What is Balance of Payment?
Balance of payments (BoP) is a statement that shows the difference between inflow and outflow of cash in and out of the country during a particular period of time.
Components of Balance of Payments
BoP is usually calculated quarterly or annually using the double-entry bookkeeping system to get a record of all financial transactions and trade conducted by public and private sectors to determine cash flow. For this, the Balance of Payments includes two types of accounts, current, and capital.
Current account
The current account shows the net trade of goods and services, earning through investments and net transfer payments between a country and the rest of the world.
Capital account
It includes foreign direct investments, portfolio investments (buying or selling of bonds and shares), reserve account (used by the central bank for purchasing and selling foreign currencies), and all other financial transactions that do not impact the economic output.
Ideally, BoP should be balanced, with the sum of all transactions being zero (as every credit in the capital account should have a corresponding debit entry in the current account and vice-versa), but it’s not always the case (due to unrecorded transactions, different accounting practices, and fluctuations in the exchange rate) and this imbalance is termed as “errors and omissions” in the BoP.
Why is the BoP Useful?
- The BoP plays an instrumental role in determining the net income and the economic performance of a country in the coming years.
A country’s Balance of Payments helps to know whether the country generated enough income to pay for the imports without taking a loan or not. It plays an instrumental role in finding the strong and weak points of an economy and the study of previous years’ BoP can give an individual a clear picture of the profit (or loss) incurred from international trade.
When the sum of transactions in the current account and the non-reserve capital account becomes zero, the Balance of Payments is said to be in equilibrium which helps it attract more foreign direct investments and leads to the growth of the economy.
It also helps in determining the value of the currency in the international markets, determining the country’s economic progress and its rank in the international market. Last but not the least, it helps the policymakers to come up with national and international economic policies for upcoming years.
