BALANCE OF PAYMENT

Meaning
The balance of payments is a comprehensive and systematic record of a country's economic
transactions with the rest of the world, encompassing goods, services, and capital flows
within a specified time frame. It comprises the current, capital, and financial accounts, each
reflecting different types of transactions. It is a statistical record of the character and
dimensions of the country’s economic relationships with the rest of the world. In short,

Balance of payment (BoP) is an accounting statement which records economic transactions

between Normal Resident of a specific country with the rest of the world.

According to Bo Sodersten, “The balance of payments is merely a way of listing receipts and
payments in international transactions for a country”.

The balance of payments is a systematic record of economic transactions between a country's

residents and the rest of the world. It shows the relationship between a country's payments to
other countries and its receipts from them, providing a statement of income and expenditure
on international account. The balance-of-payments account records a country's international
trading performance and capital flows, balancing supply and demand. The account's price
depends on the magnitude of items in the account.
Principles of Balance of Payment
Balance-of-payments accounting is a method of recording transactions that affect currency
supply or demand in foreign exchange markets. It uses double-entry bookkeeping,
representing every debit or credit as a credit or debit elsewhere. For example, an American
corporation selling jeans to Britain results in a double entry in the US account, with
transactions causing a demand for US dollars being recorded as a credit.

Features
a. It is a systematic record of all economic transactions between one country and the rest
of the world.
b. It includes all transactions, visible as well as invisible.
c. It relates to a period of time. Generally, it is an annual statement.
d. It adopts a double-entry book-keeping system. It has two sides: credit side and debit
side. Receipts are recorded on the credit side and payments on the debit side

Structure of Balance of Payments

The following are the main components that form the basis of the structure of balance of
payments.
1. Current Account: The current account is useful for monitoring inflow and outflow of
goods and services. Therefore it focuses on income and spending during trade. Thus,
this account covers all the payments and receipts that are made with respect to
manufactured goods and raw materials. Furthermore, it also includes receipts from
tourism, engineering, business services, transportation, etc.There are many categories
of trades that occur between the countries. These trades could be visible or invisible.
When trades happen in goods between the countries than it is called as visible items.
While the trade happening in import or exports of services, is referred to as invisible
items.
 2. Trade Balances: Trade Balances are the difference between Exports and Imports of
visible goods. These items can be touched, seen and measured. It shows whether a
nation enjoys surplus or deficit.
3. Capital Account: capital account deals with the movement of long- and short-term
capital. For example, a Nigerian investor exporting capital to Britain and buying
bonds in the US requires acquiring dollars. The capital transactions that occur
between the countries are monitored under the capital account. Thus, capital
transactions include the sale and purchase of assets like properties. Furthermore, the
capital account also includes the flow of taxes, sales and purchases of fixed assets for
a migrant moving in or out of the country. The three major elements of the capital
account are investments, foreign exchange reserves, and loans and borrowings.
4. Account of Financing: The surplus or deficit on account of current account, capital
account and errors or omissions is financed or bridged up through external assistance
(loans), gross drawing from the IMF, allocation of SDRs and increase (-) or decline
(+) in reserves.The different components of balance of payments account that form
the basis of the structure of balance of payments of India can be shown through the
following Table:

Equilibrium
Equilibrium in the balance of payments is said to exist when the values of the credit items in
the balance of payments account exactly match the value of the debit items. That is to say, the
country's receipts and payments with the rest of the world are equal. It should be noted that
the balance of payments equilibrium is not always possible. A balance of payments surplus,
arises when the items on the credit side are greater than the debit items. This means that the
country's reserves are increasing. A deficit in the balance of payments account arises where
the items on the debit side are greater than the items on the credit side. This means that the
nation is spending more than it is earning. A deficit means the reserves of the central bank are
running down or its foreign indebtedness is rising.
Types of Balance of Payment
Balance of Payment is classified into as:
1. Favourable Balance of Payments: Excess of goods and services exported plus capital
transferred to abroad over the goods and services imported and capital transfers from
abroad is known as favourable balance of payments
2. Unfavorable balance of payments: An imbalance in a nation's balance of payments in
which payments made by the country exceed payments received by the country. This
is also termed a balance of payments deficit.

Balance of payments surplus

A balance of payments surplus means that the flow of resources into the country from the rest
of the world is greater than the outflow of resources from the country in the period under
consideration. It can be regarded as a situation in which the country exports more than she
exports during a given period. A balance of payments surplus is always a thing of joy to a
country because it implies that citizens of the country would be better off. A balance of
payments surplus often brings about the following economic effects to a country and her
citizens:
a. Greater net income
b. Debt retirement
 c. Accelerating of economic activities
d. Inflationary tendency
Balance of payments deficit
A balance of payments deficit means a country is importing more than she is exporting,
implying that more resources go out of the country than come into the country during the
period under consideration. It is clear that a balance of payments deficit does not augur well
for the economy of a country. As a result, once a deficit occurs in the balance of payments,
the government quickly takes a number of measures to rectify the deficit.
Causes of balance of payments deficit
a. Loss of market. Since the balance of payments is the relationship between receipts
and payments of a country, a fall in the level of the country's exports will lead to
poor export earnings, with a negative impact on the balance of payments.
b. Excessive visible imports over invisible imports. Any time there is a rise in the level
of imports without a corresponding increase in exports, a balance of payments deficit
will likely occur. This was evident in Nigeria in the early 80s when excessive
importation led to the country experiencing balance of payments disequilibrium.
c. Exchange rate. A country with an over-valued currency will likely import more and
export less and vice versa. This would lead the country to pay more than it is
receiving and as a result, experience a balance of payments deficit.
d. Level of domestic prices. A country with a high level of inflation is most likely to
have balance of payments disequilibrium. As a result, its exports will fall and its
imports will rise.
e. Interest rate. A high interest rate attracts foreign capital and, hence, a favourable
balance of payments. However, low rates of interest could lead to capital flight and
this would cause a state of disequilibrium.
f. Income growth. An increase in a nation's income will usually cause increased demand
for imports. This would adversely affect the balance of payments.
Factors that Influence Balance of Payment
Several factors influence the balance of payments, and these factors can be broadly
categorized into structural, economic, and policy-related factors. Here are some key factors:
a. Conditions of foreign lenders: The conditions set by foreign lenders, such as interest
rates, repayment terms, and lending criteria, can influence a country's borrowing
behavior. If foreign lenders tighten their lending conditions, it may become more
difficult or expensive for a country to borrow money from abroad, affecting its capital
inflows and thus its balance of payments.
b. Economic policy of Government: Government economic policies, including fiscal
policy (related to government spending and taxation) and monetary policy (related to
interest rates and money supply), can significantly impact the balance of payments.
For example, expansionary fiscal or monetary policies aimed at stimulating domestic
demand may lead to higher imports, affecting the current account balance.
Conversely, contractionary policies may reduce imports but could also dampen
economic growth and affect the capital account.
c. Cost of production: The cost of production, including labor costs, utilities, and other
inputs, can influence a country's competitiveness in international markets. Higher
production costs relative to other countries may reduce exports and increase imports,
affecting the trade balance and, consequently, the overall balance of payments.
 d. Availability of raw materials: The availability and cost of raw materials can affect a
country's export competitiveness and import dependence. A country with abundant
and cheap access to raw materials may have a comparative advantage in certain
industries, boosting exports and improving the trade balance. Conversely, shortages or
high prices of essential raw materials may increase import costs and negatively impact
the balance of payments.
e. Prices of goods manufactured at home: Domestic price levels, including inflation
rates, can influence the competitiveness of domestically produced goods in both
domestic and international markets. If domestic prices rise faster than those of trading
partners, it may reduce export competitiveness and increase demand for imports,
affecting the trade balance and the overall balance of payments.
f. Trade Balance: The trade balance, representing the difference between exports and
imports, is a significant factor influencing the current account of the balance of
payments. A trade surplus (exports exceeding imports) contributes positively, while a
trade deficit has the opposite effect.
g. Exchange Rates: Fluctuations in exchange rates can impact a country's trade balance.
A weaker domestic currency may boost exports but increase the cost of imports,
potentially affecting the current account balance.
h. Economic Growth: The overall economic performance of a country, including its
GDP growth rate, can influence the balance of payments. Strong economic growth
may lead to increased exports, potentially widening the trade deficit.
i. Interest Rates: Differentials in interest rates between countries can affect capital
flows, impacting the financial account of the balance of payments. Higher interest
rates may attract foreign investment, while lower rates may lead to capital outflows.
j. Foreign Direct Investment (FDI): The level of foreign direct investment in a
country affects the capital account. Higher FDI inflows contribute positively, while
significant outflows may have a negative impact.
k. Government Policies: Fiscal and monetary policies implemented by governments
can influence the balance of payments. For instance, expansionary fiscal policies may
stimulate imports, while contractionary policies may have the opposite effect.
l. Terms of Trade: Changes in a country's terms of trade, reflecting the ratio of export
prices to import prices, can impact the trade balance. Improvements in terms of trade
can boost the value of exports relative to imports.
m. Inflation Rates: Disparities in inflation rates between countries can affect
competitiveness and trade balances. Lower inflation rates may enhance a country's
export competitiveness, while higher inflation can increase import costs.
n. Speculation and Investor Confidence: Perceptions of political stability, economic
prospects, and overall investor confidence influence capital flows. Positive sentiments
can attract foreign investment, while uncertainty may lead to capital flight.
o. Global Economic Conditions: Global economic trends, such as recessions or periods
of strong growth, can impact a country's trade balance. Reduced demand during
global downturns may lead to a decline in exports.
p. Technological Changes: Advances in technology can influence trade patterns and
competitiveness. Countries that embrace technological innovation may experience
shifts in their comparative advantages, affecting trade balances.
q. External Shocks: Unexpected events, such as natural disasters, geopolitical conflicts,
or health crises, can have significant and immediate effects on a country's balance of
payments by disrupting trade and financial flows.
Importance of Balance of Payment
A balance of payment is an essential document or transaction in the finance department as it
gives the status of a country and its economy. The importance of the balance of payment can
be calculated from the following points:
1. It reveals the economic and financial details of a country.
2. The BOP statement can be an indicator to determine whether the currency of a
country is appreciating or depreciating.
3. BOP helps the government on trade and fiscal policies.
4. It provides important information to understand and analyze the economic dealings of
one country with the other.
5. The government can formulate appropriate policies to divert the funds and technology
imported to the critical sectors of the economy that can drive future growth.
Advantages of Balance of Payment
The balance of payments (BoP) is a vital economic indicator that provides valuable insights
into a country's economic health and its interactions with the rest of the world. While the BoP
is not necessarily advantageous in itself, it offers several benefits and advantages in terms of
economic analysis, policy formulation, and understanding a nation's external financial
position. Here are some advantages of the balance of payments:
a. The BOP provides a comprehensive view of a country's economic performance,
including its current, capital, and financial accounts, enabling a holistic assessment of
its global transactions.
b. Policymakers and economists can identify trade imbalances by analyzing the current
account, which is crucial for understanding a country's global market competitiveness
and reliance on foreign goods and services.
c. BOP data is utilized by governments and central banks for policy formulation, such as
addressing persistent trade deficits by increasing exports or reducing imports.
d. BOP data aids countries in managing their foreign exchange reserves, enabling
policymakers to evaluate currency inflows and outflows, thereby influencing
monetary policy decisions.
e. A well-managed balance of payments is crucial for macroeconomic stability, as it
prevents excessive trade deficits or surpluses, which can lead to economic
imbalances, inflation, or deflation.
f. BoP data aids in forecasting economic trends by analyzing its components, enabling
economists to predict future economic conditions, risks, and opportunities.
g. Positive BoP indicators, like a surplus in the current account, can boost investor
confidence, thereby boosting foreign investment in a country.
h. BoP data aids in comprehending a nation's global economic relationships, identifying
key trading partners, assessing the influence of global economic conditions, and
highlighting the interconnectedness of financial markets..
i. Governments can use BoP data to assess trade policy effectiveness, enabling informed
adjustments to tariffs, quotas, and other trade barriers, thereby enhancing balance of
payments.
j. BoP data aids in global economic policy coordination, identifying cooperation areas
and managing international economic relations to achieve mutual benefits and
stability.
Challenges of Balance of Payment
The balance of payments (BoP) faces several challenges that can impact a country's economic
stability and financial health. These challenges arise from various economic, structural, and
policy-related factors. Here are some of the key challenges associated with the balance of
payments:
a. Trade imbalances can lead to external financing reliance and currency appreciation,
impacting export competitiveness and potentially causing chronic deficits or
surpluses.
b. Exchange rate fluctuations can significantly affect the balance of payments, affecting
import and export costs, causing uncertainties for businesses and policymakers.
c. High external debt accumulation can strain a country's balance of payments,
necessitating foreign exchange for servicing and potentially leading to a debt crisis if
payment obligations are not met.
d. The abrupt outflow of capital, known as capital flight, can have adverse effects on the
balance of payments, resulting from economic uncertainties, political instability, or
shifts in investor sentiment.
e. Global economic conditions, including downturns in major trading partners, can
reduce export demand, impact export earnings, and negatively impact a nation's
balance of payments.
f. Unforeseen events like natural disasters, geopolitical tensions, or global health crises
can disrupt international trade and financial flows, causing severe impacts on a
country's balance of payments.
g. Trade barriers such as tariffs and restrictions can hinder global trade, have adverse
effects on a nation's balance of payments, and may result in retaliatory measures and
disruptions.
h. Dependency on Commodity Prices. Countries heavily reliant on exports of
commodities are vulnerable to price fluctuations. Volatility in commodity prices can
impact export earnings, leading to challenges in maintaining a favorable balance of
payments.
i. Inadequate Foreign Exchange Reserves. Insufficient foreign exchange reserves may
limit a country's ability to stabilize its currency during times of volatility. This can
expose the nation to external pressures and challenges in managing the balance of
payments.
j. Policy Misalignment: Inconsistent or poorly coordinated fiscal, monetary, and trade
policies can contribute to imbalances in the balance of payments. Misalignment in
policies may exacerbate trade deficits, inflation, or other economic challenges.
k. Structural Issues: Structural factors, such as an overreliance on a few key industries,
limited economic diversification, or inadequate infrastructure, can contribute to trade
imbalances and hinder a country's ability to maintain a stable balance of payments.
l. Limited Export Competitiveness: Challenges related to the competitiveness of a
country's exports, including issues such as high production costs, lack of innovation,
or quality concerns, can impede efforts to improve the trade balance.
Measures of Correcting Balance of Payments Deficit
Countries typically aim for a surplus balance, but a deficit can be a concern due to its cause.
Deficits can be due to foreign loans or investments, strengthening the country's future current
account. Persistent balance of payments deficits pose a greater threat, especially for
developing countries.
a. Borrowing: A country with a deficit, as part of temporary measures, can borrow to
finance the deficit. This entails borrowing from the IMF, international credit
organisations (London Club or Paris Club), or from other wealthy countries (US,
Germany: France, etc. ). Equally, a country can raise domestic loans denominated in
foreign currencies.
b. Reducing imports: The country can also reduce imports, especially if the deficit is in
the current account. This can be done by the use of tariffs or quotas on imports,
thereby restoring balance of payments equilibrium.
c. Controlling the flow of capital: If a deficit in the balance of payments is reducing
the nation's reserves, this may be relieved by government restrictions on investment
and other capital flow abroad. However, this measure can only be used when the
deficit is in the capital account. In any case, restricting the flow of capital does
nothing to relieve a deficit on current account, the crucial part of balance of payments.
d. IMF loan: The country can equally seek assistance from the International Monetary
Fund (IMF) through the special facilities normally given by the fund to countries with
balance of payments deficits.
e. Expanding exports: Export expansion is the ideal solution to a current account
deficit since it avoids the need to cut back on imports. Direct government subsidies to
exporters may be given to encourage firms to export, for instance, by giving them tax
incentives. The government could also try to assist exporters by helping to promote
and advertise their products through trade fairs, exhibitions, providing information
about overseas markets, arranging loans on favourable rates of interest, and so on. In
Nigeria, the Nigerian Export Promotion Council was established as part of this
measure.
f. Deflation: This can be achieved through a tight monetary policy to retard inflation
and drive up interest rates (at least in the short run). The tight monetary policy can
reduce the country's rate of inflation and thereby lower its prices relative to those in
other countries. This would make its exports relatively cheaper than they were before
(if other nations did not enact a tight monetary policy), promote exports and
discourage imports, as well as generate a flow of investment funds into the country
since interest rates are higher.
g. Devaluation: This is seen as the last resort, which means a reduction in the value of a
nation's currency (that is, the rate at which it can be changed into other currencies).
Suppose the rate of exchange between the naira and the dollar was originally $1 =
N100, an American product priced at $100 would then sell in Nigeria for N10,000
(assuming that there are no transport costs). Now suppose the dollar is devalued to
N50 a dollar. The same product would now cost N5,000 in Nigeria. By devaluing a
currency, countries make their products cheaper to foreigners and so encourage their
exports. Similarly, devaluation makes imports more expensive, since it makes the
local currency cheaper, so that the citizens of other countries will give less of their
currencies to purchase goods from the country with a devalued currency.
Problems of devaluation
 a. Devaluation's success hinges on foreign demand responsiveness to cheaper export
prices, requiring elastic demand; however, if imported goods have price inelastic
demand, devaluation may fail to reduce imports effectively.
b. Devaluation, employed to correct a balance of payments deficit, raises the cost of
living, particularly in import-dependent countries, and negatively impacts domestic
markets by diverting goods for export.
c. Devaluation triggers inflation by increasing the cost of imported machines and raw
materials, prompting domestic industries to raise prices to compensate for the
heightened costs.
d. Devaluation results in a decrease in government revenue due to reduced imports,
impacting overall fiscal health.
e. Devaluation contributes to a deterioration in a country's terms of trade, as the
currency's devaluation results in lower export earnings and higher import costs,
negatively affecting the balance of trade.

Balance of Trade
The difference between a country's imports and its exports. Balance of trade is the largest
component of a country's balance of payments. Debit items include imports, foreign aid,
domestic spending abroad and domestic investments abroad. Credit items include exports,
foreign spending in the domestic economy and foreign investments in the domestic economy.
When exports are greater than imports than the BOT is favourable and if imports are greater
than exports then it is unfavourable Balance of Trade V/s Balance of Payment The Balance of
Payment takes into account all the transaction with the rest of the worlds The Balance of
Trade takes into account all the trade transaction with the rest of the worlds
BOP v/s BOT
BOP:
Features
a. It is a broad term.
b. It includes all transactions related to visible, invisible and capital transfers.
c. It is always balances itself.
d. BOP = Current Account + Capital Account + or - Balancing item (Errors and
omissions)
e. all the factors of BOT BOT 1. It is a narrow term. 2. It includes only visible items. 3.
It can be favourable or unfavourable. 4. BOT = Net Earning on Export - Net payment
for imports. 5. Following are main factors which affect BOT
Following are main factors which affect BOT
a. Exchange Rates: Exchange rate fluctuations affect the competitiveness of exports
and imports. A strong domestic currency can make exports more expensive for foreign
buyers, leading to a trade deficit, while a weaker currency can boost exports and
reduce the trade deficit.
b. Economic Growth: Economic growth influences demand for goods and services,
both domestically and internationally. Strong economic growth typically leads to
increased imports, while sluggish growth may constrain import demand.
c. Relative Prices: Price levels in domestic and foreign markets impact the
competitiveness of goods. Changes in relative prices, including inflation rates and
production costs, affect export and import volumes.
d. Trade Policies: Trade policies, including tariffs, quotas, subsidies, and trade
agreements, influence the flow of goods across borders. Protectionist measures can
distort trade patterns and affect the balance of trade.
 e. Global Demand and Supply: Changes in global demand for specific products or
shifts in global supply chains affect export and import volumes. Market trends,
consumer preferences, and technological advancements also play a role.
f. Government Interventions: Government interventions such as export subsidies,
import tariffs, and currency interventions can directly impact the balance of trade by
altering the cost and competitiveness of goods in international markets.

Importance of Balance of Trade:

1. Economic Indicator: The balance of trade serves as a vital economic indicator,
reflecting a country's trade performance and its impact on the overall economy. It
provides policymakers, analysts, and investors with valuable insights into a nation's
economic health, competitiveness, and external trade relationships.
2. Trade Policy Formulation: Governments use information from the balance of trade
to formulate and adjust trade policies. Surpluses or deficits in the balance of trade
may prompt policymakers to implement measures aimed at promoting exports,
reducing imports, or addressing structural imbalances in the economy.
3. Currency Valuation: The balance of trade influences currency valuation. A trade
surplus typically leads to an appreciation of the country's currency, as higher demand
for exports increases the demand for the national currency. Conversely, a trade deficit
may lead to currency depreciation, making exports more competitive in international
markets.
4. Impact on Employment and Growth: A favorable balance of trade, indicated by a
trade surplus, can contribute to economic growth and job creation by boosting export-
oriented industries. Conversely, persistent trade deficits may lead to job displacement
in domestic industries facing stiff competition from imports.
Advantages of Balance of Trade:
1. Export Promotion: Monitoring the balance of trade helps identify export
opportunities and areas of comparative advantage. Governments can implement
policies to support export-oriented industries, such as providing subsidies, enhancing
trade infrastructure, or negotiating trade agreements.
2. Competitiveness Assessment: Analyzing the balance of trade allows countries to
assess their competitiveness in international markets. By understanding trade patterns
and market dynamics, policymakers and businesses can make informed decisions to
improve productivity, quality, and innovation to remain competitive globally.
3. Foreign Exchange Reserves: Trade surpluses contribute to the accumulation of
foreign exchange reserves, which can be used to stabilize currency markets, finance
imports during times of economic downturns, or repay foreign debts.
Challenges of Balance of Trade:
1. Structural Imbalances: Persistent trade deficits or surpluses may indicate underlying
structural imbalances in the economy, such as overreliance on imports, lack of
competitiveness in certain industries, or inadequate investment in export-oriented
sectors.
 2. Trade Barriers and Protectionism: Trade barriers, tariffs, quotas, and other
protectionist measures imposed by trading partners can hinder exports and distort the
balance of trade. Negotiating favorable trade agreements and addressing trade barriers
require diplomatic efforts and strategic negotiations.
3. Volatility and External Shocks: Fluctuations in global demand, commodity prices,
exchange rates, and geopolitical events can lead to volatility in the balance of trade.
Sudden changes in trade conditions can affect export revenues, import costs, and
overall economic stability.
Differences between Balance of Payment and Balance of Trade
The balance of payments (BOP) and balance of trade (BOT) are crucial economic indicators
used to evaluate a country's international economic transactions.
a. BOT focuses on trade in goods between a country and its trading partners, while BOP
includes all economic transactions over a specific period.
b. The Balance of Trade (BOT) focuses on goods trade, while the Balance of Payments
(BOP) includes services, income flows, and unilateral transfers, providing a
comprehensive view of a country's economic interactions with the global market.
c. The BOT reflects a country's competitiveness in international markets and its ability
to export more than it imports. The BOP, on the other hand, assesses a country's
overall economic health and external financial position, considering earnings from
investments, capital flows, and external debt.

Accounting Principle of Balance of Payment/ Conceptual Framework of the Balance of

Payments
Basic Conventions
A country’s balance of payments tracks payments to and receipts from nonresidents.
According to the Manual, the balance of payments is “a statistical statement that
systematically summarizes, for a specific time period, the economic transactions of an
economy with the rest of the world.” Various conventions for recording items in the balance
of payments are presented below.
The Double-Entry Accounting System
The basic convention applied in constructing a balance of payments is the double-entry
accounting system. Every transaction recorded using this system is represented by two entries
with equal values but opposite signs, a debit (−) and a credit (+). Thus, by convention, certain
items are recorded as debits and others as credits, as follows:
View Table
With double-entry bookkeeping, the sum of all credits should be identical to the sum of all
debits, and the overall total should equal zero. In this sense, the balance of payments is
always in balance. The example in Box 4.1 illustrates how a shipment of cars exported from
Russia to Poland and involving a payment by a Polish importer through the banking system is
recorded under the above conventions.
Some key points in balance of payments accounting are:
1. Real and financial transactions. “Real” flows involve transactions in goods and
services (such as imports, exports, travel, and shipping). Such transactions contrast
with financial transactions, or changes in levels of financial assets and liabilities
(for example, the repayment of principal on an outstanding loan constitutes a
reduction in a liability). Transactions in goods and services are recorded in the
current account of the balance of payments. Financial transactions are recorded in
the capital and financial account of the balance of payments.
2. Transfers. Unrequited transfers across national borders are one-sided transactions.
Suppose, for example, that the Japanese government donates to the Kyrgyz
Republic buses for public transportation. To deal with such transactions, which
involve no financial compensation, the balance of payments methodology includes
a category called “transfers.” This convention allows one-sided transactions to be
converted to standard two-sided transactions. The donated buses are recorded as an
import (debit) in the accounts of the Kyrgyz Republic, having been “paid for” by a
transfer (credit). More generally, all transfers with an economic value, when no
quid pro quo is involved, give rise to a counterentry, either a current or a capital
transfer. Current transfers include cash transfers, gifts in kind (such as food and
medicines), contributions to international organizations, and remittances sent by
workers residing abroad to families back home. Capital transfers may be in cash
(investment grants) or in kind (debt forgiveness).
3. Errors and omissions. In practice, accounts tend not to balance, largely because
data are derived from different sources or because some items are underrecorded or
not recorded at all. All balance of payments accounts contain the item “net errors
and omissions,” which reflects errors in estimation and omissions of transactions
that should have been recorded. Entries are recorded net because of the possibility
that credit errors will offset debit errors—that is, an underestimation of exports may
be partly offset by an underestimation of imports. Since credit and debit errors may
offset each other, the size of the net residual cannot be taken as an indicator of the
relative accuracy of the balance of payments statement. Nonetheless, large and
persisting net residuals impede the interpretation and analysis of the balance of
 payments for an individual country. Analogously, at the level of the world as a
whole, recording discrepancies in one country are not offset by under- or
overestimation in other countries.
4. Flows and stocks. The balance of payments accounts record flows in two
directions. These flows are distinguished from the stocks associated with a
country’s international investment position—that is, the value of a country’s assets
and liabilities vis-à-vis the rest of the world. The former are measured for a specific
time period, whereas the latter are recorded at a point in time, often the end of the
year. Two stocks discussed in this workshop are the level of international reserves
(external assets of a country) and the level of external debt (a liability).
Box 4.1.
An Example of Double-Entry Accounting

View Table
Residency
The concept of residency in the balance of payments is based on the transactor’s center of
economic interest, not on the transactor’s nationality. This practice follows the System of
National Accounts (SNA) studied in Chapter 2. The main considerations relating to economic
territory are as follows:
1. Individuals living in a country are generally considered residents if they have resided
there for at least 12 months. Nonresidents include visitors (tourists, crews of ships or
aircraft, and seasonal workers); border workers (who are considered to be residents of
the country in which they live); diplomats and consular representatives; and members
of armed forces stationed in a foreign country, irrespective of the duration of their
stay.
2. Enterprises are considered residents of the economy where they are engaged in
business, provided they have at least one productive establishment and plan to operate
it over a long period of time. Therefore, subsidiaries of foreign-owned companies are
considered to be resident in the country in which they are located.
3. General government, including all agencies of the central, regional, and local
governments, together with embassies, consulates, and military establishments located
outside the country, are considered to be resident.
4. Time Periods and the Timing of Recording. In principle, the time period for
recording balance of payments flows may be of any length. However, it is usually
dictated by practical considerations, especially the frequency of data collection. Many
countries prepare balance of payments data annually because firm estimates for some
balance of payments transactions are available only once each year. However, since
other data (for example, for exports and imports) are often available quarterly and
sometimes monthly, some countries prepare quarterly balance of payments data
consistent with quarterly estimates of the national accounts.By convention, both
parties to an international transaction record it when there is a legal change of
ownership. In principle, both parties record the same transaction simultaneously,
according to the principles of accrual accounting (when transactions such as interest
payments are due to be settled, not when cash settlements are made). In practice,
trade, service, and financial transactions may be recorded at different times by the two
parties, so that adjustments need to be made to the original data derived from trade
returns, exchange records, or enterprise surveys.
Valuation
A balance of payments transaction should be valued at the market price, which reflects the
terms of a specific exchange between a willing buyer and a willing seller. The market price is
distinguished from a general price indicator (such as a world market price) for a specific
commodity. In practice, this definition creates difficulties in recording certain transactions,
including:
 Barter transactions, which involve a direct exchange of goods for other goods
rather than for money;
 Transactions between affiliated enterprises (for example, profit transfers between a
subsidiary and the parent company); and
 Transfers, which often do not have a market price.
Proxy measures are used to record these kinds of transactions. For example, bartered goods
are valued at market prices.
Exports and imports are shown f.o.b. (free on board), or excluding the cost of transportation
beyond national borders. Imports are usually recorded by customs on a c.i.f. basis (including
the cost of international insurance and freight). However, in the balance of payments
accounts, the insurance and freight components are recorded under “services.”
Unit of Account
Since transactions may be settled in any currency, an appropriate unit of account is required
for recording balance of payments transactions. Although the national currency can be used,
its analytical value loses significance over time as the exchange rate fluctuates. For this
reason, balance of payments accounts are often expressed in terms of a stable foreign
currency (such as the U.S. dollar or the SDR), facilitating comparisons across countries. The
appropriate exchange rate (the market rate prevailing on the transaction date) is used to
convert data from the currency used in a transaction into the unit of account currency.3

Disequilibrium of Balance of Payment

When a country’s current account is at a deficit or surplus, its balance of payments (BOP) is
said to be in disequilibrium. A disequilibrium in the balance of payment
means its condition of Surplus Or deficit. A Surplus in the BOP occurs when Total Receipts
exceeds Total Payments. Thus, BOP= CREDIT>DEBIT. A Deficit in the BOP occurs when
Total Payments exceeds Total Receipts.
Thus, BOP= CREDIT<DEBIT.
Types of Disequilibrium of Balance of Payment
Broadly speaking, there are five different types of disequilibrium in the BOP:
 Cyclical Disequilibrium.
 Secular Disequilibrium.
 Structural Disequilibrium.
 Short run Disequilibrium.
 Fundamental Disequilibrium
a. Cyclical Disequilibrium: Cyclical Disequilibrium in the BOP arises due to the
influences of cyclical fluctuations. Cyclical Disequilibrium in the BOP occur as a
result of business cycle/Trade cycle follow different paths and patterns in different
countries
b. Secular Disequilibrium: Secular disequilibrium in the balance of payments is a
longterm, phenomenon, caused by persistent, deep-rooted dynamic changes that
slowly take place in the economy over a long period of time. It may be caused by
changes in several dynamic forces or factors such as capital formation, population
growth, technological changes etc.
c. Structural Disequilibrium: Structural disequilibrium arises from structural changes
occurring in few sectors of the economy at home or abroad which may alter the
 demand for supply conditions for exports or imports or both. A change in foreign
demand for exports can arise from a change in technology, the invention of the
cheaper substitute. Structural disequilibrium is caused by changes in technology,
tastes and attitude towards foreign investment. Political disturbances, strikes,
lockouts, etc., which affect the supply of exports, also cause structural disequilibrium.
d. Short run Disequilibrium: Disequilibrium caused on a temporary basis for a short
period, say one year is called short run disequilibrium. Such disequilibrium does not
pose a serious threat as it can be overcome within a short run. Such an disequilibrium
may be caused due to international borrowing and lending. When a country goes for
borrowing or lending it leads to short run disequilibrium. Such disequilibrium is
justified as they do not pose a serious threat
e. Fundamental or Long Run Disequilibrium: The term fundamental disequilibrium has
been originally used by the I.M.F., to indicate a persistent and long-term
disequilibrium in a country’s balance of payments. Fundamental disequilibrium is
generally caused by dynamic factors and particularly leads to chronic deficit in the
balance.
Causes of Disequilibrium in Balance of Payment
The following are the important causes producing disequilibrium in the balance of
payments of a country:
a. Trade Cycles: Cyclical fluctuations, their phases and amplitudes, differences in
different countries, generally produce cyclical disequilibrium
b. Huge Developmental and Investment Programmes: Huge development and
investment programmes in the developing economies are the root causes of the
disequilibrium in the balance of payments of these countries. Their propensity to
import goes on increasing for want of capital for rapid industrialisation; while exports
may not be boosted up to that extent as these is the primary producing countries.
c. Changing Export Demand: A vast increase in the domestic production of foodstuffs,
raw materials, substitute goods, etc. in advanced countries has decreased their need
for import from the agrarian underdeveloped countries. Thus, export demand has
considerably changed, resulting in structural disequilibrium in these countries.
d. Population Growth: High population growth in poor countries also had adversely
affected their balance of payments position. It is easy to see that an increase in
population increases the needs of these countries for imports and decreases the
capacity to export.
e. Huge External Borrowings: Another reason for a surplus or deficit in the balance of
payments arises out of international borrowing and investment. A country may tend to
have an adverse balance of payments when it borrows heavily from another country,
while the lending country will tend to have a favourable balance and the receiving
country will have a deficit balance of payments.
f. Inflation: Owing to rapid economic development, the resulting income and price
effects will adversely affect the balance of payments position of a developing country.
With an income, the marginal propensity to import being high in these countries, their
demand for imported articles will rise.
g. Demonstration Effect: Demonstration effect is another most important factor causing
deficit in the balance of payments of a country — especially of an underdeveloped
country. When people of underdeveloped nations come into contact with those of
advanced countries through economic, political or social relations, there will be a
demonstration effect on the consumption pattern of these people and they will desire
to have western style goods and pattern of consumption so that their propensity to
import increases, whereas their export quantum may remain the same or may even
 decline with the increase i in income, thus causing an adverse balance of payments for
the country.
h. Reciprocal Demands: Since intensity of reciprocal demand for products of different
countries differs, terms of trade of a country may be set differently with different
countries under multi-trade transactions which may lead to disequilibrium in a way

Measures to Correct Disequilibrium in Balance of Payment

Following are the main methods of Correct Disequilibrium in Balance of Payments:
a. Monetary Policy: The monetary policy is concerned with money supply and credit in
the economy. The Central Bank may expand or contract the money supply in the
economy through appropriate measures which will affect the prices.
b. Fiscal Policy: Fiscal policy is government's policy on income and expenditure.
Government incurs development and non - development expenditure. It gets income
through taxation and non - tax sources. Depending upon the situation government
expenditure may be increased or decreased.
c. Exchange Rate Depreciation: By reducing the value of the domestic currency,
government can correct the disequilibrium in the BOP in the economy. Exchange rate
depreciation reduces the value of home currency in relation to foreign currency. As a
result, import becomes costlier and export becomes cheaper. It also leads to
inflationary trends in the country.
d. Devaluation: devaluation is lowering the exchange value of the official currency.
When a country devalues its currency, exports become cheaper and imports become
expensive which causes a reduction in the BOP deficit. Deflation: Deflation is the
reduction in the quantity of money to reduce prices and incomes. In the domestic
market, when the currency is deflated, there is a decrease in the income of the people.
This puts curb on consumption and government can increase exports and earn more
foreign exchange.
e. Exchange Control: All exporters are directed by the monetary authority to surrender
their foreign exchange earnings, and the total available foreign exchange is rationed
among the licensed importers. The license-holder can import any good but amount if
fixed by monetary authority.
f. Export Promotion: To control export promotions the country may adopt measures to
stimulate exports like: export duties may be reduced to boost exports; cash assistance,
subsidies can be given to exporters to increase exports; goods meant for exports can
be exempted from all types of taxes.
g. Import Substitutes: Steps may be taken to encourage the production of import
substitutes. This will save foreign exchange in the short run by replacing the use of
imports by these import substitutes.
h. Import Control: Import may be kept in check through the adoption of a wide variety
of measures like quotas and tariffs. Under the quota system, the government fixes the
maximum quantity of goods and services that can be imported during a particular time
period.
Is Balance of Payments Always in Equilibrium?
Balance of payments always balances means that the algebraic sum of the net credit and
debit balances of current account, capital account and official settlements account