Balance of Payments

BOP: A systematic record of all international transactions of a country during a given period, usually a year.

Structure of BOP:
Current Account, Capital Account and Cash Account / Official Reserve Assets Account Current A/C consists of merchandise and trade accounts; and invisibles. Invisibles: 1. 2. 3. 4. 5. 6. 7. Transporation of goods, including warehousing. Travel for whatever reason. Insurance premiums. Investment income including rent, interests, dividends and profits. Ads, commissions, film rentals etc. misc. items. Donations, remittances, legacies. Depreciation on direct investment and amortization of assests.

Capital account consists of private capital account, international institutional capital account and specie account. Private capital account includes short-term liabilities and long-term investments in form of direct real investments in industries. Institutional account comprises assistance from short-term and long-term capital supplying agencies like IMF, WB, Bank of International Settlements, IFC and IDA. Specie account records the flow of gold bullion. Cash Account / Official Reserve Assets Account includes gold stock, holdings of its convertible foreign currencies and Special Drawing Rights (SDRs). Balance of Payments always balances because it is a double entry system of accounting.

Disequilibrium in BOP
B=Rf-Pf If B=0, equilibrium, otherwise disequilibrium (surplus or deficit).

Types of disequilibrium:
1. Cyclical arising out of business cycles. 2. Secular arising out of long-term deep rooted changes like capital formation, population growth, territorial expansion, technological advancements, innovations etc. 3. Structural arising out of structural changes in the economy like adoption of liberalization policy, changing relations with exporter / importer countries etc.

Importance:
1. BoP reveals countrys international economic position. This helps government in taking decisions on monetary and fiscal policies on one hand, and external trade payments issues on the other. 2. In case of a developing economy, the BoP shows the extent of dependence of the countrys economic development on the financial assistance by the developed countries. 3. It is an indicator of changing economic position of the country. It is used to appraise nations short-term economic prospects, to evaluate the degree of its international solvency, and to determine the appropriateness of the exchange rate of a countrys currency. However, A countrys favourable balance of payment should not be taken as an indicator f economic prosperity or its adverse or unfavourable balance of payment is a reflection of bankruptcy. Though, BoP deficit per se is not the indicator of countrys economic weakness in foreign markets but if this deficit remains for a longer duration, it would imply some fundamental problems with the economy. Similarly, a favourable BoP might be due to large inflow of foreign loans and equity capital to poorer countries. Thus, a developed country might have adverse balance of payment and a developing country might have a favourable BoP. Despite, all these shortcomings, BoP continues to give important information on countrys economic dealing with other countries.