Question

Explain the balance of payments equation:

(Exports-Imports)+(Capital inflows-outflows)-change in reserves=0

Answer 1

ANSWER:

The balance of payments equation:

BOP = Current Account Balance + Capital Account Balance – Official Reserve Account = 0

or, BOP= (Exports-Imports)+(Capital inflows-outflows)-change in reserves=0

A balance of payments surplus reflects that the exports of a country are more than it imports. Government and residents are savers of the country. They give enough capital to pay for all production domestically. They own disposable reserves that they might even lend outside the country.

Balance of payments includes current account, capital account, errors and omissions, and change in foreign exchange reserves.

The main components of Current Account are export and import of goods, export and import of services, income receipts and payments to and from abroad, and Unilateral or Unrequited Transfers to and from abroad. The main components of capital account are investments to and from abroad; borrowings and landings to and from abroad, and change in Foreign Exchange Reserves. It has to be noted that change in reserves’ is recorded in the balance of payments account and not ‘reserves’.