[PDF Notes] Balance of Payments always Balance – Justify

In the accounting sense, the balance of payments of a country is always in equilibrium. The statement of balance of payments is prepared in terms of credits and debits based on the system of double-entry book-keeping.

In the double-entry system, each transaction gives rise to two equal entries: a credit entry (i.e., a receipt) and a debit entry (i.e., payment). Thus the sum of all credits equals the sum of all debits.

Similarly, an international transaction generates two equal entries: a credit (+) for an export of a good or service, or for a foreign borrowing, or for the receipt of a unilateral transfer (gifts, donations, grants, etc.); and a debit (-) for an import of a good or service, or for a foreign lending, or for the making of a unilateral transfer.

In other words, a country must pay for its imports of goods and services, or foreign borrowings, or receipts of unilateral transfers by the equal-valued export of goods and services or foreign lending, or making unilateral transfers. Thus, the sum of all international receipts (credit items) always equals the sum all international payments (debit items).

While receipts and payments in the international transactions always must be equal or must balance in the accounting sense, they may not be equal or in equilibrium in operational sense.

The accounting balance of a balance of payments account, which is merely a truism, should not be confused with the ‘economic balance which recognised the possibility of a deficit or a surplus in the balance of payments.

When the current account of the balance of payments shows a deficit or a surplus, the balance is restored through changes in the capital account. In fact, the capital account is specially prepared to neutralise the imbalance in the current account.

The deficit in the current account is neutralised by the equal amount of surplus in the capital account; and the surplus in the current account is neturalised by the equal amount of deficit in the capital account. Thus, the current and capital accounts together balance each other and restore equilibrium in the balance of payments.

Suppose, a country experiences a deficit in the current account of its balance of payments statement due to excess of imports over exports. Such a deficit can be met by resorting to the following changes in the capital account:

(i) By raising loans and getting grants from other countries:

(ii) By drawing on past accumulated balances of the country which it may be keeping in the foreign countries;

(iii) By exporting gold;

(iv) By drawings from International Monetary Fund.

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