History of BOP

Before the nineteenth century, global exchanges were named in gold, giving little adaptability to
nations encountering exchange deficiencies. Development was low, so animating an exchange
surplus was the essential strategy for fortifying a country's budgetary position. National economies
were not all around incorporated with one another, be that as it may, so steep exchange lopsided
characteristics seldom incited emergencies. The mechanical unrest expanded global financial mix,
and equalization of instalment emergencies started to happen all the more much of the time.

As the U.S. money supply increased and its trade deficit deepened, however, the government
became unable to fully redeem foreign central banks' dollar reserves for gold, and the system was
abandoned.

Definition of BOP

The balance of payments (BOP) is a statement of all transactions made between entities
in one country and the rest of the world over a defined period of time, such as a quarter or a year.

The balance of payments (BOP), also known as balance of global payments, condenses all
transactions that a nation's people, organizations, and government bodies total with people,
organizations, and government bodies outside the nation. These transactions comprise
of imports and exports of products, administrations, and capital, just as transfer payments, for
example, foreign help and settlements.

Debit and Credit of BPO

The BOP accounts records both debits and credits: -

 A debit- any transaction that supplies the countries currency in the foreign exchange market.

 A credit- any transaction that creates demand for the country’s currency in the foreign
exchange market.

 A debit is indicated by a (-) sign, because it signifies the outflow of currency.

 A credit is indicated by a (+) sign, because it signifies the inflow of money.

Sections of BOP

 Current Account

 Capital Account

 Official Reserve Account

Current Account

BOP and Current A/c is more extensive in scope than Balance of exchange. It incorporates not just
imports and exports that are tangible but also comprise of intangible goods such as:
Non-factor administrations, for example, transportations, travelling insurance, the travel industry,
the travel industry, programming administration investment income. Private and authority
transactions, for example, gifts, settlements from abroad, foreign help, funding and so on.

Components of Current Account

 Merchandise trade balance- Difference b/w export and import of physical goods. It is also
referred to as visible goods.

Merchandise trade balance = value of merchandise export – value of merchandise import

 Service balance- It is the difference b/w receipts and payments from services.

Service balance = value of service exports – value of service imports

 Net Income- It refers to the difference b/w investment income flow into and out of a
country. Such income includes compensation paid to employees investment income in the
form of direct investment, portfolio investment and other investment.

 Current Transfers- includes gifts, military aid, a financial aid, by the govt., private individuals
and organisations to foreign countries and also the inflow from other countries.

Capital Account

The capital account is part of a country's balance of payments. It measures financial transactions
that affect a country's future income, production, or savings. An example is a foreigner's purchase of
a U.S. copyright to a song, book, or film. Its value is based on what it will produce in the future. The
Federal Reserve calls these transactions non-produced, nonfinancial assets.When these transactions
generate income, they are transferred to another part of the balance of payments. If they produce
investment income, they are transferred to the financial account. If they produce income from
goods or services, they are transferred to the current account.

Component of capital account

 Loan and borrowing- It includes all types of loans from both private and public sector located
in foreign countries.

 Investment- These are the funds invested in the corporate stocks, by non- residents.

 Foreign exchange reserve- Foreign exchange reserve held by the central bank of a country to
monitor and control the exchange rate and impact of capital a/c.

Official Reserve

Consist of govt. gold and foreign currency reserve as well as govt. reserve with the
International Monitory Fund (IMF) and the Special Drawings Rights (SDR).

The SDR is an international money mechanism created by the IMF in the form of book
keeping entries that can be used by countries to settle their international a/c.
 Example :- the official reserve a/c , a sub-division of the capital account, is the foreign
currency and security held by the government, usually by its central bank , and is used to
balance the payment.

Three major components of official reserve are: -

(i) The current a/c including merchandise, investment income (rents, profits, interest)
(ii) The capital a/c measuring foreign investment in the country and the counyry
investment in abroad.
(iii) The balancing a/c allowing for changes in official reserve asset (SDR’s, gold, other
payments)

Basic Calculation of BPO

 Merchandise export – merchandise import = merchandise trade balance –(1)

 Service export – service import = service balance – (2)

 Balance in current a/c = (1) + (2) + Net income + current transfers.

 Balance in capital a/c = capital a/c + financial a/c

 Overall balance = balance in current a/c + balance in capital a/c + errors and omissions

 Reserve Assets = (-) (overall balance)

 Basic balance (based on old methods) = balance in current a/c + long term capital a/c

 Errors and Omissions- is a balancing item in which the credit and debit must be equal.

Balance of Trade

The distinction between a nation's imports and its exports. balance of exchange is the biggest
segment of a nation's balance of payment. Debit things incorporate imports, foreign help, household
spending abroad and local speculations abroad.

Credit things incorporate export, foreign spending in the household economy and foreign interests
in the local economy.

At the point when exports are more noteworthy than imports than the BOT is positive and on the
contrary when imports are more prominent than trades, at that point it is unfavourable.

Importance of BOT

 It shows how a company competes in a global market.

 It determines the health of an economy and its relationship with the rest of the world.

 It includes physical goods and intangible services.

 It is very important piece of understanding the global puzzle of international trade.

 Positive and negative balance of trade

 Positive Balance of Trade or Favourable:

When the exports are greater than imports than balance of trade is positive or favourable.

 Negative Balance of Trade or Unfavourable:

When the imports are greater than exports then balance of trade is negative or unfavourable.

Factors of Affecting Balance of Trade

 Cost of production in exporting economy compared to that in importimg economy.

 Exchange rates.

 Restriction on trade

 Cost and availability of inputs like raw materials.

 Price of locally manufactured goods.

Availability of sufficient foreign exchange to be used for payment for inputs.

Difference of BOP & BOT

BOP

 It is a broad item.

 It includes all transactions related to visible, invisible and capital transfer.

 It always balances itself.

 BOP = current account + capital account + or – balancing item (errors and omissions)

BOT

 It is a narrow items .

 It includes only visible items.

 It can be favourable or unfavourable

 BOT = net earning on exports – net payments for imports.