Balance of Payment

 

Meaning of Balance of Payments

Balance of payments is an accounting statement that provide a systematic record to all the economic transaction , between resident of a country and the rest of the world , in a given period of time.

 

Economic Transaction

1.      Visible Items 

    These include all types of physical goods which are imported and exported as they are made of some matter that can be seen, touched, measured.

2.      Invisible Items

          Invisible items of trade refers to all types of services like shipping , banking , etc…these are called invisible goods as they can not be felt , seen ,and measured

3.      Unilateral Items or transfer

           Unilateral transfer include gifts, remittance,etc.. since these transaction donot involve any claims for repayments.

4.      Capital transfer

          Capital transfer relate to capital receipts (through borrowings or sale of assets)and capital payments (through capital repayments or purchase of assets)

 

Structure of Balance of Payments

1.      Credit side:

     All inflow or sources of foreign exchange are recorded

2. Debit side

          All outflow or uses of foreign exchange are recorded on the debit side.

1.      Balanced bop

2.      Surplus bop

3.      Deficit bop

 

1.      Balance Bop

          Bop is balance when receipt of foreign exchange is equal to payments of foreign exchange.

2.      Surplus BOP

           BOP is surplus when receipt of foreign exchange is more than payments of foreign exchange.

3.      Deficit BOP

          BOP is deficit when the receipt of foreign exchange is less than payments of foreign exchange.

 

Meaning of balance of trade

Balance of trade refers to difference between the amount of export and import of visible item.

BALANCE OF TRADE = EXPORT OF GOODS - IMPORTS OF GOODS

 

Components of balance of payments

1.      Current account

           Current account refers to an account which record all the transaction relating to exports and import of goods and services and unilateral transfer during a given period of time.

           Components of current accounts

(i) Export and Import of Goods

(i) Export and Import of Goods (Merchandise Transactions 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).

 

(ii) Export and Import of Services

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. Services are generally of three kinds: (a) Shipping, (b) Banking, and (c) Insurance. Payments for these services are recorded on the negative side and receipts on the positive side.

 

(iii) Unilateral or Unrequited Transfers to and from abroad (One sided Transactions):

Unilateral or Unrequited Transfers to and from abroad (One sided Transactions): 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.

 

(iv) Income receipts and payments to and from abroad

Income receipts and payments to and from abroad: It includes investment income in the form of interest, rent and profits.

 

Balance on current account

In the current account receipt from export of goods services and unilateral receipt are entered as credit or positive item and payments for import of goods services and unilateral payments are entered as debit or negative items. The net value of credit and debit balance referred as balance on current account.

Surplus in the current account arises when Credit items are more than debit items.

Deficit in current account arises when debit items are more than Credit items

 

2.Capital account

Capital account of balance of payment record all the transaction between the resident of a country and rest of the world, which cause a change in the assets or liability of the resident of the country or its government.

 

1.Private Transaction - When private sector company receive or give short term or long term loan is known as private transactions. In which loan received will come under credit side and repayment or interest on loan come under debit side.

2.Official Transaction – Government of country also take short term and long term loans from international institutions like World bank, IMF tec. Reason could be anything , but it is affecting assets and liabilities.

3.Foreign Direct Investment-  A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company.

4.Investment to and from abroad –

 a. investment by the rest of the world in shares of Indian companies, real estate in India etc.…. such investment from abroad are recorded on the positive (credit) side as they bring in foreign exchange.

b. investment by Indian resident in shares of foreign companies, real estate abroad, etc…...such investment to abroad are recorded on the negative (debit) side as they lead to outflow of foreign exchange...

Balance on capital account

In the capital account receipt of foreign exchange like loan from abroad, sale of assets , shares of foreign countries etc. are entered as credit or positive item and Payments of foreign exchange like repayment of loans, purchase of assets or shares in foreign countries etc. are entered as debit or negative items. The net value of credit and debit balance referred as balance on capital account.

Surplus in the capital account arises when Credit items are more than debit items.

Deficit in capital account arises when debit items are more than Credit items.

 

Difference between Autonomous and Accommodating items

 

1.      Autonomous item

        ​Autonomous items: refers to those international economic transaction, which take place due to some economic motive such as profit maximization.

1.      These items are also known as above line item

2.      Autonomous transaction are independent of the state of BOP accounts.

 

Accommodating items

 

Accommodating items refer to the transaction that are undertaken to cover deficit or surplus in autonomous transaction i.e such transaction are determined by net consequences of autonomous transaction…

1.      These items are also known as below the line item.

2.      Accommodating transaction take place only on capital account .

 

Deficit in Balance of payment

1.      Fall in demand for country’s goods in the foreign markets leads to fall in exports and it adversely affects the balance of payments.

2.      High inflation- When there is inflation in the domestic economy, foreign goods become relatively cheaper as compared to domestic goods. It increases imports which causes a deficit in the BOP.

 

3.Import of services-

Underdeveloped countries import services from developed countries for which, they have to pay huge amounts of money. It leads to a deficit in the BOP.

 

Difference between Balance of Trade Vs Balance of Payments

BASIS FOR COMPARISON	BALANCE OF TRADE	BALANCE OF PAYMENT
Meaning	Balance of Trade is a statement that captures the country's export and import of goods with the remaining world.	Balance of Payment is a statement that keeps track of all economic transactions done by the country with the remaining world.
Records	Transactions related to goods only.	Transactions related to both goods and services are recorded.
Capital Transfers	Are not included in the Balance of Trade.	Are included in Balance of Payment.
Which is better?	It gives a partial view of the country's economic status.	It gives a clear view of the economic position of the country.
Result	It can be Favorable, Unfavorable or balanced.	Both the receipts and payment sides tallies.
Component	It is a component of Current Account of Balance of Payment.	Current Account and Capital Account.