Balance of Payments is a statement of every recorded transaction made between entities or business unit in one country with that of the rest of the world over a defined period of time, such as the quarter of the year.
This article will give details about the balance of payments within the context of the IAS Exam
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Description of Balance of Payments
The balance of payments (BOP), also known as balance of international payments, summarizes all transactions that a country’s individuals, companies, and government bodies complete with individuals, companies, and government bodies outside the country. These transactions consist of imports and exports of goods, services, and capital, as well as transfer payments, such as foreign aid and remittances.
A country’s balance of payments and its net international investment position together constitute its international accounts.
The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa. If a country exports an item (a current account transaction), it effectively imports foreign capital when that item is paid for (a capital account transaction).
If a country cannot fund its imports through exports of capital, it must do so by running down its reserves. This situation is often referred to as a balance of payments deficit, using the narrow definition of the capital account that excludes central bank reserves.
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What are the components of a Balance of Payments?
Balance of Payments is made up of 3 components.
- Current Account – Deals with inflow and outflow of goods and services between countries.
- Capital Account – Deals with foreign exchange reserves, investments, loans & borrowings.
- Financial Account – Deals with investments in real estates, business ventures, Foreign Direct Investments (FDI).
Why Balance of Payment is Important?
- It helps the Government to analyse a particular industry and formulate policies accordingly.
- Helps the Government to detect the state of the economy and accordingly plan the monetary policy, fiscal policies.
- It helps the government to evaluate the tax rates for exports and imports.
What is the Current Account Deficit?
The total of Current Account must balance with the total of Capital and Financial Accounts in ideal situations. When a country’s imports are more than the country’s exports then it is called the current account deficit. In a vice versa situation then it called current account surplus.
What is the Balance of Payments Formula?
Balance of Payment = Balance of Current Account + Balance of Capital Account + Balance of Financial Account.
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