Balance of Payment

What is Balance of Payment? 

Balance of payments of a country will cause the exchange rate of its  domestic currency to fluctuate. The balance of payments is a summary of all economic and financial transactions between the country and the rest of the world. It reflects the country’s international economic standing and influences its macroeconomic and micro-economic operations.The balance of payments can affect the supply and demand for foreign currencies as well as their exchange rates.

• Balance of Payment is a system of recording all the economic transactions of a country, with the rest of the world over a period, say one year.

• Typically, the transactions included in BOP are country's exports and imports of goods, services, financial capital, and financial transfers. Thus, in nut shell we can say, the BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned.
  
  

Components of Balance of Payment - 

The components of BOP are as follows - 

• Current Account - (Net export/import of goods (trade balance) Net export/import of services Net income (investment income from direct and portfolio investment plus employee compensation) Net transfers (sums sent home by migrants and permanent workers aboard, gifts, grants and pensions)

• Capital Account - (Capital transfers related to the purchase and sale of fixed assets such as real estate

• Financial Account - (Net foreign direct investment Net portfolio investment Other financial items 

• Net errors and Omissions Account - (Missing data such as illegal transfers)

• Reserves and related items: official reserve account - (Official reserve account Changes in official monetary reserves including gold, foreign exchange, and IMF position.

Calculation of Balance of Payment

BOP = BOT + (Net Earning  on foreign investment i.e. payments made to foreign investors) + Cash Transfer + Capital Account + or - Balancing Item

or

BOP = Current Account + Capital Account  + or - Balancing item ( Errors and omissions)

Favorable & Unfavorable Balance of Payment (Surplus & Deficit)

• Balance of Payment will be favorable, if  the country has surplus in current account for paying your all past loans in her capital account.

• Balance of payment will be unfavorable, if the country has current account deficit and it took more loan from foreigners. After this, it has to pay high interest on extra loan and this will make  BOP unfavorable.

Factors affecting Balance of Payments

• Conditions of foreign lenders. 

• Economic policy of Govt. 

• The cost of Production (Land, Labor, Capitals, Taxes, Incentives) in the exporting economy vis-a-vis those in the importing economy.

• The cost of availability of Raw materials, Intermediate goods and other inputs.

• Exchange Rate Movements.

• Different levels of Taxes or restrictions on trade.

• External or unavoidable factors like environmental, health or safety standards.

• The availability of adequate foreign exchange with which to pay for the imports.

• Price of goods manufactured at home in response to supply.

Significance of Balance of Payment

• Judge economic and financial status of a country in the short-term.

• In the case of a developing country, the balance of payments shows the extent of dependence of the country’s economic development on the financial assistance by the developed countries.

• Deficit signifies a tendency to take stiff measures for diminishing imports, exchange control and restrictions on repatriation of dividends/ interest.

• It helps the government in taking decisions on monetary and fiscal policies on the one hand, and on external trade and payments issues on the other.

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