Concept of Balance of Payments (BoP)

Balance of Payments is a systematic account of the value of transactions of a country with

the rest of the world in goods and services, transfer payments and capital (assets).
Definition: “An accounting statement showing the value of imports and exports of tangible ( visible)
and intangible (invisible) goods during a year.”
(Tangible or visible goods means goods which have a physical existence. Intangible or invisible goods
means services.)

Balance of Payments has a credit entry and a debit entry. All receipts by the home country from
foreigners are recorded in the credit entry and all payments by the home country to foreigners are
recorded in the debit entry.
9.8.1 Types of balance of Payments:
Balance of Payments can be (1) Balanced (2) Unbalanced.
Balance of Payments is said to be under balance when the value of entries on credit side
equals that on the debit side. Balance of payments is unbalanced when the value of entries
on the credit side is not equal to entries on the debit side.
If payments are more than the receipts or the value of credit side entries is lesser than the value
of debit side entries, there is a deficit in the Balance of Payments.
If receipts are more than payments or the value of credit side entries is greater than the value of
debit side entries, there is a surplus in the Balance of Payments.
Note: According to the double entry book keeping system, a balance of payments always
balances. However, in reality there can be a deficit or a surplus in the balance of payments.
9.8.2 Accounts of Balance of Payments:
BoP has two accounts: (1) Current account and (2) Capital account
(1) Current Account: This account records the credit and debit entries for
(i) trade in merchandise goods (tangible goods). Receipts from exports are recorded as credit
entry and payments for imports are recorded as debit entry.
The sum total on this section of current account is called the balance of trade. If the
payments for merchandise imports are greater than the receipts from merchandise exports then
there is a deficit in the balance of trade. The vice versa situation is called surplus on the balance
of trade.
(ii) trade in invisibles or services. The incomes from invisibles are recorded on credit side and
payments on debit side.
Combined balance of (i) and (ii) is called the current account balance.
(2) Capital Account: This account records receipts and payments from transactions on assets
such as money assets like stocks, gold, capital loans etc. and other forms of fixed capital.
The total of current account and capital account is called the balance of payments.
9.8.3 Factors Influencing Balance of Payments:
Factors influencing balance of payments means those factors which affect the imports,
exports, movement of capital, movement of factors of production, investment, lending etc.
in a nation. Deficit or surplus in the balance of payments can arise owing to such factors.
The impact of such factors usually depends upon the level of economic development of
a country. Some of these factors can be stated as under:
• Exchange rate.
 • Prices of tradable goods in home country and in foreign countries.
• Variety and quality of tradable goods.
• Inevitable imports.
• Level of economic development of the country.
• Legal restrictions on trade.
• Trade supporting facilities and infrastructures like transport, communication etc.

Table 9.7
Hypothetical Example of Balance of Payments
Credit Items (Receipts) Debit Items (Payments) Balance
(1) Current Account Rupees in Crores
Merchandise Exports 200 Merchandise 300
200 Imports
Trade Balance -100
Services exported 100 Services imported 200
Investment income 100 Investment money 200
earned paid
Unilateral receipts 200 Unilateral payments 100
Sub Total 600 800
Current Account -200
(Sub total on credit
side – sub total on
debit side)
(2) Capital Account
Long term borrowing 200 Long term lending 80
Short term 100 Short term lending 60
borrowing
Sale of Gold 100 Purchase of Gold 50
Sub Total 400 190
Errors and 10
Ommissions
Sub total of capital + 200
account
Total Receipts 1,000 Total Payments 1,000
Balance of 0
Payments
In reality there can be a deficit or surplus in the balance of payments.

9.9 Concept of Exchange Rate

When an Indian tourist visits a foreign country she/he may not be able to purchase
goods there in Indian Rupees. They need currency of that country. Likewise when an Indian
importer imports goods from a foreign country she/he will have to make payment in that
particular country’s currency or in an internationally acceptable currency. These are
examples of India’s demand for foreign currency.
Similarly, foreigners may demand India’s currency.
 Therefore, such tourists or traders approach banks or officially registered currency
traders to convert their domestic currency into a foreign or internationally acceptable
currency. Such conversion of currency is done at a specific rate at a specific time which is
known as the exchange rate. Exchange rate is the price of a foreign currency in terms of
domestic currency. In other words, it is the units of home currency required to buy one unit
of a foreign currency.

“The rate at which the currency of one country can be converted into currency of
another country is called exchange rate”.
“Exchange rate is the price of a foreign currency in terms of domestic currency”.
For a particular country, exchange rate is the price of one unit of a foreign currency in
units of home currency; in other words, it is the units of home currency required to buy one
unit of a foreign currency.
For example, exchange rate of US $ 1 = ₹ 60 implies that in order to buy $ 1, a price of
₹ 60 must be paid.
A rise in the exchange rate for India means that the value of Indian currency has declined
in the international market. For now, more Indian ₹ will have to be paid to buy one unit of a
foreign currency. It implies that the foreign currency becomes expensive and hence value of
Indian ₹ falls.
Initially, US $ 1 = ₹ 60
When exchange rate rises for India, US $ 1 = ₹ 65
On the other hand, when exchange rate falls for India, the value of Indian ₹ rises.
(However, in the actual analysis of rise or fall in the value of a currency, the time gap
between the rise or fall in value of the currency, prices of goods in the various countries etc.
are taken into consideration.)
Sometimes exchange rates change owing to open market forces and sometimes
government of a country may alter the exchange rate to impact imports and exports.
If the exchange rate rises for India and value of ₹ falls, the demand for imports by India
tends to decline and India’s exports tend to rise.
When the price of one US $ rises from ₹ 60 to ₹ 65, an Indian importer has to pay ₹ 65
now instead of the earlier ₹ 60 to import a commodity worth US $ 1. Hence, imports tend to
fall.
While earlier by spending US $ 1, a foreign trader could purchase goods worth ₹ 60
earlier while now she/he can buy goods worth ₹ 65. Hence, exports from India tend to rise.
The reverse happens when exchange rate for India falls.
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