What is Balance of Payment

Balance Of Payment: Meaning

 balance of payment notes:

The balance of payments of a country is a   systematic record of all economic transactions between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by them on account of goods imported and services received from the capital transferred to non-residents or foreigners.

Features:- 

ü It is a systematic record of all economic transactions between one country and the rest of the world.

ü It includes all transactions, visible as well as invisible.

ü It relates to a period of time. Generally, it is an annual statement.

ü It adopts a double-entry book-keeping system. It has two sides: the credit side and the debit side. Receipts are recorded on the credit side and payments on the debit side.

Balance of Trade  

The difference between a country's imports and its exports. The balance of trade is the largest component of a country's balance of payments. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy. When exports are greater than imports than the BOT is favourable and if imports are greater than exports then it is unfavorable

Balance of Trade V/s Balance of Payment

Ø The Balance of Payment takes into account all the transaction with the rest of the worlds

Ø The Balance of Trade takes into account all the trade transaction with the rest of the worlds

 BOP               v/s                BOT

1. It is a broad term	1. It is a narrow term.
2. It includes all transactions related to visible, invisible and capital transfers.	2. It includes only visible items.
3. It always balances itself.	3. It can be favorable or unfavourable.
4. BOP = Current Account + Capital Account + or - Balancing item (Errors and omissions)	4. BOT = Net Earning on Export - Net payment for imports.
5. Following are main factors that affect BOP a) Conditions of foreign lenders. b)Economic the policy of Govt. c) all the factors of BOT	5. Following are the main factors which affect BOT a) cost of production b) availability of raw materials c) Exchange rate d) Prices of goods manufactured at home

Importance of  Balance Of Payments

    1)    BOP records all the transactions that create demand for and supply of a currency.

    2)    Judge economic and financial status of a country in the short-term

    3)   BOP may confirm the trend in the economy’s international trade and exchange rate of the currency. This may also indicate change or reversal in the trend.

4)    This may indicate a policy shift of the monetary authority (RBI) of the country.

5)    BOP may confirm the trend in the economy’s international trade and exchange rate of the currency. This may also indicate change or reversal in the trend.

The General Rule in BOP Accounting

Ø If a transaction earns foreign currency for the nation, it is a credit and is recorded as a plus item.

Ø If a transaction involves spending of foreign currency it is a debit and is recorded as a negative item.

The various components of a BOP statement

1.    Current Account

2.    Capital Account

3.    Reserve Account

4.    Errors & Omissions

Current Account Balance

·       BOP on current account is a statement of actual receipts and payments in a short period.

·       It includes the value of export and imports of both visible and invisible goods. There can be either surplus or deficit in the current account.

·       The current account includes:- export & import of services, interests, profits, dividends and unilateral receipts/payments from/to abroad.

·       BOP on current account refers to the inclusion of three balances of namely – Merchandise balance, Services balance, and Unilateral Transfer balance

Capital Account Balance

·       The capital account records all international transactions that involve a resident of the country concerned changing either his assets with or his liabilities to a resident of another country. Transactions in the capital account reflect a change in stock – either asset or liabilities.

·       It is the difference between the receipts and payments on account of the capital account. It refers to all financial transactions.

·       The capital account involves inflows and outflows relating to investments, short term borrowings/lending, and medium-term to long term borrowing/lending.

The Reserve Account

·       Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Reserve Account.

·       The IMF account contains purchases (credits) and repurchase (debits) from the International Monetary Fund.

·       Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to time to member countries. It can be used to settle international payments between monetary authorities of two different countries.

Errors & Omissions

·       The entries under this head relate mainly to leads and lags in reporting of transactions

·       It is of a balancing entry and is needed to offset the overstated or understated components

Disequilibrium In The Balance Of Payments

Disequilibrium in the balance of payment means its condition of Surplus Or deficit

A Surplus in the BOP occurs when Total Receipts exceed Total Payments. Thus, BOP= CREDIT>DEBIT

A Deficit in the BOP occurs when Total Payments exceed Total Receipts. Thus, BOP= CREDIT<DEBIT

Causes of Disequilibrium In The Bop

o   Cyclical fluctuations

o   Short fall in the exports

o   Economic Development

o   Rapid increase in population

o   Structural Changes

o   Natural Calamites

o   International Capital Movements

Measures To Correct Disequilibrium in the BOP

I.  Monetary Measures :

1.    Monetary Policy: The monetary policy is concerned with money supply and credit in the economy. The Central Bank may expand or contract the money supply in the economy through appropriate measures which will affect the prices.

2.    Fiscal Policy: Fiscal policy is the government's policy on income and expenditure. Government incurs development and non - development expenditure,. It gets income through taxation and non - tax sources. Depending upon the situation governments expenditure may be increased or decreased.

3.    Exchange Rate Depreciation:  By reducing the value of the domestic currency, the government can correct the disequilibrium in the BoP in the economy. Exchange rate depreciation reduces the value of home currency in relation to foreign currency. As a result, import becomes costlier and export become cheaper. It also leads to inflationary trends in the country.

4.    Devaluation: devaluation is lowering the exchange value of the official currency. When a country devalues its currency, exports becomes cheaper and imports become expensive which causes a reduction in the BOPdeficit.

5.    Deflation: Deflation is the reduction in the quantity of money to reduce prices and incomes. In the domestic market, when the currency is deflated, there is a decrease in the income of the people. This puts a curb on consumption and the government can increase exports and earn more foreign exchange.

6.    Exchange Control: All exporters are directed by the monetary authority to surrender their foreign exchange earnings, and the total available foreign exchange is rationed among the licensed importers. The license-holder can import any good but amount if fixed by monetary authority.

To Correct Measures Disequilibrium in the BOP

II. Non- Monetary measures :

(A).  Export Promotion

To control export promotions the country may adopt measures to stimulate exports like:

Ø export duties may be reduced to boost exports  cash assistance, subsidies can be given to exporters to increase exports

Ø goods meant for exports can be exempted from all types of taxes.

(B). Import Substitutes

Steps may be taken to encourage the production of import substitutes. This will save foreign exchange in the short run by replacing the use of imports by these import substitutes.

(C). Import Control:

The import may be kept in check through the adoption of a wide variety of measures like quotas and tariffs. Under the quota system, the government fixes the maximum quantity of goods and services that can be imported during a particular time period.

1.    Quotas – Under the quota system, the government may fix and permit the maximum quantity or value of a commodity to be imported during a given period. By restricting imports through the quota system, the deficit is reduced and the balance of payments position is improved.

2.    Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices of imports would increase to the extent of the tariff. The increased prices will reduce the demand for imported goods and at the same time induce domestic producers to produce more of import substitutes