It is important to measure the performance of an economy. Balance of Payment (BOP) is one way to do so. It shows the big picture of the total transactions of an economy with other economies. It takes the net inflows and outflows of money into account and then differentiates them into sections. It is important to balance all accounts of BOP in case of an imbalance so that the economic transactions can be measured and taken into account in a systematic and prudent manner.
Balance of Payment is a statement that shows an economy’s transactions with the remaining world in a given duration. Sometimes also called the balance of international payments, BOP includes each and every transaction between a nation’s residents and its nonresidents.
Current Account and Capital Account
All the transactions in BOP are classified into two accounts: the current account and the capital account.
•Current account: It denotes the final net payment a nation is earning when it is in surplus, or spending when it is in deficit. It is obtained by adding the balance of trade (exports earnings minus imports expenses), factor income (foreign investment earning minus expenses for investment in a foreign country) and other cash transfers. The current word denotes that it covers transactions that are happening “here and now”.
•Capital account: It shows net change in foreign-asset-ownership of a nation. The capital account consists the reserve account (the net change of foreign exchange of a nation’s central bank in market operations), loans and investments made by the nation (excluding the future interest payments and dividends yielded by loans and investments). If net foreign exchange is negative, the capital account is said to be in deficit.
BOP data does not include the real payments. Rather, it is involved with the transactions. This means that the figure of BOP may differ significantly from net payments made to an entity over a period of time.
BOP data is crucial in deciding the national and international economic policy. Part of the BOP, such as current account imbalances and foreign direct investment (FDI), are very important issues which are addressed in the economic policies of a nation. Economic policies with specific objectives impact the BOP.