Eco notes

BOP

1) International capital flows are the financial side of international trade.

When someone imports a good or service, the buyer (the importer) gives the seller (the exporter) a
monetary payment, just as in domestic transactions. If total exports were equal to total imports,
these monetary transactions would balance at net zero: people in the country would receive as
much in financial flows as they paid out in financial flows. But generally the trade balance is not zero.
The most general description of a country’s balance of trade, covering its trade in goods and
services, income receipts, and transfers, is called its current account balance. If the country has a
surplus or deficit on its current account, there is an offsetting net financial flow consisting of
currency, securities, or other real property ownership claims. This net financial flow is called its
capital account balance.

2) In balance-of-payments accounting terms, the current-account balance, which is the total

balance of internationally traded goods and services, is just offset by the capital-account
balance, which is the total balance of claims that domestic investors and foreign investors
have acquired in newly invested financial, real property, and equity assets in each others’
countries.”
3) BOP meaning , components
4) BOP calculation
5) BOP purpose

1) Balance Of Payment (BOP) is a statement that 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, corporates and the
government and helps in monitoring the flow of funds to develop the economy.
2) When all the elements are correctly included in the BOP, it should be 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.

3) 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 its imports are more than its
exports.

Tracking the transactions under BOP is similar to the double-entry accounting system. All
transactions will have a debit entry and a corresponding credit entry.

For example:
Funds entering a country from a foreign source are booked as credit and recorded in the
BOP. Outflows from a country are recorded as debits in the BOP. Let’s say Japan exports 100
cars to the U.S. Japan books the export of the 100 cars as a debit in the BOP, while the U.S.
books the imports as a credit in the BOP.
What is the Formula for Balance of Payments?
The formula for calculating the balance of payments is current account + capital account +
financial account + balancing item = 0.

Why is the Balance of Payment (BOP) vital for a country?

A country’s BOP is vital for the following reasons:

1) The BOP of a country reveals its financial and economic status.
2) A BOP statement can be used to determine whether the country’s currency value is
appreciating or depreciating.
3) The BOP statement helps the government to decide on fiscal and trade policies.
4) It provides important information to analyse and understand the economic dealings with
other countries.

Current Account
The current account monitors 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, they make up 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.) are 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 purchasing and selling 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 three major elements of a capital account:

Loans and borrowings – It includes all types of loans from the private and public sectors
located in foreign countries.
Investments – These are funds invested in corporate stocks by non-residents.
Foreign exchange reserves – Foreign exchange reserves held by the country’s central
bank to monitor and control the exchange rate do impact the capital account.
Financial Account
The flow of funds from and to foreign countries through various investments in real
estate, 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. Analysing these changes can
be understood if the country is selling or acquiring more assets (like gold, stocks, equity,
etc.).

Illustration
If, for the year 2018, the value of exported goods from India is Rs. 80 lakh and the value
of imported items to India is 100 lakh, then India has a trade deficit of Rs. 20 lakh for the
year 2018. The BOP statement acts as an economic indicator to identify the trade deficit
or surplus situation. Analysing and understanding the BOP of a country goes beyond just
deducting the outflows of funds from inflows. As mentioned above, there are various
components of BOP and fluctuations in these accounts, which provide a clear indication
of which economic sector needs to be developed.