Balance Of Payments

Today’s topic of interest is Balance of Payments or BoP..
It must be a new term for many people but I am sure after reading this small article, you’ll definately be aware of the term.
The BoP of a country is a systematic record of all its economic transactions with the outside world in a given year.
It shows the country’s trading position, changes in its net position as foreign lender or borrower, and changes in its official reserve holdings. It is constructed on the principle of the double entry book-keeping. BoP accounting differs from business accounting in one respect.
In business accounting debits (-) are shown on the left side and credits (+) on the right side of balance sheet, while here it is just revered, credit on left side and debit on the right side of the BoP.
When a payment is received from foreign country, it is credit transaction and shown on left side, while in case of payment it is debit transaction and shown on right side.

Export, receipts of payments and investment in the country is a credit transactions while import, payments and investments outside is a credit transactions.
The BoP is divided into three sections: the current account, the capital account, and the official settlement account or the official reserve assets account.
It is shown in the figure below-

The difference between exports and imports is called as balance of trade. If visible exports exceeds the visible imports, the balance of trade is said to be favorable, otherwise unfavorable.
Transfer payments are considered as invisible items. Saying BoP as favorable or unfavorable is same as the case of balance of trade.
In capital accounts, there are two types of transactions – private and government. Private transactions include all types of investments: direct, portfolio, or short term. Government
investments consist of loans to and from foreign official agencies. The official settlement account shows the country’s net official reserve assets.
Errors and omissions is a balancing item so that the total credit and debit side must equal in accordance with the principle of double entry accounting system. Thus balance of payments of a country always balances in accounting sense.
Now the question is If the balance of payments always balances,then why does a deficit or surplus arises?
It is only when all items of BoP are included then there is no deficit or surplus but is some items are excluded then only there will be deficit or surplus.

Causes of Disequilibrium:
- Temporary Disequilibrium
- Chronic or Fundamental Disequilibrium
- Technological Changes
- National Income
- Inflation
- Economic Development
- Borrowings and Lending
The Adjustment Mechanism:
-Adjustment through Exchange Depreciation
-Devaluation
-Direct Controls
-Adjustments through Capital Movements
-Stimulation of Exports

That's it for today's article. Stay Tuned for more articles.