Subject: Economics

Topic: Balance of Payments

BALANCE OF PAYMENTS
→ Balance of payment is an accounting statement that provides a systematic record of
all the economic transactions between residents of a country and the rest of the world
in a given period of time.
→ (Residents - individuals forms and government agencies
→ DO NOT include - diplomatic staff, foreign military personnel, tourist, migratory
workers and branches of foreign companies)

ECONOMIC TRANSACTIONS
→ Transfer of the title or ownership of goods, services, money and assets

CAPITAL
TRANSFERS
- Capital receipt (sale
VISIBLE ITEMS UNILATERAL
of asset) and capital
TRANSFERS
- Physical goods payment (purchase of
- Can be seen INVISIBLE - Gifts, personal asset)
touched and ITEMS remittances
measured - One-way
- Services transactions
- Trade is open - Cannot be seen
and can be felt touched or
verified measured

STRUCTURE OF BALANCE OF PAYMENTS

→Double entry system

DEBIT: All outflows

Accounting Sense
(balanced) CREDIT: All inflows

BALANCED: Receipts are equal to payments of foreign

exchange
Economic Sense
SURPLUS: Receipts are more than payments of foreign
exchange
DEFICIT: Receipts are less than payments of Page 1|6
foreign exchange
 BALANCE OF TRADE

→ Balance of trade refers to the difference between the amounts of exports and
imports of visible items
Balance of trade = Exports of goods - Imports of goods
CREDIT (positive): Exports
SURPLUS
DEBIT (negative): Imports
- Exports more
DEFICIT
- Favourable
- Import exceeds
exports
- Unfavourable

→ It does not record any transaction of capital nature

→ It is only a part of the balance of payment account
→ Unfavourable BOT can be met out of favourable BOP

COMPONENTS OF BALANCE OF PAYMENT

CURRENT CAPITAL
ACCOUNT ACCOUNT

Current account

→ Current account records all the transactions related to export and import of goods
and services and unilateral transfers during a given period of time
→ It includes those transactions which do not impact assets and liabilities position of a
country in relation to the rest of the world
→ It does not give rise to future claims
→ It records all the actual transactions which affect the income, output and employment
of a country
→ It shows the net income generated in the foreign sector
→ Flow concept

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 INCOME RECEIPTS AND PAYMENTS
Components FROM ABROAD
- Investment income in the form of interest,
rent and profits

UNILATERAL
EXPORT AND IMPORT TRANSFERS (One sided
OF GOODS (Visible transactions)
trade) EXPORT AND IMPORT
OF SERVICES (Invisible - Gifts, donations, personal
CREDIT (positive) – trade) remittances
Receipt from export - Receipts and payments
- Shipping which take place without
DEBIT (negative) – - banking any service
Payment for import - insurance
CREDIT (positive) –
CREDIT (positive) – unilateral transfers received
Receipt from export
DEBIT (negative) –
DEBIT (negative) – unilateral transfers made
Payment for import

Balance on Current Account is the net value of credit and debit balances

CURRENT ACCOUNT DEFICIT

CURRENT ACCOUNT SURPLUS
- Debit items are more than credit
- Credit items or more than debit items items
- Net inflow foreign exchange - Foreign exchange receipts foil short
- Exports is more - nation is a lender of foreign exchange payments
to the rest of the world - Net outflow of foreign exchange
- Export is less - nation is a borrower
from rest of the world

❖ CAPITAL ACCOUNT
→ Capital account records all those transactions between the residents of a country and
rest of the world which cause a change in the assets or liabilities of the residents of
the country or its government
→ It is used to finance deficit in current account or to absorb surplus of current account
→ it does not have direct effect on income output and employment of the country
→ stock concept

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 Components
CHANGE IN FOREIGN
EXCHANGE RESERVES
- Foreign exchange reserves
are the financial assets of the
government held in the
central bank a change in the
INVESTMENTS TO AND
reserve serves as the
FROM ABROAD
BORROWINGS AND financing item in BOP
LENDINGS TO AND CREDIT (positive) –
CREDIT (positive) –
FROM ABROAD Investments from abroad –
withdrawal from reserves
bring in foreign exchange
CREDIT (positive) –
DEBIT (negative) – addition
Borrowings from abroad DEBIT (negative) –
to these reserves
Receipt/ repayment of Investments to abroad –
loans by foreigners outflow of foreign exchange
DEBIT (negative) –
Lending abroad
Repayment of loans to
abroad

Balance on Capital Account is the net value of credit and debit balances
CREDIT: Transactions which lead to the inflow of foreign exchange
DEBIT: Transactions which lead to the outflow of foreign exchange

SURPLUS DEFICIT

- Credit items or more than debit - Debit items are more than credit items
- Net inflow - Net outflow

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 AUTONOMOUS AND ACCOMODATING ITEMS

AUTONOMOUS ITEMS
ACCOMMODATING ITEMS
- International economic
- Transactions are undertaken
transactions which take place
to cover the gap in the bop
due to some economic motive
- Below the line items
such as profit maximization
- Compensating capital
- Above the line items
transactions which are meant
- Independent of the state of
to correct disequilibrium in
bop account
autonomous items of bop
- Takes place on both current
- Only on capital account
(merchandise exports and
imports of goods) and capital
accounts (receipts and
repayments of long-term
loans by private individuals)

DEFICIT (DISEQUILIBRIUM) IMBALANCE OF PAYMENTS

→ Deficit in balance of payment accounts arises when total inflows on accounts of
autonomous transactions are less than total outflows in account of such transactions
Official reserve transactions
→ Transactions carried on by monetary authorities which causes changes in official
reserves
→ Central bank finance deficit by
- Reducing reserves of foreign currency
- Borrowings from monetary authorities like IMF

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 Causes of Deficit
SOCIAL FACTORS
1. Demonstration effect:
Underdeveloped
countries start adopting
foreign pattern of
ECONOMIC FACTORS POLITICAL FACTORS
consumption - imports
1. Developmental Activities: 1. Political Instability: increase
Developing countries Large capital outflows 2. Change in taste,
depend on developing and reduce inflows of preferences, fashion
nations – Imports increase foreign funds and trends:
2. High Rate of Inflation: 2. Political Disturbances: Unfavourable change
Foreign goods become Frequent changes in for the domestic goods
relatively cheaper – Imports government, inadequate
increase support to government
3. Cyclical Fluctuations: in parliament
Domestic economy is going discourages inflow of
through a phase of boom - capital
domestic production may be
unable to satisfy domestic
demand – Imports increase
4. Change in Demand: Fall in
demand for country’s goods
in foreign markets – Fall in
exports
5. Import of Services:
Underdeveloped countries
import services from
developed countries

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