Balance of Trade vs. Balance of Payment: Key Differences

Globalisation has made the world a small place, and nowadays every country is free to transact with others. In this regard, two financial statements are prepared to keep the record of international transactions made by a country. These are called the balance of trade (BOT) and balance of payments (BOP). 

 

BOT keeps track of import and export of goods by a country with others; whereas, the BOP keeps track of every economic transaction made by a country globally. It can include goods, services, assets, etc.

 

Often these two terms are used interchangeably, but they do not share any similarities. Therefore, before discussing the difference between the balance of trade and balance of payment, you should know about these terms’ meaning and what they represent.

India has grown into a social upfront when it comes to the world market. Our country trades in humongous value with the other nations. Keeping track of all its transactions (export and import) done in a single year becomes mandatory. Thus, a system was launched which is known as Balance of Trade that calculates the export and import. Similarly, BOP or Balance of Payments was also initiated side by side which shows all the commercial transactions done by the country. 

In this context, we will discuss BOT (Balance of Trade) and BOP and their effect on our nation. 

Balance of Trade 

The term ‘trade’ refers to buying and selling of goods. However, when it is performed on an international scale, it is called imports and exports. BOT mentions the import and exports made by a nation’s economy within a specific year. BOT only records tangible items.

BOT portrays the variability of imports and exports made by a country during a period. In case a country achieves an equal status in terms of imports and exports, then this situation is regarded as Trade Equilibrium. However, if the former surpasses the latter, then it creates a Trade Deficit, which is not a favourable situation for a country. On the other hand, if the export value exceeds that of imports, then it creates a Trade Surplus, which puts an economy in a favourable situation.

Example of BOT

There is a country that is known for its cotton industry but lacks petroleum. Therefore, it imports oil from other countries and exports clothes and other cotton products to the rest of the world. In 2018, this country exported cotton products worth﹩40 billion and imported petroleum products worth﹩25 billion. Therefore, this country has registered a﹩15 billion trade surplus.

Balance of Payment

Balance of Payment is a combination of accounts that shows the commercial transactions concluded by a country within a specific period with other countries. These accounts reflect every monetary transaction, i.e., commodities, services, and incomes during that period.

The BOP combines every private and public investment to find out the money inflow and outflow in an economy over a specific period. The ideal status of BOP should be zero, which indicates that the money coming into the country is equal to the money going out of the country. However, this situation is highly unlikely. Therefore, if it is negative, then it indicates deficit, and if positive, it means a surplus. 

Balance of Payment is classified in the following accounts, these are –

1. Current account: This account keeps a record of both tangible and intangible items. 

2. Capital account: This account keeps the record of aggregate income generated by the public and private sector as well as capital expenditures. External commercial borrowing (ECB), loans to other governments, foreign direct investments are included here.

3. Errors and omissions: In case payments and receipts do not tally then the balance will be presented as errors and omissions.

BOP is presented quarterly, half-yearly, or annually. Its main focus is to keep an eye on the flow of money within an economy and formulate policies accordingly. Apart from governments, companies can also prepare BOP for their business purpose.

Example of BOP

With regards to the previous BOT example, a country has imported petroleum products worth﹩25 billion and exported cotton products of ﹩40 billion. During the same period, that company has taken foreign aid of ﹩10 billion and made investments in a petroleum company of another country worth﹩5 billion.

Therefore, this country’s BOP for that period will be –

{﹩40 billion +﹩10 billion (total inflow) –﹩25 billion +﹩5 billion (total outflow)}=﹩20 billion Here the value of exported goods and foreign aid is included in ‘total inflow’, and the value of imported goods and foreign investment is under ‘total outflow’.

Difference between the Balance of Trade and Balance of Payment

Following are the major differences between the balance of trade and balance of payment –

• Meaning

BOT is a statement that records a country’s imports and exports of goods with other countries in a period. Whereas BOP records all the economic transactions performed by that country within a period.

• Records

A major difference between BOP and BOT is regarding the records they keep. Balance of Trade only records the physical items. On the other hand, Balance of Payment records physical items along with non-physical items.

• Capital Transfers

The capital transfer is another significant difference between BOT and BOP. Capital transfers are only included in a Balance of Payment. BOP records all capital receipts and payments.

• Final result

BOT can be positive, negative, and balanced. However, BOP shall always be balanced.

• Component

Another factor that distinguishes between the balance of trade and balance of payment is that BOT is a major part of a BOP. It is a component of a BOP’s Capital Account section.

Every country in the world keeps a tab on its economic activities with the help of BOP and BOT. They reflect the actual condition of a particular economy. However, BOT only reveals a partial picture, whereas BOP reveals the complete view of a country’s economy.

The difference between the balance of trade and the balance of payment is an important chapter of economics. Students who want to learn other chapters of economics and commerce can visit the official website of Vedantu.