Balance of payments
The balance of payments is a country's systematic record of all economic transactions with the rest of the world in a period. By double entry it always balances.
Structure of the BoP (IMF BPM6)
| Account | What it records | Examples |
|---|---|---|
| Current account | Goods, services, primary income and secondary income | Software exports by Infosys; interest paid abroad; remittances from Gulf workers |
| Capital account | Capital transfers and non-produced, non-financial assets | Debt forgiveness; land bought by a foreign embassy; sale of trademarks |
| Financial account | Changes in foreign financial assets and liabilities | FDI, portfolio investment, other investment (loans, deposits), reserve assets |
| Net errors and omissions | Balancing item for gaps in data | Makes total credits equal total debits |
BPM6 and the new BPM7
In March 2025 the IMF released the seventh edition of its manual, BPM7. It keeps the current, capital and financial accounts, but shows goods and services as separate accounts and renames primary income as 'earned income' and secondary income as 'transfer income'. Countries will switch over the next few years. RBI still publishes India's BoP on the BPM6 basis, so NET questions use BPM6 terms.
Current account components
| Component | Includes |
|---|---|
| Goods (merchandise) | Exports and imports of physical goods: this is the balance of trade |
| Services | IT, travel, transport, insurance, financial services |
| Primary income | Compensation of employees, interest, dividends, profits |
| Secondary income | Current transfers: workers' remittances, gifts, grants |
Computing the balances
A country (figures in US$ billion): merchandise exports 450, merchandise imports 700, net services +160, net primary income −40, net secondary income +110, net capital and financial inflows (excluding reserves) +55. Find the trade balance, current account balance and overall balance.
- Trade balance = exports − imports = 450 − 700 = −250 (deficit).
- Net invisibles = 160 − 40 + 110 = 230.
- Current account balance = −250 + 230 = −20, a deficit of 20.
- Overall balance = current account + net capital and financial flows = −20 + 55 = +35.
- The surplus of 35 is added to foreign exchange reserves (ignoring errors and omissions).
Trade deficit 250; current account deficit 20; overall surplus 35, so reserves rise by 35.
Balance of trade vs balance of payments
A BoP 'deficit' in the news means the overall balance before changes in reserves is negative.
Disequilibrium and its correction
| Type or remedy | Meaning |
|---|---|
| Cyclical disequilibrium | Caused by trade cycles running differently across countries |
| Secular disequilibrium | Long-run changes in growth, saving and investment |
| Structural disequilibrium | Changes in demand or supply structure, such as loss of an export market |
| Fundamental disequilibrium | A persistent deficit; the term comes from the original IMF Articles |
| Monetary remedies | Deflation, devaluation or depreciation, exchange control |
| Non-monetary remedies | Tariffs, quotas, export promotion, import substitution |
NET asks you to place a transaction in the right account (remittances = current, FDI = financial), to separate balance of trade from balance of payments, and to compute a current account balance from given figures.
Typical MCQ: “Remittances sent by Gulf workers to Kerala are recorded where?” Current account, secondary income (current transfers). Trap: they are not capital account items.
Typical MCQ: “If the BoP always balances, how can a country have a BoP deficit?” In accounting terms it always balances. A 'deficit' means the autonomous items fall short and the gap is met by reserves or official borrowing.
Typical MCQ: “Drawing down forex reserves to cover a deficit is which kind of transaction?” Accommodating (compensatory). Autonomous transactions, like normal trade and investment, take place for their own sake.
C-C-F: Current = income flows (goods, services, income, transfers); Capital = capital transfers and non-produced assets; Financial = claims (FDI, portfolio, loans, reserves).