Question

Read the following text carefully:

Balance of Payments (BoP) systematically summarise, the economic transactions of an economy with the rest of the world, over a given period of time. The BoP can be broadly divided into two accounts namely: current account capital account The current account measures the transfer of goods, services, income, and transfers between an economy and rest of the world. The current account may be subdivided into merchandise account and invisible account. Merchandise account consists of transactions related to export and import of goods. In the invisible account, there are three broad categories: Non-factor services such as travel, transportation, insurance, etc. Transfer which do not involve any value in exchange. Income, which includes compensation, employee, and investment income. The capital account reflects the net changes in financial claims on rest of the world. The capital account can be broadly broken up into two categories: Non-debt flows such as direct and portfolio investments. Debt flows such as external assistance, commercial borrowings, non-resident deposits, etc. The sum of the two accounts indicates the overall balance, which could be either be in surplus or deficit. The movement in overall balance is reflected in changes in international reserves of the country. Source: https : // mospi.gov.in/109-balance – payments (adopted and modified)

On the basis of the given text and common understanding, answer the following questions:

1. Define Balance of Payments. [1]
2. Differentiate between the two accounts of ablorde Balance of Payments. [3]
3. Give the meaning of Balance of Payments deficit with formula. [2]

Answer 1

(a)

The Balance of Payments (BOP) is a detailed list of all the money flows, trade in goods and services, and financial transactions that occurred between a country and the rest of the world over a given period, usually a year. It shows how the country’s economy interacts with the rest of the world and must always be balanced financially.

(b)

Two accounts of BOP are the Current Account and the Capital Account:

Current Account	Capital Account
Records flow of goods, services, income, and transfers (e.g., exports/ imports, remittances).	Records net changes in financial assets/ liabilities (e.g., investments, loans).
Components	Components
1. Merchandise Account (trade in goods).	1. Non-debt Flows (FDI, portfolio investments).
2. Invisible Account (services, income, transfers).	2. Debt Flows (external borrowings, NRI deposits).
3. Example: Export of textiles (goods), IT services (invisibles).	3. Example: Foreign company investing in India (FDI).
4. Nature: Short-term, recurring transactions.	4. Nature: Long-term, asset-based transactions.

(c)

Meaning of BOP Deficit with Formula:

In the current and capital accounts, a BOP deficit occurs when total outflows (payments to other countries) exceed total inflows (receipts from other countries). The figure above shows that imports, loan payments, and capital outflows exceed exports, investment income, and capital inflows.

BOP Deficit = (Current Account Balance + Capital Account Balance) < 0