DR Ambedkar IAS Academy

Balance of Payments (BOP)

What is the Balance of Payments (BOP)?

The balance of payments (BOP) is a statement of all transactions made between entities in one country and the rest of the world over a defined period of time, such as a quarter or a year.

Understanding the Balance of Payments (BOP)

The balance of payments (BOP), also known as balance of international payments, summarizes all transactions that a country’s individuals, companies, and government bodies complete with individuals, companies, and government bodies outside the country. These transactions consist of imports and exports of goods, services, and capital, as well as transfer payments, such as foreign aid and remittances.

The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa. If a country exports an item (a current account transaction), it effectively imports foreign capital when that item is paid for (a capital account transaction).

If a country cannot fund its imports through exports of capital, it must do so by running down its reserves. This situation is often referred to as a balance of payments deficit, using the narrow definition of the capital account that excludes central bank reserves. In reality, however, the broadly defined balance of payments must add up to zero by definition. In practice, statistical discrepancies arise due to the difficulty of accurately counting every transaction between an economy and the rest of the world, including discrepancies caused by foreign currency translations. 

Economic Policy and the Balance of Payments

Balance of payments and international investment position data are critical in formulating national and international economic policy. Certain aspects of the balance of payments data, such as payment imbalances and foreign direct investment, are key issues that a nation’s policymakers seek to address.

Economic policies are often targeted at specific objectives that, in turn, impact the balance of payments. For example, one country might adopt policies specifically designed to attract foreign investment in a particular sector, while another might attempt to keep its currency at an artificially low level in order to stimulate exports and build up its currency reserves. The impact of these policies is ultimately captured in the balance of payments data.

Imbalances Between Countries

While a nation’s balance of payments necessarily zeroes out the current and capital accounts, imbalances can and do appear between different countries’ current accounts. According to the World Bank, the U.S. had the world’s largest current account deficit in 2019, at $498 billion. Germany had the world’s largest surplus, at $275 billion.1

Such imbalances can generate tensions between countries. Donald Trump campaigned in 2016 on a platform of reversing the U.S.’s trade deficits, particularly with Mexico and China. The Economist argued in 2017 that Germany’s surplus “puts unreasonable strain on the global trading system,” since “to offset such surpluses and sustain enough aggregate demand to keep people in work, the rest of the world must borrow and spend with equal abandon.”

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