BALANCE OF PAYMENT
Balance of Payment (BOP) is a statement which records all the monetary
transactions made between residents of a country and the rest of the world during
any given period. This statement includes all the transactions made by/to
individuals, corporate and the government and helps in monitoring the flow of funds
to develop the economy.
When all the elements are correctly included in the BOP, it should sum up to zero in
a perfect scenario. This means the inflows and outflows of funds should balance out.
However, this does not ideally happen in most cases.
A BOP statement of a country indicates whether the country has a surplus or a
deficit of funds i.e. when a country’s export is more than its import, its BOP is said
to be in surplus. On the other hand, the BOP deficit indicates that a country’s
imports are more than its exports.
FEATURES OF BOP
• It is a systematic record of all economic transactions between one country and the
rest of the world.
• It includes all transactions, visible as well as invisible.
• It relates to a period of time. Generally, it is an annual statement.
• It adopts a double-entry book-keeping system. It has two sides: credit side and
debit side. Receipts are recorded on the credit side and payments on the debit
side.
Why is Balance of Payment (BOP) vital for a country?
A country’s BOP is vital for the following reasons:
The BOP of a country reveals its financial and economic status.
A BOP statement can be used as an indicator to determine whether the
country’s currency value is appreciating or depreciating.
The BOP statement helps the Government to decide on fiscal and trade
policies.
It provides important information to analyze and understand the economic
dealings of a country with other countries.
Elements of a Balance of Payment
There are three components of balance of payment viz current account, capital
account, and financial account. The total of the current account must balance with
the total of capital and financial accounts in ideal situations.
Current Account
The current account is used to monitor the inflow and outflow of goods and services
between countries. This account covers all the receipts and payments made with
respect to raw materials and manufactured goods.
It also includes receipts from engineering, tourism, transportation, business
services, stocks, and royalties from patents and copyrights. When all the goods and
services are combined, together they make up to a country’s Balance Of Trade
(BOT).
There are various categories of trade and transfers which happen across countries.
It could be visible or invisible trading, unilateral transfers or other
payments/receipts. Trading in goods between countries is referred to as visible items
and import/export of services (banking, information technology etc) is referred to as
invisible items.
Unilateral transfers refer to money sent as gifts or donations to residents of foreign
countries. This can also be personal transfers like – money sent by relatives to their
family located in another country.
Capital Account
All capital transactions between the countries are monitored through the capital
account. Capital transactions include the purchase and sale of assets (non-financial)
like land and properties.
The capital account also includes the flow of taxes, purchase and sale of fixed assets
etc by migrants moving out/into a different country. The deficit or surplus in the
current account is managed through the finance from the capital account and vice
versa. There are 3 major elements of a capital account:
Loans and borrowings – It includes all types of loans from both the private and
public sectors located in foreign countries.
Investments – These are funds invested in the corporate stocks by non-residents.
Foreign exchange reserves – Foreign exchange reserves held by the central bank of
a country to monitor and control the exchange rate does impact the capital account
Financial Account
The flow of funds from and to foreign countries through various investments in real
estates, business ventures, foreign direct investments etc is monitored through the
financial account. This account measures the changes in the foreign ownership of
domestic assets and domestic ownership of foreign assets. On analyzing these
changes, it can be understood if the country is selling or acquiring more assets (like
gold, stocks, equity etc).
DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS
• A disequilibrium in the balance of payment means its condition of Surplus or
deficit.
• A Surplus in the BOP occurs when Total Receipts exceeds Total Payments. Thus,
BOP= CREDIT>DEBIT.
• A Deficit in the BOP occurs when Total Payments exceeds Total Receipts. Thus,
BOP= CREDIT<DEBIT.
MEASURES TO CORRECT DISEQUILIBRIUM IN THE BOP
1. MONETARY MEASURES:
a) Monetary Policy The monetary policy is concerned with money supply and
credit in the economy. The Central Bank may expand or contract the money supply
in the economy through appropriate measures which will affect the prices.
b) Fiscal Policy Fiscal policy is government's policy on income and expenditure.
Government incurs development and non - development expenditure,. It gets income
through taxation and non - tax sources. Depending upon the situation government’s
expenditure may be increased or decreased.
c) Exchange Rate Depreciation By reducing the value of the domestic currency,
government can correct the disequilibrium in the BOP in the economy. Exchange
rate depreciation reduces the value of home currency in relation to foreign currency.
As a result, import becomes costlier and export becomes cheaper. It also leads to
inflationary trends in the country
d) Devaluation: Devaluation is lowering the exchange value of the official currency.
When a country devalues its currency, exports become cheaper and imports become
expensive which causes a reduction in the BOP deficit.
e) Deflation: Deflation is the reduction in the quantity of money to reduce prices
and incomes. In the domestic market, when the currency is deflated, there is a
decrease in the income of the people. This puts curb on consumption and
government can increase exports and earn more foreign exchange.
f) Exchange Control All exporters are directed by the monetary authority to
surrender their foreign exchange earnings, and the total available foreign exchange
is rationed among the licensed importers. The license-holder can import any good
but amount if fixed by monetary authority
2. NON- MONETARY MEASURES:
a) Export Promotion To control export promotions the country may adopt
measures to stimulate exports like: export duties may be reduced to boost exports;
cash assistance, subsidies can be given to exporters to increase exports; goods
meant for exports can be exempted from all types of taxes.
b) Import Substitutes Steps may be taken to encourage the production of import
substitutes. This will save foreign exchange in the short run by replacing the use of
imports by these import substitutes.
c) Import Control Import may be kept in check through the adoption of a wide
variety of measures like quotas and tariffs. Under the quota system, the government
fixes the maximum quantity of goods and services that can be imported during a
particular time period.
1. Quotas – Under the quota system, the government may fix and permit the
maximum quantity or value of a commodity to be imported during a given period. By
restricting imports through the quota system, the deficit is reduced and the balance
of payments position is improved.
2. Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs are
imposed, the prices of imports would increase to the extent of tariff. The increased
prices will reduced the demand for imported goods and at the same time induce
domestic producers to produce more of import substitutes.
