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DEEKSHA COMMERCE
Balance of Payment
Meaning of balance of payment
Every country keeps a record of the transaction (economic) that take place between the country and the rest of the
world during a given period of time (one year). This record is termed as the country’s balance of payment (BOP).
Definition
Balance of payment is an accounting statement that provides a systematic record of all the economic transaction
between residents of a country and rest of the world in a given period of time.
Economics transaction in BOP
Economic transactions are all exchanges between the country and rest of the world in terms of currency and cause
transfer of value.
Economics transaction includes
1. Export- Import of visible item: - All types of goods those exported and imported from rest of the world which can be
touched, see and measured.
2. Export-Import of invisible item: - All types of services given and received are included under these transactions like
shipping, banking insurance, tourism etc.
3. Unilateral transfers: - Payment and received of such transfer which do not hone profit purposes like Gifts and
Grants, Scholarships, financial help etc.
4. Capital transfers: - All monetary transfers those affect assets and liability of a nations like loan, investment etc.
Components of BOP
BOP account uses the Double Entry System for recording the transactions with rest of the world. All inflows or sources
of foreign exchange are recorded on the credit side.
Account for BOP: - For BOP two accounts are there
1. Current Account:- All actual transaction are recorded under current account those completed in an accounting year
e.g.
(A) Export import of visible items (Goods)
(B) Export import of invisible item (services)
(C) Unilateral transfers/ current transfer (one sided)
(A) Export and Imports of goods:- All visible goods which are exported and imported are included. The record of these
goods is available with the ports.
The balance of export and imports of goods is referred to as the balance of trade. The trade account is also called
the merchandise account.
(B) Exports and imports of services:- The current account also records trade in services or the invisible items. Factor
income received from rest of the world record credit side and factor income paid to rest of the world in debit side.
A.Factor services:- investment income (rent+ interest+ profit), compensation of employees,
B.non- factor services:- (insurance, banking services)
(C) Unilateral transfers:- Unilateral transfers are payments and receipts that are made without any good or service
such transfers are unidirectional (one sided) like Gifts grants aid etc.

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Current account
Balance of current account
Debits (-) (Payments) Credit (+) (Receipts)
1. Import of goods 1. Export of goods
2. Import of services 2. Export of services
3. Unilateral transfer made 3. Unilateral transfers received
A. Trade balance/merchandise balance= X-M
B. Goods and services balance
= (Export of goods + export of non-factor services)-(import of goods +import of non-factor services)
=trade balance + balance on account of non- factor services
C. Invisible balance
=balance on non -factor services+ balance of factor services+ balance on current account transfers
D. Current account balance
=Trade balance+ invisible balance

Capital Account: - It is that account of BOP which records all such transaction between the residents of a country
and rest of the world which cause a change in the assets or liability of the country.
eg. Purchase and sale of gold or other assets, etc. it increases future claims.
(Purchase of machinery will be covered under merchandise account only)
(A) Foreign direct investment: - Any direct investment done by non-resident of the country by which assets are
purchased and control is consider outflow and if any foreign done in India will be consider inflow.
(B) Portfolio investment: - All such investment which does not give any direct control over the assets to the purchasers
is term as portfolio investment such as purchase of share (equity).
(C) Loan: - It includes commercial borrowings and external assistance.
(i) Commercial borrowing includes borrowing by a country (government and private sector) from the international
money market at market interest rate.
(ii) External assistance borrowing by government from international money market at concessional interest rate.
(D) Banking capital transactions: - These refer to transitions of external financial assets and liabilities of commercial
banks operating as dealers in foreign exchange.
These transactions include NRI deposits.
(E) NRI deposits
(F) Banking capital (other than NRI deposits)
(G) Short term trade credit

components of
capital account

Foreign Short term

Borrowing NRI deposits Banking capital
investment trade credit

External
external
commercial FII FDI
assistance
borrowing

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DEEKSHA COMMERCE
Capital Account
Balance of capital accounts
Debits (-) (Payments) Credit (+) (Receipts)
1. Capital payment (FDI + FII) 1. Capital receipts (FDI + FII)
2. Outflow of banking capital 2. In flow of banking capital
3. Repayment of loans by government sector 3. Loan received by government sector
4. Repayment of Loan by private sector 4. Loan received by private sector
5. Purchase of gold in international market 5. Sale of gold in international market

Official Reserve account

Official Reserve Account is a term used to denote the account where all sorts of reserves are held by the monetary authorities or
the central banks of the various countries. Or we can say the total reserves held by the authority/central bank. Through these
reserves the central bank or the government of the country attempts to balance the year on year international payments.

OVERALL BALANCE
Overall balance= Current account balance+ Capital account balance+ Error and omissions
Autonomous and Accommodating items of BOP

Autonomous items: - Autonomous items in the BOP refer to those international economic transactions which occur due
to some economic advantages such as profit maximization, earning of interest income. These transactions are
independent of the country’s BOP situation. These items are take place both on current and capital accounts. These
items are known as above the line items of the BOP
For example: - Investment by MNCs, selling and purchase of goods and services from row etc.
Accommodating items: - Accommodating items are those transactions which take place to maintain the balance in the
loop account. These items are depending on BOP status if it is in deficit than the balance is maintains by
accommodating items. These stems are known as below the line items
For example: - Suppose the autonomous receipts of foreign exchange during the year are $10,000 while autonomous
payments are $ 12,000. It means that there is a deficit of $2000. To meet this deficit the country may borrow from
abroad.
BOP is always balances: - In accounting sense BOP always balances. The overall account of the balance of payment
necessarily balances. It is because of the reason that BOP is prepared in terms of credits and debits based on the
system of double entry book keeping. Thus total credits (receipts) and total debits (payment) become equal. The two
sides thus necessarily are equal.
What is equilibrium or disequilibrium in BOP?
Current account balance capital account balance + errors and omissions=0
In the accounting sense the BOP is always balance but in functional sense BOP may be disequilibrium. Equilibrium
and disequilibrium always measured with autonomous item (Do not count accommodating items) when a country is
receiving more autonomous payment from the row than the autonomous payments, it has favorable BOP.
 Favorable BOP = Autonomous receipts > Autonomous payments
 Current account balance+ capital account balance+ errors and omissions>0
When a country is receiving less autonomous payments from row than autonomous payments it has unfavorable BOP.
 Unfavorable BOP = Autonomous receipts < Autonomous payments.
 Current account balance + capital account balance + errors and omissions<0

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Causes of Disequilibrium in BOP
1. Economic Factors
(i) Huge development expenditure: - Developing countries depend on developed nations for the supply of
machines, raw material etc. this raise the country import bill and consequently its BOP become adverse.
(ii) High rate of inflation: - When there is inflation in the domestic economy, foreign goods become relatively
cheaper as compared to domestic goods. It increases imports which cause deficit in the BOP
(iii) More demand for consumption goods
(iv) Imports of war equipment’s
(v) Slow growth of exports
(vi) Increase competition in foreign trade
(vii) Business cycle: - Boom, Recession Depression.
(viii) Difference in production cost

2. Political Factors
(i) Political instability reduces inflow of capital and increase outflow of capital
(ii) Populism policies: - At the time of elections government adopts wrong policies to gain popularity. Huge cuts in
imports duty may encourage imports which cause disequilibrium.
(iii) Economic relation with the neighbor country.
3. Social Factors
(i) Change in taste, preferences, fashion and trends
Differences between BOP & BOT
Basis of difference BOT BOP
Broad / Narrow BOT is narrow concept. It is a part of BOP BOP is Broad concept. It includes
BOT also.
Nature of items Includes only visible (goods) item trade Includes both visible and invisible
trade
Significance BOT is not as significant as BOP for BOP is more significant than BOT it is
economics analysis. uses for policy formulating.
Record BOP is partial record of foreign trade BOP is complete record of all
economics transactions.
Recovery On favorable BOT is recovered out of Unfavorable BOP cannot recovered
favorable BOP out of favorable BOT
Significance of BOP
A. Financial status of the domestic economy.
B. Net factor income from abroad.
C. Export – import
D. Market potential
E. Monetary and fiscal policies
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