Balance of payments is a statement of accounts showing all monetary transactions of a country with rest of the world. The monetary transactions may arise out of:
- export and import of goods (called merchandise)
- export and import of services called invisibles
- international sale and purchase of financial assets (like stocks and bonds)
- international sale and purchase of real assets like plant and machinery)
The balance of payments of a country is a systematic record of all economics transactions between its residents and residents of foreign countries.
Balance of payments is a set of accounts showing economic transactions of a country with rest of the world.
Significance of Balance of Payment
Significance of the BoP accounts is highlighted by the following observations:
- BoP accounts show export-import status of the country, If export>import, the level of AD tends to rise. This points to the growth potential of the economy.
- BoP accounts reflect investment by the foreigners in the purchase of stocks and bonds in the domestic market. Higher investment points to a healthy state of our economy.
- BoP accounts also show the extent of FDI (foreign direct investment). Increase in FDI is a sign of GDP growth.
- International borrowing is an important component of BOP accounts. In the context of less developed countries like India, international borrowing reflects our economic dependence on rest of the world.
- Since all forex-transactions are routed through RBI, BoP accounts reflect the movement of forex reserves with the RBI. Healthy reserves of forex is a sign of an healthy economy.
- BoP accounts help the government to formulate a suitable strategy of growth. in case growth process is hurt because of high imports and low exports, the government must take steps to curb imports and increase exports.
Briefly, BoP accounts show the performance of our economy in relation to the rest of the world. These accounts reflect the growth potential of the economy in terms of demand for domestically produced goods and services in the rest of the world d Besides, BoP accounts suggest the possible strategies of growth in terms of export g promotion, import substitution and investment from rest of the world.
Components of BoP Account
Balance of payments (BoP) accounts are broadly split as
- Current account
- Capital account
Current account records (i) export (X) and import (M) of goods, (ii) export and import of services, and (ii) current transfers. Export and import of goods is separated from the export and import of services.
Export and import of goods is considered as ‘visible trade’, while the export and import of services is considered as ‘invisible trade’. Because, goods are seen while crossing the border, but services are not. Goods are tangible while services are not. Services are further split into two components:
(i) factor services, and (ii) non-factor services. Factor services involve payments in terms of income (investment income + compensation of employees). Non-factor services (like of shipping, insurance, banking) involve payments in terms of revenue.
Curent transfers refer to ‘transfers for free’. These are unilateral transfers by way or gifts grants and workers’ remittances (residents settled abroad sending money to their home country). For purpose of BoP accounting, current transfers are also considered as an element of ‘invisibles’.So that, ‘invisibles’ in the current account BoP includes )
- Monetary transactions on account of export and import of non-factor services.
- Monetary transactions on account of export and import of factor services.