The balance of payments of a country is a systematic record of its receipts and payments in international transactions in a given year. Each transaction is entered on the credit and debit side of the balance sheet (see Table 1).
The principal items on the credit side are:
(1) Visible exports which relate to the goods exported for which the country receives payments.
(2) Invisible exports which refer to the services rendered by the country to other countries. Such services consist of banking, insurance, shipping, and other services rendered in the form of technical know-how, etc., money spent by tourists and students visiting the country for travel and education, etc.
(3) Transfer receipts in the form of gifts received from foreigners.
(4) Borrowings from abroad and investments by foreigners in the country.
(5) The official sale of reserve assets including gold to foreign countries and international institutions.
The principal items on the debit side are:
(1) Visible imports relating to goods imported for which the country makes payments to foreign countries.
(2) Invisible imports in the form of payments made by the home country for services rendered by foreign countries. These include ah items referred to under (2) in the above para.
(3) Transfer payments to foreigners in the form of gifts, etc.
(4) Loans to foreign countries, investments by residents in foreign countries, and debt repayments to foreign countries.
(5) Official purchase of reserve assets or gold from foreign countries and international institutions.
If the total receipts from foreigners on the credit side exceed the total payments to foreigners on the debit side, the balance of payments is said to be favourable. On the other hand, if the total payments to foreigners exceed the total receipts from foreigners, the balance of payments is unfavourable.
The balance of trade is the difference between the value of goods and services exported and imported. In contains the first two items of the balance of payments account on the credit and the debit side. This is known as “balance of payment on current account.” Some writers define the balance of trade as the difference between the value of merchandise exports and imports. Prof. Meade regards this way of defining the balance of trade as wrong and of minor economic significance from the point of view of the national income of the country.
In equation form, the balance of payments of Y = C + I + G + (X-M) which includes all transactions which give rise to or exhaust national income. In the equation, Y refers to national income, C to consumption expenditure, I to investment expenditure, G to government expenditure, X to exports of goods and services and M to imports of goods and services.
The expression (X – M) denotes the balance of trade. If the difference between X and M is zero, the balance of trade balances. If X is greater than M, the balance of trade is favourable, or there is surplus balance of trade. On the other hand, if X is less than M, the balance of trade is in deficit or is unfavourable.