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Why Is Balance of Payment (BOP) Vital For A Country

The document discusses the Balance of Payment (BOP) statement which records all monetary transactions between a country and the rest of the world. The BOP has three components - the current account, capital account, and financial account. The current account covers trade in goods and services, while the capital account covers capital transactions like investment. The financial account measures changes in foreign ownership of domestic assets. Tracking the flows in the BOP helps governments monitor their economic health and identify trade surpluses or deficits.

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49 views2 pages

Why Is Balance of Payment (BOP) Vital For A Country

The document discusses the Balance of Payment (BOP) statement which records all monetary transactions between a country and the rest of the world. The BOP has three components - the current account, capital account, and financial account. The current account covers trade in goods and services, while the capital account covers capital transactions like investment. The financial account measures changes in foreign ownership of domestic assets. Tracking the flows in the BOP helps governments monitor their economic health and identify trade surpluses or deficits.

Uploaded by

shibashish Panda
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Balance of Payment

Balance Of Payment (BOP) is a statement which records all the monetary transactions made
between residents of a country and the rest of the world during any given period. This statement
includes all the transactions made by/to individuals, corporate and the government and helps in
monitoring the flow of funds to develop the economy.

When all the elements are correctly included in the BOP, it should sum up to zero in a perfect
scenario. This means the inflows and outflows of funds should balance out. However, this does not
ideally happen in most cases.

A BOP statement of a country indicates whether the country has a surplus or a deficit of funds i.e
when a country’s export is more than its import, its BOP is said to be in surplus. On the other hand,
the BOP deficit indicates that a country’s imports are more than its exports.

Tracking the transactions under BOP is something similar to the double entry system of accounting.
This means, all the transactions will have a debit entry and a corresponding credit entry.

Why is Balance of Payment (BOP) vital for a country?


A country’s BOP is vital for the following reasons:

The BOP of a country reveals its financial and economic status.


A BOP statement can be used as an indicator to determine whether the country’s currency value is
appreciating or depreciating.
The BOP statement helps the Government to decide on fiscal and trade policies.
It provides important information to analyze and understand the economic dealings of a country
with other countries.
By studying its BOP statement and its components closely, one would be able to identify trends that
may be beneficial or harmful to the economy of the county and thus, then take appropriate
measures.

Elements of a Balance of Payment


There are three components of balance of payment via current account, capital account, and
financial account. The total of the current account must balance with the total of capital and
financial accounts in ideal situations.

Elements-of-balance-of-payment
Current Account
The current account is used to monitor the inflow and outflow of goods and services between
countries. This account covers all the receipts and payments made with respect to raw materials and
manufactured goods.

It also includes receipts from engineering, tourism, transportation, business services, stocks, and
royalties from patents and copyrights. When all the goods and services are combined, together they
make up to a country’s Balance Of Trade (BOT).

There are various categories of trade and transfers which happen across countries. It could be visible
or invisible trading, unilateral transfers or other payments/receipts. Trading in goods between
countries are referred to as visible items and import/export of services (banking, information
technology etc) are referred to as invisible items.

Unilateral transfers refer to money sent as gifts or donations to residents of foreign countries. This
can also be personal transfers like – money sent by relatives to their family located in another
country.

Capital Account
All capital transactions between the countries are monitored through the capital account. Capital
transactions include the purchase and sale of assets (non-financial) like land and properties.

The capital account also includes the flow of taxes, purchase and sale of fixed assets etc by migrants
moving out/into a different country. The deficit or surplus in the current account is managed
through the finance from the capital account and vice versa. There are 3 major elements of a capital
account:

Loans and borrowings – It includes all types of loans from both the private and public sectors
located in foreign countries.
Investments – These are funds invested in the corporate stocks by non-residents.
Foreign exchange reserves – Foreign exchange reserves held by the central bank of a country to
monitor and control the exchange rate does impact the capital account.
Financial Account
The flow of funds from and to foreign countries through various investments in real estates, business
ventures, foreign direct investments etc is monitored through the financial account. This account
measures the changes in the foreign ownership of domestic assets and domestic ownership of
foreign assets. On analyzing these changes, it can be understood if the country is selling or acquiring
more assets (like gold, stocks, equity etc).

Illustration
If for the year 2018 the value of exported goods from India is Rs. 80 lakh and the value of imported
items to India is 100 lakh, then India has a trade deficit of Rs. 20 lakh for the year 2018. The BOP
statement acts as an economic indicator to identify the trade deficit or surplus situation of a country.
Analyzing and understanding the BOP of a country goes beyond just deducting the outflows of funds
from inflows. As mentioned above, there are various components of BOP and fluctuations in these
accounts which provide a clear indication about which sector of the economy needs to be
developed.

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