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FOREIGN TRADE — Economics STD 12 Commerce — Question

Gujarat BoardEnglish MediumSTD 12 CommerceEconomicsFOREIGN TRADE5 Marks
Question
Write detailed note on Balance of Payments.
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Answer

$1.$ Meaning of Balance of Payments:
  • Balance of payment is a true criteria to know any country's clear, real and complete economic condition.
  • It includes all types of international payment.
  • Balance of payment means comparison of one country's balance sheet of trade with other countries.
  • Value of products and services, expense of transportation of means and value of trade capital are registered in it.
  • Definition:
  • An accounting statement showing the value of imports and exports of tangible $($visible$)$ and intangible $($invisible$)$ goods during a year is balance of payments.
  • In other words, balance of payments is a systematic account of the value of transactions in particular period $($one year$)$ of a country with the rest of the world in tangible and intangible goods and services import and export and transfer payments and capital.
  • It is known as international balance sheet.
  • The concept of balance of payments is more extensive than trade balance.
  • Trade balance includes import-export of only tangible goods while balance of payments includes invisible goods and all economic expenses related to services and transportation.
  • Balance of payment has two sides:
$(1)$ Credit Side:
  • Income earned in the country from foreign countries is shown.
$(2)$ Debit Side:
  • All payment made in foreign countries is shown.
$2.$ Types of Balance of Payments:
  • $TWO$ types of balance of payments is possible : $(1)$ Balanced $(2)$ Unbalanced.
$(1)$ Balanced:
  • The sum total of credit and debit entries is equal in balance of payments.
$(2)$ Unbalanced:
  • Balance of Payments is unbalanced when the value of entries on the credit side is not equal to entries on the debit side.
  • There is difference in the total of credit side and debit side.
  • When two situations are possible.
$(1)$ Surplus Balance of Payments:
  • If the total of credit side is more than the total of debit side, it is called surplus balance of payments.
$(b)$ Deficit Balance of Payments:
  • In the balance of payments, if the total of debit side is more than the total of credit side it is called deficit balance of payments.
  • Any country's deficit or surplus or balance is discussed in the context of its balance of payments.
  • From the view point of accounting, balance of payments is always balanced because deficit or surplus of current account is always maintained through its capital and reserve account.
$3.$ Accounts of Balance of Payments:
  • There are two accounts of balance of payments :
  • $(A)$ Current Account $(B)$ Capital Account
$(A)$ Current Account:
  • In this account for the following entries credit and debit amount are recorded.
  • It includes tangible items like food grains, garments etc. $($tangible$)$ items import-export of intangible goods/services such as banking, insurance, transportation, communication, investment in foreign countries or income on investments in foreign countries, gifts and presents, economic transactions with foreign countries including war penalty etc.
$(1)$ Value of trade of tangible goods:
  • Export income of tangible goods is showed on $($credit side$)$ and payment of it is showed on import $($debit side$).$
  • In short in all the items of import-export are included in trade balance are recorded in balance of payments.
  • The sum total of this section is called trade balance.
  • If in the country when import payment of tangible goods is less than export income then balance of trade is called deficit and if the situation is vice versa the balance of trade is called surplus.
$(2)$ Trade value of intangible services:
  • The income from invisible products/services is recorded on credit side and payments made for import are on debit side.
  • This includes banking, insurance, transportation, information technology, through which the transactions of exchange have occurred owing to import-export.
$(3)$ Capital Income:
  • Income from investment in foreign countries such as interest, dividend, income of exchange received as profit is shown on credit side and interest, dividend or profit paid is shown on debit side.
  • Foreign investment in the country on which payment is made is shown on debit side.
$(4)$ One sided Incomes:
  • During the year, country has received gifts, compensation, one sided income in form of war, punishment, grant etc.
  • This income-payment is entered in one sided balance of payments. e.g. During natural disaster grant is received from foreign countries which is not to be repaid there is no liability to repay it even in future so it is entered on income side.
  • If any country has made payment to any country as penalty of war or gift it is showed on debit side.
$(B)$ Capital Account:
  • This account record receipts and payments from transactions on assets bound, shares, gold, capital loans etc. and other forms of fixed capital.
$(1)$ Long term investment:
  • Investment of foreign countries in this country is long term investment.
  • Income $($credit$)$ is shown on credit side. While investment of this country in foreign countries payment $($debit$)$ is shown on debit side.
  • Long term investment is in two forms: $(1)$ $0$ Direct Investment $($Equity$)$ $(2)$ Securities.
$(2)$ Short term fund:
  • To cope up with nation's short term requirement of exchange the fund received from the foreign countries is shown in the income from capital account and for short term the fund going out from this country is payment $($debit$)$ shown on debit side.
$(3)$ Purchase Sale of Gold:
  • Government of any country through Federal bank from foreign country or $I.M.F.$ purchase gold means imports gold and pays in exchange, which is shown on debit side.
  • Vice versa, if any country sells gold lying in federal bank and receives exchange, is $($credit$)$ shown on credit side.
$4.$ Example:
Balance of Payment
Income $($Credit$)$ Payment $($Debit$)$
Current Account
$(1)$ Export of Product/Service $(a)$ Export of tangible items $(b)$ Export of banking, insurance, transportation etc. intangible services $(c)$ Income on investment in foreign countries $(d)$ Income from gift, compensation, war, punishment, grant etc $(1)$ Import of product/service $(a)$ Import of tangible goods $(b)$ Import of intangible services like banking insurance transportation etc. $(c)$ Payment on investment of foreign countries $(d)$ Payment made in the form of gift compensation war punishment grant etc.
Capital Account
$(1)$ Long term investment of foreign countries in this country $(a)$Direct Investment $($Equity$)$ $(b)$ Foreign investment in securities of the country $(c)$ Short term fund incoming from foreign countries $(d)$Sale of gold errors and omissions $(1)$ Long term investment of this country in foreign countries $(a)$ Direct or equity form $(b)$ Investment in foreign securities by this country $(c)$ Short term found out going to foreign countries $(d)$ Purchase of gold errors and omissions
  • Comparison of any country's balance of payments surplus or deficit of current account is settled through the transactions of its capital account and overall $($current or capital$)$ balance of payments is always balanced.
$5.$ Factors affecting Balance of Payment:
  • Factors affecting import, export transfer of capital, transfer of means $($instruments$)$ capital investment, lending affect balance of payments.
  • Changes occurring in these factors affect balance of payments.
  • Some of the factors are important as mentioned below.
$(1)$ Degree of import and export is affected when the rate of exchange changes.
$(2)$ Changes in the price of the product exported or imported bring changes and affects balance of payments.
  • The price of the product/service exported falls in the country's export and income increases.
  • When the price of the product rises in the country, import increases.
$(3)$ If variety is brought in the trade or quality is improved then export increases.
$(4)$ If the import of certain items is must for a country, variation in their price affects balance of payments.
$(5)$ Level of economic development of the nation affects balance of payments. e.g. In developing countries in the primary stage of development large scale of capital is to be imported for industrialization on the other hand exports do not increase immediately.
  • As a result balance of payments shows deficit.
$(6)$ Political and legal restrictions on import, also affect balance of payments.
$(7)$ The most significant factor affecting trade is availability of transportation, communication and infrastructural facilities in the country and with high standard of these facilities foreign trade increases.

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