Balance of Payment(BoP)

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Balance of Payment(BoP)

Balance of Payment(BoP)

If you want to see the cash coming in and going to a company, then you have to look at the account book of that company. Similarly, if we want to know the flow of cash coming in and going out of the country, then for this we have to see the account balance sheet of the country. The Balance of Payment (BoP) has two parts. 
  1. Current Account and 
  2. Capital Account
According to the IMF, there are three parts of the balance of payments - 
  1. Current Account, 
  2. Capital Account and 
  3. Financial Account. 
Without getting into the technical aspects of this topic, let's try to understand it simple.

Current account


1. The details of imports and exports remain (it is always negative because we import more than exports; Import> Export = trade deficit).
2. Details of income coming from abroad (amount of interest paid to Indian investor, interest received from FDI / FDI).
3. Transfer (gift, money sent by NRI to families. It is always positive / high because there are huge number of Indians abroad)

Capital Account / Financial Account


1. Amount received from direct investment of other countries in India (FDI, FII, ADR, purchase of land in India by foreigners, other property)
2. Borrow money from outside. External help etc.

  • If an American invests in India (via FDI, FII, ADR etc.), then we will put it in plus (+) i.e. in credit.
  • If an Indian invests in America (via FDI, FII, IDR etc) then we will put it in minus (-), that is, we will keep it in debit.
  • We monitor the flow of capital through the Balance of Payments.
  • For India, the current account has always been in deficit (in negative figure) and the capital account has always been in surplus (in positive figure)
    Ideally, both Current Account and Capital Account should be equal in Balance of Payment(BoP).
    If the current account is in deficit, then the Capital Account should remain in surplus so that balance remains in both (BoP = 0).

Why the theory of Balance of Payment = Zero?

Suppose, there are only two countries in this world. One is America (country with dollars) and the other is India (country with rupee). And there is no middleman between them, nor any agent, nor any taxation system, nor Virat Kohli nor Tarak Mehta's inverted glasses. This means that there is nothing in the world except America and India.

Now India buys an Apple phone worth 10 billion dollars from America. Since there is no Forex agent, taxation, India gives US 10 × 60 = 600 billion INR Indian currency (if $ 1 = 60). This means that many of India's rupees went to America from India's Current Account.
But what will America do to India's currency? Indian currency has no use for it. America has three options -

1. Either he buys something from India from that currency (eg, raw material, steel, plastic etc.)
2. Either compromise with India and set up a factory in India, or open some more centers of Mc Donald.
3. He should buy some share / bonds of India.

Under these three circumstances, India's money will come back to India only. Therefore, at least according to Balance of Payment theory, current capital + capital account = zero (B0P)
But, in reality, RBI never has complete details about all financial transactions and currency exchange rates (which are often descending, ie, $ 1 = 60 Rs., $ 1 = 66 Rs.). Therefore, there is every possibility of statistical anomalies, errors and omissions.

So Balance of Payment(BoP) is described as -
Current Account + Capital Account + Net Errors or Omissions = 0 (Balance of Payment).

Surplus or Deficit?

Does it mean that a country will never have Surplus or Deficit Balance of Payment(BoP) permanently?
The surplus or deficit in the balance of payment is temporary because the calculation of balance of payment is done on quarterly or annual basis. There is a very high chance that USA which earned 600 billion INR by selling apple phone to India, that is 2 years, 3 years etc. Till, do not make any investment in India.
It is possible that in the future, the Government of India should impose a trade ban on the USA so that the USA cannot invest in India.

But a long run situation will occur that will bring the whole system back in balance, like America gives INR to another country and says that you invest in India and give me 50% profit in return. Ultimately, India's money will come to India now or tomorrow.

Or the US finds an NRI(Non-Resident of India) investor who lives in the US and is ready to take 60 billion INR and that band should invest in India in due course.
The meaning of this is to say that such a situation arises after which the money sent outside the country comes back to the country i.e. Balance of Payment is always ZERO or balanced.

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