Meaning:

Balance of Payments is a Statement of Accounts recording the monetary transactions of a Country with the
Rest of the World during a period.

Bop account reflect performance of our economy in relation to the rest of world.

Monetary Transaction

International sale and International sale and

Visible trade /
Invisible Trade purchase of Financial purchase of real
Merchandise
Assets Assets

It includes exports and It includes exports and

imports of goods. they Imports of [Link]
called visibles because of called invisibles because Financial assets means Real assets means
they are in forms of of they are in the form of share,stock, bonds. plant and machinary
tangibles and can be seen intangibles and can't be etc etc.
while crossing the border seen while crossing the
of thr country. border.

Note; BOP records all the receipts and payments of forex. Receipts recorded as credit item whereas
payments recorded as debit item.
Comonents of BOP

Current A/c

Capital A/c

Official reserve A/c

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Current account;
It records such transaction which does not impact assets and liability status of a country in relation to the rest of world
i.e. such assets and liabilities neither increase nor decrease.

ln other words, current account transactions do not give rise to 'future claims'

Structure/Components of current A/c

Export (x) & Imports (M)

of Visibles/merchandise Export (x) & Imports (M)
(includes both consumer of Invisibles/Services
as well as capital goods)

Factor services Non factor services Current trannsfer

services other than uniletral transfers or

Investment Incomes Compensation to factor services. transfer for free.
(Rent , Interest, profit ) employees (wages) like Insurance,Banking, (gift,donation,
Shipping. remitance)

[Note: Current account records all payments to rest of the world as debit (indicated by the '-' sign) and all
receipts from rest of the world as credit (indicated by the '+' sign). Net receipts refer to the difference
between receipts and payments.]

Current account balances

Trade balance /
Merchandise Goods and services Invisibles balance Current account
balance balance balance

Trade balance Net balance of factor services

+
Trade balance
Exports of Goods(x) - +
Balance of non factor services +
Imports of Goods(I) Balance of non factor +
Invisible balance
services Balance of current transfer

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Capital Account
Capital account records receipts and payments of such transactions, which cause an impact on asset-liability
status of a country in relation to rest of the world i.e. such assets and liabilities will increase or decrease.

ln other words, capital account transactions lead to future claims.

Structure/Components of Capital A/c

Banking capital
Foreign Short tarde
Borrowings NRI Deposit (other than NRI
Investment credit
deposit)

External Foreign Foreign Direct

External
commercail Institutional investment
assistance
borrowing investment (FII) (FDI)

Borrowing;
 Borrowing (loan) from rest of the world increases the liability to rest of the world, but one thing must be noted
that it is recorded as credit item in the capital account and
 Borrowing of the rest of the world recorded as debit item in the capital account.
 It is sub classified in two following parts
o External commercial borrowings; it is available at the market rate of interest.
o External assistance; it is available at the concessional rate of interest.

Foreign Investment;
 It is sub classified in two parts-
o Portfolio investment; it refers to the foreign institutional investment in the share and bonds of the
domestic companies. Ex. Intel bought 2% shares in reliance JIO.
o Foreign direct investment; this type of investment is made to take ownership control in the domestic
companies by rest of the world. Ex. Walmart stores in India.
 Investment in domestic companies by rest of the world recorded as credit item.
 Investment by domestic companies to rest of world recorded as Debit Item.

NRI Deposit;
 Only such NRI deposits are to be considered (as a component of capital account) which are made in the
domestic economy. Thus, non-resident Indians should make deposits in the India.
 Remittance by NRI to their families are deferent from NRI deposits, remittance is recorded in current account
whereas NRI deposit is a part of capital account.

Banking Capital (Other than NRI Deposits):

 It refers to 'foreign assets' held by the commercial banks.
 Owing to drawdown of foreign assets of the commercial banks (the commercial banks converting their foreign
assets into liquidity), inflow of foreign exchange into the domestic economy tends to rise
Short-term Trade Credit:
 It arises on account of purchases in the international market without making immediate payment.
 Repayment of short-term debt to rest of the world leads to outflow of foreign exchange to rest of the world.
Accordingly, it is recorded in the capital account with a negative sign.
 Inward flow of foreign exchange (from rest of the world), on the other hand, is recorded with a positive sign
Overall Balance
Overall balance is estimated as the sum total of (i) current account balance, (ii) capital account balance, and (iii) errors

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and omissions (accounting for statistical discrepancies).

Overall Balance= Current account balance + Capital account balance + Errors and omissions

Official Reserves Account (indicating Reserves of Forex with the RBI)

 The overall balance is finally reflected in the Official Reserves Account of the RBI. Because, RBI is the custodian
of forex reserves of the country, and all forex transactions in the country are routed through the RBI.
 lf overall balance is positive, it causes increase in official reserves; if overall balance is negative, it causes
decrease in official reserves.
 When Official Reserves Account is shown as a part of the capital account BOP, rather than a separate
account, in this situation BOP always balances. for the purpose of balancing BOP accounts increase in the
official reserves is indicated by a negative sign, while decrease is indicated by a positive sign.
 If Official Reserves are not shown as a part of the capital account, the Official Reserves Account is separately
presented and classified as "Below the Line. In this situation BOP may in surplus or deficit.
o BOP Surplus = Current Account Surplus + Capital Account Surplus
o BOP Deficit = Current Account Deficit + Capital Account Deficit

EQUILIBRIUMAND DISEQUILIBRIUM IN BOP

 BOP equilibrium is struck when Current account balance + Capital account balance + Errors and omissions
equals to Zero. and there is no movement (increase or decrease) of official reserves of the central bank
 A disequilibrium in BOP occurs when the sum total of current account balance and capital account balance is
not zero, instead it is either some positive number or some negative number.
 ln case the sum total of current account balance and capital account balance is some positive number, it
indicates BOP Surplus.
 If the sum total of current account balance and capital account balance is some negative number, it indicates
BOP Deficit.

Autonomous and Accommodating items of BOP

Autonomous Items Accommodating Items
These are BOP transactions, which are undertaken for These transactions are free from considerations of
considerations of Profits. Profits
These items result into BOP imbalances i.e. Surplus or These items are meant to correct BOP imbalance and to
Deficit BOP. restore BOP Equilibrium.
These items involve movement of Goods and services These items involve only the movement of money i.e.
across borders. official reserves of foreign exchange.
These are known as “Above the Line Items” These are Known as “Below the Line Items”

Significance of BOP Accounts (or BOP Data)

 BOP accounts reveal financial status of the domestic economy in relation to rest of the world. Borrowing reveals
dependence on rest of the world. It points to backwardness of the domestic economy.
 Net Factor Income from Abroad: BOP data offers information on net factor income from abroad. lt is an important
component of national income.
 BOP accounts show exports and imports of a country which is an important component of AD (aggregate demand in
the domestic economy). Rise in (X – M) leads to a rise in AD.
 BOP accounts reflect market potential in the domestic economy. It is reflected by the size of foreign investment.
Larger size of foreign investment points to high market potential in the economy.
 BOP performance of a country impacts its monetary and fiscal policies. In the event of greater flow of foreign
exchange from rest of the world, there is a pressure of demand for the domestic currency. The RBI has to account for
it in the formulation of its monetary policy. Likewise, poor-flow of foreign investment in the domestic economy, may
point to hard tax laws in the domestic economy. The government must account for it in the formulation of its fiscal
policy

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