Balance of payment is a statement designed to provide a comprehensive record of all the transactions between the country and the rest of the world. It is an international balance sheet of a country that contains the details of all the international transactions in goods, services, and assets over a financial year. BoP is usually maintained under the International Transactions Accounts in national statistical data. It is just like a balance sheet which records all the assets borrowed, acquired or sold.
It is the most important tool as it concludes how the country’s economy interacts with the rest of the world.
Importance of Balance of Payments
Importance of Balance of Payments A study of BOP is important because –
It displays the financial or economic position of the country in the world.
It helps in forming the nation’s monetary, fiscal and trade policies.
As far as the national income is concerned, it tells the contribution of foreign trade and transaction to it.
It is useful to the banking sector, industries, financial institutions and individuals who are directly or indirectly engaged in international trade and financial activities.
It is an economic barometer of a country’s growth vis-à-vis the rest of the world.
Balance of Payment Accounting
The BOP accounts of a country are recorded on the basis of an accounting procedure known as double-entry bookkeeping. Double-entry bookkeeping system means that each international transaction is recorded two times, once as a credit-entry and once 49 as a debit entry of equal amount. The reason for this is that in general, every transaction has two sides that are credit and debit.
The General Rule of Payment Accounting
a. A transaction which earns a foreign currency for a nation is recorded as CREDIT.
b. A transaction which spends the foreign currency is recorded as DEBIT.
Components of Balance of Payment
Net errors and omissions account
Reserves and related items: official reserve account
The current account of a nation’s bop includes of all transactions regarding its trade in goods, services, income and unilateral transfers.
The current account includes the following-
(a) Merchandise Exports & Imports – These exports and imports are extremely vital items in the current account. It covers the significant amount of portion in the BOP.
(b) Invisible-Exports & Imports - These exports and imports are also called as service exports & imports. They are another important component of the current account. Important invisible items would be – travel transactions, insurance amount, transportation, investment income in the form of profits, dividends, etc. and Government not included elsewhere.
(c) Unilateral Transfers –. Unilateral transfers are the presents or gifts, grants, etc. either received from another country (credits) or given to another country (debits). They are one-sided transactions which could be official or private.
The capital account gauges the transfer in assets and liabilities. For example, this may involve a Uk firm building a company in India. This is counted as a credit on India’s Capital Account. The Capital account can also include the purchase of securities and liabilities, for example, a UK Banker buying Indian Government’s securities.
Capital Account Balance
There can always be a surplus or deficit balance in the capital account.
It includes - private abroad loan flow, flow in banking capital, official capital transactions, reserves money, gold movement etc.
These are classified into two categories
Direct foreign investments
The financial account tracks financial inflow and outflow from the country’s economy. The necessity of financial flows has grown speedily in the past few years, from being a relatively insignificant consideration to a major component of the BoP.
The three important categories included in the financial account are foreign direct investment (FDI), portfolio investment (PI), and official reserve transactions (ORT).
1. What are the Components of the Capital Account of the Balance of Payments?
(1) Borrowings and lendings inflow and outflow.
(2) Investments flow.
(3) Changes in foreign exchange reserves.
2. What are the Transactions of the Current Account of Balance of Payment?
Exports and imports of services.
Income receipts and payments to and from abroad.
Transfers to and from abroad.
3. What is the Difference Between Balance of Trade and Balance of Payments?
Ans. Balance of Trade or BoT is a financial statement that records the nation’s import and export of goods and services with the rest of the world.
Balance of Payment or BoP is a financial statement that keeps a record of all the economic transactions by the country with the world.
4. When the Price of Foreign Currency Increases, its Demand Falls. Explain Why.
Ans. When the price of the foreign currency increases the import cost also increase. This leads to a decreased demand for imports. Resulting in the demand for foreign exchange to fall.