1. MBA (Finance specialisation) & MBA – Banking and Finance (Trimester) Term VI Module : – International Financial Management Unit I: Balance of Payment Lesson 1.2

2. Balance of Payment Introduction  The Balance of Payments (BOP) is an accounting system that records the economic transactions between the residents and government of a particular country and the residents and governments of the rest of the world during a certain period of time, usually a year.  The BOP provides valuable information for the conduct of economic policy.

3. Balance of Payment Balance of Payments Accounting  Like other accounting statements, the BOP conforms to the principle of double entry bookkeeping.  This means that every international transaction should produce debit and credit entries of equal magnitude.  It is important to mention here that BOP is neither an income statement nor a balance sheet.  It is a sources and uses of funds statement that reflects changes in assets, liabilities and net worth during a specified period of time.

4. Balance of Payment Debits and Credits 1. Credit Transactions (+) are those that involve the receipt of payment from foreigners. The following are some of the important credit transactions a. Exports of goods or services b. Unilateral transfers (gifts) received from foreigners c. Capital inflows 2. Debit Transactions (-) are those that involve the payment of foreign exchange i.e., transactions that expend foreign exchange. The following are some of the important debit transactions a. Import of goods and services b. Unilateral transfers (or gifts) made to foreigners c. Capital outflows

5. Balance of Payment Balance of Payments Statement The balance of payment statement records all types of international transactions that a country consummates over a certain period of time. It is divided into three sections: I. The Current Account II. The Capital Account III. The Official Reserve Account.

6. Balance of Payment Debit and Credit Entries The Balance of Payment of a country is classified into three well-defined categories – 1. The Current Account, 2. The Capital Account 3. The Official Reserves Account.

7. Cont…. Debit (Outflow)Credit (Inflow) GoodsBuySell ServicesBuySell Investment IncomePayReceive Unilateral transfersGiveReceive The rules for recording a transaction as debit and credit in the current account are:

8. The rules for doubly entry recording here are as follow: Debit (Outflow)Credit (Inflow) Portfolio (short-term) Receiving a payment from a foreigner Buying a short-term asset Buying back a short-term domestic asset from its foreign owner Making a payment to a foreigner Selling a domestic short-term asset to a foreigner Selling a short-term foreign asset acquired previously Portfolio (long-term) Buying a long-term foreign asset (not for purpose of control Buying back a long-term domestic asset from its foreign owner (not for purpose of control) Selling a domestic long-term asset to a foreigner (not for purpose of control) Selling a long-term foreign asset acquired previously (not for purposes of control) Foreign direct investment Buying a foreign asset for purpose of control Buying back from its foreign owner a domestic asset previously acquired for purposes of control Selling a long-term foreign asset acquired previously (not for purposes of control) Selling a foreign asset previously acquired for purposes of control

9. Balance of Payment : Illustrations 1.Merchandise Trade : An Indian company sells Rs 4,00, 000 worth of machinery to a U S company. The U.S. company pays for the machinery in 30 days. Entries: ParticularsDebitCredit Liquid Short Term capitalRs 4,00,000 ExportsRs 4,00,000

10. Balance of Payment : Illustrations 2. Services : Services represents non-merchandise transactions such as tourist expenditures. Consider, a person visits U.K. and cashes Rs 300000 worth of his Indian Traveller’s cheque at a U.K. hotel. Before coming back to India, entire amount of Rs 3,00,000 in U.K. Entries: ParticularsDebitCredit Tourist ExpenditureRs 3,00,000 Liquid Short term capitalRs 3,00,000

11. Balance of Payment : Illustrations 3. Unilateral Transfer : This account covers gift by domestic residents to foreign residents or gift by domestic government to foreign government or vice versa. Assume that the US Red cross sends $ 10,000 worth of flood relief goods to India. Entries: ( In the US Balance of Payment) ParticularsDebitCredit Transfer Payments$ 10,000 Exports$10,000

12. Balance of Payment : Illustrations 4. Long-Term capital : This account shows inflow and outflow of capital commitments whose maturity is longer than one year. It covers investments in financial assets without significant control of the real assets. Assume that, Indian company purchases Rs 6 crores worth of U.K. bond. Entries: ( In the India Balance of Payment) ParticularsDebitCredit Portfolio investmentRs 600,00,000 Liquid Short-term capitalRs 600,00,000

13. Balance of Payment : Illustrations 5. Non-liquid Short-term capital : These are the flows of funds that are not normally sold. Bank loans represents non-liquid short term liabilities. Suppose U. S. bank lends $30,000 to an Indian company Entries: ( In the U.S. Balance of Payment) ParticularsDebitCredit Non-liquid short term capital$ 30,000 Liquid Short-term capital$ 30,000

14. Balance of Payment : Illustrations Record the following transactions and prepare the Balance of Payments statement. a.A US firm export $ 1,000 worth of goods to be paid in six months. b.A US resident visits London and spends $ 400 on hotel, meal and so on. c.US Government gives a US bank balance of $200 to the government of a developing nation as part of the US aid programme. d.A US resident purchases foreign stock for $800 and pays for it by increasing the foreign bank balance in the U.S. e.A foreign investor purchase $600 of United states treasury bills and pays by drawing down his bank balance in the United states by an equal amounts.

15. Balance of Payment : Illustrations ParticularsDebitCredit Short term capital Outflow1000 Merchandise exports1000 Travel Sevices purchased from foreigners400 Short term capital inflow400 Unilateral Transfer200 Short term capital inflow200 Long term capital outflow800 Short term capital inflow800 Short term capital outflow600 Short term capital inflow600

16. Balance of Payment : Illustrations ParticularsDebitCredit Merchandise1000 Services400 Unilateral Transfers200 Long term capital800 Short term capital, Net400 Total1400