What is Balance Of Payments (BOP)? Components of BOP

Balance of payment is a broader term and it includes balance of trade. It is more comprehensive than the balance of trade. Balance of trade refers to the merchandise account of exports and imports only.

Balance of payment refers to the net results that are drawn recording all the visible and invisible items that are imported and exported from the country. balance of payment, such as,provides a comprehensive statement over the net results of foreign trade and gives a true picture as to where the country stands in the international trade. Balance of payment clearly exposes the economic visibility,strength, and capability by correctly measuring its imports and exports, competency in goods and services as well as technical know-how. By services we mean the services of shipping lines, insurance companies banking concerns and others. Balance of payment also includes the foreign loan that is either provided by it or accepted from other country or countries.

According to Kindleberger___” Balance of payment is a systematic record of all economic transactions between the residents of the reporting country and resident of foreign countries during a given period of time”.

In other words, the balance of payment is a comprehensive record of economic transactions of the residents of a country with the rest of the world during a given period of time. The aim is to present an account of all receipts and payments on account of goods exported services rendered and capital by resident of a country and goods imported, services received and capital transferred by residents of the country. The balance of payment is an accounting statement that summarises all the economic transactions between resident of the country and residents of all other countries. It is a measure of all transactions between domestic country and international countries.

Nature of Balance Of Payments

  1. Systematic record: It is a systematic record of receipts and payments of a country with other countries.
  2. Fixed Period of Time: It is a statement of an account pertaining to a given period of time, usually a year.
  3. Comprehensiveness: It is a comprehensive record of economic transactions of the residents of a country with the rest of the world during a given period of a time. The aim is to present an account of all payments on account of goods exported services rendered and capital by residents of a country and goods imported, services received and capital transferred by resident of the country.
  4. Double Entry System: Receipts and payments are recorded on the basis of double entry system.
  5. Self-Balanced: From the point of view of accounting, double entry system keeps automatically debt and credit sides of the statement is zero.
  6. Adjustment of Differences: Whenever there are differences in actual total receipts and payments, need is felt for necessary adjustment.
  7. All Items-Government and Non-Government: Balance of payment includes receipts and payments of all items government and non-government.

Importance of Balance Of Payments

  1. Forecasting: The BOP helps forecast a country’s market potential, especially in the short run. A country experiencing a serious BOP deficit is not likely to import as much as it would if it were running a surplus.
  2. Indicator of Pressure: The BOP is an important indicator of pressure on a country’s foreign exchange rate, and thus on the potential of a firm trading with or investing in that country to experience foreign exchange gains or losses.
  3. Signal of Imposition: Changes in a country’s BOP may also signal the imposition of controls over payment of dividends and interest, license fees, royalty fees, or other cash disbursements to foreign firms or investors.

Components of BOP

Components of balance of payments are:

balance of payment components

1. Current Accounts: 

  1. Merchandise: It refers to the balance between exports and imports of tangible goods such as automobiles,computers,machinery and so on.
  2. Invisible: Services represent the second category of the current account. Services include interest payments,shipping and insurance fees,tourism,dividends and military expenditures. These trades in services are sometimes called invisible trade.
  3. Unilateral Transfers: These are gifts and grants by both private parties and governments. Private gifts and grants include personal gifts of all kinds and also relief organizations shipments.

2. Capital Account: The capital account is an accounting measure of the total domestic currency value of financial transactions between domestic residents and the rest of the world over a period of time. This account consists of loans, investments, and other transfers of financial assets and the creation of liabilities. It includes financial transactions associated with international trade as well as flows associated with portfolio shifts involving the purchase of foreign stocks,bonds and bank deposits. The capital account can be divided into three categories they are:

  1. Direct Investment
  2. Portfolio Investment
  3. Capital Flows

3. Official Reserve Account: Official reserves are government owned assets. The official reserve account represents only purchases and sales by the central bank of the country like RBI. The changes in official reserves are necessary to account for the deficit or surplus in the balance of payments.