balance of payment definition

Balance of Payment Definition and Components

Balance of Payment Definition – “It is a statement which consists of record of all the payments and receipts made by the resident of the country to the rest of the world”

According to Reserve Bank of India – Balance of Payment is a statistical statement that shows –

  1. Transactions in goods and services between an economy and the rest of the world.
  2. Changes in ownership and other changes in that economy’s  monetary gold, special drawing rights (SDRs), and financial claims on and liabilities to the rest of the world, and
  3. Unrequited transfers

Any transaction which results in outflow of cash from the country to the foreigners is debit and given a negative sign. On the contrary, transaction which results in inflow of cash in the country is credit and is given the positive sign.

Components of BOP

To understand the what does Balance of Payment definition actually means, let’s discuss its components. The transactions that are recorded in Balance of Payment are –

Current Account – This account records export and import of visible and invisible items and transfer of payments. Trade in good implies the visible items and trade in services indicates the invisible items. Here trade in service includes both factor income as well as non factor income.

Factor income consists of interest, profit or dividend on asset abroad minus the income that foreigners earn on assets in India. On the other hand, non – factor income consists of shipping, banking, insurance, software services or tourism, etc.

Transfer payments in current account consists of the remittances that the residents of country received for free. They do not have to make payment in return. For example earthquake relief fund, gifts and grants. etc.

Capital Account – BOP’s capital account records all the international sales and purchases of financial assets such as money, stock, bonds, etc. In simple words, transactions which results in change in ownership of the financial assets are part of this account.

Errors and Omissions – There are times when Balance of Payment balance does not match. This imbalance is reflected in errors and omissions. This shows the inability to record all the international transaction accurately.

BOP Surplus and Deficit

When exports exceeds the import, balance of payment is in surplus. Similarly if imports exceeds exports, BOP is in deficit. This deficit in current account is financed by the net cash inflow of the capital account. Similarly current account surplus is used in financing the low capital account balance.

Related Financial Terms of Balance of Payment