What Is the Balance of Payments (BOP)?

The balance of payments (BOP) is the method countries use to monitor all
international monetary transactions in a specific period. The BOP is usually
calculated every quarter and every calendar year.

Imports and exports are the primary components of a country's Balance of

Payments (BOP), representing the value of goods and services a nation buys from
and sells to other countries respectively; essentially, the difference between a
country's total exports and imports determines whether it has a surplus or deficit in
its BOP.

All trades conducted by both the private and public sectors are accounted for in
the BOP to determine how much money is going in and out of a country. If a
country has received money, this is known as a credit, and if a country has paid or
given money, the transaction is counted as a debit.

Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities
(debits) should balance, but in practice, this is rarely the case. Thus, the BOP can
tell the observer if a country has a deficit or a surplus and from which part of the
economy the discrepancies are stemming.

 The balance of payments (BOP) is the record of all international financial

transactions made by the residents of a country.
 There are three main categories of the BOP: the current account, the capital
account, and the financial account.
 The current account is used to mark the inflow and outflow of goods and
services into a country.
 The capital account is where all international capital transfers are recorded.
 In the financial account, international monetary flows related to investment
in business, real estate, bonds, and stocks are documented.

Importance of Balance of Payment

A balance of payment is an essential document or transaction in the finance
department as it gives the status of a country and its economy. The importance of
the balance of payment can be calculated from the following points:

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  It examines the transaction of all the exports and imports of goods and
services for a given period.
 It helps the government to analyse the potential of a particular industry
export growth and formulate policy to support that growth.
 It gives the government a broad perspective on a different range of import
and export tariffs. The government then takes measures to increase and
decrease the tax to discourage import and encourage export, respectively,
and be self-sufficient.
 If the economy urges support in the mode of import, the government plans
according to the BOP, and divert the cash flow and technology to the
unfavorable sector of the economy, and seek future growth.
 The balance of payment also indicates the government to detect the state of
the economy, and plan expansion. Monetary and fiscal policy are established
on the basis of balance of payment status of the country.

How the Balance of Payments (BOP) Is Divided

The BOP is divided into three main categories:

 Current account
 Capital account
 Financial account

The Current Account

The current account is used to mark the inflow and outflow of goods and services
into a country. Earnings on investments, both public and private, are also put into
the current account.

Goods and services together make up a country's balance of trade (BOT). The
BOT is typically the biggest count of a country’s balance of payments, as it makes
up total imports and exports. If a country has a BOT deficit, it imports more than
it exports, and if it has a BOT surplus, it exports more than it imports.

Capital account: Capital transactions like purchase and sale of assets (non-
financial) like lands and properties are monitored under this account. This account
also records the flow of taxes, acquisition, and sale of fixed assets by immigrants
moving into the different country. The shortage or excess in the current account is
governed by the finance from the capital account and vice versa.

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Finance account: The funds that flow to and from the other countries through
investments like real estate, foreign direct investments, business enterprises, etc., is
recorded in this account. This account calculates the foreign proprietor of domestic
assets and domestic proprietor of foreign assets, and analyses if it is acquiring or
selling more assets like stocks, gold, equity, etc.

Balance of trade
The balance of trade is the distinction between the value of a nation’s imports and
exports for a given time frame. The BoT is the largest constituent of a nation’s
balance of payments. Economists utilise the BoT to compute the associative
potency of a nation’s economy. The BoT is also known as the trade balance or the
international trade balance.

Balance of payment
The balance of payment is a statement of all the transactions that are made between
entities in one nation and the rest of the world over a particular time frame, such as
a quarter or a year. To put it in other words, the BoP is a set of accounts that
identifies all the commercial transactions operated by the nation in a specific
period with the remaining nations of the world. It documents a record of all the
monetary transactions performed globally by the nation on goods, services, and
income during the year.

Balance of trade Balance of payments

Definition

Balance of trade or BoT is a financial Balance of payment or BoP is a financial

statement that captures the nation’s import statement that keeps track of all the
and export of commodities with the rest of the economic transactions by the nation with
world. the rest of the world.

What does it deal with?

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It deals with the net profit or loss that a It deals with the proper accounting of the
country incurs from the import and export of transactions conducted by the nation.
goods.

Fundamental Difference

Balance of trade (BoT) is the difference that is Balance of payments (BoP) is the
obtained from the export and import of goods. difference between the inflow and outflow
of foreign exchange.

Type of transactions included

Transactions related to goods are included in Transactions related to transfers, goods,

BoT. and services are included in BoP.

What is its net effect?

The net effect of BoT can be either positive, The net effect of BoP is always
negative, or zero.

Disequilibrium in Balance of Payments

Several reasons such as differences in the value of exports and imports cause
disequilibrium in the balance of payments. The disequilibrium may be either in
minus, deficit, unfavorable side or plus, surplus, favorable side. Let us see the
favorrable and unfavourable balance of Payments concepts below:

Unfavourable/ Favourable BoP

Balance of Payments is unfavorable when the Payments (debit) of the country is

more than its receipts (credit). Meanwhile, when the receipts (credit) are more than
the Payments (debit), the BoP is said to be favorable. Disequilibrium in Balance of
Payments can be understood as:

o Favourable BoP
o Unfavourable BoP

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Favourable BoP

When the receipts are more than the Payments, then there is a favourable balance
of Payments. Such a situation increases foreign exchange reserves. The export of
goods, services, and capital receipts is more than that of the imports. It is also
known as surplus BoP

Bf = R – P > 0

Bf = Balance of Payments

R – P > 0 = Receipts are greater than Payments or their difference is positive

Unfavourable BoP

There is an unfavourable BoP when the Payments are more than the receipts. Such
a situation reduces foreign exchange reserves. As well, the exports of goods,
capital receipts, and services are less than that of the imports. It is also termed as a
deficient balance of Payments.

Bu = R – P < 0

Bu = Unfavourable BoP

R – P < 0 = Receipts are less than the Payments or their difference is negative

Equilibrium in BoP

When the capital receipts and exports (both visible and invisible) of a country are
equal to its capital imports and Payments (visible and invisible), then it is called
equilibrium in the Balance of Payments.

B=R–P=0

B = Balanced BoP

R = Receipts

P = Payments

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Causes of Disequilibrium in BoP

The main causes of unfavourable BoP in India are discussed as below:

o Import of machinery
o Import of war equipment
o Increasing demand of consumption goods
o Price Disequilibrium
o Expenditure on Embassies
o Competition from international countries
o Increasing prices of crude oil
o Payments of interest on foreign debts
o War among the gulf countries

Measures to Correct the Disequilibrium in BoP

The main reason for the disequilibrium in BoP is the excess of imports over
exports. Let us have a look at the measures to correct the disequilibrium in the
Balance of Payments:

o Promotion of exports
o Scaling up production
o Favourable trade agreements
o Encouragement of foreign investment
o Boosting foreign tourism
o Decreasing the level of economic inflation
o Devaluation of the Indian currency
o Restricting imports, specifically of luxury goods
o Exercising import substitution

Measures to Overcome Imbalances in BoP

Automatic Correction

 Under automatic correction, the BOP adjustment comes about automatically,

and it is not brought about deliberately by government policy or
intervention.

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  The burden of adjustment is on the economy and market forces and not on
the government.
 Assuming fixed or flexible exchange rates, the automatic adjustment in BOP
takes place through changes in prices, interest rates, income, and capital
flows.

Deliberate Measures
Monetary Measures

 Monetary Contraction
o The level of aggregate domestic demand, domestic price level and the
demand for imports and exports may be influenced by contraction or
expansion of money supply so that balance of payments
disequilibrium may be corrected.
o Contraction of money supply is most likely to reduce the purchasing
power and, hence the aggregate demand.
o It is also likely to lower domestic prices, which, in turn, reduces the
demand for imports and increases exports.
o Thus, the fall in imports and rise in exports would help correct the
disequilibrium.
o
 Devaluation
o It means reduction of the official rate at which the domestic currency
is exchanged for another currency.
o A country experiencing fundamental disequilibrium in its Balance of
Payments (BoP) may devalue its currency to boost exports and reduce
imports, thus correcting the imbalance.
o Devaluation makes export of goods cheaper and imports dearer.
 Exchange Control
o It is a popular strategy employed to influence the balance of payments
positions of a country.
o Under this method, the government or central bank assumes full
control over the foreign exchange reserves and earnings of the
country.
o Recipients of foreign exchange, such as exporters, are required to
surrender their foreign exchange to the government’s central bank, in
exchange for the country’s domestic currency.
o Through its control over the use of foreign exchange, the government
can control imports.

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Trade Measures

 Export Promotion
o Export promotion includes the reduction and abolition of the export
duties, providing export subsidy, encouraging export production and
export marketing by giving monetary, fiscal, physical and institutional
incentives and facilities.
 Import Control
o Import Control can be done by enhancing import duties, restricting
imports through import quotas, licensing and even prohibiting
altogether the import of certain inessential items.

Miscellaneous Measures
Some miscellaneous measures like foreign loans, Incentives to promote foreign
investments and remittances, development of tourism can be used to control BoP
imbalances.

 Foreign Loans: Deficit BoP can be corrected by government borrowing

from foreign banks etc.
 Foreign Investments: By attracting foreigners in the country by offering
them various incentives and concessions so that there is more capital inflow
in the economy that helps government reduce deficit in BOP account.
 Tourism Development: Increasing tourist by offering them various
facilities like good hotels, transportation facility, concessional travel etc. this
would increase the foreign exchange earnings of the country.
 Foreign Remittances: Government gives incentives to people working
abroad. This helps in inflow of foreign exchange.
 Import Substitution: Producing substitutes of imported goods by providing
various incentives and concessions to the domestic industries. This replaces
foreign exchange outflow.

What were the Causes of the Balance of Payment Crisis 1991?

There was a huge Macroeconomic imbalance of high current account deficit and
high fiscal deficit. The crisis did not develop overnight. It was caused by decades
of imprudence. There was reliance on populist measures. The causes of Balance of
Payment Crisis are listed below.

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 1. The Government Expenditure was more than the earnings. Hence the Fiscal
Deficit was high. The Gross Fiscal deficit rose from 9 % of GDP in 1980-81
to 12.7 % of GDP in 1990-91.
2. The Internal Debt of the Government rose due to the above reason. It rose
from 35 % of GDP in 1985-86 to 53 % of GDP in 1990-91.
3. In addition the country was importing more than exporting. Hence the
Current Account Deficit was high.
4. The current account deficit was triggered by the rise in crude oil prices
because of the Gulf War. Due to this, the Forex Reserves of India depleted
massively. Despite substantial borrowings from the International Monetary
Fund (IMF) earlier in the year.
5. By June 1991, India had less than $ 1 billion forex reserves, just sufficient to
meet import requirements for a period of 3 weeks.
6. India did not have enough Forex reserves to conduct business with the
world.
7. India was on the verge of defaulting on its International Debt Obligations.
8. Investors pulled out their money.
9. Short term credit dried up, as exporters were apprehensive that they would
not be paid.
10.There was a massive rise in inflation rates.
The above crisis was treated as Balance of Payment Crisis.

The effects of the Balance of Payment Crisis are mentioned below.

1. Imports were restricted.

2. The price of fuels were raised.
3. Bank rates were raised.
4. Government had to cut its spending.
5. India had to secure an emergency loan of $ 2.2 billion from the International
Monetary Fund by pledging 67 tonnes of Gold as collateral security.
6. In May 1991, India sent 20 tonnes of Gold to Union Bank of Switzerland,
Zurich and in July, 47 tonnes of Gold was given to Bank of England to raise
a total of $ 600 million.

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 What did Manmohan Singh do in 1991?
The Government of India led by PV Narasimha Rao, with Manmohan Singh as
Finance Minister initiated a 4 pronged strategy to put the economy back on track.

Industrial Policy Reforms

1. License Raj and Inspector Raj were removed.

2. Industrial licensing was abolished.
3. Measures were taken to ease domestic supply constraints.
4. Measures were taken to spur investments.
Trade Policy Reforms

1. To make exports competitive Rupee was devalued by 20%.

2. Licensing controls and regulations on exports were eased.
Public Sector Reforms

1. There was liberalisation of Foreign Direct Investment (FDI).

2. Public Sector companies were given more operational freedom to scale up
and make bigger contributions to the economy.
Fiscal Correction

1. Subsidies for Exports were abolished.

Navratnas, Maharatnas and Miniratnas

The Public Sector Enterprises are run by the Government under the Department of
Public Enterprises of Ministry of Heavy Industries and Public Enterprises. The
government grants the status of Navratna, Miniratna and Maharatna to Central
Public Sector Enterprises based upon the profit made by these CPSEs. The
Maharatna category has been the most recent one since 2009, other two have been
in function since 1997.

There are examples of Maharatna :

1. Bharat Heavy Electricals Limited

2. Coal India Limited
3. GAIL (India) Limited
4. Indian Oil Corporation Limited

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5. NTPC Limited
6. Oil & Natural Gas Corporation Limited
7. Steel Authority of India Limited

There are some examples of Navratna :

1. Bharat Electronics Limited

2. Container Corporation of India Limited
3. Engineers India Limited
4. Hindustan Aeronautics Limited
5. Hindustan Petroleum Corporation Limited
6. Mahanagar Telephone Nigam Limited
7. National Aluminium Company Limited

There are some examples of Miniratnas :

 Airports Authority of India (AAI)

 Bharat Dynamics Limited (BDL)
 Bharat Sanchar Nigam Limited (BSNL)
 Cochin Shipyard (CSL)
 Dredging Corporation of India (DCI)
 Garden Reach Shipbuilders & Engineers (GRSE)
 Goa Shipyard (GSL)
 India Tourism Development Corporation (ITDC)
 Indian Railway Catering & Tourism Corporation Limited (IRCTC)
 IRCON International (engineering and construction company)
 NHPC Limited (National Hydroelectric Power Cooperative)
 Mazagon Dock Shipbuilders Limited (MDL)

The International Monetary Fund (IMF) works to achieve sustainable growth and
prosperity for all of its 191 member countries. It does so by supporting economic
policies that promote financial stability and monetary cooperation, which are
essential to increase productivity, job creation, and economic well-being. The IMF
is governed by and accountable to its member countries.

How does the IMF give policy advice?

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To maintain stability and prevent crises in the international monetary system, the
IMF keeps a regular policy dialogue with the governments of its member countries.
It assesses economic conditions and recommends policies that enable sustainable
growth. The IMF also monitors regional and global economic and financial
developments.

What is Foreign Direct Investments (FDI)?

Foreign Direct Investment (FDI) occurs when a foreign entity invests in a foreign
country to establish a lasting business presence. FDI refers to and typically
involves acquiring a controlling interest in a foreign company by buying at least
10% of its shares, providing the investor with influence over the company’s
management.

FDI takes various forms, such as mergers and acquisitions, where an existing
company is purchased or merged with a local one, greenfield investments,
involving the creation of a new company in a foreign location, and joint ventures,
which entail collaborating with a local company to establish a new entity. Now, let
us find out what is FPI.

What is Foreign Portfolio Investments (FPI)?

Foreign Portfolio Investment, which is the FPI full form, refers to foreign portfolio
investors investing in securities like stocks, bonds, and other financial assets
abroad. Unlike Foreign Direct Investment (FDI), FPI doesn’t entail gaining control
of the company. It’s a short-term strategy driven by market trends, involving the
buying and selling of securities.

FPI encompasses various forms, such as equity investments (buying shares in

foreign companies), debt investments (acquiring bonds from foreign governments
or companies), and other avenues like mutual funds, exchange-traded funds, and
real estate investment trusts. Let us now explore the FDI and FPI differences.

Following are the differences between FPI vs FDI:

Aspect Foreign Portfolio Investment (FPI) Foreign Direct Investment (FDI)

Definition Investment in foreign financial assets Investment in a foreign business with

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 such as stocks, bonds, or other lasting interest and control over
securities. management and operations.
Type of Indirect Investment Direct Investment
Investment
Purpose Capitalize on market opportunities or Establish or expand business operations in
diversify your investment portfolio. a foreign country.
Nature of Short-term investment with no intention Long-term investment commitment
Investment of controlling or managing the business
Level of Control Very low or no control High control
Entry & Exit Relatively easy Difficult
Return on Returns come from dividends, interest, Profits are generated through business
Investment or capital gains on financial assets. operations and direct ownership.

Risk Volatility Stable

Impact on Can impact financial markets and Potential to contribute to employment,
Economy liquidity, but with limited direct impact technology transfer, and economic growth.
on the economy.
Regulatory Focuses on regulating capital flows and Subjected to specific regulations and
Considerations investor behaviour. government approvals.

What Is Currency Convertibility?

Currency convertibility is the ease with which a country's currency can be

converted into gold or another currency. Currency convertibility is important
for international commerce (International commerce encompasses exchanging
goods, services, capital, technology, and intellectual property across borders
between companies, organizations, and governments in different countries) as
globally sourced goods must be paid for in an agreed-upon currency that may not
be the buyer's domestic currency.

 Currency convertibility refers to how liquid a nation's currency is in terms

of exchanging with other global currencies.
 A convertible currency can be easily traded on forex markets with little to
no restrictions.1
 A convertible currency (e.g., U.S. dollar, Euro, Japanese Yen, and the
British pound) is seen as a reliable store of value, meaning an investor will
have no trouble buying and selling the currency.1
 Non-convertible and blocked currencies (e.g. Cuban Pesos or North Korean
Won) are not easily exchanged for other monies and are only used for
domestic exchange with their respective borders.2

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What is International Monetary Fund(IMF)?

International Monetary Fund came into existence on 27th December 1945 and has
its headquarters located in Washington DC, United States. It has 191 countries as
its members currently. Its board is constituted of members from as many as more
than 180 countries worldwide, thus each representing its own nation. Such
representation is congruent to the level of importance a particular nation holds as
regards to its financial position in the world.
The IMF is a global organization that works to achieve sustainable growth and
prosperity for all of its 191 member countries thereby facilitating a system of
international payments and adjustments in exchange rates among national
currencies. Furthermore, its policies and practices aimed at bringing down the
global poverty rate and promoting international trade, thus supporting the
economies worldwide.

Role of the IMF

IMF was developed as an initiative to promote international monetary cooperation,
enable international trade, achieve financial stability, stimulate high employment,
diminish poverty in the world, and sustain economic growth. Initially, there were
29 countries with a goal of redoing the global payment system. Today, the
organization has 189 members. The main objectives of the International Monetary
Fund (IMF) are mentioned below:

1. To improve and promote global monetary cooperation of the world.

2. To secure financial stability by eliminating or minimizing the exchange rate
stability.
3. To facilitate a balanced international trade.
4. To promote high employment through economic assistance and sustainable
economic growth.
5. To reduce poverty around the world.
What are the functions of the IMF?

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IMF mainly focuses on supervising the international monetary system along with
providing credits to the member countries. The functions of the International
Monetary Fund can be categorized into three types:

1. Regulatory functions: IMF functions as a regulatory body and as per the

rules of the Articles of Agreement, it also focuses on administering a code of
conduct for exchange rate policies and restrictions on payments for current
account transactions.
2. Financial functions: IMF provides financial support and resources to the
member countries to meet short term and medium term Balance of Payments
(BOP) disequilibrium.
3. Consultative functions: IMF is a centre for international cooperation for the
member countries. It also acts as a source of counsel and technical
assistance.

India & IMF

India is a founder member of the IMF. India’s Union Finance Minister is the Ex
Officio Governor on the IMF’s Board of Governors. Each member country also
has an alternate governor. The alternate governor for India is the Governor of the
RBI. There is also an Executive Director for India who represents the country at
the IMF.

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