What do you mean by Balance of payment?
Balance of payment is a statistical statement that systematically summarizes the economic transactions of an economy with the rest of the world, for a specific time period.
The IMF publication Balance of payment manual describes the concept as follows:
“The balance of payment is a statistical statement for a given period showing:-
1. Transactions in goods and services and income between an economy and the rest of the world.
2. 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.
3. Unrequited transfers and counterpart entries that are needed to Balance. In this accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting.”
A/C to Kindle Berger: The balance of payment of a country is a systematic record of all economic transactions between the residents of the reporting country and resident of foreign country during a given period of time.”
By Philip Cateora: “The system of accounts that records a nation’s international financial transactions is called its balance of payments.”
• Transactions recorded annually
• Must always be in balance
• A record of condition, not determinant of condition
A balance of payments represents the differences between receipts from foreign countries on one side and payments to them on the other.
Finally we can say that a country’s balance of payments accounts keep track of both its payments to and its receipts from foreigners.
Components of balance of payment/
Balance of Payment includes three accounts:
There are some components of balance of payment. Those are as follows: (international transactions are recorded in double entry book keeping, the Bop must always balance.)
1. The current account: A record of all merchandise exports, imports, and services plus unilateral transfers of funds;
2. The capital account: A record of direct investment, portfolio investment, and short-term capital movements to and from countries;
3. The official reserves account: A record of exports and imports of gold, increases or decreases in foreign exchange, and increases or decreases in liabilities to foreign central banks.
Of the three, the current account is of primary interest to international business.
The current account is important because it includes all international merchandise trade and service accounts, that is, accounts for the value of all merchandise and services.
In details :
1. Current account: The current account is used to mark the inflow and outflow of goods and services into a country. The current account includes all transactions which give rise to use up national income. Two types
a. Merchandise exports and imports: merchandise exports (sales of good in abroad) are credit entries because all transaction giving rise to monetary claims on foreigners represents credits. Merchandise imports (purchase of goods from abroad) are debit entries.
b. Invisible exports and imports: invisible exports (sale of service) are credit entries. Invisible imports (purchases of services) are debit entries.
2. Capital account: the capital account consists of short term and long term capital transactions.
Capital outflow represents debit. Drawings
And capital inflow represents credit. Investment
Example: if an American firms invest 100 million in India. This transaction will be represents as a Debit-in the USA Bop and credit in the India.
3. Unilateral payments account: unilateral transfer is another term for gifts, and includes private remittances, government grants, reparation and disaster relief.
Unilateral payments received from abroad are=credits
Payments made abroad are debits
Remittance from foreign country=credit
Remittance to foreign country = debit.
4. Official reserves account: official reserves represent the holdings by the government or official agencies of the means of payment that are generally accepted for the settlement of international claims.
A Balance of payments Disequilibrium. Dimensions of BOP disequilibrium:
There are some dimensions of balance of payment like equilibrium, dis-equilibrium, (deficit and surplus)
Equilibrium of Balance of payment: the balance of payments of a country is said to be in equilibrium when the demand for foreign exchange is exactly equivalent to supply to it.
Disequilibrium of Bop: the balance of payments is regarded as being in disequilibrium when it shows either a surplus or a deficit.
Deficit in balance of payment: when the demand of foreign exchange exceeds its supply then it is called deficit balance of payment.
In both debit and credit sides of Bop, there are some active and passive elements.
If AD>AC and PC>PD then the situation is a deficit of balance of payment.
Surplus of Bop: when the supply of foreign exchange exceeds the demand, then it is called the surplus of BOP.
If active credits exceed active debits or passive debits > passive credits then a country has a surplus of BOP.