Balance of Payment–Meaning,Definition,Featutes,Structure,Disequilibrium in BOP,Causes of unfavourable BOP,Suggestions to correct disequilibrium in BOP

Balance of Payment



Balance of payments refers to the recording of all economic transactions of a given country with rest of the world.Each country has got to enter into economic transactions with other countries of the world.As a result of such transactions,it receives payments to other countries.Balance of Payments is a statement of accounts of these receipts and payments.

Ordinarily a country has to deal with other country in respect of three items:

  1. Visible Items

It includes all kind of physical goods imported and exported.

  1. Invisible Items

It includes all kind of import export services.

  1. Capital Transfers

These are concerned with capital receipts and capital payments like investment by foreigners in India.

Like an ordinary trader,each country has to work out a balance in respect of its dealing,in all the above three items,with other countries of the world in a given period.Thus it comes to know how much it has to pay to other countries and how much it has to receive from other countries and what is the position of overall balance.


Acc. to Kindleberger

“The balance of payments of a country is a systematic record of all economic transactions between its residents and residents of foreign countries.”

In words of Benham

“Balance of payments of a country is record of the monetary transactions over a period of time with the rest of the world”.

Features of Balance of Payments

1. Systematic Record

It is a systematic record of receipts and payments of a country with other countries.

2. Fixed Period of Time

It is a statement of account pertaining to a give period of time,usually one year.

3. Comprehensiveness

It includes all the three items i.e. visible,invisible and capital transfers

4. Double entry System

Receipts and payments are recorded on the basis of double entry system.

5. Adjustment of Differences

Whenever there is difference in actual total receipts and payments,need for necessary adjustment is felt.In case of unfavourable balance of payments,government will have to take foreign loans or to promote foreign investment,so as to meet the difference in balance of payments.

6. All Items-Government and Non-Government.

Structure/forms of balance of payments

Balance of payments has three forms:

  1. Current account
  2. Capital account
  3. Overall balance of payments
  1. Current Account

Balance of payments on current account includes the value of imports and exports of both visible(goods) and invisible items(services). Current account transactions are called account of actual transactions,because all items included in it are actually transacted.These items have a direct effect on the income,output and employment of a country’s economy.


Balance of payments on current account may be both balanced and unbalanced.In case of balanced position of BOP,receipts and payment on account of exports and imports are equal. In case of unbalanced balance of payments,it can be in deficit or in surplus.Disequilibrium of the balance of payments on current account is usually balanced with the help of transactions in capital accounts.

  1. Capital Account

Capital account refers to financial transactions.It mainly includes foreign investment and external loans.All kinds of short term and long term international capital transfers,movement of gold,foreign debts,foreign investments,payments and receipts on account of interest and grants,etc. are also included in capital account.All transactions under capital account are concerned merely with financial transfers,between our country and other foreign countries.

  1. Overall Balance of Payments

Total of a country’s balance of payments on current account and capital account is known as overall balance of payments.

Disequilibrium in Balance of Payments

Because of several reasons,especially due to differences in the value of exports and imports,disequilibrium in balance of payments may be caused.Disequilibrium may sometimes be on minus/deficit/unfavourable side and sometimes on plus/surplus/favourable side. Unfavourable or favourable balance of payments can be explained as under:

Unfavourable or favourable balance of payments

Balance of payments is said to be unfavourable when the payments (debit) of the country are more than its receipts (credit). On the other hand, when the payments (debit) of the country are less than its receipts (credit), the balance of payments is said to be favourable. Disequilibrium in balance of payments may be of two kinds:

1.Favourable balance of Payments

When receipts are more than payments then balance of payments turns favourable.This situation increases foreign exchange reserves.In this case exports of goods ,services and capital receipts are more than import of goods, services and capital payments.It is also known as surplus balance of payments.


(Here Bf =Balanced balance of Payment;R-P>0=Receipts are greater than payments or their difference is positive.)

2. Unfavorable Balance of Payments

Balance of payments is unfavorable when its payments are more than its receipts. This situation reduces foreign exchange reserves. In this case exports of goods, services and capital receipts are less than import of goods, services and capital receipts are less than import of goods, services and capital payments. It is also known as deficient balance of payments.


(Here, BF= Favourable balance of payments; R-P <0=Receipts, are less than payments or their difference is negative.)

  • Equilibrium in Balance of Payments

When capital receipts of a country and exports(visible and invisible) are to its capital payments and imports(visible and invisible) then its balance of payments is in equilibrium.


(Here, B = balanced balance of payments; R =Reciepts,P=Payments)

In short,balance of payments is unfavourable,if to meet the deficit between receipts and payments a country either makes payments in terms of gold or borrows from abroad for a short period.On the contrary,if to meet the surplus between receipts and payments a country either receives payment in terms of gold or lends to foreign countries for a short period,the balance of payments is said to be favourable.

Causes of Unfavourable Balance of Payments/Unfavourable Balance of Trade

Main Causes of unfavourable balance of payment of India are as follows:

1.Import of Machinery:

Since independence,import of machines has increased on two scores:

i. During World War II,machines in Indian industries overworked.Consequently, these were large-scale depreciation and wear and tear of machines.In order to replace he same,large quantity of new machines was imported.

ii.Industrialisation of the country in the wake of Five year Plans also necessitated import of machines worth crores of rupees. This turned India’s Balance of payments unfavourable.

2. Import of War equipments:

In order to defend itself against China and Pakistan, large amount of war equipment were imported by India.These imports also caused disequilibrium in the balance of payments.

3. More demand of Consumption Goods

In the post war period,demand not only of foreign goods but also of Indian goods went up. Previously,large amount of oilseeds,tea, iron ores etc. used to be exported out of India.Now because of increase in population their demand within the country has gone up.So export of these goods has gone down very much.

4. Price disequilibrium

There has been wide difference in the domestic prices of the goods and the prices of goods in foreign countries.Due to inflation,domestic prices have increased more than the increase in prices of foreign goods.This has led to increase in imports and decrease in exports.

5. Expenditure on Embassies

Independent India had to establish its political relations with other countries.To that end,it had to set up its embassies in foreign countries.It was an expensive affair.It also turned balance of payments unfavourable.This item does not affect balance of trade,as it is an invisible item,but it does affect balance of payments.

6. Foreign Competition

India mainly exports jute,tea and textiles,but now foreign competition inthese goods is growing.Bangladesh is India’s rival in jute export and Sri Lanka and Indonesia in the export of tea and Korea and china in the export of cloth.This has also adversely affected our exports.

7. Increase in price of Crude Oil

Value of imports has gone up on account of constant hike in the price of crude oil.Of the exports 30% is spent on petroleum products.

8. Payments of interest on foreign Debts

The huge interest burden also caused disequilibrium in th balance of payments.This item does not affect balance of trade, as it is an invisible item.

9. Less growth in Exports

Despite various export promotion schemes,our exports are still less than our imports.Moreover growth rate of exports is less than the growth rate of imports.

10. Gulf War

In 1991,Gulf War(War between Iraq and several western countries)had also its adverse effect on India’s balance of payments.On the one hand,price of petrol shoot up and on the other,foreign remittances by Indians working in gulf area,viz., Kuwait,Iraq,etc. to India altogether stopped.It rendered the imports expenses and reduced the foreign remittances.

11. Disintegration of USSR

India had large amount of foreign trade with USSR.The disintegration of USSR had an adverse effect on India’s foreign trade.

Beside,there are some other minor factors also accounting for adverse balance of payments,viz., poor quality,malpractices of Indian traders causing impediments in exports,bad effects of high cost of production on exports, etc.

Measures/Suggestions to correct disequilibrium in the Balance of Payments

The main factor accounting for disequilibrium of payments is the excess of imports over exports.Two measures are,therefore called for to correct this disequilibrium.Exports should be promoted and imports discouraged.Import substitution should be resorted to.Following specific measures are suggested to correct disequilibrium in the balance of payments:

1.Promotion of Exports

Promotion of exports is the best measure to correct an adverse balance of payments. To achieve this end,all taxes on export goods be withdrawn,export industries should be provided raw materials and transport facilities at reduced prices,so that prices of these goods remain low. These industries should be provided credit facilities at liberal rates.To promote exports,intensive publicity of Indian goods be undertaken in foreign markets and goods be designed to the tastes of the foreign consumers.

2. Increase in Production

To cut down imports and encourage exports,it is essential that agricultural, industrial and mineral production be increased.Jute manufactured products,tea and coffee are of great importance among exports from India.Efforts have been made to increase the production of these products in Five Year Plans.Their production needs to be further increased.Recently,several new items have entered the export list viz. machines,electric fans,cycles,ready made garments,gems and jewellery etc. Raw materials should be made available to export industries at international prices.Production capacity of cement,fertilizers,iron and steel etc. should be utilized fully.

3.Trade Agreements

Government of India enters into trade agreements with the governments of other countries in order to expand trade. Many foreign trade delegates visit India to strengthen trade ties. India has negotiated trade agreements with many countries viz. Bangladesh,Bulgaria,Germany,Egypt,France,Korea,Iran,Iraq etc.On 15April,1994,India enters into trade agreements with all other countries signing GATT, automatically. India has entered into trade agreement with WTO nations, SAARC nations.As a member of World Trade Organization,India is having trade relations with other 149 member nations of WTO.More trade agreements should be done with foreign countries to promote our foreign trade and exports.

4.Encouragement to Foreign Investment

Foreign industries and multinational corporations (MNCs) are encouraged to invest their capital in India.Special facilities are provided to attract foreign capital.It leads to inflow of foreign exchange in the country.It also increases production of export goods and thus exports are encouraged.However,care should be taken that foreign capitalists do not dominate our economy.

5.Attraction to Foreign Tourists

Attractive picnic spots be developed in different parts of the country to attract foreign tourists.Government spends lot of money to develop such spots.Besides,foreign tourists be provided with transport and other facilities.Large amount of foreign exchange can be earned from foreign tourists.

6.Devaluation of Indian Currency

Lowering of the value of domestic currency in terms of foreign currencies is called devaluation.A country resorts to devaluation when its exports fall short of imports.As a result of devaluation imports become dearer and exports cheaper.India devalued its rupee in the year 1949,1966, and twice in the year 1991.But now this measure is not used,as now exchange rate of rupee with other currencies of the world is determined by market forces of demand and supply and not by government.


It means that prices of the goods produced in the country should be brought down.As a result of it,foreigners will get export goods at cheaper price.Thus exports will be encouraged.Moreover,because of availability of Indian goods at lower rates the demand of imports will also come down.

8.Restriction on Imports

Another important method of correcting balance of payments is restriction on imports. Following measures can be adopted to cut down imports.

i. Restrictions on the import of luxury goods.

ii. Issue of licenses for the import of essential goods only.

iii. Fixation of quotas for the import of different goods.

iv. Levying of new import duties and enhancing of the rates old duties.

v.Motivating the Indians to use indigenous goods.

vi. Less credit facilities for imported goods etc.

9. Import Substitution

Import substitution plays an important role to correct an adverse balance of payments.Import substitution means total or partial replacement of an imported product of the same functional requirement mainly from indigenous material and know how.Its main objective is to reduce imports.For instance,prior to independence,cycles, sewing machines,electric fans etc. used to be imported from abroad.Now,the same are being produced in the country.Similarly,in place of copper wire imported for power industry,aluminium wire produced in the country is being increasingly used.

In short,disequilibrium in the balance of payments can be corrected by increasing exports and reducing imports. Government of India has taken several measures to promote exports and popularize import substitutions.


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International Business Management


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