What is Balance of Payments and What Does it Mean for Your Business?

Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. BoP positions indicate various signals to businesses. BoP comprises current account, capital account and financial account.and services, income and current transfers. In the capital account, transactions of capital transfers, capital acquisition and non-produced non-financial assets like buildings and patents are included, while in the financial account, transactions relating to financial assets and liabilities like portfolio investments and foreign exchange reserves are included. However, the BoP account of most countries still classify transactions under two heads only capital account and current account. In such a case, financial and capital accounts are treated as one. Transactions in BoP are recorded on a double-entry bookkeeping system that is, a transaction is recorded on each sidedebit and credit of the BoP account. There are many signals that the BoP account of a country gives out. For example, large current account transactions indicate towards openness of an economy. This was the case with India as reduction in trade restrictions and duties led to increase in both exports and imports after 1991. Also large capital account transactions may indicate well-developed capital markets of an economy.

Capital and current account balances for India were quite stable between 1991 and 2001. After 2001, primarily because of increased exports of IT services and transfers, current account balance went into surplus. But due to increasing imports and an increasing oil bill, it started deteriorating after 2004 and went into deficit. Sound fundamentals and a large untapped market coupled with a deregulated regime allowed foreign investors to invest in India, thereby increasing capital inflows after 2000. However, the global meltdown has led to an outflow of capital, which has led to a sudden

fall in the capital account balance after 2007. Reserves were built up over the years mainly because of capital inflows. But a recent deficit in current account and capital outflow led to a fall in 2008-09.

Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and among investors. However, healthy BoP positions may be different for different countries. For example, surplus in current account is often more important for developed countries than surplus in capital account as most of them have sufficient capital to fund their investments. On the other hand, developing countries like India may place more importance on capital account as reserves and funding for investment is crucial for them at present. Large balances often attract foreign investors into an economy, thus bringing in precious foreign exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to businesses. Businesses can make predictions about exchange rates by studying BoP positions. A healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to engage in future contracts accordingly. Also, the BoP position influences the decisions of policy makers, which are crucial for any business. How does BoP influence economic policy? The policies of a nation are highly affected and determined by the position and status of its BoP. While formulating or deciding any economic policy, BoP position and policy effect on BoP is given special consideration. While all the policies affect BoP, policies like tariff policy, those related to foreign flows etc affect it in greater magnitude. Earlier, trade-related policies used to have special focus. But over the years the share of current account transactions in total BoP transactions has decreased. For example, in India its share was almost 60% in 1991-92, but reduced to around 44% in 2007-08. Also, mismatch has been much greater in capital account in recent years, which gave rise to Indias foreign exchange reserves. Over the years, these trends have forced policy makers to make policies keeping in mind foreign flows (capital) and effects of policies on them. However, policies at the same time could be held responsible for such flows. To improve BoP positions countries have lately often leaned towards the capital account side. The trend has shifted from import substituting policies, that is, policies in which imports are discouraged by way of tariffs, quotas toward more of foreign inflows enhancing policies in the belief that such inflows may make a country crisis-proof and lead to investments that would increase productive capacity and also may increase exports that would earn foreign exchange in future. However, BoP position in itself affects decisions of policy makers. Often, a deteriorating current account is supported by capital or financial account. A healthy BoP position often allows countries to open up their trade and to appropriate gains from it. Indias BoP India presently has a deficit in its current account of BoP, which has increased substantially after reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in 1991, Indias position of merchandise trade (exports and imports of goods) kept on deteriorating, but its position on invisibles (services, current transfers etc) improved during the period. However, one of the major factors for increasing current account deficit in the last few years has been a rising oil import bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK have deficits. India has done fairly well on the capital
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account side. In 2007-08 it had a capital account surplus of $108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million, which provided stability to the economy. Foreign investments have increased manifold since 1991, peaking in 2007-08 to $44,806 million.Indias overall current account and capital account deficit is $20,380 million for AprilDecember 2008, which is expected to rise to a figure between $25 and 30 billion by the year ending March 31, 2009. There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in March 2009. Reasons for this are portfolio flows from foreign institutional investors and the appreciation of the US dollar. But this may not pose a significant threat to the Indian economy and businesses because of large pool of reserves that are still providing enough cushion. However, some businesses like those related to equities and realty are hit when outflows from these sectors occur. Not only is there fall in asset prices and erosion of investment value, but economic activity also gets reduced in these sectors.However, recent profitability/growth numbers have indicated signs of a revival. Also political change and expected stability might bring in foreign exchange and may improve Indias capital account position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters and importers accordingly. At the same time, reserves infuse stability into the system, which in turn has positive effects on businesses and investments. Definition of 'Balance Of Payments - BOP' A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Investopedia explains 'Balance Of Payments - BOP' Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency. This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners. Definition of 'Current Account' The difference between a nation's total exports of goods, services and transfers, and its total imports of them. Current account balance calculations exclude transactions in financial assets and liabilities. Investopedia explains 'Current Account' The level of the current account is followed as an indicator of trends in foreign trade. Definition of 'Current Account Deficit'

Occurs when a country's total imports of goods, services and transfers is greater than the country's total export of goods, services and transfers. This situation makes a country a net debtor to the rest of the world. Investopedia explains 'Current Account Deficit' A substantial current account deficit is not necessarily a bad thing for certain countries. Developing counties may run a current account deficit in the short term to increase local productivity and exports in the future.