Concept and Importance of Balance of Payment

Balance of payment:

Balance of payment is defined as the systematic record of receipt and payment of a country with the rest of the world. It is a broader concept than the balance of trade because it includes both import and export of visible and invisible items. Visible items include import and export of physical goods. On the other hand, invisible items include all the services exported and imported such as banking, insurance, investment, donation, etc.

According to Kindle Berger, "Balance of payment of a country is a systematic record of all the economic transactions concerning goods, services, and capital flow between its residents and residents of a foreign country.”

In the words of R. G. Lipsey and K. A. Chrystal, "Balance of payment is a summary of a country's transactions involving payments, and receipts of foreign exchange."

Features of the balance of payment:

Balance of payment has the following features:

1. It is a systematic record of all the economic transactions between one country and the rest of the world. , '

2. It includes all the transactions: visible and invisible.

3. It is the annual statement.

4. It adopts a double bookkeeping system. It has two sides: the credit side and the debit side. Receipts are recorded on the credit side and payments on the debit side.

5. In the accounting sense, total credits and total debits in the balance of payment statement always balance.

Types of Balance of payments:

There are two types of balance of payment account which are as follows:

1. Favorable balance of payment:

If the total receipts of a country exceed its total payments, it is called a favorable balance of payment. It is also known as the surplus of the balance of payment.

Favorable Balance of Payment = Total Receipts > Total Payments

2. Unfavorable balance of payment:

If the total payments of a country exceed its total receipts, it is called unfavorable balance of payment It is also known as the deficit of the balance of payment.

Unfavorable Balance of Payment = Total Receipts < Total Payments

Structure or Components of Balance of Payment:

1. Current account:

Current account of a country with the rest of the world includes the transaction of various items like the value of export and import of goods and services, expenses on travels, transport and communication, payment of premium to the insurance companies, income received from an investment, net remittance and transfers, etc.

2. Capital account:

The capital account is related to the transaction of capital. It is the record of the exchange of financial assets. Borrowing and lending of capital, repayment of capital, purchase, and sale of foreign securities, etc. are the examples of capital transaction.

3. Cash account:

Cash account is the record of foreign exchange reserve. When current and capital accounts are positive, the cash reserve of foreign exchange increases but when there is a deficit in current and capital accounts, the foreign currency reserve decreases.

Importance of Balance of Payment:

Balance of payment is a very important macroeconomic indicator. The uses or importance of the balance of payment are as follows:

1. It shows various aspects of a country's international economic position.

2. It helps the government in taking decisions on fiscal and monetary policies as well as external trade and payment issues.

3. It also shows the extent of dependence of the country's economic development on financial assistance by the developed countries.

4. It is the measure of performance of the economy.

5. It shows expenses made on imported goods and services.

6. It shows foreign currency entering the country and going out of the country.

7. It evaluates the success of the country in exporting goods and services to foreign countries.

8. It shows the entire picture of the total transactions of an economy with other economies of the world.

9. It is useful to formulate economic policies like exchange rate policy, fiscal, policy, monetary policy, etc.