The balance of payment (BoP) records the transactions in goods, services and assets between residents of a country with the rest of the world for a specified time period typically a year. The balance of payments consists of two components: the current account and the capital account. Further, the current account reflects a country’s net income, while the capital account reflects the net change in ownership of national assets.
1. Current account tansactions
It refers to those foreign exchange transactions which does not cause changes in the asset and liability position of the country. Thus, current Account is the record of trade in goods and services and transfer payments. Additionally, a surplus current account means that the nation is a lender to other countries. A deficit current account means that the nation is a borrower from other countries.
- Trade in goods includes exports and imports of goods.
- Trade in services includes factor income and non-factor income transactions.
- Transfer payments are the receipts which the residents of a country get for ‘free’, without having to provide any goods or services in return. They consist of gifts, remittances and grants.
2. Capital account transactions
It refers to those foreign exchange transactions which cause changes in the asset and liability position of the country. Purchase of asset in foreign country, return of loan, External commercial borrowings etc. are some of the examples. It consist of the components-
- Foreign direct investment and foreign portfolio investment.
- External borrowings through debt, loan from other countries, international financial companies.
- External aids like Govt. aid, intergovernmental loan, bilateral loan etc.
Significance of the balance of payment (BoP)
1. Investment managers, government policymakers, the central bank, businessmen, etc., all use the balance of payments (BoP) data to make important decisions.
2. The BOP data is affected by vital macroeconomic variables such as exchange rate, price levels, interest rates, employment, and GDP.
3. Monetary and fiscal policies significantly impact on the balance of payments.
4. Policies can be formed with the objectives to induce or curb foreign inflows or outflows.
5. Businesses use BOP to analyze the market potential of a country, especially in the short term. Thus, a country with a large trade deficit is not as likely to import. If there is a large trade deficit, the government may adopt a policy of trade restrictions, such as quotas or tariffs.