The balance of payments (BOP) is the method countries use to monitor all international monetary transactions in a specific period. The BOP is usually calculated every quarter and every calendar year.
All trades conducted by both the private and public sectors are accounted for in the BOP to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit.
Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice, this is rarely the case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.
Balance of Payment
Balance Of Payment (BOP) is a statement that records all the monetary transactions made between residents of a country and the rest of the world during any given period. This statement includes all the transactions made by/to individuals, corporates and the government and helps in monitoring the flow of funds to develop the economy.
When all the elements are correctly included in the BOP, it should be zero in a perfect scenario. This means the inflows and outflows of funds should balance out. However, this does not ideally happen in most cases.
A BOP statement of a country indicates whether the country has a surplus or a deficit of funds, i.e. when a country’s export is more than its import, its BOP is said to be in surplus. On the other hand, the BOP deficit indicates that its imports are more than its exports.
Tracking the transactions under BOP is similar to the double-entry accounting system. All transactions will have a debit entry and a corresponding credit entry.
Importance of Balance of Payment
- BOP statement of a nation reveals its financial and economic status
- BOP statement can be set as an indicator to determine whether the country’s currency value is appreciating or depreciating
- BOP statement helps the Government to decide on fiscal and trade policies
- It provides crucial information to analyse and understand the economic dealings of a country with other countries
How the Balance of Payments (BOP) Is Divided
The BOP is divided into three main categories:
- Current account
- Capital account
- Financial account
Within these three categories are subdivisions that account for a different type of international monetary transaction. As an example, the current account includes a goods and services account, a primary income account, and a secondary income account.
The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current accountWithin the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold, or given away, possibly in the form of aid. Services refer to receipts from tourism, transportation, engineering, business service fees, and royalties from patents and copyrights.
Goods and services together make up a country’s balance of trade (BOT). The BOT is typically the biggest bulk of a country’s balance of payments, as it makes up total imports and exports. If a country has a BOT deficit, it imports more than it exports, and if it has a BOT surplus, it exports more than it imports.
Receipts from income-generating assets such as stocks—in the form of dividends—are also recorded in the current account. The last component of the current account is unilateral transfers. These are credits that are mostly workers’ remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.
The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of nonfinancial assets—for example, a physical asset such as land—and non-produced assets, which are needed for production but have not been produced, such as a mine used for the extraction of diamonds.
The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies, and, finally, uninsured damage to fixed assets.
The Financial Account
In the financial account, international monetary flows related to investment in business, real estate, bonds, and stocks are documented. Also included are government-owned assets, such as foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund (IMF), private assets held abroad, and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.
Why is the Balance of Payment (BOP) vital for a country?
A country’s BOP is vital for the following reasons:
- The BOP of a country reveals its financial and economic status.
- A BOP statement can be used to determine whether the country’s currency value is appreciating or depreciating.
- The BOP statement helps the government to decide on fiscal and trade policies.
- It provides important information to analyse and understand the economic dealings with other countries.
FAQs
What is the meaning of a deficit in the balance of payments?
When autonomous foreign exchange payments exceed autonomous foreign exchange receipts, the balance of payments deficit is the difference. Autonomous transactions in foreign exchanges are those transactions that are independent of the state’s balance of payments and are undertaken for an individual’s own sake.
What is the difference between the balance of trade and payments?
Balance of trade is the difference between exports and imports of goods. Only the visible items are considered in the balance of trade. The exchange of services between countries is not considered.
The current account of the balance of payment comprises exports and imports of goods, services and unilateral transfers like remittances, gifts, donations, etc. The net value of all these constitutes the balance of the current account. Thus, the balance of trade is a part of the current account of the balance of payments.