are a large number other items which are called invisible. The balance of payments includes all ‘visible’ and ‘nonvisible’ items.

Invisible items • • • • •

The invisible items are Services Tourists expenses Interest on borrowed capital Gifts/donations/money remitted home by foreign settlers etc

Services • India uses a good deal of foreign banking, shipping and insurance services. She does not have enough of her own ships, insurance companies and exchange banks. India has to pay for such services. • India, is filling up the gaps nowadays

Tourist’s expenses • When Indian students and tourists purchase goods and services in Europe, it is like importing these goods and services.

Interest on borrowed capital • An investment made abroad is an export item and remain so till withdrawn.

Balance of payments • The sum total of visible and invisible is called the balance of payments • Definition • The balance of payments is a comprehensive record of economic transactions of the residents of a country with the rest of the world during a given period of time.

Current and Capital account • Balance of payments has two parts, balance on current a/c and balance of capital a/c

Current and Capital account Current a/c

Capital a/c

Imports Exports Expenses on travel Transportation Insurance investments

Borrowing and lending capital Repayment of capital Sale/purchase of securities

• The nation earns foreign currencies by exporting goods and services and receiving capital inflows ( ie investments and loans). All of these are credits and are entered with a plus sign. • The nation spends these foreign currencies to import goods and services and to invest and lend abroad. These are debits and shown as a minus.

US BALANCE OF PAYMENTS 1992 THE US BALANCE OF PAYMENTS

(1992)

1 CURRENT ACCOUNT

USDBILLIONS

EXPORTS OF GOODS & SERVICES

+730

IMPORTS OF GOODS & SERVICES

-764

US GOVT GRANTS

-33

-67

2 CAPITAL ACCOUNT CAPITAL INFLOW

+89

CAPITAL OUTFLOW

-53

DISCREPANCY

-12

BALANCE ON CAPITAL ACOUNT

+24

DEFICIT IN 1992 US BALANCE OF PAYMENTS

-43

3. OFFICIAL RESERVE ACCOUNT

+43 0

How does balance of payments balance? •

The balance of payments (on current a/c) is said to balance when the total of credit items is exactly equal to the total of debit items. • Suppose there is a deficit in the current a/c of balance of payments, it will be covered by 3. Drawing from country’s foreign exchange reserve 4. By borrowing from outside 5. By exporting gold Now the I.M.F grants temporary accommodation to bridge the gap

Equilibrium, Disequilibrium and adjustment in the balance of payments • Equilibrium is a state of Balance of payments over the relevant time period. It is a sign of soundness . • The period is generally one year. Thus, seasonal inequality between exports and imports is not a sign of disequilibrium. • When the balance of payments of a country is in equilibrium, the demand for domestic currency is equal to its supply. The demand and supply situation is neither favorable nor unfavorable. • If balance of payments move against the country, adjustments may be made by encouraging exports of goods, services or by discouraging imports.

Measures • • • • •

Export promotion Import restriction Deflation Exchange control devaluation

Exports/Imports • A country having an adverse balance of payments must reduce imports or stimulate exports or do both. • Imports can be checked either by total prohibition, levying import duties or by quota system. Another method is import substitution – ie produce in the country . • Export can be stimulated by measures of export promotion – giving concession to industrialists and exporters.

Deflation • Under deflation, total money income in the country is made to reduce, so that aggregate demand in the country falls. • As a result, the people tend to import less and their demand for home made goods too become less. • Owing to fall in demand, prices also fall • So country becomes good market to buy from an a bad market to sell in. • In this way, imports get discouraged and exports are stimulated

Exchange control • Under exchange control, all exporters are asked to surrender their claims on foreign currencies to the central bank which pays in return the home currency which the exporters really want. This available foreign exchange is rationed out by central bank among the licensed importers of the essential commodities. Thus imports are restricted to the foreign exchange available and no danger of more goods being imported than exported.

Devaluation • Common method of correcting an adverse balance of payments. • The home currency is devalued against foreign currency so that foreigners have to pay less in terms of their own currencies for our goods. • The importers have to pay more for foreign goods.