All the transactions in BOP are classified into two accounts: the current account and the capital account.
● Current account − It denotes the final net payment a nation is earning when it is in surplus, or spending when it is in deficit. It is obtained by adding the balance of trade (exports earnings minus imports expenses), factor income (foreign investment earning minus expenses for investment in a foreign country) and other cash transfers. The current word denotes that it covers transactions that are happening “here and now”.
● Capital account − It shows net change in foreign-asset-ownership of a nation. The capital account consists the reserve account (the net change of foreign exchange of a nation’s central bank in market operations), loans and investments made by the nation (excluding the future interest payments and dividends yielded by loans and investments). If net foreign exchange is negative, the capital account is said to be in deficit.
BOP data does not include the real payments. Rather, it is involved with the transactions. This means that the figure of BOP may differ significantly from net payments made to an entity over a period of time.
BOP data is crucial in deciding the national and international economic policy. Part of the BOP, such as current account imbalances and foreign direct investment (FDI), are very important issues which are addressed in the economic policies of a nation. Economic policies with specific objectives impact the BOP.
The Tweak in Case of IMF
The IMF’s BOP terminology uses the term “financial account” to include the transactions that would under alternative definitions be included in the general capital account. The IMF uses the term capital account for a subset of transactions that form a small part of the overall capital account. The IMF calculates the transactions in an additional top level division of the BOP accounts.
The BOP identity, according to IMF terminology, can be written as −
Current account + Financial account + Capital account + Balancing item = 0
According to IMF, the term current account has its own three leading sub-divisions, which are: the goods and services account (the overall trade balance), the primary income account (factor income), and the secondary income account (transfer payments).
Points to Note
● BOP is an account to show the expenses made by consumers and firms on imported goods and services.
● BOP is also a pointer to how much the successful firms of a country are exporting to foreign countries.
● The money or the foreign currency entering a nation is taken as a positive entry (e.g. exports sold to foreign countries)
● The money going out or expenses of foreign currency is adjusted as a negative entry (e.g. imports such as goods and services)
