Balance of Payment is a systematic record of all economic transactions which take place among the individuals of a country and the rest of the world.
A comprehensive set of accounts that tracks the flow of currency and other monetary assets coming in to and going out of a nation. These payments are used for international trade, foreign investments, and other financial activities. The balance of payments is divided into two accounts – current account (which includes payments for imports, exports, services, and transfers) and capital account (which includes payments for physical and financial assets). A deficit in one account is matched by a surplus in the other account. The balance of trade is only one part of the overall balance of payments set of accounts.
Importance of Balance of Payment (BOP)
(a) A country’s Balance of Payments reveals various aspects of a country’s international economic position. It presents the international financial position of the country. If the economy needs support in the form of imports, the government can prepare suitable policies to switch the funds and technology imported to the critical sectors of the economy that can constrain potential growth.
(b) It helps the government in taking decisions on monetary and fiscal policies on the one hand, and on external trade and payments issues on the other. It analyses the business transactions of any economy into exports and imports of goods and services for an exacting financial year. Here, the government can recognize the areas that have the possible for export-oriented growth and can prepare policies supporting those domestic industries.
(c) In the case of a developing country, the balance of payments shows the extent of dependence of the country’s economic development on the financial assistance by the developed countries. The government can also use the indications from Balance of Payments to discern the state of the economy and formulate its policies of inflation control, monetary and fiscal policies based on that.
(d) The greatest importance of the balance of payments lies in its serving as an indicator of changing the international economic position of a country. The balance of payments is the economic barometer which can be used to appraise a nation’s short-term international economic prospects, to evaluate the degree of its international solvency, and to determine the appropriateness of the exchange rate of country’s currency.
(e) However, a country’s favorable balance of payments cannot be taken as an indicator of economic prosperity nor the adverse and even the unfavorable balance of payments is not a reflection of bankruptcy. The government can adopt some defensive measures such as advanced tariff and duties on imports so as to discourage imports of non-essential items and encourage the domestic industries to be self-sufficient.
(f) A balance of payments deficit per se is not proof of the competitive weakness of a nation in foreign markets. However, the longer the balance of payments deficit continues, the more it would imply some fundamental problems in that economy.
(g) A favorable balance of payments should not always make a country complacent. A poor country may have a favorable balance of payments due to large .inflow of foreign loans and equity capital. A developed country may have an adverse balance of payments due to massive assistance given to developing countries.
(h) It does not provide data about assets and liabilities that relate one country to others. However, despite all these shortcomings, the significance of the balance of payments lies in the fact that it provides vital information to understand a country’s economic dealings with other countries.
(i) With the development of national income accounting, the balance of payments account has been used to calculate the control of foreign trade and transitions on the level of national income of the nation.
(j) If the country has a flourishing export trade, the government can adopt measures such as the devaluation of its currency to make its goods and services available in the international market at cheaper rates and bolster exports.