Saturday, January 31, 2015

Balance of Payment

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Balance of Payments (BOP) of a country is its record of all financial transactions performed between the residents (meaning individual, firms, government) and the rest of the world (albeit within a period, usually a financial year).

Here a point need to be mentioned, BOP data isn't concerned with actual 'payments', rather with 'transactions'.

Now the question is does it really 'balances'?
The answer is may not be. Though theoretically it should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice there is mostly a mismatch.

It generally happens, when the outward transaction is more than the inward transaction, and then is termed as Balance of Payment Deficit (BOP deficit) Also, BOP surplus is possible, for the reverse case.

BOP Accounts
For the international trade, a country's BOP deals with three types of accounts -

  1. Current Account - It is the most important of the three. It has mainly four components - goods, services, income and current transfers (meaning worker's remittances, donations, aids, etc.). It is very obvious now - if the outflow of this components are more than the inflow, it will result in Current Account Deficit (CAD).
  2. Capital Account - All international capital transfers are recorded here (Capitals meaning non-financial assets, such as land and non-produced assets, such as mine)
  3. Financial Account - It contains the direct investment (remember FDI, ODI), portfolio investment, reserve assets, etc.
Often the last two accounts are mentioned as a single one - Capital and Financial Account.

Trade Deficit
From the above discussion you hopefully learned the concept of BOP deficit and Current Account Deficit (CAD). Since we are talking about 'international' transactions, its better to know about the Trade Deficit.

It is very much simple - negative balance of trade, meaning country imports more than exports. As a result currency is flowing outward
(On a personal note - Reduce gold use. Indian currency flows outward. Government spends a lot for importing gold from foreign countries!)

Other types of deficits - Revenue Deficit, Fiscal Deficit, Primary Deficit - will be discussed later.

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Happy learning!

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