Balance of Payments Deficit and Surplus

Payment Balance or BoP is a statement or record of all financial and economic transactions that are made nationally and internationally over a period of time (quarterly or yearly). These records include transactions made by individuals, companies and governments. Keeping a record of these transactions helps the country monitor cash flow and develops policies that can help build a strong economy. That is, income and expenditure must balance. But that does not happen in most cases.

The BoP country statement clearly shows that the country has either a lot of money or a shortage. The BoP surplus indicates that exports are higher than exports. The BoP deficit, on the other hand, indicates that the country’s assets are more than exports. Both of these situations have short-term and long-term effects on the global economy.

Why is the Bop Important in the Country?

The BOP of the country is important for the following reasons:

• The BOP of the country reflects its financial and economic status.

• The BOP statement can be used as an indicator to determine whether the value of a country's currency is rising or falling.

• The BOP statement helps the Government to decide on financial and trade policies.

• It provides valuable information for the analysis and understanding of international economic cooperation.

By studying its BOP statement and its components closely, one will be able to identify trends that may be beneficial or harmful to the regional economy and thus, take appropriate action.

Components of BOP

Now let’s understand the different parts of the BoP. The BoP consists of three main components - the current account, the financial account, and the financial account. As mentioned earlier, the BoP should be zero. The current account should be equal to the capital associated with the financial accounts.

Current account

The four major components of the current account are as follows:

• Visual Trade:

This is the net for export and import of goods (material). The balance of this visible trade is known as the trading balance. There is a trade deficit where imports are higher than exports and the remainder of the trade when exports are higher than imports.

• Invisible trade:

This is the net for export and import services (intangibles). Tasks mainly include shipping, IT, banking, and insurance services.

• Transfers to and from abroad:

This refers to non-elementary payments - for example, gifts or donations sent by a citizen of a country by a non-resident relative.

• Salary receipts and payments:

This includes payments and receipts. These are usually leased locally, interest rates, and interest on investments. 

Capital Account

A large account is used to finance what is missing from the current account or to accumulate money in the current account. Three main components of a large account:

• Loans and loans:

These include all loans and loans granted or received abroad. It includes both private equity loans, as well as state-owned loans.

• Investments to/from abroad:

These are investments made by non-citizens with shares in the home country or investments in real estate.

• Stored foreign exchange reserves:

Foreign exchange funds are held by the central bank to regulate the exchange rate and ultimately balance the BOP.

The current account deficit is funded by surplus funds in the Capital account and vice versa. This can be done by borrowing a lot of money from other countries or by borrowing a lot of money from non-citizens.

Financial Account

A financial account monitors the flow of funds associated with investments in businesses, real estate, and stocks. It also includes state-owned assets such as gold and Special Drawing Rights (SDRs) held by the International Monetary Fund (IMF). In addition, it includes foreign investment and foreign assets. Similarly, a financial account includes a record of assets held by outsiders.

Causes of BoP Deficit

The balance of deficit payments means that the nation imports more goods, money and services than it exports. It must take from other nations to pay for their exports.

A country can use its foreign exchange reserves to measure any shortcomings in its BoP:

• When foreign currency is sold by a reserve bank when there is a deficit, it is known as official reserve sales.

• Decreases or increases in official palaces are known as the total balance of payments or surpluses.

• The basic premise is that financial authorities are the ultimate sponsors of any shortcomings in the BoP (or recipients of any accumulated funds.

• Statutory transactions are more important under the rule of exchange rates that have changed than when the exchange rates floated.

Balance of payment refers to a financial statement which records the monetary transactions made between the residents of a country and the rest of the world. The transactions made are recorded for a particular period, say for the quarter of a year, and so on. 

This financial statement records all the transactions undertaken by or made to a government, corporations or individuals, and aids to track the flow of funds in a country. Ideally, the inflow and outflow of funds in a country should balance out, and the elements included in the balance of payment should sum up to zero. 

Following is an in-depth analysis of the balance of payment definition and what it means for a country.

What does a Country’s BoP Statement Indicate?

The BoP statement of a country indicates whether it has a deficit or surplus of funds. For instance, if a country’s export is higher than its import, then there is a surplus in the balance of payments. 

However, a BoP deficit can arise if a country’s imports amount to more than its total exports. The transactions recorded in a BoP statement follow the same rules as that of a double-entry accounting system. That is, every transaction has debit, and credit entries made corresponding to each other.

What is the Significance of BoP for a Country?

A country’s balance of payment is one of the metrics of its economic status. It also holds significance over the following areas – 

1. A country’s BoP statement can be used as an indicator to determine whether its currency value is depreciating or appreciating.

2. It acts as a comprehensive document that helps to understand and analyse a country’s economic relationship with other countries.

3. Finally, the balance of payment helps a government decide its trade and fiscal policies going forward.

BoP thus holds substantial significance by helping a government determine the policies that shape a country’s economy.

What are the Elements of BoP?

Now that we have learnt the balance of payment meaning, let us delve into the elements integrated into this statement.

Balance of payment has three components – capital account, current account and financial account.

• Capital Account

As its name suggests, this account records all capital transactions made between two countries. These include sale and purchase of fixed assets by migrants, the flow of taxes, as well as, sale and purchase of assets like property and land.

Capital account helps to manage the surplus or deficit created in the current account. Investments, loans and borrowings, and foreign exchange reserves are the three major elements of a capital account.

• Current Account

This account tracks the inflow and outflow of goods and services from one country to another. This includes recording receipts generated from tourism, transportation, engineering, stocks, business services and royalties collected from patent and copyright. Current account also monitors payments for manufactured goods and raw materials.

All the above mentioned categories combined together form a country’s Balance of Trade (BoT).

• Financial Account

This account tracks inflow and outflow of funds to and from foreign countries from investment in business ventures, real estate, foreign direct investment, etc. This account, thus, helps to gauge the domestic ownership of foreign assets and foreign ownership of domestic assets.

Ideally, the total value recorded in the current account should balance with the total of capital and financial accounts.

Causes of BoP Deficit

BoP deficit can arise due to several reasons. These are –

1. Rapid Economic Development

High outflow of foreign exchange to meet import demands like technology, machines, and equipment can lead to BoP deficit.

2. Inflation

Sustained rise in a country’s prices can often make foreign products cheaper, leading to a high volume of imports.

3. Political Disturbance

Unstable tax structures, change in government, etc. can lead to a loss in foreign investment, and give way for BoP deficit.

Apart from these, factors like population explosion, change in the preference and tastes of the general population, etc. can also contribute to the balance of payment of a country.

What is Balance of Payment Deficit?

A balance of payment deficit in a country can arise if said country imports more capital, goods and services than it exports. 

Balance of payment deficit is given by – 

(Current account + capital account receipts) < (current account + capital account payments)

This BoP deficit can be balanced by utilising the country’s foreign exchange reserves to meet the BoP shortfall. 

Following are a few crucial points to remember about the BoP deficit in a country

1. A BoP deficit can be corrected through an official reserve sale which denotes the sale of foreign exchange by the Reserve Bank.

2. The monetary authorities of a country are the financiers when any deficit arises in the country’s balance of payment. Conversely, they are also the recipients when there is a surplus in the country’s BoP.

3. An overall decrease in a country’s official reserves signifies a deficit in balance of payments.

4. Official reserve transactions can be accounted for only under the regime of fixed exchange rates. They cannot be considered when exchange rates are floating.

What is Balance of Payment Surplus?

Balance of payments surplus occurs when a country’s total exports are higher than its imports. This helps to generate capital to fund its domestic productions. With a surplus in its BoP, a country can also lend funds outside its borders.

Balance of payment surplus occurs when – 

(Current account + capital account receipts) > (current account + capital account payments)

A surplus in BoP can help to boost the short term economic growth of a country.

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