Balance of Payment UPSC Notes – Components of BOP, Formula, Current Account Deficit

By BYJU'S Exam Prep

Updated on: September 20th, 2023

Balance of Payment (BOP) is a statement that gathers all monetary transactions made between the individuals or residents of a country and with the rest of the world at a given time. It is mainly the difference between the inflow and outflow of money in a country in a particular period. The Balance of Payment has two parts- the current account and the capital account.

The current account files the net value of exports and imports of goods and services of a country. On the other hand, the capital account files the net change in national assets and liabilities of a country at a particular time. Details on the balance of payments in relation to the UPSC Exam will be provided in this post.

Balance of Payment

A Balance of Payment is a summary record of all economic transactions between residents of one country and the rest of the world during a fixed time period. It is classified as records of all receipts on account of goods exported, services returned, and capital received by residents, and payments made by them on account of goods imported, services received, and capital transferred to foreigners.

Balance of Payment is defined as the ‘balance of international payment’. It is an organized record or statement of all money-based transactions of one country with the rest of the world in a particular period which is normally one year.

BoP is an indicator that shows if a country has excess or shortage in trade. Excess exports than imports indicate a trade surplus and when imports exceed export, it indicates a trade deficit.

Components of Balance of Payment

In a perfect world, the BoP should be zero when all the components are correctly included. Thus, the balance between the inflow and outflow of money should exist. Most often, this does not ideally happen in most cases.

Balance Of Payment UPSC Notes

The balance of payments is made up of three parts:

  • Current account: concerns itself with the transfer of products and services between nations.
  • Capital account: focuses on investments, loans, borrowings, and foreign exchange reserves.
  • Financial account: focuses on real estate investments, business initiatives, and foreign direct investments.

In ideal circumstances, the sum of the current account should equal the sum of the capital and finance accounts.

Current Account – Component of BoP

A Current Account refers to an account that records the export and import of goods and services. The current account is maintained by the Reserve Bank of India on the behalf of the government.

All transactions related to export and import are shown as either inflow or outflow (credit/debit) at the end of the year current account might be positive or negative. The positive one is known as Current Account Surplus (CAS), and the negative one is known as Current Account Deficit (CAD).

Important- If a country has both deficits, Current Account Deficit (CAD) as well as Fiscal Deficit (FD), then we can say that the country is suffering from Twin Deficit.

Causes of Current Account Deficit

The causes of the Current Account Deficit are-

  • Expansion of import
  • The slow growth of export
  • Huge import of gold
  • Huge import of crude oil
  • Largely export of Agro product

In case of a Current Account Deficit, Central Bank can attempt to affect the exchange rate directly or indirectly.

  • Directly- by selling or buying foreign exchange reserves
  • Indirectly- by monetary policy that increases or decreases the interest rate.

When the sum of the country’s current account and the capital account is equal to zero, then the country is said to be in an equilibrium situation of the Balance of Payment.

Capital Account – Component of BoP

A capital account is a summary of the capital expenditure and capital income of a country with the rest of the world. It is maintained by the Reserve Bank of India on behalf of the government.

Generally, there is no deficit or surplus in Capital Account like in the Current Account.

Reasons for Calculating Balance of Payment

The following are some reasons for the calculation of the balance of payments:

  • It discloses the economic and financial status of a country.
  • It also acts as an indicator that helps to analyze whether a country is facing a trade surplus or trade deficit.
  • It helps the government to make decisions on trade and fiscal policies.
  • The Balance of Payment also helps to determine the financial relationship between one country with other countries by providing important details.

Balance of Payment Formula

The overall Balance of Payment is indicated by the total sum of the current account and capital account, which may be in surplus or in deficit. The Balance of Payment is equal to the sum of the net credit in the current account, capital account, and financial account.

Balance of Payments = Net credit in ( Current Account + Capital Account + Financial Account).

BoP Surplus

  • The surplus of the Balance of Payment is the situation where the country’s export of goods is more as compared with the import of the goods by the country.

BoP Crisis

  • A Balance of Payment crisis is a situation where the imports of the country’s goods are more as compared to the export of the country’s goods.
  • India faced a Balance of Payment (BoP) crisis in the 1990s when its foreign exchange reserve fell to an all-time low of only 5.8 billion dollars which was enough to import for a fortnight only.
  • Such a crisis leads to take help from the International Monetary Fund (IMF), which has proposed some conditions to reform the economy of the country.
  • The new economic policy in 1991 was introduced in the backdrop of the Balance of Payment (BoP) crisis which has provisions like- economic openness, ending Licence Raj, and decreasing the frontier of the state where the private sector has the ability, willingness, and expertise.

Key Points of Balance of Payment

Here are some key points regarding the Balance of Payment:

  • Balance of Payment statistics was enumerated by the Reserve Bank of India.
  • If exports exceed imports, then the BoP is going to get powerful.
  • Steps are being taken by the government to support and encourage industry and domestic manufacturing. It has raised restrictions on imports of goods and services because of Atmanirbhar’s enterprise.
  • It also examined all Free Trade Agreements (FTA) and discovered them mostly asymmetrically.
  • The firms investing in the country were ordered to stop having an ‘Assembly Workshop’ by the government. The workshop was typically characterized as Indian manufacturing.
  • Every so often, the Balance of Payment is not steady or imbalanced. This imbalanced situation is displayed in the BoP as errors and omissions. It mirrors the country’s lack of ability to consider all global monetary dealings or international money transactions precisely or without any sort of errors.

Balance Of Payment UPSC

The Balance of Payment is an important topic in the Economics portion of the UPSC Syllabus. Students preparing for the IAS Exam should go through the Economics Books for UPSC to study this vital topic of Balance of Payment or BoP.

Balance Of Payment UPSC Questions

Numerous questions from Balance of Payment appeared in the UPSC Prelims Exam, which you can find in the UPSC Previous Year Question Papers.

Question: Which of the following is correct regarding the Exchange Rate Regime?

  1. A rigid Exchange Rate Regime provides stability in foreign trade and investment.
  2. India follows the Rigid Exchange Rate Regime since 2000, after the implementation of FEMA 2000.

Choose the correct option from the given below-

  1. 1 only
  2. 2 only
  3. Both 1 and 2
  4. Neither 1 Nor 2

Answer: Option A

Question: Which of the following is correct regarding the Balance of Payment?

  1. The difference between the export and import of visible goods is known as the Balance of Payment.
  2. Current accounts and capital accounts are the types of the Balance of Payment.

Choose the correct option from the given below-

  1. 1 only
  2. 2 only
  3. Both 1 and 2
  4. Neither 1 Nor 2

Answer: Option B

Question: The part(s) of Balance of Payment is/are:

  1. Current account
  2. Capital account
  3. Both (a) and (b)
  4. None of the above

Answer: Option C

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