BALANCE OF PAYMENT ACCOUNTING & MEASURES TO CORRECT IT

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M.COM First Year Tutor Marked Solved Assignment

Course Code: IBO – 03
Course Title: India's Foreign Trade
Assignment Code: IBO-03/TMA/2019-20
Coverage: All Blocks

IBO – 03 India's Foreign Trade Solved Assignment for 2019-20

Q1.) Discuss "Balance of payment Accounting" in the context of India. Explain the main items in the balance of payments. What policy measures were taken to improve the situation of the balance of payments?

Ans: 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 i.e., it takes place between the country's residents and the residents of other countries during a specified time period. It is used as an indicator of a country's political and economic stability.

Balance of payment accounting uses the system of double-entry bookkeeping, which means that every debit or credit in the account is also represented as a credit or debit somewhere else. Balance of payment sheet, records currency inflow as credits (plus sign), whereas outflows are recorded as debits (minus sign). In the balance of payments accounting the balance of payments should be zero because every transaction is two-sided with debits balancing credits. But in practice, the balance of payments will not always be equal to zero. This can be due to a lack of statistical data to record all transactions or a country's central bank engaging in transactions that are not counted towards the country's balance of payments.

The BOP consists of three main components- current account, capital account, and reserve account. 

Current Account : 

The current account monitors the flow of funds from goods & services trade (import and export) between countries. Now this includes money received or spent on manufactured goods and raw materials. It also includes revenue from tourism, transportation receipts, revenue from specialized services ( medicine, law, engineering), and royalties from patents and copyrights. In addition, the current account includes revenue from stocks.

Capital Account : 

The capital account monitors the flow of international capital transactions. These transactions include the purchase or disposal of non-financial assets ( for example, land) and non-personal assets. The capital account records the flow of the financial assets by migrants leaving or entering a country and the transfer, sale, or purchase of fixed assets.

Reserve Account : 

It includes only the 'reserve assets' of the country. These are the assets that the monetary authority of the country uses to settle the deficits and surpluses that arise when the two categories are taken together. The official reserve increases when there is a trade surplus and decreases when there is a deficit. Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.

Measures Taken to Improve BOP : 

  1. Foreign Exchange Policy : 

Countries prefer to limit exchange rate movement within the ceiling of movements that affect the fundamentals. India had large capital inflows soon after the adoption of the market-based exchange rate system in 1993. The inflows surpassed the current account deficits and excess supply conditions prevailed in the foreign exchange market. The aim is to prevent real appreciation of exchange rate and protect external competitiveness, which can be done by the following:

• The central bank intervenes and sterilizes the foreign market.
• Trade restriction should be relaxed to permit capital flow.     

  2. Convertibility : 

In August 1994, India opted for current account convertibility (CAC). As defined by the Committee on Capital Account, Capital Account Convertibility(CAC) refers to the freedom to convert local financial assets into foreign financial assets and vice versa at market-determined rates of exchange. CAC is also applicable to foreign investors, non-resident depositors and resident corporate contraction of external commercial borrowings. To organize the financial system for CAC, the committee made many suggestions. They sought to remove market segmentation and extend uniform treatment to resident and non-resident liabilities, to introduce more stringent capital adequacy standards and prudential standards for effective supervisory systems and give greater autonomy to banks.