Balance of payment

 Definition:

The balance of payment is systematic accounting record of all economic transaction during the period between resident of countries and resident of foreign countries. When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit.

 For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter-balanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.

Accounting principle in balance of payment:

-          It is a double entry system in which each transaction have two entry debit and credit.

-         A transaction which increase demand of foreign exchange and decrease the supply of foreign exchange is record in debit side entry and each transaction which decrease demand of foreign exchange and increase supply of foreign exchange recorded in credit side entry.

Balance of payments crisis:

A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy

Valuation and timing:

-          Uniform timing of recording required.

-          Two side of transaction must recorded at same time period.

-          Export are recorded when cleared by custom and import when payment is made.

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Component of BOP:

A). Current account:

 Import and export of goods and services and unilateral transfer of goods and services.

B). The capital account:

Grouped transaction leading to change in forign assets and liability of country.

C). The reserve account:

 Same as capital account but only Reserved assets are included which used by monetary authority to settle deficit and surplus.

Meaning of deficit and surplus in BOP:

Both are just due to imbalance in export and import. In language of accountant we divide BOP in Above the line and Below the line.

If the balance is Positive above the line we called as Surplus and negative balance called deficit. There are various types of balance like Trade balance, current account balance, balance of goods and services, balance of current account and long term capital.

Recording of Typical Transactions:

The balance-of-payments accounts are commonly grouped into three major categories: (1) accounts dealing with goods, services, and income; (2) accounts recording gifts, or unilateral transfers; and (3) accounts dealing basically with financial claims (such as bank deposits and stocks and bonds).

Categories of transaction:

Commercial exports, payment for commercial exports, receipt of income frominvestment abroad, expenditure on travel abroad, gifts to foreign resident, loans to borrower abroad, purchase and sales of dollar balances by foreign central banks.

Why BOP statistics important?

BOP deficit or surplus directly affects forign exchange rate and financial decisions of business and country. In short BOP accounts are intimately connects with overall savings and investment in country national account. Continuing deficit or surplus may leads to monetary or fiscal actions design to correct the imbalance, which in turn affects exchange rate and interest rates in the country.

Causes of BOP imbalances:

There are conflicting views as to the primary cause of BOP imbalances, with much attention on the US which currently has by far the biggest deficit. The conventional view is that current account factors are the primary cause - these include the exchange rate, the government's fiscal deficit, business competitiveness, and private behaviour such as the willingness of consumers to go into debt to finance extra consumption.^] An alternative view, argued at length in a 2005 paper by Ben Bernank, is that the primary driver is the capital account, where a global saving glut  caused by savers in surplus countries, runs ahead of the available investment opportunities, and is pushed into the US resulting in excess consumption and asset price inflation.

Balancing mechanism :

Broadly speaking, there are three possible methods to correct BOP imbalances, though in practice a mixture including some degree of at least the first two methods tends to be used. These methods are adjustments of exchange rates; adjustment of nations internal prices along with its levels of demand; and rules based adjustment. Improving productivity and hence competitiveness can also help, as can increasing the desirability of exports through other means, though it is generally assumed a nation is always trying to develop and sell its products to the best of its abilities.