Question (by rs rs)
Can someone explain to me why BOP must always balance but it does not guarantee BOP equilibrium? any econs student can help?
Answer
Hi rs rs,
When your "A" level economics lecturer says that BOP must always balance, he/she is actually referring to the accounting BOP balance.
In accounting, when a company buys goods for sale using cash, it will be recorded in the accounting books as debit purchases and credit cash. For every transaction, there will be a debit entry and a credit entry.
At the end of accounting year, the accountant will prepare a statement known as a trial balance. The trial balance will total up the values of all the debit entries and all the credit entries and if there is no mistake in recording every transaction, the total debit value will be equal to the total credit value. When this happens, the accountant says that the account is in balance ie all debit value = all credit value
Similarly, when a country buys goods from abroad ie imports, the country needs to exchange its local currency for the foreign currency to buy the imports, so the country official reserves of foreign currency will decrease. This will be recorded as debit imports and credit official reserves.
Similarly, at the end of the government year, the government statistician will total up the values of all the debit entries and all the credit entries and if there is no mistake in recording every transaction, the total debit value will be equal to the total credit value. When this happens, the accounting BOP statement is said to be in balance ie all debit value = all credit value.
However, the term BOP balance is used differently in newspapers, news, economics and finance.
BOP balance can be positive, zero or negative
Positive BOP balance (commonly known as BOP surplus) means the country's international receipts are more than its international payments arising out of its international transactions ie imports, exports of goods and services, unilateral transfers, capital inflow and outflow. The excess/surplus of international receipts over international payments increases the country's official reserves of foreign currencies.
Zero BOP balance (commonly known as equilibrium BOP) means the country's international receipts are equal to its international payments arising out of its international transactions ie imports, exports of goods and services, unilateral transfers, capital inflow and outflow. No excess/shortage of international receipts over international payments leaves the country's official reserves of foreign currencies unchanged.
Negative BOP balance (commonly known as deficit BOP) means the country's international receipts are less than than its international payments arising out of its international transactions ie imports, exports of goods and services, unilateral transfers, capital inflow and outflow. The shortage/deficit of international receipts over international payments decreases the country's official reserves of foreign currencies.
Thank you for your kind attention.
Regards,
ahm97sic