Components of balance of payments, Macroeconomics

 

Components of Balance of Payments 

The BoP statement is usually divided into three major groups of accounts. These are:

i.The Current Account: This account records the imports and exports of goods and services and unilateral transfers (gifts) among countries. Exports and gifts received are recorded as credits; imports and gifts made are recorded as debits.

ii.The Capital Account: This account records inflows and outflows of capital, both short-term and long-term. These capital flows can be between private parties or between governments. Short-term capital flows correspond to financial instruments with maturities of up to one year. Long-term capital flows consist of both portfolio investments (financial investments) as well as direct investment. Capital inflows are credit items, capital outflows are debit items. An inflow involves either an increase in liabilities to foreigners or liquidation of foreign assets; an outflow involves a reduction in liabilities to foreigners or acquisition of foreign assets.

iii.The Official Reserve Account: This account records changes in foreign exchange reserves and reserves of monetary gold held by the monetary authority. Increases in reserves are debit items, reductions are credit items. 

As said above, corresponding to any sub-group of transactions we can define a concept of deficit or surplus. For instance, "trade balance" refers to excess of merchandise exports over merchandise imports. Thus, "trade deficit" implies that imports of goods exceed exports of goods. Current Account Balance refers to excess of exports of goods and services and transfers received over imports of goods and services and transfers paid. Thus, a surplus on current account implies that the former exceeds the latter.

When one says that BoP is in deficit or surplus one is generally separating the official reserve account from others. If the balance on current and capital accounts taken together is negative we say there is a BoP deficit. This has to be made good by a matching surplus on the official reserve account i.e. a reduction in foreign exchange and gold reserves. This practice is based on the assumption (not always valid) that transactions in the current and capital accounts are autonomous transactions responding to economic forces while official reserve transactions are of a compensating nature.

A number of publications including the RBI monthly bulletin provide balance of payments data. The items to be watched are trade balance and reserve movements, persistent trade deficits and decrease in reserves generally signal a devaluation and/or other measures such as import controls, increases in tariffs, etc. to reverse the trend. 

Posted Date: 9/11/2012 6:55:33 AM | Location : United States







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