What is the balance of payments?
The balance of payments (BoP) is a record of all economic dealings between the residents of a country and the rest of the world during one year.
- A credit (+) entry brings foreign money in: exports, money received, foreign investment coming in.
- A debit (−) entry sends money out: imports, money paid, our investment going abroad.
It is kept on the double-entry idea, so in total the BoP always balances.
Accounts and components
1. Current account
It records flows that do not change ownership of assets or debts.
- Visible trade (goods): exports and imports of goods. Exports − imports of goods = balance of trade (BoT).
- Invisibles: (a) services like IT, banking, shipping, tourism; (b) transfers: one-way gifts, like workers sending money home (remittances); (c) income: interest, profit, dividends and wages earned across borders.
Current account balance = BoT + net invisibles. If negative, it is a current account deficit (CAD).
2. Capital account
It records flows that change assets or debts of residents.
- Foreign direct investment (FDI): buying a lasting control, like building a factory.
- Foreign portfolio investment (FPI): buying shares and bonds without control.
- Borrowings: loans from abroad (external commercial borrowing, government loans).
- Banking capital and NRI deposits.
3. Errors and omissions
A balancing figure for mistakes in data.
Try it at home
List five things in your house made abroad (imports) and one Indian product sold abroad. Which account does each belong to?
Balance of trade vs balance of payments
| Balance of trade | Balance of payments | |
|---|---|---|
| Covers | Goods only | Goods, services, transfers, income, capital |
| Balance | Can be surplus or deficit | Always balances in accounting sense |
| Part of | Current account | The whole record |
Autonomous and accommodating items
Autonomous transactions happen for their own reason, like profit or need: trade, investment, remittances. They are called 'above the line'.
Accommodating transactions happen only to fill the gap left by autonomous ones. Example: the RBI uses or adds to its foreign exchange reserves, or the country borrows from the IMF. They are 'below the line'.
BoP surplus and deficit
- BoP surplus: autonomous receipts > autonomous payments. Foreign exchange reserves rise.
- BoP deficit: autonomous payments > autonomous receipts. Reserves fall, or the country borrows.
So when people say 'BoP always balances', they mean after accommodating items. When they say 'BoP deficit', they mean the autonomous items alone.
Why a deficit matters
- Falling reserves can cause the rupee to weaken.
- A long deficit needs foreign loans, which bring debt.
- India faced this in 1991, when reserves covered only a few weeks of imports.
Key formulas and definitions
- Balance of trade = Exports of goods − Imports of goods
- Net invisibles = net services + net transfers + net income
- Current account balance = Balance of trade + Net invisibles
- Capital account balance = Capital inflows − Capital outflows
- Overall BoP (autonomous) = Current a/c + Capital a/c + errors; Change in reserves = −(this) in the accounts, so total = 0
Worked examples
1. Exports of goods ₹400, imports of goods ₹500. Find the balance of trade.
400 − 500 = −₹100: a trade deficit of ₹100.
2. Trade deficit 100, net services +60, net transfers +30, net income 0. Find the current account balance.
−100 + 60 + 30 + 0 = −10: current account deficit of 10.
3. Classify as current or capital account: (a) Tata buys a UK firm, (b) Indian tourist in Paris, (c) NRI deposits money in an Indian bank, (d) Infosys earns fees from a US client.
(a) Capital (FDI outflow, debit). (b) Current (service import, debit). (c) Capital (inflow, credit). (d) Current (service export, credit).
4. Current account −10, capital account +40. Is there a BoP surplus or deficit? What happens to reserves?
Autonomous total = +30: a BoP surplus of 30. Reserves rise by 30.
5. Visible exports 800, visible imports 1000, net invisibles +150, net capital inflow +30. Find CAD and overall balance.
BoT = −200. CA = −200 + 150 = −50. Overall = −50 + 30 = −20: a BoP deficit of 20; reserves fall by 20.
6. Current account deficit is 60. By how much must net capital inflow be to keep reserves unchanged?
Overall must be 0, so capital account must be +60.
Common mistakes
- Saying the BoP is always in deficit or surplus. In accounting it always balances; surplus/deficit refers to autonomous items only.
- Putting remittances in the capital account. They are one-way transfers, so they belong to the current account.
- Mixing balance of trade with balance of payments. BoT is goods only.
- Treating FDI as a current account item. Buying assets abroad or foreigners buying here is capital account.