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19 August, 2024

Balance of Payment Accounts

Balance of Payment Account records the international economic transactions of a country with the rest of the world during a particular period of time.

 

Transactions are to be recorded when the real resources or financial items involved undergo a legal change of ownership which is taken to be the time the parties concerned enter the transactions in their books. Transactions should be valued at market prices.

 

Classification of Items of BOP Account:

 

The items or components of BOP A/C are grouped into two broad categories- Current and Capital

Account.

 

§    Current Account transactions are divided into those involving goods, services, incomes and unrequited transfers. These include visible exports and imports, shipment, travel, transportation, investment income, private and official unilateral transfer (involving no quid pro quo) etc.

 

§    Capital Account covers transactions in financial assets and liabilities. In addition, it incorporates supplementary information on total changes in reserve holdings, together with counterpart entries that affect those changes not due to transactions. In order to facilitate analysis, capital transactions are broken down by using several criteria: type of capital (represents direct and portfolio investment, other capital and reserves), length of maturity and assets and liabilities. Reserves (official) are composed of the monetary gold, SDR allocation in IMF, Reserve position in


The IMF, use of IMF credit and existing claims on non-residents. For the most part reserves are held by the central authorities, although funds are also held by deposit money banks but subject to effective control by the Govt. are also considered international reserves.

 

Analytical Framework for External Sector: A major purpose of BOP A/C is to provide an indication of whether there exists an external imbalance and there is need for policy adjustment in order to rectify such an imbalance. The following concepts are useful for the above purpose.

 

The narrowest definition of payments imbalance is related to the Trade Balance (TB), indicating the difference between exports and imports on an FOB basis.

 

The Current Account Balance (CAB) is represented by transactions on goods, services, and income plus unrequited transfer. It shows the net change in financial assets arising from an economy's real transactions. This corresponds to current surplus or deficit in the rest of the world sector of the national accounts.

 

The Basic Balance (BB) tries to indicate the longer-run BOP position by placing ―below the linetransactions that are likely to be reversed in the short-run (such as short-term capital flow, changes in official reserve and errors and commissions). Long-term capital flows are included ―above the line‖, in addition to current account items.

 

An Overall Balance (OB) is commonly considered as a measure of BOP ―performance. It places all current account items, capital movements and errors and omissions above the line‖, and changes in reserves below the line‖. Thus a surplus in overall balance represents a country's increase in reserves and a deficit in overall balance represents decrease in reserves.

 

The above concepts are represented by following equations: (X-M)+T+LTC+STC+    R+E=0

Where, X = Export, M = Import, T= Transfer, LTC= Long-term Capital, STC= Short Term Capital, R = Reserve, E = Error and     = Change Thus, TB= (X-M) = -(T+LTC+ STC+R+E)

CAB = (X -M) +T=- (LTC+STC+R+E)

 

BB = (X -M) +T+ LTC = - (STC+       R + E) OB = (X – M) +T+LTC+STC+E = -    R


Government Financial Accounts

 Government Finance Account records government's revenues and expenditures. One can ascertain the flow of payment between a govt. and rest of the economy during a given period of time out of this account. In other words, this account shows the activities of govt. likely to affect the rest of the economy.

 Classification of Govt. Transactions: Govt. transactions are summarized into five groups: revenue, grants, expenditure, net lending and financing.

 

§    Revenue includes all non-repayable receipts, requited and unrequited, other than grants from other governments and international institutions. Revenues can be divided into current and capital; the latter includes only receipts from the sale of capital assets. Current revenue embraces all tax revenue and current non-tax revenue. Taxes are compulsory, unrequited, non-repayable contributions exacted for public purposes.  Non-tax revenue includes receipts from property income, fees and charges, non-industrial sales, and the operating surpluses of departmental enterprises.

 

§    Grants   are   defined   as   unrequited,   non-repayable,   non-compulsory   receipts from   other governments or international institutions.

 

 

§    Expenditure  consists  of  all  non-repayable  payments  by  government,  whether  requited  or unrequited  and  whether  for  current  or  capital  purposes.  Only  requited  payments  contribute directly to production, consumption and capital formation, while unrequited expenditures or transfers  redistribute the  effective  demand  among  the  different  sectors  of  the  economy. A distinction between current and capital expenditure is necessary to measure government capital formation and savings.

 §    Net Lending (or lending minus repayments) consists of all transactions in claims upon other sectors that are undertaken for purposes of public policy other than financial management. It consists of loans by government and their repayment as well as purchase and sale of equity.

 §    Financing is equal to the balance of revenue, grants expenditure and net lending. It covers all transactions involving government's holding or currency and deposits, government liabilities, and any financial assets held by the government for the purpose of financial management rather


Than public policy.  Financing is divided into financing obtained from residents and financing obtained from non-residents. It is further classified by type of debt holder (e.g. commercial banks) any by type of debt instrument (e.g. treasury bills).

  Performance of Govt. Financial Account:

 The performances of GFA may be reflected by two measures: Overall Balance and Current Account

Balance.

 

§    Overall Balance is defined as the balance of revenue, grants, expenditure and net lending:

 Overall  Deficit/Surplus  =  (Current  Revenue  +  Capital Revenue  +  Grants)  -  (Current

Expenditure

+ Capital Expenditure + Net Lending)

 

The overall budget balance is often used as a summary measure of the stance of fiscal policy: an overall deficit indicative of an expansionary fiscal policy, while an overall surplus is indicative of a contractionary impact.

 

§    the second concept of balance is current account surplus / deficit, defined as the difference between current revenue and current expenditure. With some qualifications, this concept can be used as a measure of Govt. sector savings.