Role of Equilibrium in the Balance of Payments

Read this article to learn about the role of equilibrium in the balance of payments!

The balance of payments, in the accounting sense, must always balance. Debits must always equal credits if the entries are correctly made. Thus, there can be no disequilibrium in the balance of payments as a whole.

However, while a nation’s international accounts must always balance, its accounts need not be in equilibrium. Say, if a country’s balance of payments shows a debit balance in merchandise and services accounts (on current account side), its credit balance in the other accounts (on the capital account side) must be sufficiently large so that total debits equal total credits.

That is to say, when a country has a debit balance on current account, it is either importing capital on a long or short term or it is exporting gold, or it is receiving donations from foreigners and thereby its credit in the current account is extended to the extent of debit in the current account.

In a functional sense, thus, there may be disequilibrium in the balance of payments of a country. Operationally, a country at a time may be receiving more payments from abroad than what it has to make. Thus, when total receipts exceed total payments, there is a surplus balance of payments.

It is regarded as “a favourable balance.” Sometimes, a country has to make more payments abroad than what it receives. Then, there is a deficit in its balance of payments. It is regarded as an “unfavourable balance.”

Hence, the usual analytical approach to the balance of payments is to consider it as the difference between receipts from and payments to foreigners by the residents of the country.

Symbolically, thus, the balance of payments may be defined as:

В = R-P

Where, В stands for balance of payments,

R denotes receipts from foreigners, and

P stands for payments made to foreigners.

Clearly, thus, when В is zero, the balance of payments can be regarded as equilibrium balance of payments. That is to say, a country’s balance of payments may be said to be in equilibrium when its receipts are equal to its payments on account of its transactions with other countries of the world. Such a country with equilibrium balance of payments is often called a country in “external balance.”

However, a country’s balance of payments is said to be “favourable” or in “surplus” when the total receipts from the rest of the world exceed the total payments to the rest of the world. Symbolically, when В is positive, it is called a favourable balance of payments.

On the other hand, if a country’s receipts from foreigners fall short of its payments to foreigners, its balance of payments is said to be unfavourable or in deficit. Symbolically, when В is negative, it is called an “unfavourable” or “adverse”, balance of payments. A country whose balance of payments is in surplus is often referred to as a “surplus” country. Similarly, when its balance of payments is in deficit or adverse, it is called a ‘deficit’ country.