Balance of Payments

12.1: Meaning of Balance of Payments

- Balance of payments is an accounting statement that provides a systematic
record of all the economic transactions, between Residents of a country and the
rest of the world, in a given period of time
- Residents of a country include individuals, firms and government agencies.
- Residents do not include Diplomatic Staff, foreign military personnel, tourists,
migratory workers and branches of foreign companies, even though they work
and operate within the domestic territory of the country
- Economic transfers refer to those transitions which involve transfer of the title or
ownership of goods, services, money and assets. They are broadly categorised
as:
1. Visible items
2. Invisible items
3. Unilateral transfers
4. Capital transfers
- Structure of Balance of Payments:
➔ Balance of payments accounting uses the ‘Double Entry System’ for
recording the transactions with the rest of the world
➔ BOP account has 2 sides:
1. Credit Side
2. Debit Side
➔ In the accounting sense, BOP is always balanced like Trial Balance as it is
prepared as per the double entry system:
➔ However in an economic sense BOP need not be always be equal. It
means BOP can be:
1. Balanced BOP
2. Surplus BOP
3. Deficit BOP

12.2 Meaning of Balance of Trade:

- Balance of trade refers to the difference between the amounts of exports and
imports of visible items (goods).
- Balance of Trade = Exports of goods - Imports of goods
- Exports = credit (positive items)
- Imports are entered as debit
- BOT is also known as Balance of VIsible Trade or Trade of Balance
- The balance of trade need not balance itself, i.e., it is not necessary that exports
of goods is always equal to import of goods
 - It can also be surplus or deficit
- Surplus BOT occurs when the exports of a country is greater than the imports
- Deficit BOT occurs when the exports of a country is lesser than the imports
- Difference between Balance of Trade and Balance of Payments:

Basis Balance of Trade Balance of Payments

Meaning Refers to difference An accounting statement

between amounts of that provides a
exports and imports of systematic record of all
visible items economic transactions
between residents of a
country and rest of the
world in a given period of
time.

Components Includes only visible Includes visible items,

items invisible items, unilateral
transfers and capital
transfers

Capital Transactions Does not record any Records all transactions

transaction of capital of capital nature
nature

Scope A narrower concept as it A wider concept that

is only a part of BOP includes BOT
account

Settlement Unfavourable BOT can Unfavourable BOP

be met out of favourable cannot be met out of
BOT favourable BOT

12.3: Components of Balance of Payments

All transactions in BOP can be grouped under two broad categories:
1. Current Account:
- Refers to an account which records all the transactions relating to export
and import of goods and services and unilateral transfers during a given
period of time
- Components of Current Account:

Credit Items Debit Items Net Credit (credit-

debit)
 1. Visible Trade Import of goods Net exports of goods
Export of (BOT)
Goods

2. Invisible Trade Import of services Net exports of

Exports of services
services

3. Unilateral Transfer payments Net transfer receipts

Transfers
Transfer
Receipts

4. Income Income payments Net income receipts

Receipts and
Payments
income
Receipts

Current Receipts Current Payments Current Account

(1+2+3+4) Balance

- Balance on Current Account:

The net value of credit and debit balances is the balance on current
account
1. Current Account Surplus arises when credit items are more than
debit items. It indicates net inflow of foreign exchange
2. Current Account Deficit arise when debit items are than credit
items
2. Capital Account:
- Records all those transactions between the residents of a country and the
rest of the world which cause a change in the assets or liabilities of the
residents of the country or its government.
- It is used to:
a. Finance deficit in current account
b. Or absorb surplus of current account
- Components of Capital Account:

Credit Items Debit Items Net Credit (credit-

debit)

1. Borrowings Lendings to abroad Net borrowings from

and lendings abroad
 to and from
abroad
Borrowings
from abroad

2. Investments Investments to abroad Net investments from

from Abroad abroad
Investments
from Abroad

3. Change in Increases in foreign Net change in foreign

Foreign exchange reserves exchange reserves
Exchange
Reserves
Decreases in
foreign
exchange
reserves

Capital Receipts Capital Payments Capital Account

(1+2+3) Balance

- Balance of Capital Account Vs Balance account on Capital Account:

➔ A deficit in the current account must be settled by a surplus on the
capital account
➔ Surplus in the current account must be matched by a deficit on the
capital account
➔ Difference between Current Account and Capital Account:

Basis Current Account Capital Account

Influence on the Bring a change in Bring about a

economy the current level of a change in the
country’s income capital stock of a
country

Concept It is a flow concept It is a crock concept

as it includes all as it includes all
items of flow nature items expressign
changes in stock

Compontes Visible trade+ Borrowings and

invisible trade+ lendings to and from
 Unilateral Transfers abroad +
+ Income Receipts investments to and
and Payments from abroad +
change in foreign
exchange reserves

12.4: Autonomous and Accommodating Items

The transactions recorded in the balance of payments accounts can be categorised as
‘Autonomous Transactions’ and ‘Accommodating Transactions’.
1. Autonomous Transactions:
- Refer to those international economic transactions which take place due to
some economic motive such as profit maximisation
- Also known as ‘above the line items
- Are independent of the state of BOP account
- Take place on both current and capital accounts
- On current account merchandise exports and imports of goods are
autonomous transitions
- On capital account, receipts and payments of long-term loans by private
individuals are autonomous transactions
2. Accommodating Transactions:
- Accommodating items refer to the transactions that are undertaken to
cover the gap in the balance of payments, i.e., such transactions are
undertaken to cover deficit or surplus in the autonomous transactions
- Also known as ‘below the line items’
- Are compensating capital transactions which are meant to correct the
disequilibrium in the autonomous items of balance of payments
- The sources used to meet a deficit in BOP are:
a. Forex reserves
b. Borrowings from IMF or foreign monetary authorities

Autonomous Items VS Accommodating Items:

Basis Autonomous Items Accommodating Items

Meaning Refer to those international Refer to the transactions

economic transactions
which take place due to
some economic motive
such as profit
maximisation.
that are undertaken to
cover deficit or surplus in
autonomous transactions
Effect on BOP Independent of the state of Undertaken to balance
BOP account BOP

Current/Capital Account Take place on both current Take place only on capital
and capital account s account

Alternate Name Above the line items Below the line items

12.5: Deficit (Disequilibrium) in the Balance of Payments

- Deficit in balance of payments account arises when total inflows on account of
autonomous transactions are less than total outflows on account of such
transactions