Meaning of Balance of payment:
Balance of payment(BoP) is an accounting statement which records economic transactions between Normal Resident of a specific country with the rest of the world.
It is a double entry system, which means it compromises of debit and credit.
In this we ‘Credit’ All Incomes and Gains.
‘Debit’ All Expenses and Loses.
In an ideal scenario, BoP should be zero, but it rarely happens.
Either a country has surplus BoP(favourable) or Deficient BoP(unfavourable).
Surplus BoP arises when exports are more than imports. Deficient BoP arises when imports are more than exports. In India’s case we mostly have a deficient BoP.
Components of BoP
BoP consists of two main components:
- Current Account
- Capital Account
Current Account of BoP :
Current Account records the flow of goods and services between the countries during a given period of time. It consists of :
- Visible Items
- Invisible Items
- Income Receipts
- Unilateral Transfers
It records the imports and exports of visible items which in most of the cases are goods. These items can be touched, seen and measured.
The import and export of visible items is often known as ‘Balance of Trade’.
Balance of Trade= Export of Goods-Import of Goods
It means those items which are intangible i.e it can’t be seen or felt. Eg Shipping, Banking, Insurance etc are part of invisible items.
Income Receipts include Rent, Interest, Dividend, Wages etc received from or paid to the rest of the world.
It means one-sided transfers. It can be in the forms of remittances, donations, gifts etc. Eg A person living in Germany sends money to his family in India.
Foreign Aid received from other countries are also a part on unilateral transfers.
Capital Transfers of Balance of Payment (BoP):
It is the account which records change in assets and liabilities of normal resident with the rest of the world. It accounts for change in non financial assets, like borrowings from UN or from the other countries etc. It includes:
- Borrowings and lendings from and to the rest of the world.
- Investments to and from rest of the world.
- Change in foreign exchange reserves.
Borrowings and Lendings:
It includes commercial borrowings and external assistance, i.e external borrowings from international institutions like World Bank etc. Borrowings and Lendings goes on the Debit side of the account.
It includes Investments to and from the rest of the world. It includes Foreign Direct Investment and Portfolion Investments. Investments by rest of the world includes Investments in Indian companies shares, real estate and are recorded on the credit side. Investments by Indian companies in rest of the world is recorded on the debit side.
Change in Foreign Exchange Reserve:
It refers to the holding of Foreign Exchange with the Central Bank. The change in Foreign Reserves due to current demand or supply is recorded accordingly. When there is decrese in Foreign Reserve it is recorded on Credit side and when there is increase in Foreign Exchange it is recorded on Debit side.
Errors and Omissions
Since it is such a large account. It’s not always possible to record all the transcations in an accurate manner. So Errors and Omissions act in BoP as balancing items.