Balance of Payments Economics Notes for UGC-NET Commerce Exam (2024)

The balance of payments summons the financial transactions of an economy with the rest of the world. These dealings include the export and import of goods and services and financial assets, with the transfer payments (for, e.g. foreign aid). The balance of payments is a systematic record of all economic transactions between residents of a country and the rest of the world. It captures flows of goods, services, income, financial assets and liabilities between a nation and the rest of the world. The balance of payments accounts plays a crucial role in understanding the state of the external sector, exchange rate and monetary policy.

Balance of payments economics is a very important topic to be studied along with the topics mentioned in the UGC-NET Commerce Examination.

In this article, learners will be able to understand the balance of payments economics in detail and in-depth.

Learn about Tariff and non tariff barrier.

Structure of Balance of Payments

The balance of payments (BoP) is a comprehensive accounting framework that records a country's economic transactions with the rest of the world over a specific period, typically a year or a quarter. It is divided into three main components, each with its subcomponents:

• Current Account:
  • Trade Balance: This includes the balance of visible trade (goods) and the balance of invisible trade (services). It calculates the difference between exports and imports of goods and services.
  • Income: This component records income earned by a country's residents from foreign investments and income paid to foreign residents who have invested in the country.
  • Current Transfers: Current transfers consist of government grants, foreign aid, and remittances sent by foreign workers to their home countries. It reflects unilateral transfers of economic value.
• Capital Account:
  • Capital Transfers: Capital transfers involve the transfer of ownership of a fixed asset or the forgiveness of a liability. These transactions do not result in an equivalent exchange of economic value.
  • Acquisition or Disposal of Non-Produced, Non-Financial Assets: This includes the transfer of items like land, patents, and copyrights, which are not produced and do not represent a financial asset.
  • Financial Account: The financial account records transactions related to the acquisition or disposal of financial assets and liabilities. It includes:
    • Direct Investment: Foreign direct investment (FDI) and domestic direct investment (DDI).
    • Portfolio Investment: Investment in stocks, bonds, and other securities.
    • Other Investment: Includes loans, currency deposits, and trade credits.
    • Reserve Assets: Transactions involving central banks' reserves and foreign exchange.
• Official Reserves Account:
  • This account records the changes in a country's official reserve assets, such as foreign exchange, gold, and Special Drawing Rights (SDRs), as a result of BoP transactions.

The structure of the balance of payments allows for a comprehensive analysis of a country's economic interactions with the rest of the world. By examining each component, policymakers, economists, and analysts can gain insights into a nation's trade dynamics, financial flows, investment patterns, and overall external economic position. The BoP is a crucial tool for assessing the health and sustainability of a country's economic relationships on the global stage.

Read about Features Importance and Objective of BOP.

Balance of Payments Economics

BOP economics reflects its economic health and strength. A consistent current account deficit means a country imports more than it exports and needs to rely on foreign capital inflows. This can create economic vulnerabilities. Meanwhile, a surplus means a country can export savings to the rest of the world and build up foreign assets.

The balance of payments records all the financial transactions between a country and the rest of the world in a given period.

• Current account records a country's transactions in goods, services and financial transfers. It mainly includes trade in goods and services (exports minus imports) and unilateral transfers like foreign aid, income from abroad etc. If a country's exports exceed imports, it has a current account surplus. If imports are greater, it has a current account deficit.
• Capital account: This records financial transactions related to investment and capital flows. It includes foreign direct investment, portfolio investment, borrowing and lending between countries.

Read about Costs and benefits of FDI to home and host countries.

Economic Transaction in BOP

Economic transactions in the balance of payments is a wide topic to be studied. It has two main components of the balance of payments in economics that have been discussed below.

Current Account Transactions have been mentioned below.

• Goods: When a country exports or imports goods, this is recorded in the current account. If exports of goods exceed imports, the country has a trade surplus for goods. If imports exceed exports, it has a trade deficit for goods.
• Services: The same applies to trade-in services like tourism, consulting, financial services, etc. If services exports are greater than imports, the country has a services surplus. If imports of services exceed exports, it has a services deficit.
• Income: This includes earnings from investments abroad and remittances sent home by workers overseas. If a country receives more income from abroad than it pays out, it has an income surplus. If it pays out more income than it receives, it has an income deficit.
• Unilateral transfers: This includes things like foreign aid, grants, gifts and donations. If a country receives more transfers than it gives, it has a surplus. If it gives out more than it receives, it has a deficit.

Capital Account Transactions have been mentioned below.

• Foreign Direct Investment: When a company invests directly in a foreign country, that counts as foreign direct investment. If investments into the country exceed investments going out, it has a foreign direct investment surplus.
• Portfolio investment: This includes purchases of equities, bonds and other securities. If investors buy more securities in a country than that country's investors buy abroad, that country has a portfolio investment surplus.
• Financial derivatives: Transactions involving currency swaps, futures, options and other financial instruments are recorded here.
• Official reserves: Central banks often buy and sell foreign currency reserves - if they accumulate reserves, that shows up as a surplus.

In summary-

• Current account transactions related to trade and income flows.
• Capital account transactions related to investment and capital flows.
• Net errors and omissions to make the accounts balance out.

Also, read about EU Trade Agreements.

Conclusion

The balance of payments in economics provides a snapshot of a country's economic health and momentum. A consistent current account deficit indicates the country relies on foreign capital inflows, while a surplus means it exports savings to the world. The balance of payments must always balance, with surpluses in one account offsetting deficits in another. Policymakers monitor the balance of payments closely to gauge financial stability risks and determine appropriate economic policies.

Testbook App is a platform for completing detailed notes on exams like UGC-NET in several forms such as notes, FAQs, related topics, etc.

Read about India and SAARC relations.