Understanding the concept of Balance of Payment (BoP)

A balance of payment refers to the statement of accounts recording all economic transactions of a country with the rest of the world. Each country enters into economic transactions with other countries of the world.

A balance of payment refers to the statement of accounts recording all economic transactions of a country with the rest of the world.  Each country enters into economic transactions with other countries of the world. As a result of such transactions, it receives payments from and makes payments to other countries. The balance of payments is a statement of accounts of these receipts and payments.

What are the economic transactions under Balance of Payment (BoP)? 

Economic transactions under Balance of Payment (BoP) is broadly classified as:-

  1. Visible Items which include all types of physical goods exported and imported. These are visible as these are made of some material. These can be seen crossing the borders.
  2.  Invisible Items which include all types of services. These are invisible obviously because service like shipping is not made of material. These cannot be seen crossing the borders. 
  3. Capital transfers which are concerned with capital receipts and capital payments. These involve the transfer of assets. 

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The Balance of Trade and Balance of Payments:-

Balance of trade positive or negative is determined considering only visible items of transactions. It is the difference between export of goods and import of goods.

Balance of Trade = Export of Visible items - Import of Visible items
Note:- Balance of Trade does not account for invisible items of trade as well as capital transfers.
Example: Expenditure by the foreign tourists in the domestic market or by our tourists in the rest of the world is considered as an invisible item in the context of BoP.

Components of Balance of Payment (BoP) Account:-

(1). Current Account: Current account is that account which records import and export of goods and services and unilateral transfers. Export and import of service is often considered as export and import of invisible items. Payments on account of invisible trade include: 1. Factor payments (like rentals and profits), 2. Non-factor payments (like payments for shipping). Unilateral transfers refer to one-sided payments like aid to flood victims in other countries.

Component of Current Account: Current Account record transactions relating to the following items:-
  1. Export and Import of Goods (visible items)
  2. Export and Import of Services (invisible items)
  3. Unilateral transfers from one country to another country
Current Account Balance = Balance of Visible Trade + Balance of Invisible Trade + Balance of Invisible Trade

(2). Capital Account: Capital account is that account which records all such transactions between residents of a country and rest of the world which cause a change in the asset and the liability status of the residents of a country or its government.

Component of Capital Account: Capital account BoP includes the following components:-
  1. Foreign Investments: (1) FDI (Foreign Direct Investment), referring to the purchase of assets in rest of the world which allows control over the asset. Example- Purchase of a firm by TATA in rest of the world.  (2) Portfolio Investment, referring to the purchase of an asset in rest of the world, without any control over the asset. Example- Purchase of some shares of a company by TATA in rest of the world. 
  2. Loans or Borrowings: (1). Commercial Borrowings, referring to borrowing by a country including government and the private sector from the international money market. This involves the market rate of interest without considerations of any concession. (2). Borrowing as an external assistance, referring to borrowing by a country with considerations of assistance. It involves the lower rate of interest compared to that prevailing in the open market. 
  3. Change in reserves of Gold and Foreign exchange with the central bank of the country (RBI in India). 
Autonomous and Accommodating items of Balance of Payments (BoP):-

There are two sets of items of Balance of Payments (BoP) accounts, autonomous items and accommodating items.

1. Autonomous Items: These are those items of Balance of Payments, BoP accounts:-
  • Which are related to such transactions as are determined by consideration of profit.
  • Which are not considered by the BoP status of the country - Positive or Negative, Favourable or Unfavourable.
  • Which are not meant to establish BoP identity. 
Autonomous items in BoP accounts are often referred to as 'above the line items'.

2. Accommodating Items: These are those items of Balance of payments (BoP) accounts:- 
  • Which are not related to such transactions as are determined by considerations of profit.
  • Which are conditioned by the positive or negative BoP status of the country.
  • Which are meant to establish Balance of Payment,, BoP identity. 
Accommodating items in BoP accounts are often referred to as 'below the line items'.






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