Balance of payments (BoP) of country records its economic transactions with the rest of the world. It records all transactions between ‘residents’ of the country concerned and foreign residents over a stipulated period generally one year.
Balance of Payments Accounting
Balance of payments in accounting sense must always balance i.e. it should be zero. The entries are recorded in double-entry book keeping method. Transactions which give rise to monetary receipts are recorded in the credit side of the accounts, and transactions which lead to monetary payments abroad are recorded in the debit side
Current Account and Capital Account
Balance of payments of a country consists of – current account, capital account and reserve account.
Current Account
Current account of the balance of payments records transactions on account of trade in goods and services, unilateral transfers, donations etc. It shows the flow of goods and services in the form of exports and imports for a country during a given year
Capital Account
Financial capital inflows and outflows are recorded in the capital account. It shows the volume of private foreign investment and public grants and loans from individual nations and multilateral donor agencies such as the IMF, World Bank, etc
Reserve Account
The official reserve assets accounts comprise its gold stock, holdings of its convertible foreign currencies, and Special Drawings Rights (SDRs). This account is the balancing item in response to current and capital accounts transactions.
If the balance on current and capital accounts is negative, it would represent balance of payments “deficit”. But if the balance on current and capital accounts is positive, it would be called a balance of payments “surplus”.
Balance of Trade vs Balance of Payments
Balance of trade refers to the difference between physical imports and exports, i.e. visible items only for a period say, a year. Visible items are those which are physically exported and imported, like merchandise, gold, silver and other commodities. The types of balance of trade are:
- Balanced Trade: If the value of exports and imports of a country are equal during the year, the balance of trade is said to be balanced.
- Favourable Trade: If the value of exports of a country exceeds the value of imports, the country is said to have an export surplus or a favourable balance of trade
- Unfavourable Trade: If the value of imports coming to a country is greater than the value of exports, the balance of trade is said to be unfavourable
The balance of payments is broader than the balance of trade as it includes not only visible items but also invisible items. International trade includes not only import and export of goods but also services such as air and ocean shipping, financial and other services like banking, insurance, travel, investment income, etc. Receipts and payments for services are items of invisible trade. The balance of payments presents an account of all receipts and payments on account of goods exported, services rendered and capital received by residents/Government of a country (inflows from abroad) and goods imported, services received and capital transferred by the residents/ Government of a country (outflows abroad).
Importance of Balance of Payment
A country’s balance of payments reveals various aspects of a country’s international economic position.
- It presents the international financial position of the country.
- It helps the Government in taking decisions on monetary and fiscal policies on the one hand, and on external trade and payments issues on the other.
- In the case of a developing country, the balance of payments shows the extent of dependence of the country’s economic development on the financial assistance by the developed countries.
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