Chapter-12: Balance of Payment (BOP)
BALANCE OF PAYMENTS (BOP)
The BOP accounts is a summary of international transactions of a country for a given period, that is a financial year. The balance of payments of a country is a systematic record of all transactions in goods, services and assets between the residents of the country and the residents of foreign countries during a given period of time., usually one year.
CHARACTERISTICS OF BALANCE OF PAYMENTS
- Systematic Record: It is a record of payments and receipts of a country related to economic transactions with other countries.
- Fixed Period of Time: It is an account of fixed period of time generally a year.
- Scope: It includes all types of visible items, invisible items and capital transfers.
- Double Entry System: Payments and receipts are accounted on the basis of double entry system. It is always kept in balance.
ECONOMIC TRANSACTIONS IN BOP
- Export and Import of Goods (Visible Items of Trade): In this category, all types of physical goods exported and imported are included. These are called visible items because goods can be seen, touched and measured and are duly recorded at custom barriers.
- Export and Import of Goods (Invisible Items): Invisible items of trade refer to all types of services given and received. These includes non-factor services like shipping, banking, insurance, tourism etc. And factor services. These are invisible items because services are not visible like physical goods. Thus, under the head, two types of earnings viz. non- factor income and factor income are included. These earnings are for current services.
- Unilateral Transfers: Some economic flows between nations also take place without any payment which are called unilateral (one sided) payments or transfer payments. Such transfers can either be private and government. Private transfers would include sending gifts abroad, scholarships etc. Government transfers would include grants and aid.
- Capital transfers: Capital transfers relate to capital receipts and capital payments. These include borrowings, capital repayments, sale of assets, changes in stock of gold and reserves of foreign exchange etc. these relates to movements of long term and short term capital between nations. For example, when the residents of a country wish to borrow from the other countries, we may say that they are importing capital. Similarly, when the residents of country want to invest in other countries, we may say that they are exporting capital.
BALANCE BETWEEN BALANCE OF TRADE AND BALANCE OF PAYMENTS
|Basis||Balance of Trade||Balance of Payments|
|1. Meaning||Balance of trade is the difference between export and imports of goods of a country during the period of one year (i.e., balance of visible items of trade)||Balance of payments is a statement of all economic transactions between the residents of country and rest of the world during the period of one year.|
|It is a narrower concept, as it is a component of balance of payments.||It is a wider concept, a s it includes balance of trade.|
|3. Indicator||It is only a partial record. Hence, it is not a true indicator of economic relations with other countries.||It is a complete record of economic transactions with the rest of the world. Hence, it provides a true picture of the economy of a country with the rest of the world.|
|4. Favourable unfavourable||It may be favourable or unfavourable.||In accounting sense, it is always kept in balance.|
STRUCTURE (OR COMPONENTS) OF BOP
Balance of payments account can be broadly classified into the following two accounts :-
- Current account
- Capital account
Current account is that account of BOP which records imports and exports of goods and services and unilateral transfers. It, thus, records the following three items:
- Visible items of trade
- Invisible items and
- Unilateral transfers
Current account deals with currently produced goods and services. Current account transactions are called account by actual transactions, because all the items included in it are actually transacted.
Items of Current Account
- Exports and Import of visible Items or Goods: All visible goods (or material goods) which are exported and imported constitute items of current account. The record of these goods is available with the ports. The balance of exports and imports of goods is called as balance of trade.
- If exports are greater than imports of goods, we have a surplus in balance of trade account.
Exports of Goods > Imports of Goods => Surplus Balance of Trade
- If exports of goods are less than the imports, the balance of trade account is said to be in
Exports of Goods < Imports of Goods => Deficit Balance of Trade
- The trade account is also called the merchandise account.
- Invisible Items (or Non-Material Goods or services): Invisible items refer to items relating to trading of services with other countries. Export and import of services are called invisible items because services are not seen crossing the border and therefore, not recorded. Services include:
- Factor services: Factor services refer to the services provided by primary factors of production. These lead to factor payments or factor income. Factor income includes compensation of employees and investment income in the form of rent, interest and profit.
- Non-factor services: Non-factor services include all services, other than factor services. These include shipping, insurance, banking, tourism, software services, etc. Receipts from these sources are recorded as export of services and payments are shown as import of services.
- The balance accruing on account of export and import of services is called the balance of invisible trade.
- If exports of services are greater than imports of services, the balance of invisible account is in surplus.
Exports of Services > Imports of Services => Surplus Balance of Invisible Trade
- If exports of services are less than imports of services, the balance on the invisible account would show a deficit.
Exports of Services < Imports of Services => Deficit balance of Invisible Trade
- The invisible account is also called the service account.
(c) Unilateral Transfers: As started earlier, unilateral transfers are payments and receipts that are made without any good and service. These transfers are not trading transactions. Such transfers can be either private or government. Gifts received by residents from abroad, remittances sent by emigrants to relatives, war indemnities paid by defeated country are examples of unilateral transfers.
- It we add all the three balances – balance of visible trade, balance of invisible trade and balance of unilateral transfers, we get current account balance.
Current Account Balance = Balance of visible trade + Balance of invisible trade + Balance of unilateral transfers
- The current account is said to be in surplus when the sum export of goods and services and unilateral receipts is greater than the sum of imports of goods and services and unilateral payments.
Receipts on Current Account > Payments on Current Account
- If imports and payments on the current account are greater than exports and receipts, the current account is said to be in deficit.
Receipts on Current Account < Payments on Current Account
Significance: Current account deficit (CAD) signifies that the nation is a borrower from
Rest of the world. And current account surplus (CAS) signifies that the nation is a lender
to the rest of the world.
Structure of Current Account
The structure of current account are as follows:
- All exports (goods and services) are recorded as positive items (credit side).
- All imports (goods and services) are recorded as negative item (debit side).
- Receipts of unilateral transfers are recorded as positive items (credit side).
- Payments of unilateral transfers are recorded as negative items (debit side).
Note – All the transactions of current accounts are either recorded as credit items (all receipts) or debit items (all outflows of foreign exchange).
Capital account is that account of BOP which records all such transactions between the residents of a country and rest of the world which cause the change in the asset or liability of the country. It concerns with capital transactions – all kinds of short term and long-term international capital transfers, gold and sale/ purchase of assets. It also deals with the payments of debts and claims.
Items of Capital Account
- Direct Investment: Direct investment abroad means purchasing a real (or physical) asset in other country and at the same time acquiring control of it. Acquisition of a firm in one country by a firm in another country is an example of direct investment. Purchase of a house abroad could be another example of it.
- Portfolio Investment: Portfolio investment, on the other hand, is the form of investment under which a firm/company of a country purchases shares of a foreign company or buys bonds issued by foreign governments. Under this form of investment, firm does not have control over the asset.
- Loans: It includes commercial borrowing and external assistance. Commercial borrowing includes borrowing by a country (government and private sector both) from the international money market. This borrowing takes place at market rate of interest. On the other hand, external assistance refers to the concessional borrowing by a country.
- Banking Capital Transactions: These refer to transactions of external financial assets and liabilities of commercial banks and cooperative banks operating as dealers in foreign exchange.
The net balance of capital account shows a country’s overall balance of payments position. It is
given as under:
Net Capital Account Balance = Inflow of foreign exchange on account of sale of domestic assets or borrowing from the rest of the world – Outflow of foreign exchange on account of purchase of foreign assets or loans to the rest of the world.
The capital account balance may show surplus or deficit. Surplus implies net inflow of capital
while deficit indicates net outflow of capital.
Structure of Capital Account
The structure of capital account are as follows:
- All capital transactions causing flow of foreign exchange into the country are recorded as positive items (credit side).
- All capital transactions causing flow of foreign exchange out of the country are recorded as negative items (debit side).