CH.

7 BALANCE OF PAYMENTS
BOP refers to statement of accounts recording all economic transactions of a given
country with the rest of the world . It is an account between its residents and
residents of foreign countries .
Economic transaction in BOP
a. Visible items :
 It includes all types of physical goods exported / imported . These are
visible as these are made up of some matter or material .
b. Invisible items :
 It includes all type of services . These are invisible as they are not made up
of some matter or material .

c. Capital transfers :
It is concerned with capital receipts and capital payments . This involves
transfer of assets .
 Balance Of Trade (BOT) and Balance Of Payment(BOP)
Balance of trade positive or negative is determined considering only visible
items of transactions . It is the difference between export and import of
goods .
BOT = export of visible goods – import of visible goods.
Example :
Calculate the value of exports when BOT is RS. 500 crore and value of Import is
Rs. 300 crore.
Solution: BOT = value of exports – value of imports
500 = VOE – 300
Value of exports= 800

BOP is determined considering all economic transactions .

Components of balance of payment account
 The items which are included in the balance of payments are called
components of BOP.
 Various transaction in the BOP are grouped into two sections:
(A)Current account and (B) Capital account
A. Current account :
Current account is that account which records imports and exports of goods
and services and unilateral transfers during a given period of time .
 Components of current account :
The main components of current account are explained below-:
a. Export and import of goods (visible items)
b. Export and import of services .
c. Unilateral transfers (gifts, remittances, aids etc.)
Important observations:
 All exports are recorded as positive items .
 All imports are recorded as negative items .
 Balance occurring on account of trade of goods is recorded as Balance of
Visible items or simply balance of trade (BOT).
 Balance occurring on account of export and import of services and
unilateral transfers is recorded as balance of invisible trade .
 Net value of three balances is recorded as balance of current account.
Current account balance= (balance of visible trade+ balance of invisible
trade + balance of unilateral transfers)
B. Capital account :
Capital account is that account which records such transactions between
residents of a country and rest of the world which cause a change in the
asset or liability status of residents or government of a country .
Components of capital account:
Following are the main components of capital account.
a. Foreign investment :
 Foreign direct investment :
It refers to purchase of an asset in the rest of the world along with the power to
control them. For eg. Purchase of firm by Reliance group in the rest of the
world.
 Portfolio investment / Foreign Institutional Investment:
It refers to the purchase of an asset in the rest of the world, without any control
over it . For eg. Purchase of shares or bonds by A in the rest of the world .
b. Loans :
 Commercial borrowings :
It refers to borrowing of a country from international money market .
 Borrowings as External assistance :
Borrowings by a country with considerations of assistance . It involves
lower rate of interest as compared to open market .
c. Banking capital transactions :
 It refers to transactions of external financial assets and liabilities of
commercial banks and cooperative banks, operating as authorised dealer in
foreign exchange.

Important observations
a. All capital transactions causing flow of foreign exchange into country is
recorded as positive items.
b. All capital transactions causing flow of foreign exchange out of the country
are recorded as negative items.
c. The net value of these inflow and outflow is the balance of capital account.
 Difference between current account and capital account
Current Account Capital Account
Current account is that account which Capital account is that account
records imports and exports of goods which records such transactions
and services and unilateral transfers between residents of a country
during a given period of time. and rest of the world which cause
a change in the asset or liability
status of residents or government
of a country .

Current account= visible trade + Capital account= foreign direct

Invisible trade + unilateral transfers investment + foreign institutional
investment + commercial borrowings +
banking capital.

Current account is flow concept as it Capital account is stock concept as it

includes all items of flow nature. includes all items showing change in
stock.
Autonomous and Accommodating items in BOP
 Autonomous items / Above the line items
 Autonomous items or transactions refers to those international economic
transactions Which are done for some economic motives such as profit
maximisation.
 Or the transactions Which are not conditioned by the BOP status of the
country ( positive / negative)
 Which are not meant to establish BOP identity .
 Accommodating items / below the line items
 Accommodating items or transactions refers to those transactions which are
undertaken to cover the deficit or surplus in balance of payments.
 Which are conditioned by the positive or negative BOP status of the
country.
 Which are meant to establish BOP identity .
 Disequilibrium in Balance of Payments
 Disequilibrium in BOP is the state of either surplus(favourable) BOP status
or deficit (unfavourable) BOP status.
 Equilibrium in BOP is achieved when the net balance of all receipts and
payments is zero.
 A surplus in the BOP generally does not create much of a problem.
However, the deficit BOP often creates difficult problem for the economy.
 Causes of Disequilibrium in BOP (deficit BOP)
The main causes of deficit BOP are as follows:
1. Economic Factors :
a. Huge development expenditure by the government owing which there are
large scale of imports of machinery, capital equipments and services.
b. Business cycles in terms of recession, depression, recovery and boom.
c. High rate of inflation in domestic market, compelling large scale imports of
essential goods .
d. Development of import substitutes because of which imports are reduced
and deficit BOP equilibrium is narrowed.
2. Political Factors :
a. Political instability owing to which inflow of direct foreign investment from
abroad may shrink .
b. Policies of the government , generally pursued on the election eve .
3. Social Causes :
a. Change in taste and preferences across different parts of the world owing to
which pattern of the demand will change .
b. Cross – Border Prejudices ; which sometimes force the countries to shift
expensive sources of imports and less lucrative area of exports
 Measures to correct disequilibrium in BOP
The main measures are as follows:
1. Reducing Inflation :
Using monetary and fiscal instruments, Government should check inflation .
2. Export Promotion :
 The exports of the country can be pushed up by various ways like reduction in
export duties by providing subsidies .
3. Depreciation
It will make imports costlier and exports would become cheaper in domestic
currency .
4. Devaluation of Domestic Currency :
It makes domestic goods cheaper for foreigners. devaluation is done by
government order.
5. Import Control
Imports may be controlled by the impositions of quotas and tarrifs.
 Difference between balance of trade(BOT)and balance of payments(BOP)
Balance of trade(BOT) Balance of payments(BOP)
Balance of trade is the difference The balance of payments of the
between the money value of country is a systematic record of all
exports and imports of goods or transactions between the residents
balance of visible items of BOP. of a country and the rest of the
world.
It records only merchandise It records transactions relating to
(goods) transactions of visible both goods and services or visible
items. and invisible items.
It does not record transactions of It records transactions of capital
capital nature. nature.
It is a narrow concept. It is a part It is a wider concept.
of current account of BOP.
It may be favourable, It is always balances in accounting
unfavourable or in equilibrium. sense.
 Balance of payment always balances
 The BOP always balances in accounting sense according to the principle of
accounting.
 The balance of current account need not be equal but can show surplus or
deficit.
 If there is a deficit in current account of a country, it is offset by a matching
surplus in the capital account by borrowings from abroad or withdrawing
out of its gold and foreign exchange reserves.
 On the other hand, if there is a surplus in current account, it is offset by a
matching deficit in the capital account. So surplus or deficit of current
account is accommodated by capital account, therefore BOP is always in
equilibrium or balance.