Balance of Payment Account : Meaning, Features and Components

Balance of Payment Account : Meaning, Features and Components!

Meaning of Balance of Payment Account:

A Balance of Payment Account is a systematic record of all economic transactions between residents of a country and the rest of the world carried out in a specific period of time.

Briefly put, ‘Balance of Payment Account is a summary of international transactions of a country for a given period’ (i.e., financial year). It records a country’s transactions with the rest of the world involving inflow and outflow of foreign exchange. In short BOP Account is a summary statement of transactions in foreign exchange in a year.

Simply put, BOP account is a statement of a country’s sources and uses of foreign exchange in which main sources are: exports, transfers and remittances from abroad, borrowings from abroad, foreign investments whereas uses of foreign exchange are: imports, transfers to abroad, lending abroad and purchase of assets, etc.

BOP account, like a typical business account, is based on double entry system which contains two sides—Credit side and Debit side. Any transaction which brings in foreign exchange (currency) is recorded on credit side whereas any transaction that causes a country to lose foreign exchange is recorded on debit side. For example, export is credit item as it brings in foreign exchange whereas import is a debit item since it causes outflow of foreign exchange. Similarly, borrowing from rest of the world (ROW) is a credit item while lending to ROW is a debit item. main purpose of BOP Account is to know international economic position of a country and to help the government make appropriate trade and payment policies.

Features of Balance of Payment Account:

(i) It is a systematic record of all economic transactions between residents of one country and rest of the world.

(ii) It includes all transactions in goods (visible items), services (invisible) and assets (flow of capital) during a period of time.

(iii) It is constructed on double entry system of accounting. Thus, every international transaction will result in credit entry and debit entry of equal size.

(iv) All economic transactions that are carried out with the rest of world are either credited or debited.

(v) In accounting sense total debit will always be equal to total credits, i.e., balance of payments will always be in equilibrium. But in economic sense, if receipts are larger than payments, there is surplus in BOR Similarly, if payments are larger than receipts, there is deficit in BOP.

A hypothetical simplified example of a country’s Balance of Payment Account is given in the following table. It has two sides—credits (receipts) on the left side and debits (payments made) on the right side.

BOP account records a country’s all economic transactions with ROW which Involve inflow or outflow of foreign exchange.

Visible and Invisible items:

Visible items refer to items relating to trading in goods with other countries. For example export and import of goods (like machinery, tea, etc.) are called visible items because goods are visible items and can be verified by Custom officials. Invisible items refer to items relating to trading of services with other countries and unilateral transfers. Export and import of services are called Invisible items because services are not seen crossing the border. All types of services like services of shipping, banking, tourism, investment services and unilateral transfers are invisible items.

Components of Balance of Payment Account:

The various items which make up country’s Balance of Payment Account are listed in a simplified consolidated form in the above table. They are explained as under:

1. Export and import of goods (Merchandise):

The most straightforward way in which a country can acquire foreign currency is by exporting goods. These are called visible items because goods can be seen, touched and measured. This is shown by Row (1) which indicates that the country has exported goods to a value of Rs 550 crore. In an analogous (similar) way Row (5) shows that the country has imported goods to a value of Rs 800 crore. These two rows describe the country’s visible trade. Movement of goods between countries is known as visible trade because the movement is open and can be verified by Customs officials.

2. Services rendered and received:

(Shipping, banking, insurance, tourism, interest, dividend etc) Under this head, following types of earnings are included.

(a) Non-factor income:

Income from shipping, banking, insurance, tourism, software services is called non-factor income. All such payments are listed under Row (2) as export of services or invisible exports.

(b) Investment income (Factor income):

Interest and dividends which citizens of a country earn on investment abroad are investment income and treated as factor income. Remember, citizens of the country own land, bonds, shares, etc. in foreign countries for which the foreigners who enjoy the services of this capital will have to pay for them. These payments will be registered under Row (2) as export of services or invisible exports.

In a completely analogous way, Row(6) covers payments which residents of the country m question make to foreigners for similar services, i.e., shipping, banking, insurance payments made by residents as tourists abroad, payments in the form of interest, dividends, profits/or capital services on foreign owned capital.

3. Unilateral transfers:

(Gifts, remittances, indemnities, etc. from foreigners) The items in Row (3) are called unrequited receipts because residents of a country receive ‘for free. Nothing has to be paid in return at present or in future for these receipts. These are like transfer payments. Examples of this head are gifts received by residents from foreigners, remittances sent by emigrants to relatives, war indemnities paid by a defeated country, etc. Note: In India unrequited or unilateral transfers are treated as a part of invisible trade.

4. Capital receipts and Payments: [Borrowings, capital repayments, sale of assets, changes in foreign exchange reserve):

It records international transactions which affect assets and liabilities of domestic country with rest of the world. Items (4) and (8) of the table indicate changes in stock magnitudes and refer to capital receipts and payments .Government of a country may borrow (get loan) from another government; a firm may issue stocks abroad or a bank may float a loan in a foreign country.

In all these instances, the country in question will acquire foreign currency and these transactions will be entered as credit items in Row (4). Similarly foreigners may acquire assets in the country with whose balance of payments they are concerned.

Assets maybe in the form of land, houses, plants, and shares, etc. Changes m stock of gold or reserves of foreign currency are also included in Row (4). Analogously, if residents of the country in their turn were to acquire similar foreign assets, this would give rise to outflow of foreign currency and come as a capital transfer recorded as a debit item in Row(8).

Note: First three items of credits and debits shown in the above imaginary table are flow items because they refer to certain value of exports/imports per time period. Since all these payments/receipts are made with reference to current period of time, therefore, they comprise Current Account of Balance of Payment. As against it, the last item of debits and credits, viz. capital receipts/capital payments comprise Capital Account of Balance of Payment as they express changes in stock magnitudes.