Components of Balance of Payments

Components of Balance of Payments: (1) Current Account; (2) Capital Account

By Smriti Chand

Components of Balance of Payments: (1) Current Account; (2) Capital Account!

(1) Current Account:

Current account refers to an account which records all the transactions relating to export and import of goods and services and unilateral transfers during a given period of time.

Current account contains the receipts and payments relating to all the transactions of visible items, invisible items and unilateral transfers.

Components of Current Account:

The main components of Current Account are:
1. Export and Import of Goods (Merchandise Transactions or Visible Trade):
A major part of transactions in foreign trade is in the form of export and import of goods (visible items). Payment for import of goods is written on the negative side (debit items) and receipt from exports is shown on the positive side (credit items). Balance of these visible exports and imports is known as balance of trade (or trade balance).
2. Export and Import of Services (Invisible Trade):
It includes a large variety of non- factor services (known as invisible items) sold and purchased by the residents of a country, to and from the rest of the world. Payments are either received or made to the other countries for use of these services.
Services are generally of three kinds:
(a) Shipping,
(b) Banking, and
(c) Insurance.
Payments for these services are recorded on the negative side and receipts on the positive side.
3. Unilateral or Unrequited Transfers to and from abroad (One sided Transactions):
Unilateral transfers include gifts, donations, personal remittances and other ‘one-way’ transactions. These refer to those receipts and payments, which take place without any service in return. Receipt of unilateral transfers from rest of the world is shown on the credit side and unilateral transfers to rest of the world on the debit side.
4. Income receipts and payments to and from abroad:
It includes investment income in the form of interest, rent and profits.

Current Account shows the Net Income:

Current Account records all the actual transactions of goods and services which affect the income, output and employment of a country. So, it shows the net income generated in the foreign sector.
Difference between Balance of Trade and Current Account:

Basis	Balance of Trade (BOT)	Current Account
Components:	Balance of trade includes only visible items.	Current Account records both visible and invisible items.
Scope:	It is a narrow concept as it is only a part of current account	It is a wider concept and it includes BOT.

Balance on Current Account:

In the current account, receipts from export of goods, services and unilateral receipts are entered as credit or positive items and payments for import of goods, services and unilateral payments are entered as debit or negative items. The net value of credit and debit balances is the balance on current account.
1. Surplus in current account arises when credit items are more than debit items. It indicates net inflow of foreign exchange.
2. Deficit in current account arises when debit items are more than credit items. It indicates net outflow of foreign exchange.

Components of Current Account:

Credit Items	Debit Items	Net Credit (Credit – Debit)
1. Visible Trade Exports of goods:	Imports of goods	Net Exports of goods (Balance of Trade)
2. Invisible Trade Exports of services:	Imports of services	Net Exports of services
3. Unilateral Transfers Transfer Receipts:	Transfer Payments	Net Transfer Receipts
4. Income Receipts & Payments Income Receipts:	Income Payments	Net Income Receipts
Current Receipts (1+2+3+4)	Current Payments	Current Account Balance

(2) Capital Account:

Capital account of BOP records all those transactions, between the residents of a country and the rest of the world, which cause a change in the assets or liabilities of the residents of the country or its government. It is related to claims and liabilities of financial nature.
Capital Account is used to:
(i) Finance deficit in current account; or
(ii) Absorb surplus of current account.
Capital account is concerned with financial transfers. So, it does not have direct effect on income, output and employment of the country.

Components of Capital Account:

The main components of capital account are:
1. Borrowings and landings to and from abroad: It includes:
A. All transactions relating to borrowings from abroad by private sector, government, etc. Receipts of such loans and repayment of loans by foreigners are recorded on the positive (credit) side.
B. All transactions of lending to abroad by private sector and government. Lending abroad and repayment of loans to abroad is recorded as negative or debit item.
2. Investments to and from abroad: It includes:
A. Investments by rest of the world in shares of Indian companies, real estate in India, etc. Such investments from abroad are recorded on the positive (credit) side as they bring in foreign exchange.
B. Investments by Indian residents in shares of foreign companies, real estate abroad, etc. Such investments to abroad be recorded on the negative (debit) side as they lead to outflow of foreign exchange.
3. Change in Foreign Exchange Reserves:
The foreign exchange reserves are the financial assets of the government held in the central bank. A change in reserves serves as the financing item in India’s BOP. So, any withdrawal from the reserves is recorded on the positive (credit) side and any addition to these reserves is recorded on the negative (debit) side. It must be noted that ‘change in reserves’ is recorded in the BOP account and not ‘reserves’.

Balance on Capital Account:

The transactions, which lead to inflow of foreign exchange (like receipt of loan from abroad, sale of assets or shares in foreign countries, etc.), are recorded on the credit or positive side of capital account. Similarly, transactions, which lead to outflow of foreign exchange (like repayment of loans, purchase of assets or shares in foreign countries, etc.), are recorded on the debit or negative side. The net value of credit and debit balances is the balance on capital account.
A. Surplus in capital account arises when credit items are more than debit items. It indicates net inflow of capital.
B. Deficit in capital account arises when debit items are more than credit items. It indicates net outflow of capital.
In addition to current account and capital account, there is one more element in BOP, known as ‘Errors and Omissions’. It is the balancing item, which reflects the inability to record all international transactions accurately.

Credit Items	Debit Items	Net Credit (Credit – Debit)
1. Borrowings and lending’s to and from abroad Borrowings from abroad:	Landings to abroad	Net Borrowings from abroad
2. Investments from abroad Investments from abroad:	Investments to abroad	Net Investments from abroad
3. Change in Foreign Exchange Reserves. Decreases in foreign exchange reserves:	Increases in foreign exchange reserves	Net change in foreign exchange reserves
Capital Receipts (1+2+3):	Capital Payments	Capital Account Balance

Balance on Current Account Vs. Balance on Capital Account:

Balance on current account and balance on capital account are interrelated.
A. A deficit in the current account must be settled by a surplus on the capital account.
B. A surplus in the current account must be matched by a deficit on the capital account.