Title Chapter 5 Balance of payment.docx ✅

1 UNIT V: BALANCE OF PAYMENTS Basic Concepts and Account Meaning of balance of payment Balance of payment is a systematic and comprehensive records all visible and invisible economic transactions of a country to rest of other countries during a given fiscal year. It is a statistical record of the character and dimensions of the country's economic relationship with the rest of the world. These systematic records of all economic transactions consist of visible records-recorded in custom offices of the country. That is airways custom and roadway customs and invisible records recorded in other than custom offices. That is in Nepal Rastra Bank, department and ministry of the government; which are called invisible economic transactions. Therefore, Balance of payment shows that the relationship between one country's total payment to all other countries and its total receipts from them. Balance of Payment thus is statement of payments and receipts on international transactions. According to Bo Sodersten "The balance of payment is merely a way of listing receipts and payments in international transactions for a country." BOP consists of three major accounts like, current account, capital and official settlement account , capital and official settlement accounts which are prepared under the principle of "Double entry book keeping system(DEBKS)" in which the credit(receipt) items are put on left side and debit(payment) items are put on right side of the balance of payment sheet. Features of Balance of Payments Balance of payments has the following features; 1) It is a systematic record of all economic transactions between one country and the rest of the world. 2) It includes all transactions, visible as well as invisible. 3) It relates to a period of time. Generally, it is an annual statement. 4) It adopts a double-entry book keeping system. It has two sides, Credit side and debit side. Receipts are recorded in the credit side and payments on the debit side. 5) When receipts are equal to payments, the balance of payments is in equilibrium, when receipts are greater than payments there is surplus in the balance of payments, when payments are greater than receipts, there is deficit in the balance of payments.
2 6) In the accounting sense total credits and debits in the balance of payments statement always balance each other. Accounts of Balance of payment / Structure of Balance of payment Balance of payment consists of the three different accounts: a) Current Account The current account of the balance of payments statement relates to real and short-term transactions. It contains receipts and payment on accounts of exports of visible and invisible items. Transaction in the current accounts are called real transactions because they are concerned with actual transfer of goods and services which affects income, output and expenditure of the country. In summary form, current account includes the three sub accounts (3T) like Trade, Travel and Transfer payment. 1) Trade: Trade account includes only the visible exports(X) – import(M) of all commodities. It means trade account includes only the transaction of good not the transactions of services. Therefore, export and imports of materials goods are visible. 2) Travel: Travel account includes all expenses on pleasure, business, education, health, religious, culture, sports, international convention, transportation (Transit expenses), insurance premium, and income of foreign investment (rent, interest, profit, dividend) 3) Transfer payments: It includes the pension, remittance, interest of foreign loans, foreign grants, gift, donation, prices and lottery etc. b) Capital account: The capital account of the balance of payments of a country deals with the financial transactions it includes all types of short run and long run international movements of capital. Therefore, capital account shows international flow of loans and investments, and represents a change in the country's foreign assets and liabilities. If a country invests or lends abroad, it is a payment and will be recorded on the debit side. On the other hand, capital inflows in the form of borrowing from abroad or the foreign investment in the home country are entered on the credit side of the balance of payment account. These all are financial transactions relating only to the transfer of money and therefore have no direct impact on the level of income and output of the economy. It consists of foreign deposits foreign loans, foreign direct investment (FDI), transaction of foreign financial assets (foreign bills, bonds, and equities) and flow of baking capital except the central bank etc. c)
3 Official settlement (Financial) Account: The official settlements account or officials reserve assets account is in fact a part of the capital account. But, U.K and U.S balance of payments accounts show it as a separate account. It consists of all transactions of the central bank with the rest of the world like gold/Silver, foreign deposits, foreign financial assets, special drawing rights (SDRs), net- tranche position of the central bank with the IMF etc. So, the difference between the total credit(receipts) and debits(payments) amount of given three accounts during a given fiscal year shows the position of BOP. If the total credits (receipts) = Total Debits (Payments); it is called the balanced BOP. If the total credits(receipts) < Total debits(payments); it is called the deficit (Unfavorable)BOP If the total Credits(receipts)> Total debits (Payments); it is called the surplus (Favorable) BOP. Which is desirable as it shows the prosperity and rich in purchasing power of the economy in foreign market. Besides, there is an additional item namely 'Errors and omission' which is used for making a balance between the total credit and total debits of the given three account under the principle of the 'Double entry Book Keeping System.' However, the major aims of preparing BOP account is to show the purchasing power in foreign market, foreign assets reserves of a country' position of foreign loans/grants and overall economic position of a country at international level and that helps in formulation of monetary and fiscal policy of the nation. Is Balance of Payments always in Equilibrium? Balance of payments always balance means that the algebraic sum of the net credit and debit balance of current account, capital account and official settlements account must equal to zero. Balance of payment is written as, B = Rf – Pf Where, B represents balance of payments, R f receipts from foreigners P f payments made to foreigners When B = R f – P f = 0, the balance of payments is in equilibrium. In practice, the position of balance of payment (BOP) is either surplus or deficit. But in an accounting sense, BOP of a country is always balanced, that can be shown with the help of three different ways like. 1) Double Entry Book Keeping System: Balance of payment (BOP) is prepared under the principle of 'Double entry book keeping system' in which both side of total Credits /receipts) and total debits(payments) must be, balanced, which is made with the help of an adjustment account of errors and omission,
4 by adjusting some required amount. Therefore, it is said that the BOP of a country always balances in the accounting sense. 2) National Income Accounting: In accounting sense, BOP can be shown with the help of given equation of the national income like, C+ I + G + (X –M) = Y = C + S + T Where C = Consumption Expenditure I = Domestic investment G = Government Expenditure X – M = Net Export Y = National Income S = Domestic Saving T = Tax revenue of the government. The given equation shows that the national income(Y) from income side (C + S + T) must be equal to the rational income from expenditure side (C + I + G) with X = M. But if there is X>M due to any cause, it must be offset by an excess domestic saving over investment (Sd>I) and vice versa. Therefore, the BOP is always in equilibrium in national income accounts sense. 3) Borrowing from and Investment to Abroad: Similarly, if the borrowing (BFc) from foreign countries and investment (IFc) to foreign countries are adjusted to the balance of trade (X = M), it becomes like, X +B FC = M + IFC or, X – M = IFC – BFC or (X- M) – (IFC – BFC) = 0 It shows that if here is any positive (+ve) balance in current account, it is exactly offset by the negative balance of the capital account and vice-versa. So, BOP is again balanced in accounting sense. 4) World BOP: If BOP of the world (all Countries) is prepared, it is always balanced as the total receipts and payments of all countries in the world must be equal. Cause of Balance of Payment (BOP) Disequilibrium Generally, the balance of payment is either deficit or surplus in practice. The deficit BOP will be due to either deficit in current account or deficit in capital account or deficit both accounts at a time. However, some major causes of deficit BOP (current account or capital account) are as given below;