Question

Read the following text carefully:
Balance of Payments (BoP) systematically summarises 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 the rest of the world. The current account may be sub-divided 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 of employees 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 in surplus or deficit. The movement in overall balance is reflected in changes in international reserves of the country. Source: \url{https://mopsi.gov.in/109-balance-payments} (adopted and modified) % Question subparts On the basis of the given text and common understanding, answer the following questions:

• (a) Define Balance of Payments.
• (b) Differentiate between the two accounts of Balance of Payments.
• (c) Give the meaning of Balance of Payments deficit with formula.

Hint:

Balance of Payments records all economic transactions between a country and the world, helping to assess the country's financial stability and external economic relations.

Answer 1

1. (a) Balance of Payments: Balance of Payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world over a given period of time. It includes the exchange of goods, services, income, and transfers. It is divided into two main accounts: the current account and the capital account.
2. (b) Difference between the two accounts of Balance of Payments:
   • Current Account: This account records the import and export of goods and services, income from investments, and unilateral transfers (e.g., remittances). It consists of merchandise trade, services, income, and transfers.
   • Capital Account: This account records the transactions involving financial assets between the country and the rest of the world, including investments and borrowing. It includes non-debt flows such as direct investments and debt flows like loans.
3. (c) Balance of Payments Deficit: A Balance of Payments deficit occurs when the total outflows of money (such as imports, external debt repayments, etc.) exceed the total inflows (such as exports, investments, etc.) within a given period. \[ \text{BOP Deficit} = \text{Total Outflows} - \text{Total Inflows} \] When the sum of the current and capital accounts is negative, it reflects a deficit in the Balance of Payments.