Definition of Balance of Payments (BOP)

The balance of Payments of a country is a record of all financial transactions between residents of that country and residents of foreign countries. (Residents‟ in this sense does not just refer to individuals but would also include companies, corporations and the government). Thus all transactions are recorded whether they derive from trade in goods and services or transfer of capital.
Like all balance sheets, the balance of payments is bound to balance. For if the country has “overspent” then it must have acquired the finance for this “overspending” from somewhere (either by running up debts or using its reserves) and when this item is included in the accounts they will balance. It follows, therefore that when reference is made to a balance of payments “deficit” or “surplus” this only looks at a part of the total transactions eg. that part involving trade in goods and services which is termed the
“balance of Payments on current account”.
If the value of exports exceed the value of imports the balance of payments is said to be in Trade Surplus. This is regarded as a favourable position because a persistent trade surplus means the country’s foreign exchange reserves are rising and so its ability to pay for its imports and settle its international debts. Also persistent balance of payments trade deficit is regarded as a sign of failure in the country’s trade with other countries and is therefore politically undesirable.
The structure of the Balance of Payments takes three forms: current, capital and monetary accounts.
The current account reflects transactions involving recently produced goods and services rendered.
These include the visible and invisible trade transactions. Invisibles cover services such as insurance, shipping and tourism. The account also includes transfer of interest, profits, dividends currently earned on assets abroad and other transfers such as gifts and migrant remittances, thus the current account records the imports and exports of goods and services and all the net private and government transfers.
The capital account records movements of capital goods, investment and other short term capital movement. All payments arising from transfers of capital or assets plus the extension of credit official or private fall under the capital account.
At this point a line is drawn to reflect the balance of all transactions current and capital struck and the out turn which may be a surplus or deficit is described as the balance for official financing. The monetary account is then a balancing account including changes in foreign reserves. This section shows all those official transactions including the use of or the addition to the external reserves and the use of funds borrowed from the IMF or other governments, the purpose of which is to accommodate or finance the
balance on current and capital items.

The processes leading to deficits are associated with:

  • Excessive imports over exports,
  • Excessive capital outflows; and
  • Overvalued domestic currencies

Some steps necessary to correct the situation:

  • Limitation of imports through import substitution
  • Some degree of devaluation/depreciation
  • Improvement of the balance on capital account through encouraging more capital inflows (in form or FDI‟s foreign aid etc).
  • Expanding the stock of official reserves.

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