2 BUSINESS

ENVIRONMENT

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UNIT – II :
INDIAN
FINANCIAL
SYSTEM
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Industry; Trade & Balance Of Payment
 BALANCE OF TRADE:- The balance of trade is the difference between the
monetary value of exports and imports of output in an economy over a certain
period. It is the relationship between a nation's imports and exports. A positive
balance is known as a trade surplus if it consists of exporting more than is
imported; a negative balance is referred to as a trade deficit or, informally, a
trade gap.

 BALANCE OF PAYMENT:- Balance of payments (BoP) accounts are an

accounting record of all monetary transactions between a country and the rest
of the world. These transactions include payments for the country's exports and
imports of goods, services, financial capital, and financial transfers. The BoP
accounts summarize international transactions for a specific period, usually a
year, and are prepared in a single currency.

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THE GENERAL RULE IN BOP ACCOUNTING

a) If a transaction earns foreign currency for the nation, it is a credit and

is recorded as a plus item.
b) If a transaction involves spending of foreign currency it is a debit
and is recorded as a negative item.

COMPONENTS OF BALANCE OF PAYMENTS

Current Account

Capital Account

Official Account

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CURRENT ACCOUNT

The current account on the balance of payments measures the inflow

and outflow of goods, services, investment incomes and transfer
payments.

The main components of the current account are:

o Trade in goods (visible balance)
o Trade in services (invisible balance), e.g. insurance and services
o Investment incomes, e.g. dividends, interest and migrants remittances
from abroad
o Net transfers – e.g. International aid

A deficit on the current account means that the value of imports is

greater than the value of exports.
A surplus on the current account means that the value of imports is less
than the value of exports.
.

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 CURRENT ACCOUNT

CREDIT DEBIT
VISIBLE : VISIBLE :

1. Merchandise Exports 1. Merchandise Imports

2. Sell Of Goods 2. Purchase Of Goods

INVISIBLE : INVISIBLE :

1. Transfer and Insurance services 1. Transfer and Insurance services

sold abroad. brought from abroad.

2. Foreign tourist expenditure in 2. Indian tourist expenditure

the country. outside the country.

3. Income received on loans and 3. Interest on incomes payment on

investment abroad. loans and investment abroad.

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CAPITAL ACCOUNT

The capital account of a country consist of its transaction in financial assets in the
form of short-term and long-term lending and borrowing.
Capital accounts deals with the accounts related to cash or liquid assets.

 Capital account includes :-

1. Short term capital movements:-

• Purchase of short-term securities.
• Cash balance held with Foreign countries for a time period less than a
year.
2. Long term capital movements:-
• Direct investments in shares, bonds, real-estate, plant, building, etc.
• Cash balance held with Foreign countries for a time period more than a
year.

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 CAPITAL ACCOUNT
CREDIT DEBIT
Foreign Long-Term Long-Term investment
investment in Home country Abroad
a)Direct investment in home a)Direct investment abroad.
country.

b)Foreign investment in Domestic b)Investment in Foreign securities.

securities.

c)Foreign corporate loan to the c)Government LOAN to foreign

home country. countries.

Foreign Short-Term Foreign Short-Term

investment In Home country investment In Home country
a)Purchase of shares by foreigners. a)Purchase of shares in foreign.

b)Short-term loans. (for less than 1 b)Short-term loans.(for less than 1

yr.) yr.)
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THE OFFICIAL RESERVES ACCOUNT
Official reserves assets include gold, foreign currencies, SDRs, reserve positions in
the IMF.

UNILATERAL TRANSFER ACCOUNT

These accounts deal with the transactions related to the donation factors like,
DISASTER RELIEF
GIFTS FROM GOVERNMENT
CHARITIES. Etc.

OFFICIAL SETTLEMENT ACCOUNTS

CREDIT DEBIT
Official sales of foreign currencies Official purchase of foreign
or other reserve assets abroad. currencies or other reserve
assets.

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DISEQUILLIBRIUM OF BOP

MEANING:- 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.
DEFICIT:- Disequilibrium of Deficit arises when our receipts from the
foreigners fall below our payment to foreigners. It arises when the effective
demand for foreign exchange of the country exceeds its supply at a given rate
of exchange. This is called an 'unfavourable balance'.
\SURPLUS:- Disequilibrium of Surplus arises when the receipts of the
country exceed its payments. Such a situation arises when the effective
demand for foreign exchange is less than its supply. Such a surplus
disequilibrium is termed as 'favourable balance'.

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CAUSES OF DISEQUILIBRIUM IN BALANCE OF PAYMENTS
1. Population Growth
◦ Most countries experience an increase in the population and in some like India
and China the population is not only large but increases at a faster rate. To meet
their needs, imports become essential and the quantity of imports may increase as
population increases.

2. Development Programmes
◦ Developing countries which have embarked upon planned development
programmes require to import capital goods, some raw materials which are not
available at home and highly skilled and specialized manpower. Since
development is a continuous process, imports of these items continue for the long
time landing these countries in a balance of payment deficit.

3. Demonstration Effect
◦ When the people in the less developed countries imitate the consumption pattern
of the people in the developed countries, their import will increase. Their export
may remain constant or decline causing disequilibrium in the balance of
payments.

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4. Natural Factors
◦ Natural calamities such as the failure of rains or the coming floods may easily
cause disequilibrium in the balance of payments by adversely affecting agriculture
and industrial production in the country. The exports may decline while the
imports may go up causing a discrepancy in the country's balance of payments.

5. Cyclical Fluctuations
◦ Business fluctuations introduced by the operations of the trade cycles may also
cause disequilibrium in the country's balance of payments. For example, if there
occurs a business recession in foreign countries, it may easily cause a fall in the
exports and exchange earning of the country concerned, resulting in a
disequilibrium in the balance of payments.

6. Inflation
◦ An increase in income and price level owing to rapid economic development in
developing countries, will increase imports and reduce exports causing a deficit in
balance of payments.

7. Poor Marketing Strategies

◦ The superior marketing of the developed countries have increased their

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surplus. The poor marketing facilities of the developing countries have pushed them
into huge deficits.

8. Borrowing and lending

◦ A country which gives loans and grants on a large scale to other countries has a
deficit in its balance of payments on capital account. On the other hand, a
developing country borrowing large funds from other countries may have a
favorable balance of payments.

9. Change in exchange rate

◦ This change arise due to change in exports and imports. If exports of the country
are more then imports the demand for its currency increase so that the rate of
exchange moves in favors. On the other hand if imports are more than exports the
demand for the foreign currency increase and the rate of exchange will against the
country.
10. Globalization
◦ Due to globalization there has been more liberal and open atmosphere for
international movement of goods, services and capital. Competition has beer
increased due to the globalization of international economic relations. The
emerging new global economic order has brought in certain problems for some
countries which have resulted in the balance of payments disequilibrium
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Measures to correct disequilibrium in BOP

(i) Export promotion:

◦ Exports should be encouraged by granting various bounties to manufacturers and
exporters. At the same time, imports should be discouraged by undertaking import
substitution and imposing reasonable tariffs.

(ii) Import
◦ Restrictions and Import Substitution are other measures of correcting
disequilibrium.

(iii) Reducing inflation

◦ Inflation (continuous rise in prices) discourages exports and encourages imports.
Therefore, government should check inflation and lower the prices in the country.

(iv) Exchange control

◦ Government should control foreign exchange by ordering all exporters to
surrender their foreign exchange to the central bank and then ration out among
licensed importers.

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(v) Devaluation of domestic currency
◦ It means fall in the external (exchange) value of domestic currency in terms of a
unit of foreign exchange which makes domestic goods cheaper for the foreigners.
Devaluation is done by a government order when a country has adopted a fixed
exchange rate system. Care should be taken that devaluation should not cause rise
in internal price level.

(vi) Foreign Loans

◦ The government can also secure loans from foreign banks or foreign governments
to reduce the deficit in the balance of payments.
◦ Since the repayment of these loans is spread over a long period, This helps the
government to remove the deficit in the Balance of payments.

(vii) Encouragement to Foreign Investment

◦ The government induces the foreigners to make an investment in the country
offering them all sorts of investors incentives and concessions.
◦ This provides the government with extra foreign exchanges which are utilized to
reduce the deficit in the Balance of payments.

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“

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Thanks!

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