BALANCE OF PAYMENTS
Economics
INTRODUCTION TO BALANCE OF PAYMENTS (BOP)
Balance of Payments is a systematic and comprehensive record of all economic transactions carried out between the residents of a country and the rest of the world during a specific period, usually one financial year.
The main objectives of maintaining BOP are:
- To assess the international economic position of a country
- To help the government frame appropriate monetary and fiscal policies
- To guide trade, exchange rate and external sector policies
- To understand trends in foreign exchange inflows and outflows
STRUCTURE OF BALANCE OF PAYMENTS
The Balance of Payments account is broadly divided into:
- Current Account
- Capital Account
CURRENT ACCOUNT
The current account records all transactions related to trade in goods and services, income flows and transfer payments between one country and the rest of the world.
It reflects whether a country is a net exporter or net importer of goods and services.
TRADE IN GOODS (MERCHANDISE TRADE)
Exports of India: India exports a wide range of goods to global markets.
Major exported goods:
- Petroleum products
- Pearls, precious and semi-precious stones
- Drug formulations and pharmaceuticals
- Gold jewellery
- Iron and steel
Countries with which India has trade surplus:
- United States of America
- United Arab Emirates
- Singapore
Export Preparedness Index:
- Developed by NITI Aayog
- Ranks states based on infrastructure, transport connectivity and ease of doing business
Remittances:
- India is the largest recipient of remittances globally
- Followed by China and Mexico
IMPORTS OF INDIA
Major imported goods:
- Petroleum crude
- Gold
- Pearls, precious and semi-precious stones
- Petroleum products
- Coal and coke
Major imported services:
- Business services
- Travel services
- Transport services
- Software services
Countries with which India has trade deficit:
- China
- Switzerland
- Middle East nations
TRADE IN SERVICES (INVISIBLES)
Trade in services includes both factor and non-factor income transactions.
Net Factor Income from Abroad:
- Difference between income earned by domestic residents abroad and income earned by foreign residents within the country
- Includes wages, interest, dividends and profits
Net Non-Factor Income from Abroad:
- Includes remittances from overseas migrants
- Excludes investment income and capital flows
Non-Factor Services:
- Shipping and transport services
- Passenger services
- Tourism
- Other invisible transactions not classified elsewhere
TRANSFER PAYMENTS
Transfer payments are one-sided transactions without any quid pro quo.
They include:
- Grants
- Gifts
- Remittances
- Repatriation of savings
Official transfers:
- Grants and donations received by Government of India from foreign governments and multilateral institutions
- Similar transfers made by India to other countries
BALANCE ON CURRENT ACCOUNT
The current account is said to be in balance when receipts equal payments.
Components:
- Balance of Trade (BOT)
- Balance of Invisibles
- Balance of Transfers
Balance of Trade (BOT):
- Difference between value of exports and imports of goods
- Trade deficit occurs when imports exceed exports
Balance of Invisibles:
- Services, income and remittances
- Helps offset merchandise trade deficit
Balance of Transfers:
- Net transfer receipts from abroad
KEY COMPONENTS AFFECTING CURRENT ACCOUNT
CRUDE OIL
Factors affecting oil prices:
- Global supply disruptions
- Economic growth and demand
- Geopolitical uncertainty
India’s major oil suppliers:
- Iraq
- Saudi Arabia
- United States
Strategic Petroleum Reserves of India:
- Visakhapatnam
- Chandikhol
- Padur
- Mangalore
- Stored in underground rock caverns
Global Oil Benchmarks:
- West Texas Intermediate (WTI): US benchmark
- Brent Crude: North West Europe benchmark
GOLD AND CURRENT ACCOUNT
Reasons for high gold imports:
- Cultural importance
- Hedge against inflation
- Safe asset
- Limited domestic production
Sovereign Gold Bond Scheme:
- Issued in denominations of one gram
- Tenure of 8 years
- Interest rate of 2.5 percent
- Tradable on stock exchanges
Gold Monetisation Scheme:
- Allows deposit of old jewellery with banks
- Tenure ranges from 1 to 15 years
- Interest around 2 percent
- Redemption in gold or cash
Gold Coins:
- Available in 5, 10 and 20 grams
- Not legal tender
CAPITAL ACCOUNT
The capital account records all transactions related to acquisition and disposal of financial and non-financial assets.
It reflects changes in a country’s foreign assets and liabilities.
FOREIGN DIRECT INVESTMENT (FDI)
FDI refers to investment made by a foreign entity in a domestic enterprise with the intention of long-term control and management.
Benefits:
- Capital inflow
- Technology transfer
- Skill development
- Employment generation
Components:
- Equity capital
- Reinvested earnings
- Intra-company loans
FDI in India:
- India is the world’s largest greenfield FDI destination
- Computer software and hardware receive major inflows
- Singapore is the top source country
FDI ROUTES
Automatic Route:
- No prior approval required
- Sectors include medical devices, power, ports, rail infrastructure and insurance (up to prescribed limits)
Government Route:
- Approval required through Foreign Investment Facilitation Portal
- Decision taken in consultation with DPIIT
Prohibited Sectors:
- Lottery
- Gambling
- Nidhi companies
- Chit funds
- Tobacco manufacturing
- Atomic energy
- Certain railway operations
FDI Reforms 2020–21:
- Insurance FDI limit raised to 74 percent
- Telecom sector opened up to 100 percent FDI under automatic route
PORTFOLIO INVESTMENT
Portfolio investment involves purchase of financial assets without management control.
Foreign Portfolio Investment (FPI):
- Highly liquid
- Short-term and speculative
- Often referred to as hot money
Foreign Institutional Investors (FIIs):
- Institutional investors bringing portfolio investments
- Must be registered with SEBI
EXTERNAL BORROWINGS AND ASSISTANCE
External Borrowings:
- Loans from foreign banks, governments and institutions
External Assistance:
- Loans and aid received by India
- Assistance provided by India to other countries
India’s External Debt:
- Commercial borrowings are the largest component
- NRI deposits second largest
- Short-term trade credit third largest
Currency composition:
- Dominated by US dollar
- Rising share of Indian rupee denominated debt
EXCHANGE RATE SYSTEM
Exchange rate refers to the value of domestic currency in terms of foreign currency.
Types of Exchange Rate Systems:
Flexible Exchange Rate:
- Determined by market forces
- Minimal government intervention
Fixed Exchange Rate:
- Fixed by government
- Maintained through central bank intervention
Managed Floating Exchange Rate:
- Market-determined with RBI intervention
- Followed by India
DEVALUATION AND REVALUATION
Devaluation:
- Official reduction in currency value
- Promotes exports and discourages imports
Revaluation:
- Official increase in currency value
- Makes imports cheaper and exports costlier
NOMINAL AND REAL EXCHANGE RATE
Nominal Exchange Rate:
- Market price of one currency in terms of another
Real Exchange Rate:
- Adjusted for inflation differentials
- Reflects real purchasing power
NEER and REER:
- NEER: Weighted average of bilateral exchange rates
- REER: NEER adjusted for inflation
Higher REER:
- Reduces export competitiveness
CURRENCY CLASSIFICATION
Hard Currency:
- Stable and widely accepted
- Examples: US Dollar, Euro, Yen
Soft Currency:
- Volatile and unstable
- Common in developing economies
Hot Money:
- Short-term speculative capital flows
CONVERTIBILITY OF RUPEE
Current Account Convertibility:
- Fully convertible since 1994
Capital Account Convertibility:
- Partially allowed
- Governed by FEMA, 1999
- Based on Tarapore Committee recommendations
FOREIGN EXCHANGE RESERVES
Foreign exchange reserves include:
- Foreign currency assets
- Gold
- SDRs
- IMF reserve position
Objectives:
- Exchange rate stability
- Crisis management
- Confidence in external sector
India’s forex reserves:
- Around 600 billion US dollars
TRADE RELATED CONCEPTS
Safeguard Measures:
- Emergency protection against import surge
Arbitrage:
- Profit from price differences across markets
SPECIAL ECONOMIC ZONES (SEZ)
Definition:
- Treated as foreign territory for trade and taxation
Legislation:
- SEZ Act, 2005
Features:
- Tax incentives
- Single window clearance
- Government support in infrastructure
Asia’s first SEZ:
- Kandla, Gujarat (1965)
FOREIGN TRADE POLICY (2015–20)
Nodal Agency:
- Directorate General of Foreign Trade
Objective:
- Double exports
Key Schemes:
- Interest Equalisation Scheme
- Advance Authorisation Scheme
- Niryat Bandhu Scheme
INTERNATIONAL FINANCIAL SERVICES CENTRE (IFSC)
Objective:
- Make India a global financial hub
Structure:
- Set up as SEZ
- Regulated by IFSC Authority Act, 2019
Authority Composition:
- Chairperson
- Members from RBI, SEBI, IRDAI and PFRDA
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Subject: Economics
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