Balance of Payments — Meaning and Components

The Balance of Payments (BOP) is a much wider and more complete concept than the Balance of Trade. It is a systematic statement (record) of ALL economic transactions — not merchandise trade alone — between the residents of one country and the residents of the rest of the world, during a given period, usually a year.

The Balance of Payments is organised into two principal accounts:

1. Current Account. The Current Account records transactions of a recurring, income-generating nature. It has three main components:

• Trade in goods (visible trade) — exports and imports of physical merchandise; this is exactly the same visible trade that the narrower Balance of Trade measures on its own.
• Trade in services (invisible trade) — exports and imports of services such as banking, insurance, shipping, tourism, and software/IT services.
• Income and unilateral transfers — investment income (interest, profits and dividends earned on foreign investments) and unilateral (one-way) transfers such as remittances sent home by Indians working abroad, gifts, and donations, none of which involve a corresponding good or service flowing the other way.

2. Capital Account. The Capital Account records transactions relating to a change in a country's assets and liabilities vis-à-vis the rest of the world — that is, international CAPITAL movements rather than trade in goods/services/income. Its main components include:

• Foreign Direct Investment (FDI) — foreign investors acquiring a lasting stake in domestic businesses.
• Foreign Portfolio Investment (FPI) — foreign investment in domestic shares, bonds and other financial securities.
• External borrowing and lending — loans taken by, or extended by, the country's government and businesses to/from abroad.
• Changes in foreign exchange reserves held by the country's central bank (the Reserve Bank of India, in India's case).

Balance of Payments = Current Account Balance + Capital Account Balance …