BALANCE OF PAYMENTS
Dr. Manish Kumar
Assistant Professor
Management Studies under SOET
The balance of payments or B.O.P of a country
is the record of all economic transactions
between the residents of the country and the
rest of the world in a particular period of time.
It is also known as balance of international
payments and abbreviated as B.O.P.
These transactions are made by individuals,
firms and government bodies.
Thus the balance of payments includes all
external visible and non-visible transactions
of a country.
Harvey and Johnson have defined these
accounts in these words, “The balance of
payments accounts for a country set out, in
summary form, all the current and capital
transactions which have taken place
between the residents of that country and
the rest of the world in a given period of
time.”
Importance of BOP
The balance of payment provides detailed information
concerning the demand and supply of a country's
currency.
A country's balance of payments data may signal its
potential as a business partner for the rest of the world.
A country with a significant balance of payments surplus
would be more likely to expand imports.
It offers marketing opportunities for foreign enterprises,
and less likely to impose foreign exchange restrictions.
Balance of payments data can be used to
evaluate the performance of the country in
international economic competition.
If a country experiencing trade deficits year
after year, it means domestic industries of that
country lacks international competitiveness.
COMPONENTS OF BALANCE OF PAYMENTS
The balance of payment has three components:
1. The Current Account.
2. The Financial Account.
3. The Capital Account
The current account measures following things:
international trade,
net income on investments,
and direct payments.
CURRENT ACCOUNT
There are four components of Current Account:
1. Trade: Trade in goods and services is the largest
component of the current account. A trade deficit alone
is enough to create a current account deficit.
2. Net Income: This is income received by the country’s
residents minus income paid to foreigners. The country’s
residents receive income from two sources. The first is
earned on foreign assets owned by a nation's residents
and businesses. That includes interest and dividends
earned on investments held overseas. The second source
is income earned by a country's residents who work
overseas.
3. Direct Transfers: This includes remittances from
workers to their home country. For
example, India receives $24.8 billion from
abroad. FDI and bank loans to foreigners can be
source of direct transfers to any country.
4. Asset Income: This is composed of increases or
decreases in assets like bank deposits, the central
bank, and government reserves, securities, and
real estate. For example, if a country’s assets do
well, asset income will be high.
FINANCIAL ACCOUNT
The Financial account describes the change in
international ownership of assets.
The owners can be individuals, businesses, the
government, or its central bank.
The assets include direct investments,
securities like stocks and bonds, and
commodities such as gold and hard currency.
There are two subaccounts of Financial Account:
1. The first is domestic ownership of foreign assets.
2. Second is foreign ownership of domestic assets.
Domestic ownership of foreign assets: If this
increases, it subtracts from the financial account.
This subaccount is further divided into three types
of ownership:
private,
government,
and central bank reserves.
Private owners can be either individuals or
businesses. Their assets include:
Deposits at Foreign Banks
Loans to Foreigners
Securities of Foreign-Owned Companies
Direct Investments Made in Foreign Countries
Commodities, Such as Gold, Held in Other
Countries
Government owners can be at the central, state,
or local level.
Most foreign assets are owned by the central
government.
Its assets can include all of the above, but most
are gold and foreign currencies held in reserve.
This component also includes the government's
reserve position in the International Monetary
Fund.
The nation's central bank can own all of the
above except for the reserve position in the IMF.
REFERENCES:
https://www.thebalance.com/what-is-the-fi
nancial-account-3306269
https://www.thebalance.com/what-is-the-ca
pital-account-measurement-and-examples-
3306266
https://www.thebalance.com/current-accoun
t-definition-and-4-components-3306265
https://www.thebalance.com/what-is-balanc
e-of-payments-components-and-deficit-33
06278
http://www.economicsdiscussion.net/balanc
Foreign Ownership of Domestic Assets:
This subaccount is further divided into two
types of ownership:
private and
foreign official assets.
When foreigners increase their ownership of a
country's assets, it adds to the financial
account.
These domestic assets include:
Deposits owned by foreigners held at the
country's banks.
Loans made by foreign banks to domestic
banks. Foreign private purchases of a country's
government bonds, such as Treasury notes.
Corporate securities, such as stocks and
bonds, owned by foreigners.
Foreign direct investment, such as reinvested
earnings, equities, and debt.
Other debts owed to foreigners.
Hard assets, such as gold and other
commodities.
The country's currency.
Foreign official assets include:
Assets mentioned above that are held by
foreign governments or foreign central banks.
Net shipments of the country's currency to
foreign governments or foreign central banks.
CAPITAL ACCOUNT
The capital account includes any other financial
transactions that don't affect the nation's
economic output
It measures financial transactions that affect a
country's future income, production, or savings.
An example is a foreigner's purchase of a U.S.
copyright to a song, book, or film.
Its value is based on what it will produce in the
future.
Examples include international transfers of
drilling rights, trademarks, and copyrights.
CAPITAL ACCOUNT
The capital account has two main
subaccounts:
1. Acquisition and Disposal of Non-produced, Non-
financial Assets.
This measures the purchase and sale of two types of
assets: tangible and intangible assets.
Tangible assets include the rights to natural resources
, such as mineral rights, parts of the electromagnetic
spectrum, and offshore drilling rights.
Intangible assets include patents, copyrights, and
trademarks. They also include franchises and leases.
2. Capital Transfer. There are three
components of the capital transfer sub-
account.
The first is insured catastrophic losses. These
are large, but infrequent, insurance payments
from foreign insurance companies..
The second component of this sub-account is
debt forgiveness. The only part of the debt
that is measured is the principal and any
overdue interest payments.
Deficit
Acquisitions of non-produced, non-financial assets
create a deficit in the capital account. An example
is the purchase of rights to natural resources. When
a country's residents, businesses, or government
forgive a debt, their action also adds to the deficit.
Surplus
Disposals of non-produced, non-financial assets
create a surplus. An example is the sale of rights to
natural resources. When foreign insurance
companies pay to cover catastrophic losses, they
also add to the surplus.
Current Account: Deficit
A current account deficit is when a country's
residents spend more on imports than they
save. To fund the deficit, other countries lend
to, or invest in, the deficit country's businesses.
If the current account deficit continues for a
long time, it will slow economic growth.
Foreign lenders will begin to wonder whether
they will get an adequate return on their
investment.
Current Account: Trade Deficit Definition
A trade deficit results when a country's imports more than it
exports. Imports are any goods and services produced in a
foreign country, even if these are produced overseas by a
domestic company.
Current Account: Trade Balance
The trade balance measures a country's imports and exports.
This is the largest component of the current account, which
is itself the largest component of the balance of payments.
Most countries try to avoid a trade deficit, but it's a good
thing for emerging market countries. It helps them grow
faster than they could if they maintained a surplus.
HYPOTHETICAL EXAMPLE
EXPLANATION
In Table 20.3, rows 1 and 8 are related to visible exports and
imports. Rows 2 and 9 represent the export and import of services
(invisible trade).
Rows 3 and 10 refer to investment income. Rows 4 and 11 signify
unilateral transfers (such as private and official gifts and donations).
Rows 5, 6, 12 and 13 are connected with capital movements.
Items 7 and 14 refer to outflow and inflow of gold. The item 15
concerning errors and omissions, in this account, is the balancing
item.
The items 1, 2. 3, 4, 8. 9. 10 and 11 are related to the current
account. These have the dimensions of flows.
The items 5, 6, 7, 12. 13 and 14 are related to the capital account
and these have the dimensions of stocks.
From the Table 20.3, it follows that the total value of all credits and
debits is exactly the same, i.e., Rs. 3150 crores.
Table 20.3 can be reconstituted as shown in
Table 20.4
EXPLANATION
Thus in the accounting sense, there is
inevitable equality between total credits and
total debits (3150-3150 = 0).
There is deficit on the balance of current
account (- 150). But at the same time there is
surplus on the capital account amounting to (+
170).
In the actual balance of payments accounts, the
credits and debits may not balance.
The balance is, therefore, achieved by
including some adjusting or balancing item.
