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Balance of Payments

Balance of Payments

About Balance of Payments

  • Balance of payments is a statement that summarizes an economy’s transactions with the rest of the world for a specified time period.
  • Balance of payments records only those transactions that have implications on forex reserves with the country.
  • Also known as balance of international payments, it records all trades involving forex conducted by both the private and public sectors in order to determine how much money is going in and out of a country.
  • The balance of payments classifies these transactions in two accounts: current account and capital account.

Purposes of calculation of Balance of Payment:

  • The basic purpose of BOP accounting is to know the strength and weaknesses of the Economy in international relations.
  • BOP statements give warning signals for future policy formation.
  • By analyzing the BOP accounts of the last year one can come to know the overall gains and losses from international trade. It can be ascertained that whether composition and direction of international trade and capital movements have improved or caused deterioration in the economic condition of the country.

Components of the Balance of payments (BOP)

The components of the balance of payment are:

  • Current account: It includes the financial transactions dealing with the export and import of goods, services, unilateral transfers, investment income etc.
  • Capital account: It includes the financial transactions dealing with assets such as foreign direct investment, foreign portfolio investment, foreign loans etc.
  • Official reserve transactions: It conducted by the central bank in case of the BOP deficit or BOP surplus.
  • Errors and omissions: It is the element of BOP (other than the current account and the capital account) which refers to the balancing items reflecting the inability to record all the international financial transactions.

Causes of deficit in BOP

Social causes

  • Changes in taste, preferences, fashion, and style, etc.
    • A favorable change for imported goods increases the demand for imported goods and lead to a deficit in the balance of payment.
  • Population explosion
    • Population explosion in underdeveloped nations, also generally, results in large scale imports and causes a deficit in the Balance of Payment.
  • Demonstration effect
    • Most of the developing countries get influenced by developed nations and start adopting the foreign pattern of consumption.
    • This results in a sharp rise in imports leading to a deficit in the Balance of Payment.

Economic causes

  • Inflation
    • Inflation i.e. continuous rise in prices in a country makes foreign goods relatively cheaper.
    • It increases imports which cause a deficit in the Balance of Payment.
  • Fast Economic Development
    • For fast development, developing countries import machines, technology, and other equipment.
    • This leads to a high level of outflows of foreign exchange that can result in a deficit in the BOP account.

Political causes

  • Political disturbances
    • Frequent changes in government, unstable tax structure, etc. result in loss of trust of foreign investors and discourage inflows of capital.
    • Domestic investors also prefer to invest outside the economy. As a result, an adverse position created in the balance of Payment.
  • Political Instability
    • Due to uncertainty, there may be large capital outflows and lesser inflows of foreign funds. It can create an adverse position in the Balance of Payment.       (Balance of Payments)

Factors Responsible  For The Balance Of Payment Crisis In 1991

  • The first important factor responsible for this growing crisis in BOP was the policy of import liberalisation introduced by the Congress (I) Government headed by Late Rajiv Gandhi resulting in a huge inflow of imports particularly after the announcement of Exim Policy in 1985.
  • The second factor responsible for the crisis was the existing heavy import base of the country. In-spite of attaining an encouraging 18.7 percent annual growth rate of exports during Seventh Plan, which was even higher than the annual growth rate of imports (16.8 per cent), the BOP position deteriorate to a serious point as the country started with larger volume imports.
  • The third factor responsible for this BOP crisis is the higher import intensity in the industrial development resulting from import intensive industrialisation process followed in the country for meeting the requirements of elitist consumption (viz., colour TVs, VCRs, refrigerators, motor cycles, cars) etc.
  • The steep depreciation of rupee with dollar and other currencies during 1987-91 had resulted in a considerable increase- in the value of imports.
  • The worsening of the current account deficit in BOP in 1990-91 and therefore was partly on account of Gulf war and the higher price of petroleum imports and higher volume of petroleum imports continuously.
  • The current account deficit in 1990-91 weakened the ability to finance deficit massively. Political uncertainty at home, copied with rising inflation and widening fiscal deficits, led to a loss of international confidence. This had resulted in drying up of commercial borrowing and an outflow of NRI deposits.

Government response

  • To tackle such a grave crisis, the government’s immediate response was to secure an emergency loan from the International Monetary Fund by pledging tons of India’s gold reserves as collateral security.
  • Furthermore, the Narsimha Rao government brought wide ranging reforms which were collectively called LPG reforms (Liberalisation-Privatisation-Globalisation) and these formed part of the New Economic Policy (NEP).
  • Liberalisation- Liberalisation was introduced to put an end to restrictions and open up various sectors of the economy. Deregulation of Industrial sector, financial sector reforms, tax reforms, foriegn exchange reforms and trade and investment policy reform formed part of this measure.
  • Privatisation- It implies shedding of the ownership or management of a government owned enterprise. Privatisation of the public sector enterprises by selling off part of the equity of PSEs to the public is known as disinvestment.        (Balance of Payments )
  • Globalisation- Globalisation is the outcome of the policies of liberalisation and privatisation. It means an integration of the economy of the country with the world economy.

Conclusion  (Balance of Payments )

  • The crisis that erupted in the early 1990s was basically an outcome of the deep-rooted inequalities in Indian society and the economic reform policies further aggravated the inequalities.
  • But the process of globalisation through liberalisation and privatisation policies has produced positive as well which has helped leapfrog economic development in India.
  • (Balance of Payments)

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