Balance of payments or BoP, is also known as balance of international payments. It is a statement that records all the monetary transactions that take place between a country’s residents and the rest of the world during a given period.
There are three components of the balance of payments (BoP).
- Capital account
- Current account
- Financial account
Capital account includes the non-financial sale and purchase of assets and the flow of taxes. The main components of the capital account are forex reserves, investments, and loans.
Current accounts deal with the sale or purchase of goods that can either be raw materials or manufactured goods. This account is meant for daily transactions to keep the flow of money smooth, and get and make payments on time.
Financial account deals with the monetary inflows and outflows pertaining to the investments made in various sectors such as foreign direct investment, real estate, or other business ventures.
Ideally, the current account should be balanced with the combination of the financial account and capital account.
In theory, BoP should be zero, but it rarely happens. Therefore, BoP is used to determine whether the country is having surplus or deficit and the sections that cause this surplus or deficit.
The balance of payments formula can be expressed as follows:
Balance of payments = Balance of current account + Balance of capital account + Balance of financial account + Balancing item
BoP surplus means that exports are more than imports. In contrast, a BoP deficit indicates that imports are more than exports.
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