BALANCE OF PAYMENT

Just as individuals and business keep a record of their economic transactions, a  country also record of its transactions with rest of the world. when you lend money to your friend, you make a note on your diary that how much money was lent, to whom and when and so on. similarly, when a nation makes transaction with other nations that must be recorded, in the balance of payment.

BALANCE OF PAYMENT SIMPLY REFERS TO THE SUMMARY OF ALL TRANSACTIONS BETWEEN CITIZENS OF THE TWO COUNTRIES IN A GIVEN PERIOD.

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ACCORDING TO IMF "BOP OF A COUNTRY IS A SYSTEMATIC RECORD OF ALL ECONOMIC TRANSACTIONS BETWEEN ITS RESIDENTS AND THE RESIDENTS OF THE REST OF THE WORLD DURING THE A SPECIFIED ACCOUNTING PERIOD"

1. A record of international transactions between residents of one country and the rest of the world
2. International transactions include exchanges of goods, services or assets
3. “Residents” means businesses, individuals and government agencies, including citizens temporarily living abroad but excluding local subsidiaries of foreign corporations

CONTENTS IN BALANCE OF PAYMENT

• Merchandise exports (valued f.o.b.)
• Transportation and travel receipts
• Income received from investments abroad
• Gifts received from foreign residents
• Aid received from foreign governments
• Merchandise imports
• Transportation and travel expenditures
• Income paid on investments of foreigners
• Gifts to foreign residents
• Aid given by home government
• Overseas investments by home country resident

Balance of payment of accounting

we know that every business firm prepares its periodic balance sheet of it's transactions with the rest of society for knowing its assets and liabilities. Like that every country carries various transactions with the rest of world and prepares balance of payment account. This is essential to know, how much it has to pay to other countries and how much it has to receive from other countries.

Double-entry Accounting in the BOP

All transactions are either debit or credit transactions

Credit transactions result in receipt of payment from foreigners

• Merchandise exports (valued f.o.b.)
• Transportation and travel receipts
• Income received from investments abroad
• Gifts received from foreign residents
• Aid received from foreign governments

Debit transactions involve to payments to foreigners

• Merchandise imports
• Transportation and travel expenditures
• Income paid on investments of foreigners
• Gifts to foreign residents
• Aid given by home government
• Overseas investments by home country residents

Each credit transaction has a balancing debit transaction, and vice versa, so the overall balance of payments is always in balance.

Account Overview

Current Account

Merchandise trade

exports

imports

Trade Balance

Services

military trans. (net)

other services, net

Service Balance

Balance on goods & services

Investment income, net

Unilateral transfers

US government grants

US govt pensions, and

other transfers

Private remittances and

other transfers

All transfers, net

Balance on current account

Capital Account

Changes in US assets abroad, net

other US govt assets

US private assets

All changes, net

Changes in foreign assets in the US,

net foreign private assets

All changes, net

Changes in holdings of official international reserves, net

Statistical discrepancy

Balance on capital account

Current Account (all real transfers)

• Merchandise trade
• Service trade
• Transfers

Capital and Financial Account (transfers of ownership and financial assets and liabilities)

• Changes in private assets
• Changes in holdings of official international reserves
• Statistical Discrepancy

The current account is that balance of payments account in which all short- term flows of payments are listed:

• Goods and services balance (exports – imports)
• Merchandise trade balance (exports – imports)
• Services balance (exports – imports)
• Net Investment income
• Unilateral transfers
• Private transfer payments
• Governmental transfers

The capital and financial account is that balance of payments account in which all cross-border transactions involving financial assets are listed. This includes transactions between foreign and domestic residents, and foreign and domestic governments.

• All purchases or sales of assets, including:
• Direct investment
• Securities (debt)
• Bank claims and liabilities
• Official reserves transactions

When U.S. citizens buy foreign securities or when foreigners buy U.S. securities, they are listed here as outflows and inflows, respectively.

Balance of payment equilibrium

since the BOP is constructed on the basis of double-entry accounting basis, credit is always equal to debit. Thus in accounting sense, BOP is always balanced. BOP always balances means that the sum of net credit transactions and debit transactions of current account, capital account and official settlement account must be equal to zero.

Current Account Surplus and Deficit

A current account surplus means exports of goods and services, investment income and transfers exceed imports and outflows.

A current account deficit means imports of goods and services, and outflows are greater than exports and inflows; must be financed by borrowing (capital account inflows).

Meaning of Overall Balance

The current account and the capital account measure the private and non-U.S. government supply of and demand for dollars.

Official Settlements Balance: B = CA + KA

Because the balance of payments must sum to zero, any imbalance in the official settlements balance must be financed (paid for) by official reserves flows: B + OR = 0