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Balance of Payment (BoP) -Calculation, Purpose, Components & More!
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The Balance of Payment is a report or statement that includes the transactions made by the inhabitants of a particular country with the remaining world over a particular time period. It is also called the balance of international payments and is abbreviated as BOP. It sums up all payments and earnings by entities, individuals, and the country’s government. The transactions can either be factored payments or transfer payments. The BOP statement records every financial transaction made between the entities during a given span. It helps in monitoring the funds coming into the country and aids in assessing a country’s financial situation in a better way.
In this article, let us look at the Balance of Payments (BoP), their features, purposes of calculation, components, and the Balance of payment crisis for the UPSC IAS Exam.
What is a Balance of Payment?
The balance of payments (BOP) is a system that countries employ to track all international financial transactions within a specific timeframe, typically on a quarterly and yearly basis. All economic activities, whether by private or public entities, are recorded in the BOP to ascertain the flow of funds in and out of a country. When a country receives funds, it is categorized as a credit, and when it disburses funds, the transaction is labeled as a debit. In an ideal scenario, the BOP should be in equilibrium, indicating that credits (assets) and debits (liabilities) should match. However, in practice, this balance is seldom achieved. Consequently, the BOP provides insights into whether a country has a deficit or surplus and identifies the sector of the economy responsible for the disparities.
Features of Balance of Payment (BOP)
- The statement comprises all the international transactions that encompass individual, corporate, and government transactions.
- In an ideal scenario, i.e., when all the fund flows are properly included in the balance of payment, the sum will always be zero.
- This means that the inflow and outflow of funds have been balanced out.
- As mentioned, this is an ideal situation and, hence, might not take place in a day-to-day situation.
- A BOP surplus indicates that the funds of a country have been on the positive side with regard to international transactions.
- A BOP deficit specifies that a country’s funds have been on the negative side in international transactions.
- This means that the inflow and outflow of funds have been balanced out.
- As mentioned, this is an ideal situation and, hence, might not take place in a day-to-day situation.
Check this article on Gini Coefficient.
Calculation of Balance of Payments
- The current account should be in balance with the combination of the financial account and the capital account.
- Theoretically, the Balance of Payment should always be zero, but it hardly happens in practice.
- Hence, BoP is used to decide whether the country is having a surplus or deficit and the areas that are actually causing this surplus or deficit.
- The balance of payments formula can be written as follows:
Check this linked article on the Bank Board Bureau.
What is a Balance of Payment Deficit?
- A balance of payment deficit can occur in a country if the said country imports more capital, goods, and services from outside than the amount it exports to other countries.
- The balance of payment deficit is determined by –
- The BoP deficit that occurs in a country can be balanced by making use of the country’s foreign exchange reserves to meet the shortfall in BoP.
- Following are a few vital points to remember about the BoP deficit of a nation.
- A shortfall in BoP can be rectified through the sale of official reserves, which signifies the sale of foreign exchange reserves by the Central Bank of the country.
- The monetary authorities of a country are the financiers when any shortfall emerges in the country’s balance of payment statement. On the other hand, they are also the beneficiaries when there is a surplus in the country’s BoP.
- An overall decline in the official reserves of a country indicates a deficit in the balance of payments.
- A shortfall in BoP can be rectified through the sale of official reserves, which signifies the sale of foreign exchange reserves by the Central Bank of the country.
- The monetary authorities of a country are the financiers when any shortfall emerges in the country’s balance of payment statement. On the other hand, they are also the beneficiaries when there is a surplus in the country’s BoP.
- An overall decline in the official reserves of a country indicates a deficit in the balance of payments.
Check this linked article on CRR, repo rate and reverse repo rate.
What is a Balance of Payment Surplus?
- Balance of payments surplus can occur in a country when the country’s total exports to other countries are higher than the quantity of its imports.
- This assists in generating capital to fund the domestic productions taking place in a country.
- With a surplus in the BoP, a country can also offer funds outside its borders.
- The Balance of payment surplus occurs when –
- A surplus in BoP can help bolster the short term economic advancement of a country.
- To remove the BOP surplus, the government will:
- Deposit the excess foreign exchange in the Foreign Exchange Reserves of the nation.
- This accommodating transaction of the government is made only to bring equilibrium in the Balance of Payment.
- Deposit the excess foreign exchange in the Foreign Exchange Reserves of the nation.
- This accommodating transaction of the government is made only to bring equilibrium in the Balance of Payment.
Check this linked article on Insolvency And Bankruptcy Code (IBC).
Purposes of BoP Calculation
- The Balance of Payment uncovers the fiscal and economic position of a nation.
- The BoP can be used as a pointer to determine the appreciation or depreciation of a country’s currency value.
- It helps the country’s government to decide on financial and trade policies.
- It gives important information to analyze the economic transactions of a country with other countries.
Check this article on the Consumer Price index.
Components of Balance of Payment (BOP)
For preparing the BOP statement, economic dealings between a country and the remaining world are divided into three major categories: the current account, the capital account and the financial account. Each of these three categories has sub-divisions, each of which accounts for a different type of international financial transaction. It also includes Errors and Omissions and the changes in Foreign Exchange Reserves.
- Current account
It is that part of the balance of payment that aids in knowing the status of exports and imports of a country. A surplus in the current account suggests that a country’s exports are more than its imports, whereas a deficit in the current account specifies a country’s import outweighs the exports.
The current account comprises the following:
- Balance of Trade
It covers a country’s monetary transactions while dealing with goods. So, the balance of trade primarily includes international transactions involving the sale/purchase of goods.
- Balance of Invisibles
It covers a country’s monetary transactions while dealing with services. So, the balance of invisible primarily includes international transactions involving the sale/purchase of services.
- Transfer payment
The elements such as donations, grants and remittances are a component of transfer payment.
- Capital account
Capital transactions involve the purchase and sale of assets or properties that are both financial and non-financial in nature such as land, etc.
The capital account comprises the following three elements.
- Loans and borrowings
This includes all types of loans that have been taken from both the private and public sectors that are housed in foreign countries.
- Investments
It involves elements like Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI), among other investments.
- Foreign exchange reserves
Foreign exchange reserves are held by the central bank of a nation, RBI in the case of India, for monitoring the rate of exchange.
- The Financial Account
The financial account consists of the international fund flows with regards to investment in a business, real estate, bonds and stocks. The account also includes assets possessed by the government, such as foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund (IMF), private assets that are held overseas and direct foreign investment. Individual and official assets owned by foreigners are also logged in the financial account.
- Errors and Omissions
Net errors and omissions indicate the imbalances resulting from shortcomings in source data and the calculation of the balance of payments accounts. Net errors and omissions represent a residual category and it is the ‘balancing item’ that reflects our inadequacy to log all international transactions precisely.
- Changes in Foreign Exchange Reserves
Movements in the reserves include changes in the foreign currency reserves held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) held with the IMF.
Check this article on New Economic Policy 1991.
Balance of Payment vs. Balance of Trade
Balance of trade
Balance of payments
Balance of trade or BoT is a fiscal statement that records the nation’s import and export of goods and commodities with the other parts of the world.
Balance of payment or BoP is a financial statement that logs all the economic transactions carried out by the nation with the other parts of the world.
It deals with the net profit or loss a country may incur from the import and export of commodities.
It deals with the accurate accounting of the transactions carried out by the nation.
Balance of trade (BoT) is the difference that is gained from the export and import of commodities.
Balance of payments (BoP) is the difference between the flow of foreign exchange from and to the country.
The transactions with regard to goods are logged in Balance of Trade.
The transactions related to money transfers, goods and services are included in Balance of Payment.
Balance of Trade does not encompass capital transfers.
Balance of Payment encompasses transfer of capital.
The net effect of BoT can be either positive, negative or zero.
The net effect of BoP is always zero.
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Balance of trade |
Balance of payments |
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Balance of trade or BoT is a fiscal statement that records the nation’s import and export of goods and commodities with the other parts of the world. |
Balance of payment or BoP is a financial statement that logs all the economic transactions carried out by the nation with the other parts of the world. |
|
It deals with the net profit or loss a country may incur from the import and export of commodities. |
It deals with the accurate accounting of the transactions carried out by the nation. |
|
Balance of trade (BoT) is the difference that is gained from the export and import of commodities. |
Balance of payments (BoP) is the difference between the flow of foreign exchange from and to the country. |
|
The transactions with regard to goods are logged in Balance of Trade. |
The transactions related to money transfers, goods and services are included in Balance of Payment. |
|
Balance of Trade does not encompass capital transfers. |
Balance of Payment encompasses transfer of capital. |
|
The net effect of BoT can be either positive, negative or zero. |
The net effect of BoP is always zero. |
Check this linked article on the National Company Law Tribunal (NCLT).
Balance of Payment Crisis (BoP) Crisis
- Balance of payment crisis is also known as the currency crisis.
- Countries that experience deficits in current accounts, can run into difficulties. If the shortfall is huge and the country’s economy is not able to generate adequate inflows of foreign investment, then its currency reserves will fall.
- At some point, the country may be required to seek emergency borrowing from organizations like the International Monetary Fund, leading to external debt.
- Nations with current account deficits will continue to build up debt and/or witness an increasing foreign possession of their assets.
Check this linked article on Non tax revenue receipts.
India’s Balance of Payments Status
As per the Reserve Bank of India (RBI), the Current Account Deficit (CAD) for the first half of 2022-23 was recorded at 3.3% of the Gross Domestic Product (GDP). Projections suggest that CAD is likely to decrease in the latter half of 2022-23 and remain easily manageable within sustainable limits. In January 2023, the trade deficit contracted to $17.7 billion, primarily due to a significant reduction in non-oil imports. Furthermore, there has been a decrease in Foreign Portfolio Investment (FPI) outflows, while workers' remittances increased. Additionally, imports of gold have seen a decline.
Check this linked article on Fiscal Consolidation.
We hope all your doubts regarding the Balance of Payment Crisis would have been addressed by now. Testbook provides comprehensive study material for different competitive examinations. Succeed in your UPSC IAS exam preparations with the Testbook App!
Balance of Payment FAQs
How to calculate the Balance of Payments statement?
The total sum of the current account and capital account specifies the total balance, which could either be in excess or in deficit.Balance of Payments is the net credit in the Current Account and Capital Account together.BoP = Net credit in the (Current Account + Capital Account and Financial Account).The formula used for calculation is current account + capital account + financial account + balancing item = 0.
What are the main factors that impact the balance of payments?
The factors, growth rates, relative prices and rates of return that drive national savings and decisions on investment most directly decide the balance of payments of a country.
Differentiate the balance of payments statement and the current and capital accounts.
The current account and the capital accounts are two important components of a country's balance of payments statement. The current account is the difference between a nation's investment and savings. A country's capital account registers the net change in assets and liabilities over a certain period of time.
Is a surplus in the balance of payment of a country good?
A surplus in the balance of payments of a country means the country's exports outweigh its imports. It provides sufficient capital to pay for all the production taking place in the domestic market. The country can even lend outside the national borders. It enhances economic growth.
Why is a balance of payments deficit considered a problem for a country's economy?
A balance of payments that is very high may, at some point, cause a loss of confidence among overseas investors. Therefore, there is always a risk that investors may pull out their investments leading to a large fall in the value of the country's currency causing devaluation.
What is the current status of India’s Balance of Payments account?
India is a country that has a balance of payment surplus as a result of the capital account surplus. Although the country faces a deficit in the current account, the surplus in the capital account is much higher leading to a balance of payment surplus.
Is a surplus in the current account always considered to be good for a country?
A current account surplus is considered to be good for an economy. It indicates that the country’s exports are more than the imports. But, it is not always good. For a country like India that is dependent on imports, when the current account balance is in surplus, it means that the demand has decreased leading to a reduction in imports. Demand reduction is an indication of economic stagnancy.
What is referred to as a current account deficit?
A country's current account deficit is an assessment of a country's trade where the measure of the goods and services it imports from other nations exceeds the value of the goods it exports to other nations.