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written by | April 18, 2022

The Importance of Balance of Payments for Every Country

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What is a balance of payment? Every nation across the world is involved in trade transactions with other countries. Some countries are heavily into exports whereas others are involved in a lot of imports due to their economic conditions. Such activities result in a large amount of exchange of money. 

When a country receives revenue, it is termed as credit, and when it makes a payment, it is termed as a debit to the country. The difference between these two is known as balance of payment (BOP). Balance of payment clarifies the special drawing rights (SDRs) of a country, details of its liabilities to other countries, and what they owe it. It also states monetary transfers made by a country on humanitarian grounds, where the country makes the transfer without any expectations from the beneficiaries. A balance of payment deficit implies that the volume of imports by a nation exceeds the volume of its exports. A balance of payment surplus implies that its volume of exports exceeds its volume of imports.

Did you know?

That China is said to have the largest trade surplus globally and Germany has the largest in Europe?

Understanding the Concept of Balance of Payment

The balance of payments gives clarity on the total number of monetary dealings which are made by a country’s citizens and business houses. A zero balance of payment is the sign of a healthy economy but this rarely occurs. Many countries experience a consistent debit while few experience a seamless credit inflow. The difference between the two, known as the balance of payments, is calculated every four months or once in a calendar year, i.e., Jan 1 to 31st December. The three distinct components of the balance of payments include:

  • Current account
  • Capital account
  • Financial account

Also Read: Top Performing Import-Export Business Ideas In India

Current Account

This includes all revenues from the sales and purchase of foods and services to other countries as well as from other countries. The industries from which these revenues accrue include manufacturing, transport, tourism, raw materials, among others. This also includes special fees paid for charting through territory owned by another country for transportation of goods and services by sea. Revenues from sources like stocks are also included in this account. When NRIs send money to their native country, that is also included in this account. If a country, e.g., Bangladesh, is a beneficiary of aid from India, that will be included in the beneficiary’s current account.

Capital Account

This category in the balance of payment refers to all inflow of revenues that accrue from the buying or selling of fixed assets as well as the taxes that are paid. It also includes various types of loans that are availed from the public or private sectors on foreign soil. Transfer of goods, as well as the transfer of monetary assets, are included in the capital account. Any funds generated from the sale of such assets are included in the capital account. Any overseas purchase or sale of bonds, stocks, or even assets are considered under this account. 

The capital, as well as the current accounts, form the key accounts in the balance of payment.

Financial Account

Any direct foreign investment made by a corporate or government in another country is included in the financial account. Every type of asset which is held by a foreigner in another country is also included in the financial account.

If, e.g., India holds a fixed asset in the UK, it is considered a capital account outflow. However, if that fixed asset in a foreign land is sold, the money that India gets is considered as a capital account inflow. If a country has a balance of payment deficit and resorts to its capital account to overcome the situation, it is considered as revenues inflow. Globalisation has introduced an increased number of economic transactions leading to increased commerce between countries worldwide. The earlier restrictions on transactions that came under the purview of the financial as well as capital accounts, e.g., owning fixed assets in a foreign country, have been considerably relaxed. This has enabled most countries to benefit from the revenue inflow. This has brought about an increase in foreign direct investments. It has also led to a boom in the capital markets. Investors are now able to make appropriate investments.

Also Read: How to Get Export Orders from Abroad & How You Can Fulfil Them

What is the Importance of the Balance of Payment to a Country?

A vibrant and dynamic economy helps a country grow and progress faster. Every country needs to monitor all its transactions on a regular basis. These transactions could be lending aid or money to impoverished countries or procuring the same from other countries. Balance of payments enables a country to understand the total revenues which are incoming and the number of outgoing revenues. This gives the central government insight into net gain or net loss that accrues from foreign trading. It also reveals the loopholes, if any, and how the country can overcome them.

A balance of payment clearly indicates the number of reserves a country has to be able to make payments for its various imports of goods and services. It gives an insight into a country’s economic strengths for future growth and development. A deficit scenario signals a country’s inability to meet the demands of its development. This leads to more borrowings and more debt. A persistent situation of deficit could mean a sale of its naturals resources as well. A scenario of trade surplus indicates an increased volume of exports. A country is in a strong position to meet all its production and manufacturing expenditures as well as offer assistance to needy nations.

Conclusion

A country’s balance of payments indicates its total profits or losses through international trade for a calendar year. A state of equilibrium where the balance of payment should be zero is rare. A balance of payment specifies whether a nation is experiencing a trade surplus or a deficit. It also clearly indicates which section of the economy contributes to either of the situations. 

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FAQs

Q: What kind of economic and financial deals does a balance of payment include?

Ans:

It includes multiple transactions, some of which are:

  • Importing of goods
  • Exporting of goods
  •  Importing of services
  • Exporting of services
  • Importing and exporting of assets which are financial
  • Transfer of payments, special aid given to nations that may require it because of various contingencies like economic upheavals, civil war, war with neighbour countries, bad crop produce amongst others.

Q: What is a typical example of a balance of payment?

Ans:

If India exports 1,000 Mahindra tractors to America (for their farmers) – this will make a positive credit in India’s balance of payments.

Q: Which are the three components of the balance of payment?

Ans:

The three components include the following 3 accounts, namely:

Current, Capital, and Financial

Q: How is the balance of payments formula calculated?

Ans:

The balance of payment formula is the sum of the three accounts, as well as the balancing item (which could be negative or positive), equals zero.

Current capital financial balancing item = 0 (zero)

Q: What is the meaning of balance of payment?

Ans:

The balance of payment is a summary of all the monetary transactions which are made by a country with the rest of the world during a specific time frame.

Q: What is the balance of payments definition?

Ans:

Balance of payments can be best defined as the actual difference in the value of all payments received into a country or made by a country to another.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.