Balance Of Payments

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Information about Balance Of Payments

Published on May 15, 2010

Author: diptesh7


Slide 1: BALANCE OF PAYMENTS Group Members : Group Members Richa Venkatesh Jasmeet Diptesh Ankur Ramya :  What do we want to find out? What kind of records should be kept? What kind of things do governments wish to know? Slide 4: What is the international demand for our currency doing to its value? Does our trade promote full employment? Who keeps track of India’s balance of payments transactions with other countries? Contents : Contents The meaning and purpose of BOP The accounting method of BOP The cause and kind of disequilibrium in BOP The method of correcting disequilibrium India’s BOP – 2006 - 09 Balance of Payments (BOP) : Balance of Payments (BOP) Backdrop BOP - Definition : BOP - Definition " Systematic statement of all economic transaction of a country with the rest of the world during a period of time usually one year”.    “ A systematic accounting of all economic transactions between the residents of a nation and the rest of the world during a period of time, usually one year.” :  Economic Transactions   Double entry book keeping System. BOP Definition BOP - Definition : BOP - Definition :  Keeping tack of country's foreign reciept And Payments. Strength & weakness Gain & loss Facilitating in futrue policy formulation. BOP Purpose :  How is information recorded in balance of payments accounting? :  Current A/c Transactions Capital A/c Transactions BOP Accounts :  BOP Accounts: Current a/c :  BOT = “ Net Balance of visible trade” = Export (X) – Import (M) If X> M Trade Surplus If M>X Trade deficit Balance of Trade :  Visible net + Invisible net = Current a/c balance Credit > Debit Current a/c Surplus Credit < Debit Current a/c deficit Current a/c Balance :  Capital Account A. Short term capital movements include: - Purchase of short-term securities - Speculative purchase of foreign currency - Cash balance held with foreign countries :  Capital Account B. Long term capital movements include: - Direct investments in shares, bonds, real estate, plant, building etc - Portfolio investment like govt. securities, securities of firms - Amortization of capital, repurchase and resale of securities to FDI’s Capital Account : Capital Account - Commercial Borrowings - IMF borrowings - non-residents deposits - external assistance 18 :  Capital Account C. Inflow and Outflow of Gold and foreign exchange reserves :  BOP Disequilibrium :  BOP Disequilibrium BOP statements are prepared on the principles of accounting There is often a surplus or deficit in BOP This is called Disequilibrium in BOP :  Autonomous and Induced Transactions Autonomous transactions are carried out on their own with a view to consume more or make profit They take place on both current and capital accounts Unrequited items like gifts, donation and aid are autonomous transactions Induced Transactions : Induced Transactions Balancing transactions are in form of international borrowing and lending They are made for making payments for deficits in Balance of Trade Assessment of BOP : Assessment of BOP Autonomous transactions only are taken into account BOP disequilibrium is of either surplus nature or deficit nature Current account deficit = Net capital inflow Current account deficit is the result of autonomous transaction Net capital inflow is induced transaction Capital account transactions : Capital account transactions Autonomous transactions Official transactions The decrease in official foreign exchange reserves gives the measure of BOP deficit BOP deficit = decrease in official foreign exchange reserves = current account deficit + net capital inflow Causes and Kinds of BOP : Causes and Kinds of BOP Inflation and Fundamental Disequilibrium Business cycle and Cyclic Disequilibrium Structural Changes and Structural Disequilibrium Short-term Disequilibrium Seasonal deficits caused by crop failure Rapid growth of population in food-deficient countries Ambitious development plans Demonstration effect of advanced countries on developing nations :  Automatic Adjustment in BOP BOP Adjustment can be done in two ways Classical Approach Policy Measures :  BOP Adjustment Under Fixed Exchange Rate 0 Y0 Y1 Y2 Income Y Interest Rate i3 i2 i0 F E G LM0 LM1 LM2 BOP IS0 i(%) :  BOP Disequilibrium(Surplus) and Automatic Adjustment Under Flexible Exchange Rate 0 Y1 Y2 Income Y Interest Rate i2 i1 F E LM IS2 BOP2 BOP1 i(%) IS1 :  BOP Disequilibrium(Deficit) and Automatic Adjustment Under Flexible Exchange Rate 0 Y1 Y2 Income Y Interest Rate i2 i1 F E IS1 BOP1 BOP2 i(%) IS2 LM BOP Deficit :  BOP adjustment by policy measures :  BOP adjustment by policy measures Mundell -Fleming Model Why Mundell – Fleming model: Required market condition do not exist Economic cost is very high Surplus countries unwilling to allow adjustment :  What are policy measures? Expenditure changing policies: - Monetary policy - Fiscal policy Expenditure switching policy: - Devaluation - Revaluation Monetary approach :  Trade Deficit (C + I + G) – Y C + I + G Monetary Policy Fiscal Policy Assumption fixed Exchange Rate Expenditure Changing Policies :  BOP Adjustment through Monetary Policy :  BOP Adjustment through Fiscal Policy Y0 Y1 Y2 Income (Y) Interest Rate (r) LM r1 r2 r3 IS3 IS2 IS1 K J E3 EB EB’ E1 E2 :  BOP Adjustment through Mix Policy :  Assignment Dilemmas in Policy Mix :  Mundellian policy Assingment :  Parameters are unknown and difficult to determine Determination of exact combination is difficult Prediction may differ due to non-economic factors Capital flow is accommodating not autonomous Conflict between nations Problems in Mundellian policy Assignment :  Exchange Depreciation Exchange Appreciation Expenditure Switching Policy :  Pre-Devaluation Bc 1 = Ac 5 A’s Import = 350 (Y) x Bc 30 = Bc 10,500 A’s Export = 100 (X) x Bc 60 = Bc 6,000 Trade deficit = Bc 4,500 Expenditure Switching Policy :  Post-Devaluation Bc 1 = Ac 7 A’s Import = 300 (Y) x Bc 25 = Bc 7,500 A’s Export = 150 (X) x Bc 45 = Bc 6,750 Trade deficit = Bc 750 Expenditure Switching Policy :  Devaluation and Internal and External Balance :  Marshall – Lerner Condition: BOP deficit only if demand is elastic BOP deficit if demand is perfectly inelastic No effect if sum of price-elasticity equals Effectiveness of Devaluation :  Empirical Evidence and J-curve effect :  Monetary Approach to BOP :  Monetary Approach to BOP It was developed by Robert Mundell in 1968 and 1971 and Harry Johnson in 1972. According to the modern monetary approach BOP disequilibrium is a monetary phenomenon. :  Monetary Approach to BOP Demand and the supply of money is transitory phenomenon and is self correcting in the long run. BOP surplus results when there is excess of demand of money over the supply of money and vice versa. “BOP bottoms up.” :  The Self Correcting mechanism 0 100 200 300 400 500 600 20 40 60 80 Ms m (DB) Md E K J L M Surplus Deficit International Reserves (bn Rs.) India’s BOP 2006 - 09 : India’s BOP 2006 - 09 India’s BOP 2006 - 09 : India’s BOP 2006 - 09 :  :  THANK YOU

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