Balance of Payments is a statement of every recorded transaction made between entities or business unit in one country with that of the rest of the world over a defined period of time, such as the quarter of the year.
This article will give details about the balance of payments within the context of the IAS Exam.
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Balance of Payment Latest Developments
The latest balance of payment (BoP) data (2023) reveal some positive developments, but there are also some concerns for the medium-term outlook.
Overview of Latest BoP Trends:
- The latest data on the balance of payments (BoP) for Q3FY23 reveals a significant improvement in the current account deficit (CAD), which has reduced to 2.2% of gross domestic product (GDP) from the previous quarter’s 3.7%.
- This is a positive indication of the strengthening external sector fundamentals.
- The improvement in CAD is driven by a notable reduction in the merchandise trade deficit and a sharp increase in services trade surplus and net remittances received, which are at historic high levels.
- In addition, the overall BoP has returned to a surplus of $11 billion in Q3 after a considerable deficit in Q2.
- The short-term outlook for the BoP appears optimistic, and a further reduction in the CAD is anticipated in Q4.
- The trade deficit has already shrunk considerably in the first two months of Q4, averaging at $17 billion compared to $24 billion per month in Q3.
- Furthermore, services exports have remained strong, keeping the surplus in this account near record highs.
- The balance of payments (BoP) outlook for India is uncertain in the medium term due to two factors – India’s GDP growth and the interest rate differential with the rest of the world.
- While India’s growth is expected to remain strong, a slowdown in major export destinations may affect the country’s exports.
- On the other hand, domestic macroeconomic factors and the government’s investment focus are positive signs for imports.
- The BoP is also impacted by bond yield differentials and foreign investment flows, which have been decreasing lately.
Impact of Global Commodity Prices:
- Global commodity prices are expected to decrease in FY24 due to slowing growth, which may provide some relief to the current account deficit (CAD).
- However, it is uncertain whether this will be enough to maintain a surplus in the balance of payments (BoP) and help the Indian rupee recover from its decline in FY23.
Description of Balance of Payments
The balance of payments (BOP), also known as balance of international payments, summarizes all transactions that a country’s individuals, companies, and government bodies complete with individuals, companies, and government bodies outside the country. These transactions consist of imports and exports of goods, services, and capital, as well as transfer payments, such as foreign aid and remittances.
A country’s balance of payments and its net international investment position together constitute its international accounts.
The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa. If a country exports an item (a current account transaction), it effectively imports foreign capital when that item is paid for (a capital account transaction).
If a country cannot fund its imports through exports of capital, it must do so by running down its reserves. This situation is often referred to as a balance of payments deficit, using the narrow definition of the capital account that excludes central bank reserves.
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What are the components of a Balance of Payments?
Balance of Payments is made up of 3 components.
- Current Account – Deals with inflow and outflow of goods and services between countries.
- Capital Account – Deals with foreign exchange reserves, investments, loans & borrowings.
- Financial Account – Deals with investments in real estates, business ventures, Foreign Direct Investments (FDI).
Why Balance of Payment is Important?
- It helps the Government to analyse a particular industry and formulate policies accordingly.
- Helps the Government to detect the state of the economy and accordingly plan the monetary policy, fiscal policies.
- It helps the government to evaluate the tax rates for exports and imports.
What is the Current Account Deficit?
The total of Current Account must balance with the total of Capital and Financial Accounts in ideal situations. When a country’s imports are more than the country’s exports then it is called the current account deficit. In a vice versa situation then it called current account surplus.
What is the Balance of Payments Formula?
Balance of Payment = Balance of Current Account + Balance of Capital Account + Balance of Financial Account.
- The recent BoP trends have been positive for the Indian economy, but there are also some medium-term concerns.
- By keeping a close eye on the BoP trends, policymakers can make informed decisions to ensure the stability and growth of the Indian economy.
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