Concept of Balance of Payments

Think of a country like a household. Just as a family keeps track of all the money it earns and spends, a country keeps a record of all the money it earns from and pays to the rest of the world. This record is called the Balance of Payments (BOP).

• BOP covers all economic transactions — goods, services, and assets​
• Transactions are between residents of the country and the rest of the world​
• BOP is a flow concept — it records transactions over a period (one year), not at a point in time
• It is maintained using the Double Entry System — every transaction has a credit (inflow) entry and a debit (outflow) entry

1. According to Kindleberger, "The balance of payments of a country is a systematic record of all economic transactions between its residents and residents of foreign countries."
2. According to Sodersten, "The Balance of Payments is merely a way of listing receipts and payments in international transactions for a country."
3. According to James O. Ingram, "The Balance of Payments is a summary record of all economic transactions between residents of one country and the rest of the world during a given period of time."

Point 1 — It covers ALL Economic Transactions

• Economic transactions = flow of goods, services, and assets
• Normally, a transaction involves the payment and receipt of money in exchange
• BUT some flows happen without payment — like gifts received from abroad
• Such flows are called Transfer Payments
• So BOP records all receipts AND all payments arising from international transactions

Point 2 — It is between the "Residents" of Two Countries

• BOP records transactions between residents of the reporting country and residents of foreign countries
• "Residents" = the normal residents of that country (citizens, businesses, government)

Point 3 — It is a FLOW Concept

• All transactions in BOP have a flow dimension — they refer to values over a time period, not at one moment
• BOP always refers to a specific time period — usually a calendar year

• BOP is prepared in the form of a Balance Sheet / Account
• It shows:
  How much a country has received from foreigners (Credits)
  How much a country has paid to other countries (Debits)
• Prepared on an annual basis, regularly every year

Think of BOP as a health report card for a country's economy — it tells you whether the country is financially strong or weak in its dealings with the world.

BOP maintains a detailed, classified record of two sides:

Balance of Trade (BOT) = Only merchandise (physical goods) exports and imports
Balance of Payments (BOP) = Everything — goods, services, capital, transfers

(A) Current Account
Includes three types of items:

(B) Capital Account
Includes:

• All transactions affecting the country's international financial position
• Changes in foreign financial assets and liabilities
• Both private/banking transactions AND official (government) transactions

Double Entry System

• BOP is maintained on the double-entry system of bookkeeping
• Every transaction is recorded twice — once as a credit, once as a debit

What Happens When There is a Deficit?
If a country faces a deficit in the Current Account, it has two options to cover it:

1. Liquidate (sell) its assets — use up savings or sell foreign investments
2. Borrow from abroad — take loans from other countries or international institutions (like the IMF)