Balance of Payments- a guide to Indian economy

Balance of Payments is a way to enlist receipts and payments of transaction for a nation. It depicts how well the country is doing in trade, attracting capital from abroad (FII) and the effect of the same on the foreign reserves.

Structure of Balance of Payment

The balance of payment is based on the doctrine of double entry system. It means for every debit there is a credit. However, it differs from accounting in one respect. In business accounting all debits are shown on the left side and credits are shown on the right side of the income statements.

While, in balance of payments the debits are shown on the right side and credits are shown in the left side of the income statements.

Principles

·         If a payment is received by a country in overseas transaction, it is known as a credit transaction.

·         If the payment is made in an overseas transaction; it is known as a debit transaction.

·         The chief items that are presented in the credit side are exports of goods and services, transferred receipts, subscription from overseas account, borrowings from overseas account, investment by overseas account and sale of reserve assets.

·         The debit side consists of imports of goods and services, payments to overseas accounts like gifts, lending to overseas account and purchase of reserve assets or gold to overseas account or overseas agencies.

·         The credits and debits are presented in form of double entry system of book keeping.

·         They are categorized as current account, capital account, and official reserve or official settlement account.

Current account- Current account represents all transactions related to business merchandise, services and transfers.

·         Service transaction includes cost of transportation of services, insurance earnings, reimbursement of overseas investments.

·         It includes goods like raw materials, manufactured goods and services include receipts of tourism, transportation, business service fees, royalty from patents and copyrights.

·         Transfer payments include gifts, subscription, overseas assistance and remittance made by private companies or organization, etc.

·         When all these products and services are combined together it becomes balance of trade. If a country has a trade deficit it is means imports are more than exports, while if you have balance of trade surplus, it means exports are more than imports.

·         Receipts from stock trade and dividends are also added in current account.

·         On the right side imports are included in balance of payments and it is computed based on costs, insurance and freight.

Capital account

The capital account is a place where all capital transfers are added. It means acquisition and disposal of asset like land, and non produced assets that are used for production but have not been produced, seems confusing isn’t it?

For example, a mine cannot be produced but it is used in extraction of diamonds.

Thus the capital account can be divided into various categories like monetary flows from debts, transfer of goods, financial assets by immigrants entering or exiting the country, transfer of funds related to sale and acquisition of assets, gift taxes, inheritance taxes, uninsured damage to fixed assets, if any.

The financial account

The financial account represents international monetary flows that can be related to investment in real estate, bonds and stocks.

Also, in financial account, you can include foreign reserves, gold, special drawing rights that are held with IMF, private assets and FDI. Assets that are owned by non residents and are private and official are also recorded in capital account.

Balancing account

The current account should always balance with capital account, but this rarely happens.  Moreover, the fluctuating exchange rates can add fuel to the fire.