Balance of trade and balance of payment

Foreign trade refers to a country’s trade with other countries.

It consists of exports and imports.

A country receives payments from other countries for its exports and makes payments to other countries for its imports.

The difference between total receipts on account of exports of goods and total payments on account of imports of goods is called Balance of Trade.

However, these receipts and payments are not necessarily in a country’s own currency.

Besides, receipts and payments on account of trade of goods, some other receipts and Payments also take place between countries.


Balance of trade—

Trade account of the balance of payments includes exports and imports of goods in a year.

The difference between the value of exports of goods and value of imports of goods is called balance of trade.

Trade account includes exports and imports of goods only.

No other items are included in it.

Exports and imports of goods are also called transactions of visible items or merchandise.

Therefore balance of trade is also called balance on visibles.

Since Independence, India has generally been having a deficit balance of trade.

This is because during this period our imports have been continuously rising at a faster rate than growth of exports.

Growth in import has been caused by many factors such as growing population, increasing consumption requirements, need for imports of capital goods for development of the economy etc.

India’s exports too have grown but their rate of growth has been lower than that of imports.


Balance on account of invisibles—

Services are part of invisibles.

These include shipping, belong, insurance and consultancy services, foreign travel, investment income, transfer payments etc.

The difference between total receipts and total payments of foreign currencies on account of invisibles is called balance on account of invisibles.

If the receipts on account of invisibles are greater than payments on account of invisibles then there will be a surplus balance on invisibles.

on the other hand if the foreign exchange receipts on account of invisibles are less than foreign exchange payments on this account , then there will be a deficit balance on invisibles.


Current account of balance of payments account—

Trade account and invisibles account together constitute the current account.

In other words, by adding the balance of trade and balance on invisibles we get the balance on current account.

So current account of balance of payments account records all transactions relating to sale and purchase of all visible items as well as all transactions relating to invisible items.

Whereas India’s balance of trade has always been negative, its balance on invisibles account has been positive for most of the years.

The balance on current account has been arrived at by adding the trade balance and net invisibles.

A deficit on current account means that India’s receipt of foreign currencies on account of trade and invisibles has been less than its payments.


Capital account of balance of payments account—

The capital account shows all the inflows and outflows of capital.

The flow of capital  maybe in the form of borrowing from and lending to abroad and receipts and payments of capital on account of sales and purchases of shares and securities to other  countries or from other countries.

The items included in the capital account are—

[1] Autonomous capital transactions

[2] Accommodating capital transactions

Autonomous capital transactions—      

Investment made by foreigners in a country results in inflow of capital.

Investment made by the people of a country results in outflow of capital.

These flows are not as a result of the deficit or surplus on current account of the balance of payments of a country. So these are called autonomic capital transactions.


Accommodating capital transaction—                

The transactions that take place due to the deficit or surplus in the balance of payments (the sum of current account balance and balance of autonomous capital transactions) are called accommodating capital transaction.

If a country has a deficit in the balance of payments, it means the total receipts of foreign exchange falls short of the total payments that the country has to make (in foreign change).

This deficit is covered by assistance from foreign governments or international institutions such as International Monetary Fund.

Such receipts of foreign exchange are accommodating receipts.

However, if the deficit is not fully covered by such accommodation then the balance of deficit will have to be covered by withdraw from its stock of foreign exchange reserve.