Balance of Payments (BoP) is the record of all economic transactions between the residents of a country and the rest of the world during a given period of time. These transactions are made by individuals, firms and government bodies and includes payments for the country's exports and imports of goods, services, financial capital, and financial transfers. It represents a sum total of country's current demand and supply of the claims on foreign currencies and of foreign claims on its currency and are prepared in a single currency, typically the domestic currency for the country concerned.
Components of Balance of Payments (BoP):
1. Current Account
2. Capital Account
3. Unilateral Transfers
4. Official Settlement Accounts
1. The current account: It shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It can be calculated as sum total of the balance of trade (net earnings on exports minus payments made for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers. It is called the current account as it covers transactions that are currently being done and not the transactions those are referred for future.
2. The Capital Account: It records the net change in ownership of foreign assets i.e. the change in claims of one country on the assets of another country. It includes the reserve account along with loans and investments between the country and the rest of world. A country can hold the claims over the assets of other country in the form of:
They can even purchase other countries assets like business franchises, office buildings etc.
3. Unilateral transfers: Unilateral transfers include private remittances, government grants, disaster relief, etc. It is the amount sent or received as gift, such payments received from abroad are credits and those made abroad are debits.
4. Official Settlement Accounts: It represents the holdings by the government or official agencies. This account records foreign exchange reserve, bank deposits and gold at central bank. These are maintained for the settlement of international claims.
Is Balance of Payments Always in Equilibrium?
Balance of payments is at equilibrium means that the sum of net credit and debit balances of current account, capital account and official settlements account must equal zero.
Balance of payments is written as.
B = Rf -Pf
B = where, В represents balance of payments,
Rf , represents receipts from foreigners,
Pf , represents payments made to foreigners.
When В = Rf-- Pf = 0, the balance of payments is in equilibrium.
When Rf – Pf > 0, it implies receipts from foreigners are exceeding from the payments made to foreigners and there is surplus in the balance of payments. On the other hand, when Rf - Pf < 0 or Rf < Pf - there is deficit in the balance of payments as this means that the payments made to foreigners are exceeding as compared to receipts from foreigners. This also explains the concept of Disequilibrium in the BOP of a country which may be either a deficit or a surplus. A deficit or surplus in BOP of a country appears when its autonomous receipts (credits) do not match its autonomous payments (debits).