Before we examine the balance of payment, let us look at the balance of trade concept.
Balance of Trade
Balance of trade is the relationship between the value of a country’s exports and imports of merchandise within a given period of time usually a year. When the difference between the two is equal to zero, we say there is balance of trade. When visible exports exceed visible imports, we say there is favourable balance of trade. But when visible exports falls below visible imports, we say there is unfavourable balance of trade. In this case, balance of trade gives information on visible exports and imports.
Balance of Payments
Balance of payment is a record showing a country’s financial position with the rest of the world for a particular period usually a year. It is thus a statement showing the relationship between a country’s total payments to other countries, and its total receipts from them. From its record, the balance of payment gives information on visible and invisible trade, loan and foreign exchange reserves. It gives a complete picture of a country’s financial dealing with the rest of the world.
Components of Balance of Payments
A country’s balance of payment is made up of three main components. They include:
(i) Current Account
(ii) Capital Account, and
(iii) Monetary Movement Account.
(i) The Current Account
This is made up of visible and invisible trade accounts. Visible items in international trade include exports and imports of physical goods. On the other hand, invisible items include payments for and receipts from services rendered, such as shipping, banking, insurance, tourism, etc. The difference between the two accounts will determine whether there will be a deficit or surplus in the current account.
(ii) The Capital Account
This account deals with short and long-term capital movements in the form of investment funds and loan. Long-term investment refers to investment with a maturity period of one year or more. Long-term capital may be direct investment in factories, machinery or bridges. It can also be in the form of portfolio investment e.g. purchase of stocks, share, bonds, etc., while short term investment is an investment maturing in less than one year. There will be a surplus in the capital account if the receipts of a country exceed her payment; while there will be a deficit if her payments exceed receipts.
(iii) The Monetary Movement Account
This account shows how the balance on both the current and capital account are settled. For example, if a deficit or surplus occurs on both accounts, the monetary movement account tells us how the deficit is financed and the surplus is expended. The monetary movements account, therefore, keeps the balance of payments always in balance. This is why balance of payment is always balanced.