Balance Of Trade And Balance Of Payments: An Ugly Difference

Trade surplus does not necessarily mean balance of pays surplus. There are some difference between Balance Of Trade And balance of payments on current account.

Balance of Trade

Balance of trade refers to the net difference between the value of exports and imports of commodities from/into a country. The movement of goods or commodities between countries is known as visible trade. Therefore, balance of trade refers to the net balance of the visible trade of the country.

When the country exports commodities it gains foreign exchange. When it imports it has to pay in foreign exchange, or it loses foreign exchange. When the exports of goods exceed imports, there is a net gain of foreign exchange to the country and the balance of trade is said to be ‘favorable’. If the imports of goods exceed exports, it results in net payment by the country of foreign exchange to other countries from its reserves. The balance of trade in such cases is said to be ‘unfavorable’. Since imports and exports of a country seldom the balance of payments will not ordinarily balance. During any given period, the balance of trade will show either a favorable or unfavorable balance.

Balance of payments

Foreign trade, in its broad sense, includes not only visible trade involving import and export of commodities but invisible items also. These invisible items include shipping, banking, tourist traffic, insurance, gifts, investments, interest on investments, etc.

The balance arrived at taking into account both the visible and invisible items in foreign trade, or in other words, all items for payment or receipt of foreign exchange by a country, is known as the
balance of payments.

Thus, balance of payments is more comprehensive than balance of trade. Balance of payments includes balance of trade and other invisible items of foreign trade. As in the case of balance of trade the total amounts payable and receivable do not balance and the balance of payments for a given period ends up in favorable (surplus) or unfavorable (deficit) balance.

Current and Capital Accounts. The balance of payments as defined above which takes into account total transactions of a country in merchandise, services and transfers with other countries is known as the current account of the balance of payments. When we use the term balance of payments, we refer to the current account of the balance of payments.

Any import or export by a country has a corresponding effect on the country’s holding of exchange reserves. For example, when a country exports certain commodities the country’s resources are depleted to the extent of goods exported. But this increases foreign exchange reserves of the country because payments for exports are received in the form of foreign exchange.

Similarly, when imports are made the country’s resources are augmented, but this involves decrease in the foreign exchange reserves of the country. These transfers of money and other capital items and changes in the country’s foreign assets and liabilities resulting from the transactions in the current account of balance of payments are recorded in the capital account of balance of payments.

It would be observed that the current and capital accounts of balance of payments are maintained on the double entry principle cf accountancy. When export takes place it is credited in the current account representing depletion of domestic assets and debited in capital account representing resenting acquisition of financial assets.

Similarly, imports are debited in current account and credited in capital account. Since the same transactions are recorded in opposite sides in the two accounts, they should balance each other provided there is no inaccuracy in recording the transactions. If there is a surplus in the current account there would be a deficit in the capital account for the same amount and vice versa. In such cases they are made to agree by placing the difference as ‘errors and omissions’.

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