BBA II Year International Business III Semester

Unit V: Balance of Payments

1. Introduction
2. Balance of trade and Balance of Payment
3. Components of Balance of Payments

Introduction:
The balance of payment is the statement that files all the transactions between the
entities, government anatomies, or individuals of one country to another for a given
period of time. All the transaction details are mentioned in the statement, giving the
authority a clear vision of the flow of funds.
After all, if the items are included in the statement, then the inflow and the outflow
of the fund should match. For a country, the balance of payment specifies whether
the country has an excess or shortage of funds. It gives an indication of whether the
country’s export is more than its import or vice versa.
What Is the Balance of Payments (BOP)
The balance of payments (BOP) is the method countries use to monitor all
international monetary transactions in a specific period. The BOP is usually
calculated every quarter and every calendar year.
All trades conducted by both the private and public sectors are accounted for in the
BOP to determine how much money is going in and out of a country. If a country
has received money, this is known as a credit, and if a country has paid or given
money, the transaction is counted as a debit.
Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities
(debits) should balance, but in practice, this is rarely the case. Thus, the BOP can
tell the observer if a country has a deficit or a surplus and from which part of the
economy the discrepancies are stemming.
- The balance of payments (BOP) is the record of all international financial
transactions made by the residents of a country.
- There are three main categories of the BOP: the current account, the capital
account, and the financial account.
- The current account is used to mark the inflow and outflow of goods and services
into a country.
- The capital account is where all international capital transfers are recorded.

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BBA II Year International Business III Semester

- In the financial account, international monetary flows related to investment in

business, real estate, bonds, and stocks are documented.
- The current account should be balanced versus the combined capital and financial
accounts, leaving the BOP at zero, but this rarely occurs.
How to calculate the balance of payments?
Balance of Payments = Net Current Account + Net Financial Account + Net
Capital Account + Balancing Item

Components/Types of Balance of Payment

The BOP is divided into three main categories: the current account (which includes
a goods and services account, a primary income account, and a secondary income
account), the capital account, and the financial account. Within these three categories
are subdivisions, each of which accounts for a different type of international
monetary transaction.
The balance of payment is divided into three types:
1. Current account:
The current account is used to mark the inflow and outflow of goods and services
into a country. Earnings on investments, both public and private, are also put into
the current account.
This account scans all the incoming and outgoing of goods and services between
countries. All the payments made for raw materials and constructed goods are
covered under this account. Few other deliveries that are included in this category
are from tourism, engineering, stocks, business services, transportation, and
royalties from licenses and copyrights. All these combine together to make a BOP
of a country.
Within the current account are credits and debits on the trade of merchandise, which
includes goods such as raw materials and manufactured goods that are bought, sold,
or given away (possibly in the form of aid). Services refer to receipts from tourism,
transportation (such as the levy that must be paid in Egypt when a ship passes
through the Suez Canal), engineering, business service fees (from lawyers or
management consulting, for example), and royalties from patents and copyrights.

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BBA II Year International Business III Semester

Goods and services together make up a country's balance of trade (BOT). The BOT
is typically the biggest bulk of a country’s balance of payments, as it makes up
total imports and exports. If a country has a BOT deficit, it imports more than it
exports, and if it has a BOT surplus, it exports more than it imports.
Receipts from income-generating assets such as stocks (in the form of dividends) are
also recorded in the current account. The last component of the current account is
unilateral transfers. These are credits that are mostly workers’ remittances, which
are salaries sent back into the home country of a national working abroad, as well as
foreign aid that is directly received.
The current account indicates the country’s economic activity. The current account
is divided into four main components, which record the transactions of a country's
capital markets, industries, services, and governments. The four components are:
1. Balance of trade in goods. Tangible items are recorded here.
2. Balance of trade in services. Intangible items like tourism are recorded here.
3. Net income flows (primary income flows). Wages and investment income are
examples of what would be included in this section.
4. Net current account transfers (secondary income flows). Government transfers
to the United Nations (UN) or European Union (EU) would be recorded here.
The current account balance is calculated using this formula:
Current Account = Balance in trade + Balance in services + Net income flows +
Net current transfers
The current account can either be in a surplus or deficit.
2. Capital account:
“Debt forgiveness refers to when a country cancels or reduces the amount of debt it
has to pay.”
The capital account is where all international capital transfers are recorded. This
refers to the acquisition or disposal of nonfinancial assets (for example, a physical
asset such as land) and non-produced assets, which are needed for production but
have not been produced, such as a mine used for the extraction of diamonds.
The capital account is broken down into the monetary flows branching from debt
forgiveness, the transfer of goods, and financial assets by migrants leaving or

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BBA II Year International Business III Semester

entering a country, the transfer of ownership on fixed assets (assets such as

equipment used in the production process to generate income), the transfer of funds
received to the sale or acquisition of fixed assets, gift and inheritance taxes, death
levies, and, finally, uninsured damage to fixed assets.
Capital transactions like purchase and sale of assets (non-financial) like lands and
properties are monitored under this account. This account also records the flow of
taxes, acquisition, and sale of fixed assets by immigrants moving into the different
country. The shortage or excess in the current account is governed by the finance
from the capital account and vice versa.
3. Finance account:
The financial account shows the monetary movements into and out of the
country.
The financial account is split into three main parts:
1. Direct investment. This records the net investments from abroad.
2. Portfolio investment. This records financial flows such as the purchasing of
bonds.
3. Other investments. This records other financial investments such as loans.
In the financial account, international monetary flows related to investment in
business, real estate, bonds, and stocks are documented. Also included are
government-owned assets, such as foreign reserves, gold, special drawing
rights (SDRs) held with the International Monetary Fund (IMF), private assets held
abroad, and direct foreign investment. Assets owned by foreigners, private and
official, are also recorded in the financial account.
The funds that flow to and from the other countries through investments like real
estate, foreign direct investments, business enterprises, etc., is recorded in this
account. This account calculates the foreign proprietor of domestic assets and
domestic proprietor of foreign assets, and analyses if it is acquiring or selling more
assets like stocks, gold, equity, etc.

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How the BOP Is Balanced

The current account should be balanced against the combined capital and financial
accounts; however, as mentioned above, this rarely happens. We should also note
that with fluctuating exchange rates, the change in the value of money can add to
BOP discrepancies.
If a country has a fixed asset abroad, this borrowed amount is marked as a capital
account outflow. However, the sale of that fixed asset would be considered a current
account inflow (earnings from investments). The current account deficit would thus
be funded.
When a country has a current account deficit that is financed by the capital account,
the country is actually foregoing capital assets for more goods and services. If a
country is borrowing money to fund its current account deficit, this would appear as
an inflow of foreign capital in the BOP.
Importance of Balance of Payment
A balance of payment is an essential document or transaction in the finance
department as it gives the status of a country and its economy. The importance of
the balance of payment can be calculated from the following points:
 It examines the transaction of all the exports and imports of goods and services
for a given period.
 It helps the government to analyse the potential of a particular industry export
growth and formulate policy to support that growth.
 It gives the government a broad perspective on a different range of import and
export tariffs. The government then takes measures to increase and decrease the
tax to discourage import and encourage export, respectively, and be self-
sufficient.
 If the economy urges support in the mode of import, the government plans
according to the BOP, and divert the cash flow and technology to the
unfavourable sector of the economy, and seek future growth.
 The balance of payment also indicates the government to detect the state of the
economy, and plan expansion. Monetary and fiscal policy are established on the
basis of balance of payment status of the country.

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BBA II Year International Business III Semester

Example of Balance of Payments:

1. Country A brings in goods worth $10 million, and this is an inflow to the
country under the Current Account. In exchange for these goods, Country A
paid money to Country B. This is an outflow of money under the Financial
Account.
2. Imagine a fictional country called "ToyLand" that exports toys and imports
electronics. When ToyLand sells toys to other countries, it earns money, which
goes into its current account. When it buys electronics from other countries, it
spends money, which also affects the current account. The capital account
reflects the sale or purchase of assets like real estate, while the financial account
covers investments and loans. By tracking these transactions, the balance of
payments offers a clear picture of ToyLand's economic health and its
relationship with the global economy.
What Is the Balance of Trade (BOT)?
Balance of trade (BOT) is the difference between the value of a country's exports and
the value of a country's imports for a given period. Balance of trade is the largest
component of a country's balance of payments (BOP). Sometimes the balance of
trade between a country's goods and the balance of trade between its services are
distinguished as two separate figures.
The balance of trade is also referred to as the trade balance, the international trade
balance, the commercial balance, or the net exports.
 Balance of trade (BOT) is the difference between the value of a country's imports
and exports for a given period and is the largest component of a country's balance
of payments (BOP).
 A country that imports more goods and services than it exports in terms of value
has a trade deficit while a country that exports more goods and services than it
imports has a trade surplus.
 Viewed alone, a favorable balance of trade is not sufficient to gauge the health of
an economy. It is important to consider the balance of trade with respect to other
economic indicators, business cycles, and other indicators.
 The United States regularly runs a trade deficit, while China usually runs a large
trade surplus.

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BBA II Year International Business III Semester

Understanding the Balance of Trade (BOT)

The formula for calculating the BOT can be simplified as the total value of exports
minus the total value of its imports. Economists use the BOT to measure the relative
strength of a country's economy.
A country that imports more goods and services than it exports in terms of value has
a trade deficit or a negative trade balance. Conversely, a country that exports more
goods and services than it imports has a trade surplus or a positive trade balance.
A positive balance of trade indicates that a country's producers have an active foreign
market. After producing enough goods to satisfy local demand, there is enough
demand from customers abroad to keep local producers busy. A negative balance of
trade means that currency flows outwards to pay for exports, indicating that the
country may be overly reliant on foreign goods.
Calculating the Balance of Trade
A country's balance of trade is calculated by the following formula:
BOT=Exports−Imports
Where exports represents the currency value of all goods sold to foreign countries,
as well as other outflows due to remittances, foreign aid, donations or loan
repayments. Imports represents the dollar value of all foreign goods imported from
abroad, as well as incoming remittances, donations, and aid.
Debit items include imports, foreign aid, domestic spending abroad, and domestic
investments abroad. Credit items include exports, foreign spending in the domestic
economy, and foreign investments in the domestic economy. By subtracting the
credit items from the debit items, economists arrive at a trade deficit or trade surplus
for a given country over the period of a month, a quarter, or a year.
Example of How to Calculate the BOT
Here's an example of how to calculate the balance of trade:
Let's say that a country's exports of goods in a given year are worth 100 million, and
its imports of goods are worth 80 million. To calculate the balance of trade, you
would subtract the value of the imports from the value of the exports:

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BBA II Year International Business III Semester

Balance of trade = Exports - Imports

= 100 million - 80 million
= 20 million
In this example, the balance of trade is 20 million, which means that the country has
a trade surplus of +20 million.
It's important to note that the balance of trade is typically measured in the currency
of the country whose trade balance is being calculated. For example, if the country
in the above example is the United States, the balance of trade would be measured
in US dollars. If the country is Japan, it would be measured in Japanese yen, and so
on.
Examples of Balance of Trade
The United States imported $239 billion in goods and services in August 2020 but
exported only $171.9 billion in goods and services to other countries. So, in August,
the United States had a trade balance of -$67.1 billion, or a $67.1 billion trade deficit.
A trade deficit is not a recent occurrence in the United States. In fact, the country
has had a persistent trade deficit since the 1970s. Throughout most of the 19th
century, the country also had a trade deficit (between 1800 and 1870, the United
States ran a trade deficit for all but three years).
Conversely, China's trade surplus has increased even as the pandemic has reduced
global trade. In Aug. 2022, China exported goods worth $314.9 billion and imported
goods worth $231.7 billion. This generated a trade surplus of $79.4 billion for that
month, a drop from $101 billion the preceding month.

Balance of Trade: Favorable vs. Unfavorable

A favorable balance of trade, also known as a trade surplus, occurs when a country
exports more goods than it imports. This means that the country is earning more
from its exports than it is spending on its imports, and it is generally seen as a sign
of economic strength. A trade surplus can be a result of a country having a
competitive advantage in the production and export of certain goods, or it can be the
result of a country's currency being relatively undervalued, making its exports
cheaper for foreign buyers.
On the other hand, an unfavorable balance of trade, also known as a trade deficit,
occurs when a country imports more goods than it exports. This means that the
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BBA II Year International Business III Semester

country is spending more on imports than it is earning from exports, and it can be a
cause for concern if it persists over a long period of time. A trade deficit can be the
result of a country having a comparative disadvantage in the production of certain
goods, or it can be the result of a country's currency being relatively overvalued,
making its imports cheaper and its exports more expensive.
In general, a favorable balance of trade is seen as a positive sign for a country's
economy, while an unfavorable balance of trade is seen as a negative sign. However,
it's important to note that a trade deficit or surplus is not always a sign of economic
strength or weakness, and other factors such as a country's overall economic growth,
employment rate, and inflation rate should also be taken into account.
Balance of Trade vs. Balance of Payments
 The balance of trade is the difference between a country's exports and imports of
goods, while the balance of payments is a record of all international economic
transactions made by a country's residents, including trade in goods and services,
as well as financial capital and financial transfers.
 The balance of trade is a part of the balance of payments and is represented in the
current account, which also includes income from investments and transfers such
as foreign aid and gifts.
 The capital account, which is another part of the balance of payments, includes
financial capital and financial transfers.
 It's important to note that the balance of trade and the balance of payments are
not the same thing, although they are related.
 The balance of trade measures the flow of goods into and out of a country, while
the balance of payments measures all international economic transactions,
including trade in goods and services, financial capital, and financial transfers.
 A country can have a positive balance of trade (a trade surplus) and a negative
balance of payments (a deficit) if it is exporting more goods than it is importing,
but it is also losing financial capital or making financial transfers.
 Conversely, a country can have a negative balance of trade (a trade deficit) and a
positive balance of payments (a surplus) if it is importing more goods than it is
exporting, but it is also receiving a large amount of financial capital or making
financial transfers.

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