Balance of Payments
The Balance of International payments or Balance of Payments refers to the systematic and summary record of a country’s economic and financial transactions with the rest of the world, over a period of time.
As per IMF, the Balance of payments is a statistical statement for a given period showing:
- Transactions in goods and services and income between an economy and the rest of the world;
- Changes of ownership and other changes in that country’s monetary gold, Special Drawing Rights (SDRs) and claims on and liabilities to the rest of the world; and
- Unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting.
How Balance of Payments and Balance of Trade are related?
The balance of trade refers to the difference between the monetary value of exports and imports of output in an economy over a certain period. A positive balance is known as a trade surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit. Trade gap refers to trade deficit. The BoP is a wider term.
The Balance of Trade gives only partial picture, while the BoP gives a complete enumeration of the international transactions, by adding the net trade balance and all other payments and receipts.
The Balance of Payments account has various debit and credit entries, which are generally grouped under the following heads:
- Current Account
- Capital Account
- Unilateral Payments Account
- Official Reserves Assets Account
Current account includes all those transactions which give rise to or use up national income. Thus, the Current Account consists of two major items
- Merchandise exports and imports
- Invisible exports and imports.
- Please note that the Merchandise exports, which refer to sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits.
- Merchandise imports, i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Merchandise imports and exports form the most import international transactions of most of the countries.
- The Merchandise imports and exports are the most import international transactions of most of the countries.
- Invisible Exports refer to the sale of services. The export of services is credit entries and invisible imports, i.e., purchase of services, are debit entries.
Please note the following:
- The Expenditure of Foreign Tourists in India is a Credit entry because it is an invisible export.
- Income such as interests or dividends, received from the loans and investments made abroad is are invisible exports, so they are counted as credit entries.
- Purchase of foreign services like transport and insurance, tourist expenditure abroad and income paid on loans and investments (by foreigners) in the home country form the important invisible entries on the debit side. This is a debit entry and deemed to be invisible imports.
- In India, the Software exports have emerged as a very important invisible item of India’s current account.
The capital account consists is made up of both the short-term and long-term capital transactions. The Capital Transaction may be Capital outflow or capital inflow.
- Capital outflow represents debit and capital inflow represents credit.
We take an example here: We assume that an American company is investing $ 100 million in India. This investment will be represented as a debit entry in the BoP of America and credit entry in the BoP of India.
Unilateral Transfers Account
Unilateral transfers refers to the transactions such as gifts, private remittances, government grants, reparations and disaster relief.
Unilateral payments received from abroad are credit enries and those made abroad are debit entries.
Official Reserves Account
Official reserves refer to the holdings by the government of official agencies of the means of payment that are generally accepted for the settlement of international claims.