BALANCE OF PAYMENT

Meaning – It is an accounting statement that provides the systematic records of all the economic
transactions between resident of the country with rest of the world in the given period of time.
(Usually one year)

Meaning of economic transaction – These are the transactions which involve transfer of title or
ownership of goods, services, money or Assets.

It includes trading of various items such as:

 Visible items (Trading of physical goods)

 Invisible items (Trading of services)
 Unilateral transfers (Gifts and other one way transactions)
 Capital transfers (Trading of of assets or property)

Structure of Balance of payment – The balance of of payment follows double entry system it
contains 2 sides

Credit side – In the credit side all inflows of money are recorded

Debit side – In the debit side all the outflows of money are recorded

Balance of payment can be of 3 types –

 Balanced BOP – Receipts of foreign exchange = Payment of foreign exchange ( credit

side = Debit side)
 Surplus BOP – Receipt of foreign exchange>payment of foreign exchange ( Credit side >
Debit side)
 Deficit BOP – Receipt of foreign exchange < payment of foreign exchange (credit side <
Debit side)

Components of Balance of payment

1. Current Account – It refers to an account which records all the transactions related to
export and imports of goods ( visible items), services ( invisible items) and unilateral
transfers during the given period of time.
Current account shows the net income generated in the foreign sector.
Balance of current Account –
Inflow of foreign exchange = recorded in credit side of this account.
Outflow of foreign exchange = recorded in debit side of this account.
2. Capital Account – Under capital account those transactions are recorded which causes a
change in assets (property) or liabilities ( responsibility to pay) of the residents or
government of the country.
Components of capital Accounts
 Private transactions (private sector of the country receives long term foreign
loans)
 Official transactions (government borrows loan from foreign sector)
 Banking capital (Deposits of any commercial banks and cooperative bank in
foreign sector)
 Foreign Direct Investment (FDI) – It refers to the purchase of an asset in the rest
of the world such that, it gives direct control to the purchaser over the asset.
 Portfolio Investment – It refers to purchase of assets in Rest of the world such
that, it does not give any direct control to the purchaser over the assets.
Foreign Institutional investment – It is also a part of portfolio investment. Capital
account is concerned with financial transfers.
Balance of capital account
Inflow = Credit side
Outflow = Debit side

AUTONOMOUS AND ACCOMMODATING ITEMS

1. Autonomous Items – It refers to those international economic transactions

which takes place due to some economic motive such as profit maximization
Autonomous items in current Account – Receipts and repayment of foreign
loans.
Autonomous Surplus – Autonomous receipts > Autonomous payment
Autonomous deficit – Autonomous receipts < Autonomous payment.

2. Accommodating items – It refers to those transactions that are undertaken in

order to maintain the balance in BOP ( Debit side = Credit side)
These are compensating capital transactions which are meant to correct
disequilibrium in autonomous items and to balance the BOP.
Example – If current account of BOP is in deficit (Debit side > Credit side), then this
Deficit is settled by capital inflow from abroad.
DEFICIT (DISEQUILIBRIUM) IN BALANCE OF PAYMENT

Deficit in BOP = Debit side > Credit side

Causes of deficit in balance of payment

1 ECONOMIC FACTORS –
 Development Activities – Developing countries mainly depends upon the
foreign nations for supply of assets.This leads to increase in level of
imports which inversely increases the outflow of foreign exchange.
 High rate of inflation (rise in price) – Due to inflation,foreign goods
become cheaper as compared to domestic goods and increases which
causes the deficit in BOP.
 Cyclical fluctuation – When domestic country is going through recession
or depression ( deficit demand) The domestic production may be unable
to satisfy the domestic demand which leads to increase in imports which
causes deficit in BOP.
 Decrease in exports – IF the demand of domestic goods decreases in
international market it reduces the exports from domestic country and
hence causes deficit in BOP.
 Import of services – Underdeveloped country import services from
developed country.
For importing services, the domestic country has to pay huge amount of
money which causes deficit in BOP.

2 .POLITICAL FACTORS
 Political Instability – Capital outflows and reduce in inflow of foreign
funds creates disequilibrium in BOP
 Political Disturbance – Inadequate support of government,
discouragement of government in capital inflows leads to disequilibrium
in BOP.

3. SOCIAL FACTORS

 Demonstration Effect – Generally, people of underdeveloped country

adapt the pattern of developed country, which leads to increase in
imports of foreign goods which creates disequilibrium in BOP of the
domestic country.
 Change in preference – An unfavorable change in preference and taste
of the citizen of the country could result in deficit of BOP.
 BALANCE OF PAYMENT VS BALANCE OF TRADE
Balance of payment
It is an accounting statement that provides the
systematic records of all the economic
transactions between resident of the country
with rest of the world in the given period of
time.
It includes transfer of visible items
It includes transfer of visible items (goods)
invisible items (services) unilateral (one sided)
transfers and capital items.
This is main account
Includes current and capital account
Balance of trade
It is an accounting statement that provides the
systematic records of all the physical
transactions of goods between resident of a
country with rest of the world in the given
period of time.
It includes transfer of only visible items i.e
physical items/goods.
This is part of balance of payment
It is part of current account of balance of
payment.