BALANCE OF PAYMENTS “A record of international transactions between
residents of one country and the rest of the world”
INTRODUCTION
BALANCE OF PAYMENT:- Balance of payments (BoP) accounts are an
accounting record of all monetary transactions between a country and the rest of
the world. These transactions include payments for the country's exports and
imports of goods, services, financial capital, and financial transfers. The BoP
accounts summarize international transactions for a specific period, usually a year,
and are prepared in a single currency.
BALANCE OF TRADE:- The balance of trade is the difference between the
monetary value of exports and imports of output in an economy over a
certain period. It is the relationship between a nation's imports and exports.
A positive balance is known as a trade surplus if it consists of exporting
more than is imported; a negative balance is referred to as a trade deficit or,
informally, a trade gap.
OBJECTIVE
Its main objective is to represent the economic position of a country, whether its
currency is rising or falling in its external value.
THE GENERAL RULE IN BOP ACCOUNTING
a) If a transaction earns foreign currency for the nation, it is a credit and is
recorded as a plus item.
b) If a transaction involves spending of foreign currency it is a debit and is
recorded as a negative item.
COMPONENTS OF BALANCE OF PAYMENTS
1. Current Account
2. Capital Account
3. Official Account
CURRENT ACCOUNT
BOP on current account refers to the inclusion of three balances of namely –
Merchandise balance, Services balance and Unilateral Transfer balance. In
other words it reflects the net flow of goods, services and unilateral transfers
(gifts). The net value of the balances of visible trade and of invisible trade
and of unilateral transfers defines the balance on current account.
CAPITAL ACCOUNT
The capital account of a country consist of its transaction in financial assets in the
form of short-term and long-term lending and borrowing.
Capital accounts deals with the accounts related to cash or liquid assets.
Capital account includes :-
1. Short term capital movements:- • Purchase of short-term securities. • Cash
balance held with Foreign countries for a time period less than a year.
2. Long term capital movements:- • Direct investments in shares, bonds, real-
estate, plant, building, etc. • Cash balance held with Foreign countries for a time
period more than a year.
THE OFFICIAL RESERVES ACCOUNT
Official reserves assets include gold, foreign currencies, SDRs, reserve positions
in the IMF.
UNILATERAL TRANSFER ACCOUNT
These accounts deal with the transactions related to the donation factors like,
GIFTS FROM GOVERNMENT
DISASTER RELIEF CHARITIES. Etc.
DISEQUILLIBRIUM OF BOP
MEANING:- Though the credit and debit are written balanced in the
balance of payment account, it may not remain balanced always. Very often, debit
exceeds credit or the credit exceeds debit causing an imbalance in the balance of
payment account. Such an imbalance is called the disequilibrium.
Disequilibrium may take place either in the form of deficit or in the form of
surplus.
DEFICIT:- Disequilibrium of Deficit arises when our receipts from the
foreigners fall below our payment to foreigners. It arises when the effective
demand for foreign exchange of the country exceeds its supply at a given rate of
exchange. This is called an 'unfavourable balance'.
SURPLUS:- Disequilibrium of Surplus arises when the receipts of the
country exceed its payments. Such a situation arises when the effective demand
for foreign exchange is less than its supply. Such a surplus disequilibrium is
termed as 'favourable balance'.
CAUSES OF DISEQUILLIBRIUM
A number of factors may cause disequilibrium in the balance of payments. These
various causes may be broadly categorized into:
(i) Economic factors
(ii) Political factors and
(iii) Sociological factors
Causes of Disequilibrium in BOP
A. Economic Factors: the economic factor which cause disequilibrium in the
balance of payment of the country are:
1. Cyclical fluctuations: Business fluctuations arises out of the occurrences
of trade cycle cause disequilibrium in BOP of a country. If there is business
recession in the foreign countries, it will result in fall in exports of the
country concerned leading to disequilibrium in the balance of payment.
2. Inflationary pressures in the Economy: an inflationary rise in prices in
the economy leads to disequilibrium in BOP. Due to rising money income of
the people an increasing prices of the goods and services, exports tends to
decline, import tends to rise for increased domestic demand and there by
causes disequilibrium in BOP.
3. Capital Movements: if due to political instability and other factors, there
is flight of capital from the country, it would cause disequilibrium in BOP.
Likewise a country may tend to have an adverse balance when it borrows
heavily from other countries, while the lending country will tend to have a
favorable balance.
4. Fall in Exports and Rise in Imports: A fall in exports and rise in
imports of the country causes a disequilibrium in its BOP, the fall in exports
and rise in imports may be due to:
Contraction of economy
Fall in domestic production and rising demand for imported goods
Inferior quality and high prices of the goods to be exported
Currency appreciation
Obstructive government policies
Demonstration effect
Cheaper price and better quality of foreign goods
Increase in money income due to inflation policy.
2) POLITICAL FACTOR:- Certain political factors may also produce a balance
of payments disequilibrium. For instance, a country plagued with political
instability may experience large capital outflows, inadequacy of domestic
investment and production, etc. These factors may sometimes, cause
disequilibrium in the balance of payments.
3) SOCIAL FACTOR:- Certain social factors influence the balance of
payments. For instance, changes in tastes, preferences, fashions, etc. may affect
imports and exports and thereby affect the balance of payments.
Temporary Causes- Temporary causes may arises due to variations in the trade,
effect of weather on agriculture production etc.
National Income - Another cause is the change in country’s national
income. If the national income of a country increases, it will lead to an
increase in imports thereby creating a deficit in balance of payments.
Inflation- Inflation is another cause of disequilibrium in the balance of
payment. If there is inflation in the country prices of exports increase,
thus increase in export prices leading to decline in exports and rise in
imports result in adverse.
Economic Development- A country’s balance of payments also depends
on its stage of economic development. If a country is developing it will
have a deficit in its balance of payments.
Borrowing and lending- A country which gives loans and grants on a
large scale to other countries has a deficit in its balance of payments on
capital account. On the other hand, a developing country borrowing large
funds from other countries may have a favourable balance of payments.
Change in exchange rate – This change arise due to change in exports
and imports. If exports of the country are more then imports the demand
for its currency increase so that the rate of exchange moves in favours. On
the other hand if imports are more than exports the demand for the foreign
currency increase and the rate of exchange will against the country.
