MBA IB, INTERNATIONAL ECONOMICS

PRESENTED BY

(GROUP-6)
Shivina Gupta
Dolly Agrawal
Vishal Vaibhav
Pradeep Kumar
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Gangotri yadav
 DEFINITION
it is a systematic record showing the economic
transactions between the residents and non residents of
a country for a Specific time period.

It presents a classified record of all receipts on account

of goods exported, services rendered and capital
received by residents and payments made by them on the
account of goods imported and services received from
the capital transferred to non-residents or foreigners.

Reserve Bank of India has been compiling and

publishing BoP data since 1948.
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 FEATURES OF BOP
➢ BOP records all the transactions that create demand
for and supply of a currency. This indicates demand-
supply equation of the currency. This can drive
changes in exchange rate of the currency with other
currencies.

➢ BOP may confirm trend in economy’s international

trade and exchange rate of the currency. This may
also indicate change or reversal in the trend.

➢ It relates to a period of time. Generally it is an annual

statement.
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IMPORTANCE OF BoP
❑BOP of a country reveals its financial and economic status.

❑BOP statement can be used as an indicator to determine whether

the country’s currency value is appreciating or depreciating.

❑BOP statement helps the Government to decide on fiscal and

trade policies.

❑It provides important information to analyze and understand the

economic dealings of a country with other countries.

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 COMPONENTS OF BoP
Current Capital IMF accounting standards of the
account account BoP statement divides
international transactions into
three accounts: the current
account, the capital account,
and the financial account,
where the current account
should be balanced by capital
account and transactions, but,
in countries like India, the
financial account is included in
the capital itself.

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 CURRENT ACCOUNT
It is the Statement of actual receipts and payments relating to export and
import of goods and services and unilateral transfers during a year.

BOP on current account refers to the inclusion of three balances of namely –

Merchandise balance, Services balance and Unilateral Transfer balance. In
other words it reflects the net flow of goods, services and unilateral
transfers (gifts). The net value of the balances of visible trade and of invisible
trade and of unilateral transfers defines the balance on current account.

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 Components of Current Account

Visible Trade in
account goods

Invisible Trade in Income Unilateral

account services transfers transfers

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VISIBLE ACCOUNT – MERCHANDIZE EXPORTS AND
IMPORTS
❑In the trade or merchandise account, only transactions relating to
goods are entered. That is, all goods exported and imported are
recorded in the trade account.
❑Merchandise exports, which refers to sale of goods, are credit
entries, because all transactions giving rise to monetary claims on
foreigners represents credits.
❑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 represents debits.

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 INVISIBLE ACCOUNT
1. Services Account
➢ The services account records all the services rendered and
received by residents of the nation. It consists of such items
as banking and insurance charges, interest on loans tourist
expenditure, transport charges, etc.

➢ Invisible export refers to the sale of services. The export of

services is credit entries and invisible imports that is
purchase of services, are debit entries.

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2. Investment Income
➢ It refers to the income from the investments made in
foreign countries, profits from the subsidiaries of
companies located abroad, interest earned from
loans and investments abroad, dividend income from
the shares in the foreign companies etc.

➢ If the income is received from foreign sources, it is

shown as a credit to the current account and if the
payments are made to the residents of foreign
countries, then its is shown as a debit to the current
account.
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 3. Unilateral transfers
➢ This account includes gifts, grants, remittances received from foreign
countries and paid to foreign countries.

➢ These are also called “Unrequited transfers”. They are called so because
the flow of transfer is unidirectional or in one direction.

➢ These items are simply gifts, and grants exchanged between

governments and people of one country with that of another.

➢ Example- An Indian (Keralite) working in UAE remitting Rs 15000 to his

aged parents in Kerala, India.

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CAPITAL ACCOUNT
The capital account records all those transactions between
the residents of the country and the rest of the
world,which cause a change in the assets or liabilities of
the residents of a country or its government.

Example – If ONGC buys drilling rights in Russia

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 COMPONENTS OF CAPITAL ACCOUNT

Foreign investments
1. (FDI)- Foreign Direct
Investment
Loans
FDI refers to long-term capital
investment such as purchase
FCNR Accounts
of construction machinery, 1. Sovereign loans -Loans of
buildings etc. the government of a country It is a fixed deposit account
held in foreign currency by
NRI’s.
2. (FPI)- Foreign Portfolio 2. External commercial
Investment Borrowings -Loans of private
It refers to short term capital entities
investing in financial assets like
bonds, stocks etc.

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ERRORS AND OMISSIONS
➢ It is a balancing entry and is needed to offset the
overstated or understated components due to recording of
transactions at different places. Different point of time and
different method of evaluation

➢ The errors under errors and omissions due to deliberate

actions and frequently illegal transactions such as drug
smuggling, money laundering, etc.

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SITUTUATIONS OF BoP
EXPORT > IMPORT :A balance of payments surplus means
the country exports more than it imports. It provides enough
capital to pay for all domestic production. The country
might even lend outside its borders

EXPORT = IMPORT

EXPORT < IMPORT :A balance of payments deficit means

the country imports more goods, services, and capital than
they export. It must borrow from other countries to pay for
its imports

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INDIA ‘S BOP SITUATION

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 BALANCE OF PAYMENT
ADJUSTMENT MECHANISM

❖If part of the balance of payments is in deficit or

surplus for a period of time, mechanisms are
needed to restore equilibrium.

❖Adjustment mechanism returns the BoP to its

equilibrium after its initial equilibrium is
disrupted.

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(1) PRICE ADJUSTMENT MECHANISM
➢ The original theory of balance of payments adjustments is credited
to David Hume, the English philosopher and economist.

➢ His theory arose from his concern with the prevailing mercantilist
view that advocated government controls to ensure a continuous
favourable balance of payments. According to Hume, this strategy
was self- defeating over the long run because a nation’s balance of
payments tends to move towards equillibrium automatically.

➢ Hume’s theory stresses the role that adjustments in national price

levels play in promoting balance- of- payments equilibrium.

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 1. Gold Standard
The classical gold standard that existed from the late 1800s to the early
1900s was characterized by three conditions:

1. Each member nation’s money supply consisted of gold or paper

money backed by gold

2. Each member nation defined the official price of gold in terms of its
national currency and was prepared to buy or sell gold at that price

3. Free import and export of gold were permitted by member nations.

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Under these conditions, a nation’s money supply was directly tied
to its balance of payments. Conversely, the money supply of a
deficit nation would decline as the result of a gold outflow.

The central bank of the country was always ready to buy and sell
gold at the specified price. The rate at which the standard money
of the country was convertible into gold was called the mint price
of gold.
This rate was called the mint parity or mint par of exchange
because it was based on the mint price of gold. But the actual
rate of exchange could vary above and below the mint parity by
the cost of shipping gold between the two countries.

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 2. Quantity theory of money
➢ The essence of the classical price- adjustment mechanism is embodied in the quantity
theory of money.

➢ In this theory , the adjustment of disequilibrium in BOP is bought about by the changes
in exchange rates between currencies. The changes in exchange rates, ultimately bring
about the changes in the relative price levels between countries.

➢ The exchange rate for a currency is the price in foreign currency terms of a unit of the
home country’s money

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The theory of adjustment was based on a number of implicit
assumptions:

(i) The validity of the quantity theory of money;

(ii) The efficiency of the banking arrangements whereby an increase in
the money supply had an immediate impact on the domestic monetary
situation;
(iii) Complete mobility of factors within the country concerned;
(iv) Completely flexible prices; and
(v) In the country and the world at large, a quick and considerable
reaction of both demand and supply to price changes.

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(2) MONETARY ADJUSTMENT MECHANISM
▪ The monetary approach views
disequilibrium in the balance of
payments as a monetary
phenomenon.

▪ Money acts both as a disturbance

and adjustment to the balance of
payment.

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Automatic Price Adjustment under Flexible
Exchange Rates (Price Effect)
Under flexible (or floating) exchange rates, the disequilibrium in the balance of
payments is automatically solved by the forces of demand and supply for foreign
exchange. An exchange rate is the price of a currency which is determined, like any
other commodity, by demand and supply. “The exchange rate varies with varying
supply and demand conditions, but it is always possible to find an equilibrium
exchange rate which clears the foreign exchange market and creates external
equilibrium.”
This is automatically achieved by a depreciation (or appreciation) of a country’s
currency in case of a deficit (or surplus) in its balance of payments. Depreciation (or
appreciation) of a currency means that its relative value decreases (or increases)

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Its Criticism:
The practical use of flexible exchange rates is severely limited.
Depreciation and appreciation lead to fall and rise in prices in the
countries adopting them. They lead to severe depressions and
inflations respectively.
Further, they create insecurity and uncertainty. This is more due to
speculation in foreign exchange which destabilizes the economies of
countries adopting flexible exchange rates. Governments, therefore,
favour fixed exchange rates which require adjustments in the
balance of payments by adopting policy measures.

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Despite these criticisms, the monetary approach is realistic in that
it takes into consideration both domestic money and foreign money.
Emphasis is not on relative price changes, but on the extent to
which the demand for real money balances will be satisfied from
internal sources, through credit creation or from external sources
through surplus or deficit in the balance of payments.

A balance of payments deficit or surplus can be corrected through

changes in money supply and their consequent effects on income
and expenditure of more generally on production and consumption
of goods.

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