Balance of Payment

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.

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.

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.

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 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 analyse and understand the economic dealings with other
countries.

Elements of a Balance of Payment

There are three components of the 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 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 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.).

The importance of the balance of payment in India can be determined from the following points:

It monitors the transaction of all the imports and exports of services and goods for a given period.
It helps the government analyse a particular industry’s export growth potential and formulate policies
to sustain it.
It gives the government a comprehensive perspective on a different range of import and export tariffs.
The government then increases and decreases the tax to discourage imports and encourage export,
individually, and self-sufficiency.

What is the difference between the balance of trade and payments?

Balance of trade is the difference between exports and imports of goods. Only the visible items are
considered in the balance of trade. The exchange of services between countries is not considered.
The current account of the balance of payment comprises exports and imports of goods, services and
unilateral transfers like remittances, gifts, donations, etc. The net value of all these constitutes the balance
of the current account. Thus, the balance of trade is a part of the current account of the balance of
payments.