Full-Form of BOP (Balance of Payment)
The full form of BOP stands for Balance of Payment. If you see the word carefully, “Balance Of Payment” it means what is the balance after all payments are made. So it is actually a calculation of all the payments and receipts of several goods and services between one country and the rest of the world in a given period of time. This is a kind of record keeping where you maintain double-entry accounting. Lots of information can be obtained by studying the BOP structure of a country.
- The main feature of BOP is that it is a record-keeping system that helps to maintain all transactions between one country and the rest of the world systematically. All transactions are included, like export-import of goods, services, and everything.
- Whenever there is an inflow of foreign exchange, then that is recorded as a credit item, and whenever there is an outflow of foreign exchange, then that is recorded as a debit item.
- The records are maintained in the Double-entry accounting forms. So the balance will tally.
- The overall BOP will always match as double entry is maintained, but individual accounts can portray balances that give an idea of the inflow or outflow of funds.
There is no such formula. The concept is that by adding balances of the three accounts, the net should be zero. So:
Differences will show if there is a deficit or surplus of foreign exchange.
Calculate BOP based on the information mentioned below:
- Export of Goods – $ 2,000,000
- Imports of Goods – $ 5,000,000
- Export of Services – $ 1,000,000
- Import of services – $ 2,000,000
- Import of research – $500,000
- Non-Financial Assets bought in other countries – $5,000,000
- Financial Investments are made in other countries – $7,000,000
- FDI received – $5,000,000
- FII received – $ 4,000,000
- Reserve of the country – $50,000,000
Calculate the BOP
- Step 1: Calculate the total Current account. Here the goods and services between countries are recorded. The Net Total of Current Account is -$4,500,000
- Step 2: Calculate the total Capital account. Here the Non-Financial Investments are recorded. The investment can either be from other countries or your country investing abroad. The net total is $5,000,000
- Step 3: Calculate the total financial Account. It consists of financial investments, whether inflow or outflow. The Net Total is $2,000,000
- Step 4: The BOP balance is coming out to be -$7,500,000
- Step 5: This balance represents a deficit. So this deficit in foreign exchange must be balanced with the help of Reserves. So the government will use reserves worth $7,500,000
#1 – Current Account
It deals with the various inflow and outflow from goods and services exchanged between nations. If goods and services are being exported to different nations, then that leads to an inflow of money. So this carries a credit balance.
#2 – Capital Account
This account impacts when non-financial assets are either bought or sold. Suppose the land is being sold to individuals from other nations. Then that is an inflow of money, so it will carry a credit balance.
#3 – Financial Account
This is a volatile account, and it depends on the investments made by other nations for the purchase of securities. If individuals from your country buy financial securities in other nations, then that is the outflow of money, so debit.
- BOP is needed to understand the state of a country. If there is a positive balance in the current account of BOP, then it means that the country is doing exports more than imports.
- It helps to gauge whether the currency will appreciate or depreciate. If the current account has a deficit, it means that the country is importing more than it is exporting. So its currency is being used more to buy other currencies. Hence the demand for the currency will fall and it will depreciate.
- By studying these accounts, the government can make estimates whether a particular sector is flourishing. If a sector is flourishing, then its exports will increase.
- If BOP is having deficit year on year, then there will not be enough reserves to support the deficit. So the government will have to borrow money from foreign countries. Does BOP help to make these decisions?
- If too much import is happening in a particular sector, then the government should put measures to help that sector internally, so that import drops.
Difference Between BOP and Balance of Trade
The balance of trade only focuses on the difference between export and import of goods, but BOP is the actual movement of foreign exchange. The foreign exchange movement can be for several factors. The export and import of goods is a part of it. So if someone wants to concentrate only on the import and export of goods, then they should consider the balance of trade.
BOP is needed to understand the state of a country. It helps the government to focus on sectors that need attention. So BOP should be properly maintained, and proper action should be taken to see the indicators from BOP.
This has been a guide to the What is the Full Form of BOP, i.e. (Balance of Payment) and its definition. Here we discuss the formula to calculate the BOP example, features, and components along with importance. You may refer to the following articles to learn more about finance –