BAL ANCE OF

PAYMENT
CLASS 12
BOP (OR BOP ACCOUNTS)
It is a statement of accounts showing all monetary transactions (or economic transactions) of a
country with the rest of the world during a period of time, generally one year.
These transactions may be made by the individuals, firms and the government of a country.
Broadly, the monetary transactions relate to:
(i) Export and import of goods also called as ‘merchandise' or 'visible trade’
(ii) Export and import of services also called 'invisible trade’
(iii)International sale and purchase of financial assets like stocks and bonds, etc.
(iv) International sale and purchase of real assets like plant and machinery.
COMPONENTS OF BOP ACCOUNT

1. Current Account
It records receipt and payment of foreign exchange on account of such transactions which do not
impact asset-liability status of a country in relation to rest of the world. Liabilities or assets of a
country (in relation to rest of the world) are neither raised nor reduced. In other words, current
account transactions do not give rise to 'future claims' .
COMPONENTS OF CURRENT ACCOUNT BOP

(i) Export and Import of Goods is treated as ' merchandise' or 'visible trade’ because goods are
tangible (material) and therefore, can be seen while crossing the borders.
Eg: Smartphones and Motor vehicle sale all throughout the world.
(ii) Export and Import of Services is treated as 'invisible trade’ and cannot be seen while crossing the
borders. Eg: Customer service outsourcing, overseas banking transactions, medical, tourism
industry
Services are further classified as factor services and non factor services.
COMPONENTS OF CURRENT
ACCOUNT BOP
• Factor Services: Factor services are those w hich lead to factor payments or factor income. In the BoP
accounts, monetary transactions related to factor incomes are split as:
(i) Investment income ( Rent + Interest + Profit)
(ii) Compensation of employees
• Non-factor Services: include all services, other than factor services like Outsourcing, Insurance
Monetary transactions related to nonfactor services are recorded as receipts when these services are
exported, and as payments when these services are imported.
(iii) Current Transfers refer to 'transfers for free'. These are unilateral transfers made by way of gifts,
grants and remittances (by the residents settled abroad).
In the BoP accounts, current transfers are treated as an element of 'invisibles
ESTIMATION OF BALANCE RELATED TO
CURRENT ACCOUNT

Trade Balance/ X- M.
Merchandise Balance Trade Deficit when M > X, and
Trade Surplus when X > M.

Goods and Services Balance (Exports of Goods+ Exports of non factor services) – (Import of Goods +
Import of non-factor services)

Invisibles Balance Balance of Non factor Services + Balance on Income (factor services) +
Balance on current transfers

Current A/c Balance Trade Balance + Invisible Balance

COMPONENTS OF BOP
ACCOUNT
2. Capital Account

Transactions which cause an impact on asset-liability status of a country in relation to

rest of the world. Liabilities or assets of a country are either or  which leads to
future claims.

Important point here is to be taken into consideration is that export and import of all
types of goods either consumer or capital goods are to be recorded as Visible trade in
current account of BOP which means export and import of capital goods has nothing
to do with capital account of BOP
PRINCIPAL COMPONENTS OF BOP
ACCOUNT

(1)Borrowing:
• External commercial borrowing is available at the market rate of interest in the
international money market, while external assistance is available at the
concessional rate of interest.
• Borrowing  our liability to rest of the world but is recorded as a 'credit item'
in the capital account. Borrowing of rest of the world (or lending) would be
recorded as 'debit item' in the capital account, as it causes flow of foreign
exchange from our country
PRINCIPAL COMPONENTS OF
BOP ACCOUNT
(2) Foreign Investment:
• Portfolio Investment: refers to foreign institutional investment (FIi). It is investment
by rest of the world in shares and bonds of the domestic companies.
• Foreign Direct Investment relates to ownership of enterprises (in the domestic
economy) by rest of the world. Example: Walmart stores in India.
OTHER COMPONENTS OF CAPITAL
ACCOUNT

3. NRI Deposits
Only such NRI deposits are to be considered (as a component of capital account) which are made in the
domestic economy i.e. deposits in India by non-resident Indians.
Money sent by the NRls to their families in India is to be treated as 'current transfers', and are to be
recorded in current account of BoP. Only deposits held by NRls in the domestic economy are to be
considered as a component of capital account.
4. Banking Capital
refers to 'foreign assets' held by the commercial banks.
OTHER COMPONENTS OF
CAPITAL ACCOUNT
5. Short-term Trade credit

It arises on account of purchases in the international market without making

immediate payment. Repayment of short-term debt to rest of the world leads
to outflow of foreign exchange to rest of the world.

Accordingly, it is recorded in the capital account with a negative sign. Inward

flow of foreign exchange (from rest of the world), on the other hand, is
recorded with a positive sign.
OVERALL BALANCE

In the Indian BoP accounting system, overall balance is estimated as the sum
total of current account balance , capital account balance, and errors and
omissions (accounting for statistical discrepancies).
Overall Balance = Current account balance + Capital account balance + Errors
and omissions
OFFICIAL RESERVES ACCOUNT

It indicates Reserves of Forex with the RBI

Overall balance is finally reflected in the Official Reserves Account of the RBI.
Because, RBI is the custodian of forex reserves of the country, and all forex
transactions in the country are routed through the RBI.
If overall balance is (+)  causes increase in official reserves
If overall balance is (-)  causes decrease in official reserves
• Note: Official Reserves Account is shown as a part of the capital account BoP, rather than a
separate account.
Note: () in official reserves is indicated by a (-), while () is indicated by (+).
EQUILIBRIUM AND DISEQUILIBRIUM IN BOP

BoP equilibrium is struck when:

Current account bal. + Capital account bal. + Errors and omissions = Zero,
and there is no movement (increase or decrease) of official reserves of the central
bank.

In a state of BoP equilibrium,

Inward flow of foreign exchange = Outward flow of foreign exchange
and there is no change in official reserves (of foreign exchange and gold) with
the central bank of the country
EQUILIBRIUM AND
DISEQUILIBRIUM IN BOP
(i) BoP Disequilibrium

Current account balance + Capital account balance) ≠ 0, and it causes the movement of official reserves.
ii) BoP Surplus
Current account balance + Capital account balance is some positive number, pointing to net inward flow of
foreign exchange, and leading to an increase in official reserves.
(iii) BoP Deficit
Current account balance + Capital account balance is some negative number, pointing to net outward flow of
foreign exchange, and leading to a decrease in official reserves
AUTONOMOUS ITEMS OF BOP
ACCOUNT
refer to those international economic transactions, which take place due to some
economic motive such as profit maximization. These items are also known as ‘above the
line items’. Autonomous transactions are independent of the state of BOP account.
For example, if a foreign company is making investments in India with the aim of
earning profit, then such a transaction is independent of the country’s BOP situation.
Autonomous transactions take place on both current and capital accounts.
On the current account, merchandise exports and imports of goods are autonomous
transactions.
AUTONOMOUS ITEMS OF
BOP ACCOUNT
• On the capital account, receipts and repayments of long-term loans by private
individuals are autonomous transactions.
Surplus or Deficit in BOP:
BOP account is in surplus when autonomous receipts are more than the autonomous
payments. BOP is in deficit when autonomous receipts are less than autonomous
payments
ACCOMMODATING ITEMS
OF BOP ACCOUNT
refer to the transactions that are undertaken to cover deficit or surplus in autonomous
transactions, i.e. such transactions are determined by net consequences of autonomous
transactions. These items are also known as ‘below the line items’.
Accommodating transactions are compensating capital transactions which are meant to
correct the disequilibrium in autonomous items of BOP.
For example, if there is a current account deficit in the BOP, then this deficit is settled by
capital inflow from abroad.
The sources used to meet a deficit in BOP, are:
(i) Foreign exchange reserves;
(ii) Borrowings from IMF or foreign monetary authorities.
DIFFERENCE
Basis of Autonomous Transactions Accommodating Transactions
distinction
Motive These take place due to some economic These take place to cover deficit or surplus
motive like profit maximisation in the autonomous transactions
Nature These transactions are independent of These transactions are in the nature of
balance of payment considerations. compensatory transactions to balance the
imbalance in BoP
Name These transactions are called “above the These transactions are called “below the
line” transactions. line” transactions
Movement of Items may involve the movement of goods Items do not involve the movement of
Goods across the borders (like export and import goods across the borders. These items only
of consumer goods or capital goods). involve the movement of official reserves
with the RBI.
SIGNIFICANCE OF BOP ACCOUNTS

1.BoP indicates a country’s financial position with foreign countries, thereby a country’s
ability to buy foreign goods or services.
2.BoP is important indicator of pressure on a country’s exchange rate, and thus on the
potential of a firm trading with or investing in that country to experience foreign
exchange gains or losses. Changes in BoP may presage the impositions of foreign
exchange controls.
3.BoP data helps in knowing the changes in a country’s BoP may also signal imposition
(or removal) of controls over payments, dividends, and interest, license fees, royalty
fees, or other cash disbursements to foreign firms or investors.
SIGNIFICANCE OF BOP ACCOUNTS

4. BoP data helps to forecast a country’s market potential, especially in the short- run. A
country experiencing a serious BoP deficit is not likely to import as much as it would if it
were running a surplus.
5. BoP data can also signal increased riskiness of lending to particular country and it also helps
to in the formulation of trade and fiscal policies.
 DIFFERENCE
Basis Capital Account Current Account
Definition The Capital Account mainly focuses on The current account mainly focuses on
recording the trading of foreign assets and recording the export and import of
liabilities during a year by a country. merchandise along with any unilateral
transfers that are completed within the
year by a country.
Implication The capital account reflects the net change The current account reflects the total net
in the ownership of national assets of a income of a country within a year.
country within a year.
Transaction The capital account mainly focuses on the The current account mainly focuses on
sources and utilisation of capital. the receipts and disbursements related to
the cash and non-capital items.
Objective The capital account is mainly concerned The current account is mainly concerned
with the sources and utilisations of the with the receipts and payment of cash
capital items. and non-capital items.
DIFFERENCE

Basis Capital Account Current Account

Components Foreign direct investment Export and import of goods and services
Portfolio investment Investment income and
Loans by the government of one Current transfers
country to another
Evaluation The main purpose of a capital account The main purpose of a current account is
is to help the investors determine the that it helps the investors find out the trade
net investment position of a country. deficit or trade surplus of a country.
Balance If there is a surplus in the capital If the current account balance is negative,
account, it indicates an inflow of money then a country is a net borrower. Similarly,
for a country. Similarly, if there is a if the account balance is positive, then the
deficit in the capital account, it indicates country is a net lender.
an outflow of currency from the country.
DIFFERENCE
Basis Balance of trade (BoT) Balance of Payment (BoP)
Definition BoT is a financial statement that captures BoP is a financial statement that keeps
the nation’s import and export of track of all the economic transactions by
commodities with the rest of the world. the nation with the rest of the world.

Deals It deals with the net profit or loss that a It deals with the proper accounting of the
country incurs from the import and export transactions conducted by the nation.
of goods

Measurement It is the difference that is obtained from the It is the difference between the inflow and
export and import of goods. outflow of foreign exchange.

Transactions Includes goods only Includes transfers, goods, and services

Capital transfers Not included Included

Net effect Can be (+) or (-) or (0) Always 0

DIFFERENCE
Balance of Trade Current account BOP

It records import and export of goods only It records

(a) import and export of goods,
(b) import and export of services, and
(c) current transfers.

It is the difference between visible exports and It is the sum total of trade balance and invisibles
visible imports balance. Invisibles balance includes
(a) balance on non-factor services,
(b) balance on income arising out of factor
services, &
(c) balance on transfers.

It involves international transactions relating to It involves international transactions relating

physical goods which can be seen crossing the to physical goods (which can be seen crossing
borders. the borders) as well as transactions relating
to services which cannot be seen crossing the
borders.