BALANCE OF PAYMENTS ADJUSTMENTS

When we discuss import licensing policy or exchange control we assume that the objective of the government is to restrict import so that the domestic import competing industries are given encouragement to expand and replace imported goods. Very often, however, the government’s objective is not so much to promote import substitution (because the country may not even produce the goods that are imported) but to reduce the import bill. This takes us to the concept of the balance of payment. Every country is like a company vis-a-vis the rest of the world and it has to settle accounts with the other countries. The statement of a country's financial transactions with the rest of the world is called the balance of payment statement. You may look at any issue of Economic Survey for India’s balance of payment statement. You have also learnt the balance of payment in Unit 3. To recapitulate, the statement is divided into three parts: the current account, the capital account and the official account, the entries in the current account show values of exports and imports during the financial year. The difference between the value of export and the value of imports (in rupees or dollars) is the balance on trade account. So we have a trade surplus or a trade deficit depending on whether the balance on trade account is positive or negative. There are other entries in the current account, like travel or tourism which are called invisibles. The invisibles are also like exports and imports of goods. When a foreign traveler comes to India and purchases hotel services, it is our invisible export. When our tourists go abroad and do the same thing, it is our invisible import. The balance on invisible trade (export minus import) plus the balance on trade account (trade deficit or surplus) is called the current account balance. Then we come to the capital account of the balance of payment statement. The transactions here are in the nature of capital import or export. If the government of India or an Indian company makes an investment abroad, say by purchasing a financial asset, it is capital export. If the foreigner invests in India it is capital import. The foreign investment may be either direct investment or portfolio investment. If a foreign company comes to India and sets up a factory or a shop to do business directly with the Indian people, it is direct investment. On the other hand, if the foreigner simply invests in shares and bonds floated by Indian companies, it is portfolio investment. There is an element of asymmetry between current account and capital account. In current account imports are items for which we make payments to the foreigners and exports are our receipts from the foreigners. In the capital account import of capital is a receipt item and the export of capital is a payment item. Therefore the balance on capital account is total capital import minus total capital export and a positive balance is a surplus and a negative balance is a deficit.

The total balance, i.e., the balance on current account plus the balance on capital account is called the balance of payment which may show an overall deficit or surplus. A country may have a deficit in the current account but a surplus in the capital account and an overall deficit in the balance of payment. This was precisely the position in India’s balance of payment in the last financial year. A balance of payment deficit simply means that certain payments are due to the foreigners and a surplus means that the foreigners are indebted to us in respect of certain payments. Since a deficit or a surplus needs adjustment, we have an official account showing how this adjustment is made. A BOP deficit may be adjusted by the Reserve Bank of India through sale of foreign currencies released from the foreign exchange reserves, or by borrowing from the International Monetary fund or by foreign aid. A surplus may be adjusted by increasing the foreign exchange reserves. When all these official transactions take place, the grand balance, i.e., balance on current account plus balance on capital account plus balance on official account, becomes zero and this has to happen by the law of accounting.