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The Balance Of Trade, The Balance Of Current Account, The Balance Of Capital Account And The Balance Of Payments


Balance of Trade may be defined as the difference between the value of goods sold to foreigners by the residents and firms of the home country and the value of goods purchased by them from foreigners. In our example, it is then difference between row 1 items and row 5 items. If value of exports of goods is equal to the value of imports of goods, we say that there is balance of trade equilibrium and if the latter exceeds the former, then we say that there is balance of trade deficit.


But if the former exceeds the latter, i.e., if value of exports of goods is more than the value of imports of goods, we say there is surplus balance of trade. In our example, since imports of goods (Row 5) exceed the exports of goods (Row 1) we have a deficit balance of trade amounting to Rs .250 crores (Rs. 800 crores - Rs. 550 crores) or we say we have a negative balance of trade as Rs. (-) 250 crores.

Balance of current account

Balance of current account is a broader concept than the balance of trade. It includes balance of services and balance of unilateral transfers (i.e., unrequited transfers) besides including balance trade. Balance of services records all eh services exported and imported by a country in a year. Unlike goods which are visible and tangible, services are invisible and are not tangible. The services transactions basically include:

(i)       transportation, banking and insurance receipts and payments from and to the foreign countries,

(ii)      tourism, travel services and tourist purchases of goods and services received from foreign visitors to home country and paid out in foreign countries by home country citizens,

expense of diplomatic and military personnel from overseas as well as receipts from similar personnel from overseas who are stationed in the home country

Interest, profits, dividends and royalties received and paid from and to the foreigners Balance of services is the sum of all invisible service receipts and payments which could be zero, positive or negative. In our example, balance of service is positive and equal to Rs. 100 crore (Row 2- Row 6).

Balance of unrequited transfers includes all gifts, donations, grants and reparation, receipts and payments to foreign countries. In other example, it is positive and equal to Rs. 20 crores (Row 3 - Row 7).

All these balances, i.e., balance of trade, balance of services and balance of unrequited transfers constitute balance of current account. It could again be positive, negative or zero depending upon the values of these balances. In our example, it is negative and equal to (-) Rs. 130 crores. This is found out by adding values of rows 1, 2, 3 and subtracting the sum obtained from the sum of values of rows, 5, 6, 7. This can also be found by adding balance of trade (-) Rs. 250 crores, balance of services (Rs. 100) and balance of unrequited transfers (Rs. 20 crores).

Balance of payments on capital account

Balance of payments on capital account includes balances of private direct investments, private portfolio investments and government loans to foreign governments. In our example, it is the difference between Row 4 and Row 8 and is equal to Rs. 40 crores. Balance of capital account basically deals with debts and claims of the country in question or we say it deals with borrowings or landings of the country in question.

The Balance Of Payments

balance of payments is the sum of balance of current account and balance of capital account. It includes all international monetary transactions of the reporting country vis-à-vis the rest of the world. Notice that the balance of payments must always balance in a book keeping sense. This is because for any surplus (or deficit) in the overall balance of payments there must be a corresponding debit (or credit) entry in the net changes in external reserves. In other words, if balance of current account exceeds the balance of capital account, the net figure affects the net changes in external reserves. To understand this, we will again refer to our example. Here we had balance of current account as Rs. (–) 130 crores and balance of capital account at Rs. 40 crores. Overall there was a negative; balance of Rs. (-) 90 crores in balance of payments.


This was made good by drawing down the external reserves by Rs. 90 crore. If we had positive balance in balance of payments i.e., balance of capital exceeded balance of current account) then it would have led to an increase in the external reserves of the country.

In a nutshell, regardless of whether the country has an actual surplus or a deficit in its overall balance of payments, there can be no surplus or a deficit in any country's balance of payments in the accounting sense.

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