BALANCE OF TRADE (BOT)
Balance of Trade (BOT) show visible trade transactions with rest of the world during a year refers to the difference in the imports and exports of goods.
BOT = VX – VM
Where VX = Value of goods exported
VM = Value of goods imported
If the value of export is more than the value of import of goods it is called favourable BOT and vice versa.
Types of BOT
Balance of trade may be of three types:
- Favourable Balance of Trade. When total value of the goods exported by it exceeds total value of the goods imported by it.
- Unfavourable Balance of Trade. When the total value of the goods imported is above total value of the goods exported by it.
- Equilibrium in Balance of Trade. When the total value of the goods exported by it equal to the total value of the goods imported by it.
BALANCE OF PAYMENTS (BOP)
BOP is an accounting statement that provides a systematic record of all economic transactions between the residents of a country and the rest-of-the-world in a given period of time, usually one year. ‘Economic transaction’ include all transactions that involve the transfer of title or ownership of goods, services, money and assets. ‘residents’ mean the nationals of the reporting country. Exclude diplomatic staff, tourists, foreign military personnel, migratory workers and branches of the companies.
FEATURES OF BOP
Main features of balance of payments are as under:
(a) Systematic Record. Refers to systematic record of receipts payments of a country with other countries.
(b) Fixed Period of Time is a statement of account for a given period of time, generally one year.
(c) Comprehensiveness. It comprises of all the items, i.e., visible, invisible and capital transfers.
(d) Double Entry System.
(e) Balanced System. Keep debit and credit sides accounts in balance.
Economic transaction in BOP are categorized into:
(a) Visible items. Include all types of physical goods exported/imported made of some matter or material.
(b) Invisible items. It includes all types of services, investment income and unilateral transfers. Unilateral transfers include gifts, donations, etc.
(c) Capital transfers are concerned with capital receipts and capital payments.
DIFFERENCE BETWEEN BOP AND BOT
CURRENT ACCOUNT AND CAPITAL ACCOUNT OF BOP
BOP account is divided into two accounts – current account and capital account.
Current account records imports and exports of goods, services and unilateral transfers.
(a) Goods. Shows export and import of visible items like wheat, rice, machine, etc.
(b) Services/Invisibles. Main services that are made use of in the international trade are shipping, insurance
and banking services.
(i) Shipping, Insurance and Banking Services. Ships have to be hired for transporting goods from one country to another. The merchandise carried by the ships has to be insured for any loss and damage in transit. Banking services are used to facilitate receipts from and payments to foreign dealers.
(ii) Investment Income. When foreign companies make investment in India’s industry and trade, the profit made by them in India have to be paid to their shareholders in the form of dividend. Similarly, interest has to be paid to foreign creditors for money borrowed in the past.
(iii) Foreign Travel. When foreign tourists come to India, they bring in foreign currency with them and convert it into our currency to spend it in our domestic market. The country receives foreign currency. Similarly, when Indian tourists go abroad, they have to convert Indian currency foreign currency to spend it abroad. This involves an outflow payment of foreign exchange.
(iv) Miscellaneous. Includes all residual transactions of the current account such as royalties, management fees, subscription journals, consultancy, telephone and telegraph services, etc.
(c) Transfer Payments. Unilateral transfers between residents and non – residents. Can be private which gifts, donations, etc., or official which include donations, grants by foreign governments, contribution from UN, WHO, etc.
Capital account records capital transfer such as loans and investment between one country and the rest of the world which causes a change in the asset or liability status of the residents of a country or its government.
(a) Private Capital. Only resident’s long-term or short-term capital transactions are included.
(b) Banking Capital. Includes foreign financial assets and liabilities the government and the central bank receipts of repurchases from IMF.
(c) Official Capital is divided into:
(i) Loan includes credit granted by foreign governments and international institutions to central and state governments.
(ii) Amortisations of capital means purchase and resale of securities sold to the foreigners.
(iii) Miscellaneous errors and omissions indicate understatement or overstatement of receipts and payments.
(d) Gold and Foreign Capital are essential for stabilizing foreign exchange rate of the home currency. Net balance of capital account shows a country’s overall balance payments positions. The capital account balance may show surplus deficit.
It is obtained by adding current account balance capital account balance and needs to be cleared at the end of an accounting year. Balance of payments of a country can be understood in two ways:
- Balance of Payments in an Accounting Sense
- Balance of Payments in an Operational Sense
- Balance of Payments in an Accounting Sense. Under the system, receipts side is always equal to payments side. Thus, balance of payments always balances.
- Balance of Payments in an Operational Sense. In an operational sense, balance of payments economic balance, i.e,. if there is an overall BOP deficit, it is financed by drawing down of foreign reserve, drawing from IMF or sale of gold. There is a surplus in balance payment, it leads to an increase in foreign reserve, purchase of gold, etc.
STRUCTURE OF BOP
The BOP of a country includes five major accounts. They are :
Category I. Goods and Services Account
Category II. Unilateral Transfers Account
Category III. Long-term Capital Account
Category IV. Short – term Private Capital Account
Category V. Short-term Official Capital Account
Ques. What are credit item and debit item?
Ans. Any transaction that brings in foreign exchange for a country is a credit item and any transaction that causes a country to lose foreign exchange is a debit item.
AUTONOMOUS AND ACCOMMODATING ITEMS
Autonomous items in the BOP refer to all transactions economic transactions in current and capital account that are undertaken for profit.
Accommodating items in the BOP refer to all transactions occur because of other activity in the BOP, such as government financing.
DISEQUILIBRIUM IN BOP
When there is either deficit or surplus, BOP is said to be in disequilibrium.
A deficit in the current account is offset either by a surplus the capital account or by drawing down the gold and foreign exchange reserves. Surplus in the current account, is offset by deficit on the capital account resulting in loans or depletion of gold foreign exchange reserves.
For assessing BOP position, only those transactions which are carried out on their own are taken into account.
Causes of Disequilibrium in BOP
A. Economic Factors
- Inflation. Increase in prices due to higher wages, higher prices materials, etc., makes export costlier. Which results in deficit in balance of payments.
- Expenditure on Developing Relations. Result in spend huge amount of money on ambassadors, missions, etc. Which has adverse effect on balance of payments.
- Changes in Foreign Exchange Rate. If external value of a country’s currency is increased, imports become cheaper and export become dearer. As a result, imports rise and exports fall.
- Fall in Demand. In foreign markets, exports reduce and results in adverse balance payments.
- Business Cycles. Leads to inflation and depression situations. During depression due to fall in income of the people in foreign countries, the exports to those countries fall. It results in disequilibrium in the balance of payments.
- Import of Services. Underdeveloped countries import capital and other services and have to pay huge amount of money on account of interest, wages, profits, etc. The result is deficit in BOP.
- Population Explosion. Aggregate consumption demand rises due to rapid increase in population. This results in fall in export surplus and adverse balance of payments.
B. Social Factors
When people of underdeveloped countries try to imitate the consumption pattern of developed countries. Their imports increase and results in disequilibrium in balance of payments.
C. Political Factors
Political instability of a country has an adverse effect on balance of payments of a country.
Effects of Disequilibrium in BOP
- Lowers economic credibility
- Hampers economic development
- Reduces foreign exchange reserves of a country.
- Leads to exploitation of a country as foreign dependence sometimes assumes the form of political dependence.