The No. 1 Question Everyone Working in Balance Of Payment And Forex Reserves Should Know How to Answer
According to the Ministry of Commerce and Industry, India’s Balance of Payments (BoP) in 2020-21 is going to be very strong. What would happen if a country spends more than it receives from abroad? , What would happen if an individual spends more than his income? He must finance the same by some other means, right? It may be by borrowing or by selling assets. The same way, if a country has a deficit in its current account (spending more abroad than it receives from sales to the rest of the world), it must finance it by borrowing abroad or selling assets. Thus, any current account deficit is of necessity financed by a net capital inflow.
BoP is a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year. It indicates whether the country has a surplus or a deficit in trade. When exports exceed imports, the account is said to be on surplus and imports exceed exports, it is said to be in deficit.
It also indicates whether a country’s currency is appreciating or depreciating. BoP accounts are categorized into Current account, Capital account, and Errors and Omissions. Current account: It shows export and import of visible (goods) and Invisibles (services). Capital account: It shows a capital expenditure and income for a country (both private and public investments).
Sometimes the balance of payment does not balance.
This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately. Forex reserves are assets denominated in a foreign currency that is held on reserve by a central bank. BoP shows changes in Forex reserves.
If there is a deficit in BoP then it can be bridged by taking money from the Foreign Exchange (Forex) Account. If the reserves in the forex account are falling short then this scenario is referred to as the BoP crisis.
Understand the concept behind the Balance of Payments (BoP): The Balance of Payments (BoP) and Balance of Trade (BoT) are two confusing concepts for even economics graduates. These terms are connected with international trade accounting.
What is Balance of Payments (BoP)?
The balance of payments (BoP) records the transactions in goods, services, and assets between residents of a country with the rest of the world for a specified time period typically a year. It represents a summation of the country’s current demand and supply of the claims on foreign currencies and of foreign claims on its currency.
There are two main accounts in the BoP – the current account and the capital account. Current Account: The current account records exports and imports in goods, trade in services, and transfer payments. Capital Account: The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc. It includes foreign investments and loans.
Strong BoP: The BoP is going to be strong on the back of significant improvement in exports and a fall in imports.
The exports in July 2020 is at about 91% export level of July 2019 figures. Imports are still at about 70-71% level as of July 2019.
Trade Surplus in June 2020: India’s trade has turned surplus for the first time in 18 years as imports dropped by 47.59% in June 2020 as compared to June 2019. The country posted a trade surplus of USD 0.79 billion in June 2020.
Domestic Manufacturing Being Boosted: The government is taking steps to support and promote domestic manufacturing and industry. It has increased curbs on imports of products and parts, especially from China, as part of its ‘Atmanirbhar' Initiative. The government also reviewed all Free-Trade Agreements (FTA) done between 2009 and 2011 and found most of them to be asymmetrical.
FTAs done earlier have permitted foreign goods to come easily into the country. But Indian goods have not been allowed reciprocal entry. E.g. European countries have opposed technical standards imposed by India on the import of tires, even as they have restricted the export of tires from India.
Change in Mode of Manufacturing: The government has also asked firms investing in the country to stop having an “assembly workshop” approach that has typically characterized Indian manufacturing. Balance of Payment Definition: Balance of Payment (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.
It indicates whether the country has a surplus or a deficit in trade. When exports exceed imports, there is a trade surplus and when imports exceed exports there is a trade deficit.
Purposes of calculation of BoP: Reveals the financial and economic status of a country. Can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating. Helps the Government to decide on fiscal and trade policies. Provides important information to analyze and understand the economic dealings of a country with other countries. Components of BoP: For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under - Current account, Capital account, and Errors, and Omissions.
It also shows changes in Foreign Exchange Reserves. Current Account: It shows export and import of visible (also called merchandise or goods - represent trade balance) and Invisibles (also called non-merchandise). Invisibles include services, transfers, and income. Capital Account:
It shows a capital expenditure and income for a country. It gives a summary of the net flow of both private and public investment into an economy. External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of the capital account.
Errors and Omissions: Sometimes the balance of payment does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately. Changes in Foreign Exchange Reserves: Movements in the reserves comprise changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) balances. Overall the BoP account can be a surplus or a deficit.
If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account. If the reserves in the forex account are falling short then this scenario is referred to as the BoP crisis.
Note: The IMF accounting standards of the BOP statement divide 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 financial account transactions. But, in countries like India, the financial account is included in the capital account itself.