Balance of Payment (BOP)

Introduction
In the modern world, there is hardly any
country which is self-sufficient and produces all
the goods and services it needs.
Every country imports from other countries
the goods that cannot be produced in the
country or can be produced only at an unduly
high cost.
Similarly, a country exports to other countries
the commodities which those countries prefer to
buy from abroad rather than producing at home.
Besides, trade of goods and services, there are
flows of capital.
Foreign capital flows are in the form of
investment by foreign institutional investors or
in the form of foreign direct investment.
The balance of payments position of the
country reflects on its economic health.
Definition of BOP
“BOP is a comprehensive and systematic
accounts of all the different transactions
occurred between the residents of a country and
the rest of the world during a particular period
of time.”
 Components of BOP
The three main components of Balance of
Payment are:
1.Current Account
2.Capital Account
3.Official Financing
 Current Account
Current account refers to an account which
records all the transactions relating to export
and import of goods and services and unilateral
transfers during a given period of time.
Current account contains the receipts and
payments relating to all the transactions of
visible items, invisible items and unilateral
transfers.
Components of Current Account
1. Export and Import of Goods or Visible Trade
A major part of transactions in foreign trade is in the
form of export and import of goods (visible items).
Payment for import of goods is written on the
negative side (debit items) and receipt from exports is
shown on the positive side (credit items).
Balance of these visible exports and imports is known
as balance of trade (or trade balance).
2. Export and Import of Services (Invisible Trade)
It includes a large variety of non- factor services
(known as invisible items) sold and purchased by the
residents of a country, to and from the rest of the
world.
Payments are either received or made to the other
countries for use of these services.
The main invisibles are as follows:
A. Government Expenditure
Government expenditure on embassies, contributions
to IMF and other international bodies, military
bases/forces abroad, and overseas aid. All these create
a substantial deficit.
B. Interest, Profits and Dividends
The earnings from loans, companies and shares,
respectively, earn substantial surpluses for the Indian
economy.
C. Other Financial Services
The earnings of solicitors, brokers, merchants and
pensioners also contribute benefits to the invisible
account.
D. Transport
The earnings on passenger carrier by sea and air are two
major items.
E. Tourism
This covers the expenditure of travelers abroad.
F. Unilateral Transfers
Unilateral transfers include gifts, donations, personal
remittances and other ‘one-way’ transactions.
These refer to those receipts and payments, which
take place without any service in return.
Receipt of unilateral transfers from rest of the world
is shown on the credit side and unilateral transfers to
rest of the world on the debit side.
 Balance on Current Account
In the current account, receipts from export of
goods, services and unilateral receipts are entered
as credit or positive items and payments for
import of goods, services and unilateral payments
are entered as debit or negative items.
The net value of credit and debit balances is the
balance on current account.
1. Surplus in current account arises when credit
items are more than debit items. It indicates net
inflow of foreign exchange.
2. Deficit in current account arises when debit
items are more than credit items. It indicates net
outflow of foreign exchange.
 Capital Account
Capital account of BOP records all those transactions,
between the residents of a country and the rest of the
world, which cause a change in the assets or liabilities of
the residents of the country or its government.
It is related to claims and liabilities of financial nature.
Capital Account is used to:
(i) Finance deficit in current account; or
(ii) Absorb surplus of current account.
Components of Capital Account
1. Borrowings and lending to and from Abroad
A. All transactions relating to borrowings from abroad
by private sector, government, etc.
Receipts of such loans and repayment of loans by
foreigners are recorded on the positive (credit) side.
B. All transactions of lending to abroad by private
sector and government.
Lending abroad and repayment of loans to abroad is
recorded as negative or debit item.
2. Investments to and from Abroad
A. Investments by rest of the world in shares of Indian
companies, real estate in India, etc. Such investments
from abroad are recorded on the positive (credit) side
as they bring in foreign exchange.
B. Investments by Indian residents in shares of foreign
companies, real estate abroad, etc. Such investments
to abroad be recorded on the negative (debit) side as
they lead to outflow of foreign exchange.
3. Change in Foreign Exchange Reserves:
The foreign exchange reserves are the financial assets
of the government held in the central bank.
A change in reserves serves as the financing item in
India’s BOP.
So, any withdrawal from the reserves is recorded on
the positive (credit) side and any addition to these
reserves is recorded on the negative (debit) side.
It must be noted that ‘change in reserves’ is recorded
in the BOP account and not ‘reserves’.
 Balance on Capital Account
The transactions, which lead to inflow of foreign
exchange (like receipt of loan from abroad, sale of
assets or shares in foreign countries, etc.), are recorded
on the credit or positive side of capital account.
Similarly, transactions, which lead to outflow of
foreign exchange (like repayment of loans, purchase of
assets or shares in foreign countries, etc.), are recorded
on the debit or negative side.
The net value of credit and debit balances is the
balance on capital account.
A. Surplus in capital account arises when credit items
are more than debit items. It indicates net inflow of
capital.
B. Deficit in capital account arises when debit items are
more than credit items. It indicates net outflow of
capital.
 Official Financing
The Balance for Official Financing shows the
balance of monetary movements into and out of
the country.
A positive figure reveals a net inflow of funds into
a country.
Alternatively, a net outflow is represented by a
negative figure.
When there is a negative figure, the amount has
to be paid for either by:
(a) borrowing from other central banks and
international organisations, or
(b) using up reserves which have been saved over
the years.
When the balance for official financing is
positive, then loans can be repaid and reserves
replenished.
Governments do sometimes borrow even when
the balance for official financing is positive; this
is in order to build up reserves for the future.
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.
Some of the benefits of BOP are summerised
as follows-
BOP provides a basis of Forecasting and
Evaluating Business and Economic
Conditions.
Balance of payments can also serve as a
basis to evaluate a country’s solvency.
BOP also reveals the nature, size,
composition and direction of a country’s
international trade.
BOP clarifies the foreign exchange
position of a country.
BOP also helps to decide the trade,
industrial and economic policies of the
Government.
 Balance of Trade
Balance of Trade is the difference between the
monetary value of exports and imports of output
in an economy over a certain period.
A positive balance is known as a trade surplus
if it consists of exporting more than is imported;
it is also known as favorable trade balance.
A negative balance is referred to as a trade
deficit.
Factors that can affect the Balance of Trade
include
The cost of production (Land, Labour, Capital, Taxes,
Incentives, etc.) in the exporting and importing countries
The cost and availability of raw materials,
intermediate goods and other inputs;
Exchange rate movements;
Multilateral, bilateral and unilateral taxes or
restrictions on trade;
Non-tariff barriers such as environmental, health or
safety standards;
The availability of adequate foreign exchange with
which to pay for imports;
Prices of goods manufactured at home (influenced by
the responsiveness of supply)
The stage in business cycle such as recession, boom,
stagnation etc.
The End