Balance of Payments

Definition: According to the RBI, balance of payment is a

statistical statement that shows:

1. The transaction in goods, services and income between an

economy and the rest of the world,

2. Changes of ownership and other changes in that economy's

monetary gold, special drawing rights (SDRs), and financial claims
on and liabilities to the rest of the world, and

3. Unrequited /Unreturned transfers.

• Each exchange is assigned both a positive and a negative
value: Generally, a positive value (+) is assigned to exports—
and that includes exports of money or other financial assets
as well as exports of products.
• Generally, a negative value (-) is assigned to imports—and
that includes imports of money and other financial assets as
well as imports of products
• The actual accounting simply records the flows as they are
measured over any specified time period.
DOUBLE ENTRY ACCOUNTING
 Description: The transactions in BOP are categorized in:

a) Current account showing export and import of visibles (also

called merchandise) and invisibles (also called non-merchandise).
Invisibles take into account services, transfers and income. Export
receipts are shown on the credit side and the imports are shown
on the debit side.
• The current account consists of trade in services, dividends,
unilateral receipts, investment income, etc. After entering the
details, balancing is performed for the current account. This balance
is referred to as the balance of current account.

• When debits are more than credits deficit occurs. Current account
surplus will take place when credits are higher than debits. Current
account balance is extremely important. It exhibits a country’s
earning and payments in foreign currency. A surplus balance
improves the country’s financial position. It may be utilized for
growth and development of the country.
b) Capital account showing a capital expenditure and income for
a country. It gives a summary of the net flow of both private
and public investment into an economy.

External commercial borrowing (ECB), foreign direct investment,

foreign portfolio investment, etc form a part of capital
account.
• The Capital account includes all the short-term and long-term
transactions between a country and the world. Usually, these types of
flows of money are related to saving and investment, but speculation has
turned into a major component of the account in recent times.

• In the capital account, both direct and portfolio foreign investment is

recorded. External assistance and commercial borrowing are presented
net repayment. Direct investment identifies the money which moves
across national boundaries with the intention of investing in a business.

• Portfolio investment moves across national boundaries with the

intention of purchasing shares and bonds. The Official reserves means
the reserves of gold and foreign exchange kept by the Reserve Bank of
India to be used by the government.
c) Errors and omissions: Sometimes the balance of payment does not
balance. This imbalance is shown in the BOP as errors and
omissions. BOP is compiled using the double entry book keeping
system consisting assets and liabilities.

The statistical discrepancy occurs due to complications associated with

collecting balance of payments data. You can find different sources
of data which occasionally differ in their approach. For instance,
merchandise is shipped in March, however the payments are
received in April. If statistics are compiled on the 31st March, the
numbers will differ. The errors and omissions amount is equal to
the amount required to balance both the sides.
Trade Balance
• It is the difference between exports and imports of items, typically
referenced as visible or tangible items. In case the exports are
higher compared to imports, you will see trade surplus and if
imports are more than exports, you will have trade deficit. Trade
balance shows whether a nation enjoys a surplus or deficit.
Developing countries usually have trade deficit. The trade balance
is a part of current account.
• The balance of payments always balances. Goods, services, and
resources traded internationally are paid for; thus every
movement of products is offset by a balancing movement of
money or some other financial asset.
– If a U.S. retailer imports $1 million of Japanese televisions, there is
a corresponding or balancing movement of money to the
Japanese producer.

• A surplus in the Current account is by definition offset by

a deficit in the Capital account.
– Another way to think of this is that if we export goods and
services, then we import financial assets of the foreigners who
purchased those goods and services.

• Similarly, a deficit in the Current account must be offset by

a surplus in the Capital account.
– In practical terms, if Americans import foreign products, then we
export our financial assets to pay for them.
Open House