Balance of Payments Deficit and Surplus

Balance of payment refers to a financial statement which records the monetary transactions made between the residents of a country and the rest of the world. The transactions made are recorded for a particular period, say for the quarter of a year, and so on. 

This financial statement records all the transactions undertaken by or made to a government, corporations or individuals, and aids to track the flow of funds in a country. Ideally, the inflow and outflow of funds in a country should balance out, and the elements included in the balance of payment should sum up to zero. 

Following is an in-depth analysis of the balance of payment definition and what it means for a country.

What does a Country’s BoP Statement Indicate?

The BoP statement of a country indicates whether it has a deficit or surplus of funds. For instance, if a country’s export is higher than its import, then there is a surplus in the balance of payments. 

However, a BoP deficit can arise if a country’s imports amount to more than its total exports. The transactions recorded in a BoP statement follow the same rules as that of a double-entry accounting system. That is, every transaction has debit, and credit entries made corresponding to each other.

What is the Significance of BoP for a Country?

A country’s balance of payment is one of the metrics of its economic status. It also holds significance over the following areas – 

  1. A country’s BoP statement can be used as an indicator to determine whether its currency value is depreciating or appreciating.

  2. It acts as a comprehensive document that helps to understand and analyse a country’s economic relationship with other countries.

  3. Finally, the balance of payment helps a government decide its trade and fiscal policies going forward.

BoP thus holds substantial significance by helping a government determine the policies that shape a country’s economy.

What are the Elements of BoP?

Now that we have learnt the balance of payment meaning, let us delve into the elements integrated into this statement.

Balance of payment has three components – capital account, current account and financial account.

  • Capital Account – 

As its name suggests, this account records all capital transactions made between two countries. These include sale and purchase of fixed assets by migrants, the flow of taxes, as well as, sale and purchase of assets like property and land.

Capital account helps to manage the surplus or deficit created in the current account. Investments, loans and borrowings, and foreign exchange reserves are the three major elements of a capital account.

  • Current Account -

This account tracks the inflow and outflow of goods and services from one country to another. This includes recording receipts generated from tourism, transportation, engineering, stocks, business services and royalties collected from patent and copyright. Current account also monitors payments for manufactured goods and raw materials.

All the above mentioned categories combined together form a country’s Balance of Trade (BoT).

  • Financial Account – 

This account tracks inflow and outflow of funds to and from foreign countries from investment in business ventures, real estate, foreign direct investment, etc. This account, thus, helps to gauge the domestic ownership of foreign assets and foreign ownership of domestic assets.

Ideally, the total value recorded in the current account should balance with the total of capital and financial accounts.

What is Balance of Payment Deficit?

A balance of payment deficit in a country can arise if said country imports more capital, goods and services than it exports. 

Balance of payment deficit is given by – 

(Current account + capital account receipts) < (current account + capital account payments)

This BoP deficit can be balanced by utilising the country’s foreign exchange reserves to meet the BoP shortfall. 

Following are a few crucial points to remember about the BoP deficit in a country – 

  1. A BoP deficit can be corrected through an official reserve sale which denotes the sale of foreign exchange by the Reserve Bank.

  2. The monetary authorities of a country are the financiers when any deficit arises in the country’s balance of payment. Conversely, they are also the recipients when there is a surplus in the country’s BoP.

  3. An overall decrease in a country’s official reserves signifies a deficit in balance of payments.

  4. Official reserve transactions can be accounted for only under the regime of fixed exchange rates. They cannot be considered when exchange rates are floating.

Causes of BoP Deficit –

BoP deficit can arise due to several reasons. These are –

  1. Rapid Economic Development

High outflow of foreign exchange to meet import demands like technology, machines, and equipment can lead to BoP deficit.

  1. Inflation

Sustained rise in a country’s prices can often make foreign products cheaper, leading to a high volume of imports.

  1. Political Disturbance

Unstable tax structures, change in government, etc. can lead to a loss in foreign investment, and give way for BoP deficit.

Apart from these, factors like population explosion, change in the preference and tastes of the general population, etc. can also contribute to the balance of payment of a country.

What is Balance of Payment Surplus?

Balance of payments surplus occurs when a country’s total exports are higher than its imports. This helps to generate capital to fund its domestic productions. With a surplus in its BoP, a country can also lend funds outside its borders.

Balance of payment surplus occurs when – 

(Current account + capital account receipts) > (current account + capital account payments)

A surplus in BoP can help to boost the short term economic growth of a country.

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FAQ (Frequently Asked Questions)

1. What is the BoP Deficit?

Ans. Balance of payment refers to the situation when a country’s imports are higher than its total exports. The country then has to pay for its imports by utilising its foreign exchange reserves to meet the deficit that arises in due course.

2. What is Meant by Balance of Payment?

Ans. Balance of payment is a statement that records the financial transactions between the residents of a country and the rest of the world. These transactions are recorded periodically – like for a quarter of a year or more. This statement helps to determine the economic status of a country.

3. What is BoP Surplus?

Ans. Balance of payment surplus occurs when a country’s total exports and higher than its total imports. This surplus helps countries to fund their domestic productions and even allows it to lend it to other countries. BoP surplus signifies a boost in a country’s economic growth.