The Balance of Payment (BOP) is also named the Balance of International payments. The balance of payment is a statement consisting of all the transactions that are made between entities in one country and the entire world over a particular time. 

The balance of payment displays all transactions that are completed by a country’s companies and government institutions with companies, government institutions, and companies located outside the country. The balance of payment contains imports as well as exports of goods, capital, and services along with transfer payments. The balance of payment separates the transactions into two categories namely the current account and the capital account. 

Historical background of Balance of Payment 

International transactions were used to be made in gold before the 19th century. This provided very little flexibility to the countries that were facing trade deficits. To strengthen the Nation’s financial position, stimulation of growth surplus took place. The increase of the Industrial revolution led to international economic integration and the balance of payment crisis started occurring frequently. 

The Great Depression resulted in the abandonment of the gold standard in countries and engaging in competitive devaluation of their respective currencies. However, the introduction of a gold-convertible dollar with fixed exchange rates to other currencies happened after the Bretton Woods system that continued from the end of World War II until the 1970s. Therefore, the U.S. money supply increased and its trade deficit intensified. But the government failed to fully redeem foreign central banks’ dollar reserves for gold, and the system was rejected. 

Numerous countries embarked on competitive devaluation of their currencies to try to strengthen their exports during the period of the great recession. All the world’s major central banks tried to control the financial crisis by executing dramatically expansionary monetary policy. This resulted in other country’s currencies appreciating in comparison to the dollar of the US as well as other main currencies. Most of the nations tried to loosen their control on their monetary policy to support their exports, especially those nations whose exports were under pressure from stagnant global demand during the Great Recession.

Components of Balance of Payment 

Balance of Payment consists of three major components. Those three components are named as the current account, the capital account, and the financial account. There must be a balance between total current accounts and capital and financial accounts. 

Components of current account and capital account 

Current Account 

Following are the components of the current account: 

  • Visible Trade
  • Invisible Trade
  • Income receipts and payments 
  • Unilateral transfers to and from abroad 

Capital account 

Following are the components of capital account:

  1. Investments to and from abroad 
  2. Changes in foreign exchange reserves 
  3. Loans to and borrowings from abroad 

Significance of Balance of Payment in a country 

Balance of Payment is vital to a country because of the following reasons:

  1. Balance of Payment of a country expresses the financial as well as economic position. 
  2. The Balance of payment statement helps the government to take decisions upon the fiscal and trade policies. 
  3. The Balance of payment provides vital details to comprehend the economic transactions of a country with another country. 
  4. The Balance of payment can be utilized as an indicator to determine if the country’s currency value is appreciating or depreciating. 

Example 

Given below is an example of how the balance of payment works:

  1. The balance of payment statement determines the trade surplus or trade deficit of a country for a certain period. 
  2. In the mentioned example, the balance of payment proved beneficial in determining if India is experiencing a trade surplus or trade deficit. The balance of payment helped us get to know whether India is having a trade deficit or not.

Conclusion 

The Balance of payment is a statement that records all the transactions that take place between a country and its outside countries. The balance of payment contains imports and exports. Balance of Payment has three major components that are the current account, the capital account, and the financial account. Balance of Payment is very vital to a country as it helps in determining the financial and economic status of a country, making decisions on trade and fiscal policies, and indicating if the country’s currency value is appreciating or depreciating.