Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers.
The Bop is a collection of accounts conventionally grouped into three main categories with subdivisions in each. The three main categories are: (a) The Current Account: Under this are included imports and exports of goods and services and uni-lateral transfers of goods and services. (b) The Capital Account: Under this are grouped transactions leading to changes in foreign financial assets and liabilities of the country. (c) The Reserve Account: In principle this is no different from the capital account in as much as it also relates to financial assets and liabilities. However, in this category only ―reserve assets‖ are included.
The IMF definition: The International Monetary Fund (IMF) use a particular set of definitions for the BOP accounts, which is also used by the Organization for Economic Cooperation and Development (OECD), and the United Nations System of National Accounts (SNA). The main difference in the IMF's terminology is that it uses the term "financial account" to capture transactions that would under alternative definitions be recorded in the capital account. The IMF uses the term capital account to designate a subset of transactions that, according to other usage, form a small part of the overall capital account. The IMF separates these transactions out to form an additional top level division of the BOP accounts. Expressed with the IMF definition, the BOP identity can be written:
Current account financial account capital account balancing item=0.
The IMF uses the term current account with the same meaning as that used by other organizations, although it has its own names for its three leading subdivisions, which are:
The goods and services account (the overall trade balance)
The primary income account (factor income such as from loans and investments) The secondary income account (transfer payments)
Current account of balance of Payment
- Current Account transactions
The Current accounts records the transaction in merchandise and invisibles with the rest of the world. Merchandise covers imports and exports and invisibles include travel transportation insurance, investment and other services. The current account mainly consists of 4 types of transactions.
- Exports and imports of goods: Exports of goods are credits (+) to the current account. Imports of goods are debits (-) to the current account.
- Exports and imports of services: Exports of services are credits (+) to the current account. Imports of services are debits (-) to the current account.
Interest payments on international investments
Interest, dividends and other income received on U.S. assets held abroad are credits (+). Interest, dividends and payments made on foreign assets held in the U.S. are debits (-). Since 1994, the U.S. has run a net debit in the investment income account: more payments are made to foreigners than foreigners make to U.S. investors.
Remittances by Americans working abroad, pensions paid by foreign countries to their citizens living in the U.S., aid offered by foreigners to the U.S. count as credits (+).
Remittances by foreigners working in the U.S., pensions paid by the United States to its citizens living abroad, aid offered to foreigners by the U.S. count as debits (-) As expected the U.S. runs a deficit in current transfers.
The sum of these components is known as the current account balance. A negative number is called a current account deficit and a positive number called a current account surplus. As expected, given that it runs a surplus only in the services component of the current account, the U.S. runs a substantial current account deficit.
Capital account of Balance of payment
In the case of the capital account an increase (decrease) in the county foreign financial assets are debit (credit) whereas any increase (decrease) in the country foreign financial liabilities are credits (debits). The transaction under the Capital account is classified as:
- Foreign Investment
- Banking Capital
- Rupee debt services
- Other debt capital
Loans include the concessional loans received by the government‘ or public sector bodies , long term loan and medium term borrowings from the commercial capital market in the form of loans Bond issue and short term credits. Disbursement received by Indian resident entities is the credit Items while payment and loans made by the Indians are the credit items
All inflow of the foreign capital comes credit item of the Balance of payment/Banking capital covers the changes in the foreign assets and liabilities of commercial banks whether privately owned or the comparative and government owned. An decrease in assets and increase in liability is a credit item. The item Rupee debt services defined as the cost of meeting inters payments and regular contractual repayments of the principal of a loan along with the any administrate charges in rupee by India.
Factors affecting the components of BOP account
Exports of goods and services affected by following factors
- The prevailing rate of domestic currency
- Inflation rate
- Income of foreigners
- World price of the commodity
- Trade barriers.
Imports of Goods and services
- Level of Domestic Income
- International prices
- Inflation rate
- Value of Domestic Currency
- Trade Barriers
Factors affecting the international financial Market
- Cost of Labor: Firms in countries where labor costs are low commonly have an advantage when competing globally, especially in labor intensive industries
- Inflation: Current account decreases if inflation increases relative to trade partners.
- National Income: Current account decreases if national income increases relative to other countries
- Government Policies: can increase imports through:
- Restrictions on imports
- Subsidies for exporters
- Lack of Restriction on piracy
- Environmental restrictions
- Labor laws
- Tax breaks
- Country security laws
- Exchange Rates: current account decreases if currency appreciates relative to other currenices.
Impact of Government Policies:
- Restrictions on Imports: Taxes (tariffs) on imported goods increase prices and limit Quotas limit the volume of imports.
- Subsidies for Exporters: Government subsidies help firms produce at a lower cost than their global competitors.
- Restrictions on Piracy: A government can affect international trade flows by its lack of restrictions on piracy.
- Environmental Restrictions: Environmental restrictions impose higher costs on local firms, placing them at a global disadvantage compared to firms in other countries that are not subject to the same restrictions.
- Labor Laws: countries with more restrictive laws will incur higher expenses for labor, other factors being
- Business Laws: Firms in countries with more restrictive bribery laws may not be able to compete globally in some situations.
- Tax Breaks: Though not necessarily a subsidy, but still a form of government financial support that might benefit many firms that exports products.
- Country Security Laws: Governments may impose certain restrictions when national security is a concern, which can affect on trade.
Impact of Exchange Rates
Effect of exchange rate on balance of trade deficit:
When a home currency is exchanged for a foreign currency to buy foreign goods, then the home currency faces downward pressure, leading to increased foreign demand for the country‘s products. On the other way, Exchange rates will not automatically correct any international trade balances when other forces are at work.