Balance of Trade and Balance of Payments
NCERT Class 12 • Introductory Macroeconomics • Chapter "Open Economy Macroeconomics"
Balance of Trade and Balance of Payments
The balance of trade records only the export and import of goods. The balance of payments is much wider: it records every economic transaction between residents of a country and the rest of the world in a year, including goods, services, income and capital flows.
The Two Accounts
- The current account records trade in goods, trade in services, income from investment and unilateral transfers such as remittances and gifts.
- Goods trade within it is the visible part and services trade the invisible part.
- The capital account records transactions that change the country's assets and liabilities abroad.
- It includes foreign direct investment, portfolio investment, loans and changes in official reserves.
- Foreign direct investment brings lasting control and usually technology and management; portfolio investment is financial and can leave quickly.
- The balance of payments as a whole must balance, because any gap on the current account has to be financed on the capital account.
Surplus, Deficit and Financing
- A current account surplus means the country is earning more from the world than it spends, so it is lending abroad on net.
- A current account deficit means the opposite, and it must be financed by borrowing, by foreign investment, or by drawing down reserves.
- A deficit is not automatically bad: borrowing to import capital goods builds future capacity.
- It becomes dangerous when it is large, persistent and financed by volatile short term flows.
- Remittances from workers abroad are a large and relatively stable credit item for India's current account.
- Foreign exchange reserves act as the cushion that lets a country meet its payments when flows reverse.
- Reserves are usually judged by how many months of imports they can cover.
- Autonomous transactions happen for their own sake, while accommodating transactions are made to cover the gap they leave.
- A country's external debt and its reserves are read together to judge how safely it can meet its obligations.
| Account | What It Records |
|---|---|
| Current account | Goods, services, income, transfers |
| Capital account | Investment, loans, reserve changes |
| Balance of trade | Goods exports minus goods imports |
Balance of payments — a systematic record of all economic transactions between residents of a country and the rest of the world during a year.
Exam me kaise aata hai
- Which account records remittances — the current account
- Which account records foreign direct investment — the capital account
- Balance of trade covers only — goods
- Investment that can leave quickly is called — portfolio investment
UPSC/State PSC ke liye
- A current account deficit financed by foreign direct investment is far safer than one financed by short term portfolio money, since the latter can reverse suddenly.
- Remittances make India's current account more stable than its trade balance alone would suggest.
Yahan confuse hote hain
✗ Balance of trade and balance of payments are the same | Trade covers only goods; payments covers everything | ✓
✗ A current account deficit is always harmful | It can be sound if it finances productive capacity | ✓
✗ Remittances are recorded in the capital account | They are unilateral transfers in the current account | ✓
Ek nazar me
- Balance of trade covers goods only; balance of payments covers everything.
- Current account: goods, services, income and transfers.
- Capital account: investment, loans and reserve changes.
- A deficit financed by stable long term flows is far safer than one financed by hot money.