Balance of payment: All you need to know

[ecis2016.org] Balance of payments is a statement of all transactions made between entities in one country and the rest of the world.

Balance of payment (BOP) records all financial transactions between the world and the residents of a country. It helps to understand the flow of funds into the country and see how well the funds are utilised. It helps to know whether an economy is developing or not. 

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An ideal balance of payment is zero – the net inflow and outflow of funds should cancel out. A BOP helps understand whether a country has a surplus or deficit of funds available. If the import is more than the export, the country is said to have a deficit of funds.

How to calculate balance of payment?

The formula for calculating BOP is:

Current Account + Financial Account + Capital Account + Balancing Item= 0

What is BOP made of?

There are three parts of BOP- current account, financial account and capital account. The sum total of capital and financial account should be balanced out by the current account in an ideal situation.

Capital account

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This includes the buying and selling of non-financial assets like land and property. It also includes the sale, purchase and taxes generated by the moving of assets along with the migrants.

The deficit or excess from the current account is managed by the capital account and vice versa. It has three major elements-

• Loans and Borrowings – All types of loans and borrowings from another country.
• Investments – Funds invested by residents in corporate stocks by residents
• Foreign Exchange Reserves – Held by the central bank of every country and have a direct impact on the economy.

Current account

It helps monitor the inflow and outflow of goods into the country. It covers all receipts in terms of raw materials and manufactured goods.

It also includes exchanges of trade, tourism, stock, transportation, business services and royalties from patents and copyrights. When all the above commodities are added, they make the BOT (Balance of Trade).

There are two types of exchanges that occur between countries- visible and invisible. Invisible exchange includes services like tourism, banking etc., while visible exchange includes the export and import of goods. 

Unilateral transfers include the direct money sent to residents of other countries. This also includes the money sent by relatives to their families in other countries.

Financial account

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This includes money invested by residents in real estate, business ventures and foreign direct investments. It monitors changes in foreign ownership of domestic assets and domestic ownership of foreign assets, and analyses whether a country is acquiring more assets or not. 

Importance of BOP for a country

There are many reasons that BOP is essential for a country. Some of them are-

• It helps to know whether the currency’s value is improving or depreciating.
• It helps to know a country’s financial and economical status,
• It helps the government to make decisions about trade and fiscal policies.
• It helps to analyse the economic dealings with other countries.

Must know facts

What is the difference between BOT and BOP?

BOT or balance of trade includes only visible products, thus calculating only the export and import of goods.  The current account of the balance of payment includes transfers from goods, unilateral remittances, services etc. The sum total of these constitute the current account. Thus, the BOT constitutes a part of the BOP in the form of the current account.

What is meant by a deficit in the balance of payments?

When autonomous foreign exchange payments exceed the autonomous foreign exchange receipts, it is known as a deficit in the balance of payments. Autonomous transactions are undertaken for the individual’s sake.

What are official reserve transactions? Why are they important?

If a country has a surplus balance of payments it can buy foreign exchange and expand its assets. However, if a country has a deficit then the foreign exchange assets of a country need to be run down. BOP helps the government monitor and implement various policies to plan the future movement of assets in and out of the country. 

Source: https://ecis2016.org/.
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Source: https://ecis2016.org
Category: Must Knows