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The balance of payments, also known as balance of international payments and abbreviated BoP, of a country is the

record of all economic transactions between the residents of the country and the rest of the world in a particular period
(over a quarter of a year or more commonly over a year). These transactions are made by individuals, firms and
government bodies. Thus the balance of payments includes all external visible and non-visible transactions of a country

Components of Balance of Payments:


(1) Current Account; (2) Capital Account
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Components of Balance of Payments: (1) Current Account; (2) Capital Account!

(1) Current Account:

Current account refers to an account which records all the transactions relating to export and import of goods
and services and unilateral transfers during a given period of time.

Current account contains the receipts and payments relating to all the transactions of visible items, invisible
items and unilateral transfers.

Components of Current Account:

The main components of Current Account are:

ADVERTISEMENTS:

1. Export and Import of Goods (Merchandise Transactions or Visible Trade):

A major part of transactions in foreign trade is in the form of export and import of goods (visible items).
Payment for import of goods is written on the negative side (debit items) and receipt from exports is shown on
the positive side (credit items). Balance of these visible exports and imports is known as balance of trade (or
trade balance).

2. Export and Import of Services (Invisible Trade):

ADVERTISEMENTS:

It includes a large variety of non- factor services (known as invisible items) sold and purchased by the residents
of a country, to and from the rest of the world. Payments are either received or made to the other countries for
use of these services.

Services are generally of three kinds:

(a) Shipping,

(b) Banking, and


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(c) Insurance.

Payments for these services are recorded on the negative side and receipts on the positive side.

3. Unilateral or Unrequited Transfers to and from abroad (One sided Transactions):

Unilateral transfers include gifts, donations, personal remittances and other one-way transactions. These refer
to those receipts and payments, which take place without any service in return. Receipt of unilateral transfers
from rest of the world is shown on the credit side and unilateral transfers to rest of the world on the debit side.

ADVERTISEMENTS:

4. Income receipts and payments to and from abroad:

It includes investment income in the form of interest, rent and profits.

Current Account shows the Net Income:

Current Account records all the actual transactions of goods and services which affect the income, output and
employment of a country. So, it shows the net income generated in the foreign sector.

Difference between Balance of Trade and Current Account:

Basis Balance of Trade Current Account


(BOT)
Components: Balance of trade Current Account
includes only records both visible
visible items. and invisible items.
Scope: It is a narrow It is a wider concept
concept as it is and it includes BOT.
only a part of
current account

Balance on Current Account:

In the current account, receipts from export of goods, services and unilateral receipts are entered as credit or
positive items and payments for import of goods, services and unilateral payments are entered as debit or
negative items. The net value of credit and debit balances is the balance on current account.

1. Surplus in current account arises when credit items are more than debit items. It indicates net inflow of
foreign exchange.

2. Deficit in current account arises when debit items are more than credit items. It indicates net outflow of
foreign exchange.

Components of Current Account:

Credit Items Debit Items Net Credit (Credit


Debit)
1. Visible Trade Imports of goods Net Exports of goods
Exports of goods: (Balance of Trade)
2. Invisible Trade Imports of services Net Exports of
Exports of services
services:
3. Unilateral Transfer Payments Net Transfer Receipts
Transfers
Transfer
Receipts:
4. Income Income Payments Net Income Receipts
Receipts &
Payments Income
Receipts:
Current Receipts Current Payments Current Account
Balance
(1+2+3+4)

(2) Capital Account:

Capital account of BOP records all those transactions, between the residents of a country and the rest of the
world, which cause a change in the assets or liabilities of the residents of the country or its government. It is
related to claims and liabilities of financial nature.

Capital Account is used to:

(i) Finance deficit in current account; or

(ii) Absorb surplus of current account.

Capital account is concerned with financial transfers. So, it does not have direct effect on income, output and
employment of the country.

Components of Capital Account:

The main components of capital account are:

1. Borrowings and landings to and from abroad: It includes:

A. All transactions relating to borrowings from abroad by private sector, government, etc. Receipts of such
loans and repayment of loans by foreigners are recorded on the positive (credit) side.

B. All transactions of lending to abroad by private sector and government. Lending abroad and repayment of
loans to abroad is recorded as negative or debit item.

2. Investments to and from abroad: It includes:

A. Investments by rest of the world in shares of Indian companies, real estate in India, etc. Such investments
from abroad are recorded on the positive (credit) side as they bring in foreign exchange.

B. Investments by Indian residents in shares of foreign companies, real estate abroad, etc. Such investments to
abroad be recorded on the negative (debit) side as they lead to outflow of foreign exchange.
3. Change in Foreign Exchange Reserves:

The foreign exchange reserves are the financial assets of the government held in the central bank. A change in
reserves serves as the financing item in Indias BOP. So, any withdrawal from the reserves is recorded on the
positive (credit) side and any addition to these reserves is recorded on the negative (debit) side. It must be noted
that change in reserves is recorded in the BOP account and not reserves.

Balance on Capital Account:

The transactions, which lead to inflow of foreign exchange (like receipt of loan from abroad, sale of assets or
shares in foreign countries, etc.), are recorded on the credit or positive side of capital account. Similarly,
transactions, which lead to outflow of foreign exchange (like repayment of loans, purchase of assets or shares in
foreign countries, etc.), are recorded on the debit or negative side. The net value of credit and debit balances is
the balance on capital account.

A. Surplus in capital account arises when credit items are more than debit items. It indicates net inflow of
capital.

B. Deficit in capital account arises when debit items are more than credit items. It indicates net outflow of
capital.

In addition to current account and capital account, there is one more element in BOP, known as Errors and
Omissions. It is the balancing item, which reflects the inability to record all international transactions
accurately.

Credit Items Debit Items Net Credit (Credit


Debit)
1. Borrowings Landings to abroad Net Borrowings from
and lendings to abroad
and from abroad
Borrowings from
abroad:
2. Investments Investments to Net Investments from
from abroad abroad abroad
Investments from
abroad:
3. Change in Increases in foreign Net change in foreign
Foreign exchange reserves exchange reserves
Exchange
Reserves.

Decreases in
foreign exchange
reserves:
Capital Receipts Capital Payments Capital Account
Balance
(1+2+3):

Causes and Measures of Disequilibrium (Balance of


Payment)
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Causes and Measures of Disequilibrium!

Overall account of BOP is always in equilibrium. This balance or equilibrium is only in accounting sense
because deficit or surplus is restored with the help of capital account.

In fact, when we talk of disequilibrium, it refers to current account of balance of payment. If autonomous
receipts are less than autonomous payments, the balance of payment is in deficit reflecting disequilibrium in
balance of payment.

1. Causes of disequilibrium in BOP:

There are several factors which cause disequilibrium in the BOP indicating either surplus or deficit.

Such causes for disequilibrium in BOP are listed below:

(i) Economic Factors:

(a) Imbalance between exports and imports. (It is the main cause of disequilibrium in BOR), (b) Large scale
development expenditure which causes large imports, (c) High domestic prices which lead to imports, (d)
Cyclical fluctuations (like recession or depression) in general business activity, (e) New sources of supply and
new substitutes.

(ii) Political Factors:

Experience shows that political instability and disturbances cause large capital outflows and hinder Inflows of
foreign capital.

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(iii) Social Factors:

(a) Changes in fashions, tastes and preferences of the people bring disequilibrium in BOP by influencing
imports and exports; (b) High population growth in poor countries adversely affects their BOP because it
increases the needs of the countries for imports and decreases their capacity to export.

2. Measures to correct disequilibrium in BOP:

Sustained or prolonged deficit has to be settled by short term loans or depletion of capital reserve of foreign
exchange and gold.

Following remedial measures are recommended:

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(i) Export promotion:

Exports should be encouraged by granting various bounties to manufacturers and exporters. At the same time,
imports should be discouraged by undertaking import substitution and imposing reasonable tariffs.

(ii) Import:
Restrictions and Import Substitution are other measures of correcting disequilibrium.

(iii) Reducing inflation:

Inflation (continuous rise in prices) discourages exports and encourages imports. Therefore, government should
check inflation and lower the prices in the country.

(iv) Exchange control:

Government should control foreign exchange by ordering all exporters to surrender their foreign exchange to
the central bank and then ration out among licensed importers.

(v) Devaluation of domestic currency:

It means fall in the external (exchange) value of domestic currency in terms of a unit of foreign exchange which
makes domestic goods cheaper for the foreigners. Devaluation is done by a government order when a country
has adopted a fixed exchange rate system. Care should be taken that devaluation should not cause rise in
internal price level.

(vi) Depreciation:

Like devaluation, depreciation leads to fall in external purchasing power of home currency. Depreciation occurs
in a free market system wherein demand for foreign exchange far exceeds the supply of foreign exchange in
foreign exchange market of a country (Mind, devaluation is done in fixed exchange rate system.)

Causes of Disequilibrium in Balance of Payment

1. Population Growth

Most countries experience an increase in the population and in some like India and China the population is not
only large but increases at a faster rate. To meet their needs, imports become essential and the quantity of
imports may increase as population increases.

2. Development Programmes

Developing countries which have embarked upon planned development programmes require to import capital
goods, some raw materials which are not available at home and highly skilled and specialized manpower. Since
development is a continuous process, imports of these items continue for the long time landing these countries
in a balance of payment deficit.

3. Demonstration Effect
When the people in the less developed countries imitate the consumption pattern of the people in the developed
countries, their import will increase. Their export may remain constant or decline causing disequilibrium in the
balance of payments.

4. Natural Factors

Natural calamities such as the failure of rains or the coming floods may easily cause disequilibrium in the
balance of payments by adversely affecting agriculture and industrial production in the country. The exports
may decline while the imports may go up causing a discrepancy in the country's balance of payments.

5. Cyclical Fluctuations

Business fluctuations introduced by the operations of the trade cycles may also cause disequilibrium in the
country's balance of payments. For example, if there occurs a business recession in foreign countries, it may
easily cause a fall in the exports and exchange earning of the country concerned, resulting in a disequilibrium in
the balance of payments.

6. Inflation

An increase in income and price level owing to rapid economic development in developing countries, will
increase imports and reduce exports causing a deficit in balance of payments.

7. Poor Marketing Strategies

The superior marketing of the developed countries have increased their surplus. The poor marketing facilities of
the developing countries have pushed them into huge deficits.

8. Flight Of Capital

Due to speculative reasons, countries may lose foreign exchange or gold stocks People in developing countries
may also shift their capital to developed countries to safeguard against political uncertainties. These capital
movements adversely affect the balance of payments position.

9. Globalisation
Due to globalisation there has been more liberal and open atmosphere for international movement of goods,
services and capital. Competition has beer increased due to the globalisation of international economic relations.
The emerging new global economic order has brought in certain problems for some countries which have
resulted in the balance of payments disequilibrium