Question

Write a detailed note on the constituents of balance of payments.

Explain the components of the current account of the balance of payments.

Answer 1

The parts in both of these accounts are referred to as balance-of-payment components or constituents. The components or items of each account are described as follows:

I. Components or Items of Current Account:

1. Export and Import of Visible goods: The import and export of physical goods and valuable metals are part of this. Simply put, all items involved in the balance of trade are key components of the current account.
2. Invisible Items-Services: The import and export of invisible goods, meaning various types of services, are also included in the current account. The main services covered are: 
   1. Services Rendered by Commercial Undertaking: Businesses such as shipping companies, insurance firms, and banks from one or more countries provide services to each other across borders. The exchange of these services is included in the current account.
   2. Services of Experts: Most countries use the services of foreign professionals such as doctors, engineers, and soldiers, and also offer their own experts to assist other nations.
   3. Travellings: Travel is one of the key invisible items in the balance of payments. These trips can be for various purposes such as business, education, medical treatment, conferences, or tourism. For the country being visited, such travel is considered an export, while for the country the traveler comes from, it is counted as an import.
   4. Transportation: The transportation of goods between countries is another invisible item recorded in the current account of the balance of payments.
   5. Investment Income: Interest, rent, dividends, and profits are also classified as invisible items in the balance of payments. When a country earns income from its investments in other countries, it is recorded as a ‘receipt’. On the other hand, when foreign investors earn returns from their investments within the country, it is recorded as a ‘payment’.
   6. Governmental Transactions: Governments set up embassies, high commission offices, and other missions in foreign countries, and spend considerable amounts on their upkeep. These expenses are recorded as 'payments'. Additionally, contributions or subscriptions to international organizations are also included in this category.
   7. Donations and Gifts: Donations and gifts received from other countries are recorded as ‘receipts’, while those given to foreign countries are listed under ‘payments’.
   8. Miscellaneous: These include invisible items such as advertising commissions, rent, patent fees, royalties, membership charges, and more. Any amount received from abroad under these categories is recorded as a credit item, while payments made to other countries are recorded as debit items.

II. Items of Capital Account:

1. Private Foreign Loan Flow: Foreign loans obtained by the private sector are recorded in the ‘credit account’, while the repayment of these loans is entered in the ‘debit account’.
2. Movement in Banking Capital: Inflow of banking capital, excluding that of the central bank, is recorded as a ‘credit item’, while its outflow is recorded as a ‘debit item’.
3. Official Capital Transactions: Loans obtained by the public sector from foreign sources or the International Monetary Fund are recorded as “credit items,” while the repayment of these loans is recorded as “debit items.”
4. Reserves Monetary Gold and SDR: Foreign currency holdings of the government, existing reserves of the central bank, Special Drawing Rights (SDRs) from the IMF, and similar capital-related transactions are classified as ‘credit items’, while all types of outgoing payments fall under ‘debit items’.
5. Gold Movement: When a country’s central bank purchases gold from abroad, it pays the foreign sellers, and this is recorded as a ‘debit item’. Conversely, when it sells gold to other countries, the transaction is recorded as a ‘credit item’.
6. Miscellaneous: In addition to the items mentioned above, all other types of government capital receipts, including those of the central bank, are recorded on the “credit side,” while all corresponding payments are listed on the “debit side.”