WHAT IS BALANCE OF PAYMENTS (BOP)

The balance of payments (BoP) records all economic transactions in goods, services, and assets of the country with the rest of the world for a specified time period, usually a year. In simple terms, it is a systematic accounting balance sheet of the country and includes both debit and credit transactions. BoP is used to monitor all international monetary transactions. All trades conducted by both the private and public sectors are accounted for in the BoP in order to determine how much money is going in and out of the country.

 

The basic purpose of BoP accounting is to know the strength and weaknesses of the economy. By analysing the BoP accounts of the previous year, you can know the overall gains and losses from international trade.

 

There are two main accounts in the BoP – the current account and the capital account. The current account records exports and imports in goods, trade in services and transfer payments. The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc. It also includes foreign investments and loans.

 

The country is said to be in balance of payments equilibrium when the sum of its current account and its non-reserve capital account equals zero so that the current account balance is financed entirely by international lending. The balance of payments deficit or surplus is obtained after adding the current and capital account balances. The decrease in official reserves is called the overall BoP deficit and the increase in reserves is BoP surplus.

 

Countries with current account deficits can run into difficulties. If the deficit is large and the economy is not able to attract enough foreign investment inflows, the country’s currency reserves dwindle. In 1991, India found itself in its worst BoP crisis ever. The inflow of foreign borrowing had increased at a rapid rate during the late 1980s. Coupled with this, high oil prices and excessive domestic spending ballooned into a crisis. India was on the verge of defaulting on its international commitments and was denied access to external credit. The only way out for India was to borrow against the security of its gold reserves. The crisis paved way for the much-needed and long-overdue reforms in the industry and trade policy.