Balance Of Payment (BOP): Explained

Mukunda Tripathee

Balance Of Payment (BOP)

We frequently listen to the word BOP deficit or surplus in economic transactions. Actually, what does BOP mean? How is it calculated and what are the components of the BOP? Everyone should have a general understanding regarding this topic as it has huge importance in a country’s economy.

Balance of payment (BOP) is a comprehensive summary of receipts and payments in the international transactions for a country. It is a systematic record of all transactions done between the residents of the reporting state and residents of foreign states during the stipulated time period.

As per data released by NRB under the title of Current Macroeconomic and Financial Situation of Nepal (based on Mid-November, 2020/21), the Balance of Payment of Nepal was recognized as a surplus of Rs. 110.65 billion in the review period. It means excess receipts over the payments in economic transactions.

If receipts are greater than payments, then there is a favorable or surplus balance of payments. Likewise, if payments are greater than receipts, then there is an unfavorable or deficit balance of payment. If the amount of receipts and payments is equal then the balance of payment is said to be in equilibrium.

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Components of Balance Of Payment (BOP)

Current Account

Current Account in BOP refers to the difference between exports and imports of a country. If the amount of exports is greater than the amount of imports, the trade is favorable to the nation. Likewise, if the amount of imports is larger than the amount of exports, then it is unfavorable to the nation. Export of merchandise goods is the source of funds for the nation which creates an inflow of funds. Likewise, imports of merchandise goods is the uses of funds and creates an outflow of fund from the nation. Thus, current accounts monitor the inflow and outflow of funds between the countries. It also considers invisible items/transactions such as travel, international transportation, insurance premium, investment income, miscellaneous, transfer payments, repayments of commercial credits, depreciation or amortization of direct investment.

Capital Account

Capital Account has been named financial account in the year 1999. The financial account is concerned with different international borrowing and lending in terms of short term and long-term facilities. If there is an increase in borrowing, naturally lending will decrease. If the foreign ownership of domestic assets has increased more rapidly than the domestic ownership of foreign assets, then the country will have a financial accounts surplus in the year. There will be an opposite scenario when borrowing is decreasing and lending increases and domestic ownership of foreign assets increases more rapidly than the foreign ownership of domestic assets.

Suppose, the value of imported items to Nepal is Rs. 1000 billion in the second quarter of the fiscal year but the value of exported items of Nepal is Rs. 800 billion at the same time. Then Nepal would have a negative Rs. 200 billion BOP or trade deficit.

Similarly, Nepal and India are trading between them.  Nepal produces milk and India produces Iron. Nepal bought $2,500 worth of iron from India and India bought $500 of milk from Nepal. India also invested $4,000 buying land in Nepal and Nepal bought $5,000 of stocks from a company situated in India.

Imports are debited:  $2,500 (current account) +$5,000 (financial account), total of debit amount is $7,500- fund outflows

Exported are credited: $500 (current account) +$4,000(capital account), total of credit amount is $ 4,500- fund inflows

In the above example imports is greater than exports the situation is unfavorable i.e. balance of payment is deficit by $ 3,000.

Importance Of BOP

The BOP is useful to economists, analysts, businessmen, government and central bank, and so on. It helps to evaluate the financial strength of a country’s economy in comparison to other countries of the world. If the country’s BOP is surplus, then its economic condition is better and is in a fine position. It can afford to import other additional goods and services for the nations when needed. However, if the country’s BOP is in deficit, they have to borrow money to purchase goods and services from other countries which create an imbalance of BOP and creates internal tensions, crisis, and problems within the nation.

(Mr. Mukunda Tripathee is currently working in the banking sector.)

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