2. Balance of Payments
• Includes all international economic transactions
– Merchandise trade(BoT)
– Services
– Banking and Insurance
– Capital flows
– Buying & selling of gold etc
• It’s a combination of
– Visible items
– Invisible items
• Uses the principle of double-entry book keeping
• Has provisions for “errors and omissions”
• Prepared in the domestic currency
3. INDIA’S BALANCE OF PAYMENT - Sample
A. CURRENT ACCOUNT
• MERCHANDISE
– Exports
– Imports
• INVISIBLES
– Services
• Travel, Transportation, Insurance, Misc
– Transfers
• Official, Private
– Investment Income
Credit Debit Net
4. INDIA’S BALANCE OF PAYMENT - Sample
B. CAPITAL ACCOUNT
• FOREIGN INVESTMENT
– In India
• Direct, Portfolio
– Abroad
• LOANS
– External Assistance
• By India, To India
– Commercial borrowings
– Short term
• BANKING CAPITAL
– Commercial Banks
• Assets, Liabilities, Non-
Resident Deposits
– NBFCs
• RUPEE DEBT SERVICE
• OTHER CAPITAL
C. ERRORS &
OMISSIONS
D. OVERALL BALANCE
(A+B+C)
E. MONETARY
MOVEMENTS
– IMF
– Foreign Exchange
Reserves
(Increase or Decrease)
Credit Debit Net
5. Balance of Trade
• Difference between
– Total receipts on account of export of goods and
– Total payments on account of import of good
– Trade surplus
– Trade deficit
• Considers only the pure forms of imports and
exports
• Refers to merchandise accounts of E and I only
9. DISEQUILIBRIUM IN BALANCE OF PAYMENT :
• Though the credit and debit are written balanced in the balance of payment
account, it may not remain balanced always.
• Very often, debit exceeds credit or the credit exceeds debit causing an imbalance
in the balance of payment account.
• Such an imbalance is called the disequilibrium. Disequilibrium may take place
either in the form of deficit or in the form of surplus.
• When there is either deficit or surplus balance of payment it is said to be in
disequilibrium.
• When a country is incurring more payments from abroad than it has to make then
it is considered favorable balance of payment which is in surplus.
• Contrary to it if a country makes more payments abroad than what it receives then
BOP is said to be unfavorable because it is in deficit.
10. The main causes of adverse BOP/ Causes of
Disequilibrium in BOP
1. Population Growth
2. Development Program
3. Demonstration Effect
4. Natural Factors
5. Cyclical Fluctuations
6. Inflation
11. METHODS TO CORRECT BALANCE OF PAYMENTS
1. Monetary methods
• Deflation
• Devaluation
• Exchange Depreciation
• Exchange Control
2. Non monetary measures
• Export promotion
• Import substitutes
• Import licensing
• Import quotas
13. International Finance
• Management of and trading in International
money and monetary assets
• Monetary assets are claims on
– Foreign currency
– Foreign deposits and investments and/or
– Foreign assets
• Claims are
– Denominated in various foreign currencies
purchased and sold.
– Involves exchange between various currencies
14. Components of International Finance
• All claims based transactions give rise to
(i) Borrowing and lending operations in foreign
currencies or trading in financial assets
denominated in foreign currencies - FOREIGN
CURRENCY MARKET
(ii) A foreign exchange transaction involving an
exchange of one currency for another –
FOREIGN EXCHANGE MARKET
(iii) INTERNATIONAL CAPITAL MARKETS
(iv) BONDS MARKETS
17. The Currency Market:
where money denominated in one currency is
bought and sold with money denominated in
another currency
International Trade and Capital Transactions:
facilitated with the ability to transfer purchasing
power between countries
18. Organization of the foreign exchange market
PARTICIPANTS AND TYPES
A. Participants at 2 Levels
1. Wholesale Level (95%) - major banks
2. Retail Level - business customers.
B. Two Types of Currency Markets
1. Spot Market:
- immediate transaction
- recorded by 2nd business day
2. Forward Market:
- transactions take place at a specified future
date
19. Organization of the foreign exchange market
C. Participants by Market
1. Spot Market
a. Commercial banks
b. Brokers
c. Customers of commercial and central
banks
2. Forward Market
a. Arbitrageurs
b. Traders
c. Hedgers
d. Speculators
20. Spot Rates
In finance, a spot contract, spot transaction, or simply “spot,” is a contract of
buying or selling a commodity, security, or currency for settlement (payment and
delivery) on the spot date, which is normally two business days after the trade
date. The settlement price (or rate) is called a “spot price” or “spot rate. ”
Forward Rates
A spot contract is in contrast with a forward contract where contract terms
are agreed now but delivery and payment will occur at a future date. The
settlement price of a forward contract is called a “forward price” or “forward rate.
” Depending on the item being traded, spot prices can indicate market
expectations of future price movements.
Cross Rates
A cross rate is the currency exchange rate between two currencies, both of
which are not the official currencies of the country in which the exchange rate
quote is given in.
• For example, if an exchange rate between the euro and the Japanese yen was quoted in an
American newspaper, this would be considered a cross rate in this context, because neither
the euro or the yen is the standard currency of the U.S. However, if the exchange rate
between the euro and the U.S. dollar were quoted in that same newspaper, it would not be
considered a cross rate because the quote involves the U.S. official currency.
21. Exchange Rate Determination
The trade and other economic and commercial
transactions involve receipts and payments as
between countries
These will lead to exchange of one currency for
others
The demand for and supply of each of the
currencies against an alternative currency
determines the rate at which two currencies are
exchanged
22. Devaluation and Depreciation of
currency
Devaluation
• A devaluation is when a country makes a
conscious decision to lower its exchange rate
in a fixed or semi-fixed exchange rate.
Therefore, technically a devaluation is only
possible if a country is a member of some
fixed exchange rate policy
Depreciation
• When there is a fall in the value of a currency
in a floating exchange rate. This is not due to
a government’s decision, but due to supply
and demand side factors.
23. Reasons to pursue a policy of
devaluation:
1. To Boost Exports
2. To Shrink Trade Deficits
3. To Reduce Sovereign Debt Burdens
24. Sources of Foreign Exchange
1. International Trade: The trade of goods and
services between countries requires each to
purchase the currency of the other in order to
make payments. Therefore, the international
demand for a country's output (exports) directly
affects the demand, and consequently the price,
of its currency.
2. Currency: In addition to global demand for a
country's securities and exports, a country's
currency is affected by day-to-day movements in
prices driven heavily by speculative trading
activity, such as day trading.
25. Institutions in Intl Finance
• National banks and domestic financial institutions which
deal in foreign currencies and foreign credits.
• International brokers of repute.
• Regional or multi-national banks or corporations dealing
in international markets and borrowing/ lending in these
markets.
• Regional Finance and Development Corporations and
banks such as the Asian Development Bank,
Commonwealth Finance Corporation, Latin American
Development Bank, Bank for International Settlements,
etc.
• International financial organizations like International
Monetary Fund (IMF), International Bank for
Reconstruction and Development (IBRD), International
