The BOP’s is the systematic record of economic transactions of a nation with the rest of the world in a single accounting year. The main purpose of the BOP is to inform the government of the international position of the nation and to help it in its formulation of monetary, fiscal, and trade policies. Governments also regularly consult the BOP of important trade partners in making policy decisions.
The BOP can be classified into two major accounts, that is, the Current Account and Capital Account. The current account comprises export and import of goods/merchandise and balance in the invisible account. Goods Account or Trade Balance constitutes export and import of goods/ merchandise, and because goods are tangible or visible, this account is also called as Visible Trade Balance or Balance of Trade. If exports of goods are greater than imports of goods we get trade surplus; and if exports of goods are less than imports of goods we get trade deficit.
The invisible account is further divided into (1) Non-Factor Services, (2) Income, and (3) Private Transfers. As the name suggests the invisible account contains invisible or intangible items. Non-Factor Services include export and import of travel, transportation, insurance, Government not included elsewhere (GNIE), and miscellaneous. Miscellaneous includes communication, construction, financial, software, news agency, royalties, management, and business services. Income includes interests, profits, and dividends received from foreign countries and paid out to foreign countries. Private Transfers (also foreign remittances, unilateral transfer, or unrequited transfer) are the flow in one direction with no automatic reverse flow in other direction. For example, an Indian settled in Australia remitting $100 to his aged parents in Chandigarh is a private transfer inflow item in India’s BOP.
The Capital account can be classified by instrument (debt or equity) and maturity (short or long term). The external assistance is of two types: the first is borrowings from/to other countries called as bilateral debt; and the second is borrowing from international financial institutions, also called as multilateral debt. External Commercial Borrowings (ECBs) comprise funds raised by Indian companies from markets abroad via Global depository receipts/American depository receipts. Non-Resident Indian (NRI) deposits in banks, bonds, or other financial instruments also constitute debt component of India’s BOP. However, Foreign Direct Investment FDI and Foreign Portfolio Investment (FPI) constitutes non-debt component of India’s BOP. FDI is long-term investment that goes into production of goods and services whereas FPI is short-term capital,which goes into hedge funds, shares, mutual funds, etc. The current account and capital account together constitute the overall BOP of the country. The increase in reserves indicates an overall surplus in BOP and decrease in reserves indicate overall deficit of BOP.