Balance of Payments (BoP)

The BoP records the transactions in goods, services, and assets between residents of a country with the rest of the world for a specified period typically a year. BoP follows the Double Entry System to record transactions with the rest of the world and has two sides – Credit side and Debit side

BoP Surplus	Balanced BoP	BoP Deficit
Credit Side > Debit Side	Credit Side = Debit Side	Credit Side < Debit Side

Components of BOP

Accounts in the BoP include

Current account
Capital account

Current Account

It is the record of trade in goods and services and transfer payments.
It records all the transactions that relate to the actual receipts and payments of visible items, invisible items, and unilateral transfers during a specific period.

Components of Current Account include

Trade in goods (Visible Trade or Merchandise Transactions) – It includes exports and imports of goods.

Trade in services (Invisible Trade) – It includes factor income and non-factor income transactions.

Factor income – Includes net international earnings on factors of production (like labor, land, and capital).
Non-factor income – It is a net sale of service products like shipping, banking, tourism, software services, etc.

Transfer payments – These are the receipts that the residents get for free without having to provide any goods or services in return. They consist of gifts, remittances, and grants.

Income receipts and payments to and from abroad – It involves investment income in the form of rent, profits, and interest.

Current Account Surplus	Balanced Current Account	Current Account Deficit
Receipts > Payments	Receipts = Payments	Receipts < Payments

A surplus current account – The nation is a lender to other countries
A deficit current account – The nation is a borrower from other countries

Components of Current Account include

Balance of Trade
Balance on Invisibles

Balance of Trade (BOT) – It is the difference between the value of exports and the value of imports of goods of a country in a given period.

It is also known as Trade Balance.

Trade Surplus	Balanced BOT	Trade Deficit
Exports > Imports	Exports = Imports	Exports < Imports

Net Invisibles – It is the difference between the value of exports and the value of imports of invisibles of a country in a given period.
Invisibles include services, transfers, and flows of income that take place between different countries.
Services trade includes both factor and non-factor income.

Capital Account

It includes those transactions, which cause a change in the assets or liabilities of a country’s residents or its government.

Components of Capital Account include

Borrowings and Lendings to and from abroad – Includes all the transactions related to borrowings from abroad by the government, private sector, etc.

Investments to and from abroad – Includes all the investments by the rest of the world in shares of Indian companies, real estate, etc. The investments to and from abroad are:

Foreign Direct Investment – FDI consists of the purchase of an asset, which gives direct control to the buyer over the asset. For example, the purchase of land, buildings, etc.
Portfolio Investment – It is the cross-border transactions and positions involving equity or debt securities, other than direct investment or reserve assets.
Ex – FII (Foreign Institutional Investment).

Change in Foreign Exchange Reserves – The financial assets of the government held in the central bank are Foreign Exchange Reserves.

Capital Account Surplus	Capital Current Account	Capital Account Deficit
Capital inflows > Capital outflows	Capital inflows = Capital outflows	Capital inflows < Capital outflows

A country could use its forex reserves to balance its balance of payments deficit.
The reserve bank sells foreign exchange when there is a deficit. This is called official reserve sale.
The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus).