BALANCE

OF
PAYMENT
Balance of Payment of a country is one of the
important indicators for International trade, which
significantly affect the economic policies of a
government.

As every country strives to a have a favorable

balance of payments, the trends in, and the position
of, the balance of payments will significantly
influence the nature and types of regulation of
export and import business
Balance of Payments is a systematic and summary record of
a country’s economic and financial transactions with the rest
of the world over a period of time.

Balance of payment is the systematic record of economic

transactions of the residents of country with the rest of
world during a specific period of time, normally a financial
year.
Features
Economic transactions
The statement is a summary of
economic records/transactions of the country with the
outsiders.
An economic transaction arises when values are
exchanged or moved between nations. These are:
1) Movement of goods ( export and Import)
2) Rendering a services.
3) Gifts and Grants.
4) Investment made Abroad.
5) Income on Investment.
 Residents with non residents

Generally transactions takes place between the residents of

other country with residents of other countries are recorded
in B.O.P.
Residents mean Individuals, Institutions, Government, etc.

A Flow Statement

A B.O.P is a compilation of the flow of economic transactions

of the country during the period.
It’s a Fund flow of a country not a balance sheet
Periodicity

Normally a balance of payment statement is prepared

covering a period of 1 year. How ever depending on the
government it may be for a period of 6 months, quarter
or even a month.
Balance of Trade and Balance of Payments

The Balance of Trade takes into account only the

transactions arising out of the exports and imports of the
visible terms; it does not consider the exchange of invisible
terms such as the services rendered by shipping, insurance
and banking; payment of interest, and dividend; expenditure
by tourists, etc.

The balance of payments takes into account the exchange

of both the visible and invisible terms. Hence, the balance of
payments presents a better picture of a country’s economic
and financial transactions with the rest of the world than the
balance of trade.
Nature of Balance of Payments Accounting

The transactions that fall under Balance of Payments are

recorded in the standard double-entry book-keeping form,
under which each international transaction undertaken by
the country results in a credit entry and a debit entry of equal
size,

As the international transactions are record in the double-

entry book-keeping form, the balance of payments must
always balance, i.e., the total amount of debits must equal
the total amount of credits. Sometimes, the balancing item,
error and omissions, must be added to balance the balance
of payments.
Accounting used for recording business transactions
recognizes that every transaction has two aspects.

A sale for instance, result in the inflow of cash and outflow of

goods for the business concern.

In accounting concern, Inflow of value is recorded as debit

and outflow as credit.

This is known as Double Entry System.

Credit is indicated by the arithmetic sign ( +) and
represent outflow of real assets ( export) from the
country or incur liability abroad or decrease foreign
assets.

Debit is indicated by the arithmetic sign ( -) and represent

the inflow of real assets (import) into the country or
decrease in foreign liability or increase in foreign
assets.
Components of Balance of Payments

Balance of Payments is generally grouped under

the following heads

i) Current Account
ii) Capital Account
iii) Unilateral Payments Account
iv) Official Settlement Account.
Current Account

“The Current Account includes all transactions which give

rise to or use up national income.”

The Current Account consists of two major items, namely:

i) Merchandise exports and imports, and

ii) Invisible exports and imports.

Merchandise exports, i.e., the sale of goods abroad, are

credit entries because all transactions giving rise to
monetary claims on foreigners represent credits.

On the other hand,

Merchandise imports, i.e., purchase of goods from abroad,
are debit entries because all transactions giving rise to
foreign money claims on the home country represent
debits.

Merchandise imports and exports form the most important

international transaction of most of the countries
Invisible exports, i.e., sales of services, are credit entries.
invisible imports, i.e. purchases of services, are debit
entries.

Important invisible exports include the sale abroad of such

services as transport, insurance, etc., foreign tourist
expenditure abroad and income paid on loans and
investments (by foreigners) in the home country form the
important invisible entries on the debit side.
Capital Account

The Capital Account consists of short- terms and long-term

capital transactions

A capital outflow represents a debit and a capital inflow

represents a credit.

For instance, if an American firm invests Rs.100 million in

India, this transaction will be represented as a debit in the US
balance of payments and a credit in the balance of payments
of India.
The payment of interest on loans and dividend payments are
recorded in the Current Account, since they are really
payments for the services of capital.

As has already been mentioned above, the interest paid on

loans given by foreigners of dividend on foreign investments
in the home country are debits.

For the home country, while, on the other hand, the interest
received on loans given abroad and dividends on
investments abroad are credit.
Unilateral Transfers Account

Unilateral transfers is another terms for gifts. These

unilateral transfers include private remittances, government
grants, disaster relief, etc.

Unilateral payments received from abroad are credits and

those made abroad are debits.
Official Settlements Accounts

Official reserves represent the holdings by the government

or official agencies of the means of payment that are
generally accepted for the settlement of international
claims.
Balance of Payments Disequilibrium

The balance of payments of a country is said to be in

equilibrium when the demand for foreign exchange is
exactly equivalent to the supply of it.

The balance of payments is in disequilibrium when there is

either a surplus or a deficit in the balance of payments.

When there is a deficit in the balance of payments, the

demand for foreign exchange exceeds the demand for it.
Disequilibrium may be of 3 types:

It may be of 3 types:

Surplus B.O.P.:- Export < Import

Equal B.O.P.:- Export = Import

Deficit B.O.P.:- Export > Import

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
Economic Factors : A number of economic factors may
cause disequilibrium in the balance of
payments. These are
:

Development Disequilibrium

Large-scale development expenditures usually increase the

purchasing power, aggregate demand and prices, resulting in
substantially large imports. The development disequilibrium
is common in developing countries, because the above
factors, and large-scale capital goods imports needed for
carrying out the various development
Capital Disequilibrium

Cyclical fluctuations in general business activity are one of

the prominent reasons for the balance of payments
disequilibrium.

As Lawrence W. Towle points out, depression always brings

about a drastic shrinkage in world trade, while prosperity
stimulates it. A country enjoying a boom all by itselt ordinarily
experiences more rapid growth in its imports than its exports,
while the opposite is true of other countries. But production
in the other countries will be activated as a result of the
increased exports to the boom country
Secular Disequilibrium

Sometimes, the balance of payments disequilibrium persists

for a long time because of certain secular trends in the
economy.
For instance, in a developed country, the disposable income
is generally very high and, therefore, the aggregate demand,
too, is very high. At the same time, production costs are very
high because of the higher wages. This naturally results in
higher prices.

These two factors – high aggregate demand and higher

domestic prices may result in the imports being much higher
than the exports. This could be one of the reasons for the
persistent balance of payments deficits of the USA.
Structural Disequilibrium

Structural changes in the economy may also cause balance

of payments disequilibrium. Such structural changes include
the development of alternative sources of supply, the
development of better substitutes, the exhaustion of
productive resources, the changes in transport routes and
costs, etc.
Political Factors

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.

Further, factors like war, changes in world trade routes, etc.,

may also produce balance of payments difficulties
Social Factors

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.