The balance of payments accounts is a record of all international transactions that are undertaken between residents of one country and residents of other countries during the year. The accounts are divided into several subaccounts, the most important being the current account and the financial account. The current account is often further subdivided into the merchandise trade account and the service account.
|Current Account||Record of all international transactions for goods and services, income payments and receipts, and unilateral transfers. The current account is used in the national income identity for GNP.|
|Merchandise Trade Account||Record of all international transactions for goods only. Goods include physical items like autos, steel, food, clothes, appliances, furniture, etc.|
|Services Account||Record of all international transactions for services only. Services include transportation, insurance, hotel, restaurant, legal, consulting, etc.|
|Goods and Services Account||Record of all international transactions for goods and services only. The goods and services account is used in the national income identity for GDP.|
|Financial Account||Record of all international transactions for assets. Assets include bonds, Treasury bills, bank deposits, stocks, currency, real estate, etc.|
Components of BOP
The BOP comprises of two accounts: Current and Capital.
The four major components of the Current account are as follows:
- Visible trade – This is the net of export and imports of goods (visible items). The balance of this visible trade is known as the trade balance. There is a trade deficit when imports are higher than exports and a trade surplus when exports are higher than imports.
- Invisible trade – This is the net of exports and imports of services (invisible items). Transactions mainly consist of shipping, IT, banking and insurance services.
- Unilateral transfers to and from abroad – These refer to payments that are not factor payments. For example, gifts or donations sent to the resident of a country by a non-resident relative.
- Income receipts and payments – These include factor payments and receipts. These are generally rent on property, interest on capital, and profits on investments.
The Capital account is used to finance the deficit in the current account or absorb the surplus in the current account. The three major components of the Capital account:
- Loans to and borrowings from abroad – These consist of all loans and borrowings given to or received from abroad. It includes both private sector loans, as well as public sector loans.
- Investments to/from abroad – These are investments made by nonresidents in shares in the home country or investment in real estate in any other country.
- Changes in foreign exchange reserves – Foreign exchange reserves are maintained by the central bank to control the exchange rate and ultimately balance the BOP.
A Current account deficit is financed by a surplus in the Capital account and vice versa. This can be done by borrowing more money from abroad or lending more money to non-residents.
Importance of Balance of Payment:
A balance of payment is an essential document in the finance department or transaction as it gives the status of a country and it’s economy. The importance of the balance of payment can be calculated from the below points:
- It examines the transaction of all the export and import of goods and services for a given period
- It helps the government to analyse the potential of a particular industry export growth and formulate policy to support that growth
- It gives the government a broad perspective on a different range of import and export tariff. The government then takes measure to increase and decrease the tax to discourage import and encourage export respectively and be self-sufficient
- If the economy urges support in the mode of import, the government plan according to the BOP and divert the cash flow and technology to the unfavourable sector of the economy, and seek future growth
- The Balance of Payment also indicates the government to detect the state of the economy, and plan expansion, monetary, and fiscal policy establish on that