Worked example 14 — Reading a balance of payments statement

Students learn that the balance of payments always balances and then use the phrase balance of payments deficit in the next sentence. Both statements are correct, and the reconciliation between them is the topic. This example assembles a real quarter, shows where the balancing happens, and shows what the shape of the Indian account actually is.

A Balance of Payment Account is a systematic record of all economic transactions between residents of a country and the rest of the world carried out in a specific period of time — a summary of international transactions of a country for a given period, normally a financial year, recording transactions involving inflow and outflow of foreign exchange.

Five features, and they are a standard question:

1. It is a systematic record of all economic transactions between residents of one country and the rest of the world.
2. It includes all transactions in goods, the visible items; services, the invisibles; and assets, the flow of capital.
3. It is constructed on the double entry system of accounting, so every international transaction results in a credit entry and a debit entry of equal size.
4. All economic transactions carried out with the rest of the world are either credited or debited.
5. In the accounting sense total debit will always be equal to total credits, so the balance of payments is always in equilibrium; but in the economic sense, if receipts are larger than payments there is a surplus, and if payments are larger than receipts there is a deficit.

Feature 5 is the reconciliation. The books always balance because every transaction is entered twice. What people mean by a balance of payments deficit is a deficit on a part of the account — usually the current account — offset by borrowing, investment inflows or a drawdown of reserves elsewhere.

1. Merchandise, visible trade. The most straightforward way in which a country can acquire foreign currency is by exporting goods. These are called visible items because goods can be seen, touched and measured, and the movement is known as visible trade because it is open and can be verified by Customs officials. Exports credit, imports debit.

2. Services, invisible trade. Two kinds, and the distinction decides where a line sits.

• Non-factor income — income from shipping, banking, insurance, tourism and software services, entered as export of services or invisible exports.
• Investment income, or factor income — interest and dividends which citizens of a country earn on investment abroad. Residents own land, bonds and shares abroad, and foreigners enjoying the services of that capital pay for them.

The debit side is the same in reverse: payments residents make to foreigners for shipping, banking and insurance, payments by residents as tourists abroad, and payments in the form of interest, dividends, profits or capital services on foreign owned capital.

3. Unilateral transfers. These are called unrequited receipts because residents receive them for free — nothing has to be paid in return at present or in future. They are like transfer payments: gifts received by residents from foreigners, remittances sent by emigrants to relatives, war indemnities paid by a defeated country. In India unrequited or unilateral transfers are treated as part of invisible trade.

For India this is not a footnote. Remittances from Indians working abroad are one of the largest single credits in the account, and they arrive with no corresponding obligation — which is why they cushion the trade deficit year after year.

4. Capital receipts and payments. This head records international transactions which affect the assets and liabilities of the domestic country with the rest of the world — borrowings, capital repayments, sale of assets, changes in foreign exchange reserves. A government may borrow from another government; a firm may issue stocks abroad or a bank may float a loan in a foreign country; in each case the country acquires foreign currency, entered as a credit.

The difference in kind matters. Current-account items are income and expenditure; capital-account items are changes in the balance sheet. Selling a bond abroad brings in foreign exchange today and creates an obligation for tomorrow. It is the same distinction as revenue and capital receipts in the Budget chapter — and the same trap: an inflow is not the same thing as earnings.

India, first quarter of 2025-26, April to June 2025. All figures US$ billion, from the Reserve Bank's release; the corresponding quarter of the previous year is given for comparison where the release supplies it.

| Item | Q1 2025-26 | Q1 2024-25 | Direction | |---|---|---|---| | Merchandise trade deficit | 68.5 | 63.8 | debit, and wider | | Net services receipts | 47.9 | 39.7 | credit, and larger | | Net outgo on primary income | 12.8 | 10.9 | debit, and larger | | Personal transfer receipts | 33.2 | 28.6 | credit, and larger | | CURRENT ACCOUNT DEFICIT | 2.4 (0.2 per cent of GDP) | 8.6 (0.9 per cent) | deficit, much narrower | | Foreign direct investment, net inflow | 5.7 | 6.2 | credit | | Foreign portfolio investment, net inflow | 1.6 | 0.9 | credit | | External commercial borrowings | 3.7 | 1.6 | credit | | NRI deposits | 3.6 | 4.0 | credit | | Accretion to foreign exchange reserves, BoP basis | 4.5 | — | the balancing item |

The release also records that the preceding quarter had a current account surplus of US$ 13.5 billion, 1.3 per cent of GDP — a useful reminder that the quarterly figure swings.

Take the current account items in order and watch the deficit being closed:

• Goods deficit –68.5
• Services +47.9 → running total –20.6
• Primary income –12.8 → running total –33.4
• Personal transfers +33.2 → running total –0.2

The residual difference from the published –2.4 is made up of the other current-account items the release does not itemise here; the point is not the last decimal but the sequence. India runs a large deficit on goods, which is more than two-thirds covered by a large surplus on services, and almost all of the remainder covered by remittances.

That is the shape of the Indian external account, and it has been for years: a manufacturing trade gap financed by software exports and by Indians working abroad. If one sentence about India's external sector is worth memorising, that is it.

Services exports rose in major categories such as business services and computer services, and personal transfer receipts mainly represent remittances by Indians employed overseas.

(a) Primary income outgo is the price of past inflows. The US$ 12.8 billion debit primarily reflects payments of investment income — foreign investors taking their return home. A country that finances deficits by attracting capital therefore acquires a permanent debit item in the current account. This year's financing is next decade's outgo.

(b) How a deficit is financed matters as much as its size. FDI builds something and is hard to withdraw; FPI is a claim that can leave in a week. A current account deficit financed by FDI is a different proposition from one financed by portfolio flows. In this quarter FDI (5.7) exceeded FPI (1.6) by a wide margin, which is the more comfortable configuration.

The account connects to national income directly. Start from the Module 1 identity:

Y = C + I + G + (X – M), with Y = C + S + T

where C is consumption expenditure, S domestic saving, T tax receipts, I investment expenditure, G government expenditure, X exports of goods and services and M imports.

Write A = C + I + G, called absorption — what the country actually uses. In the accounting sense total domestic expenditures (C + I + G) must equal current income (C + S + T), that is A = Y. From which an export surplus on current account (X greater than M) must be offset by an excess of domestic saving over investment (S greater than I).

Turn it round for a deficit and you have the single most useful sentence in this topic:

A current account deficit is, by identity, an excess of investment over domestic saving. The country is absorbing more than it produces, and the gap is being financed from abroad.

Whether that is a problem depends entirely on what the borrowed resources are used for: investment that raises future output can service the debt; consumption cannot. That is the analytical frame in which a deficit of 0.2 per cent of GDP financed largely by FDI is a wholly different thing from a deficit financed by short-term borrowing to sustain consumption.

Since the account always balances, disequilibrium means a persistent imbalance on the current account that has to be financed — by borrowing, by attracting capital, or by running down reserves. Reserves are finite. When they run out, and lenders stop lending, the country cannot pay for its imports. That is a balance of payments crisis, and India had one in 1991; worked example 15 takes it up.

Note also the direction of the reserves line in step 3. An accretion of US$ 4.5 billion is a quarter in which inflows exceeded the current account gap, so reserves rose. In the crisis case the same line runs the other way, and it is the line that runs out.

The balance of payments is the reason a body of law exists. Exchange control legislation, the regime governing external commercial borrowings, the rules on foreign direct and portfolio investment, customs law and the classification disputes it generates — each is an instrument for managing one line of this account. Read the statement and the statute book maps onto it row by row.

And the account is itself a recognised legal justification. Quantitative restrictions covered all agricultural imports in India for balance of payments reasons: the balance of payments is a ground, under the WTO agreements as well as under domestic law, for restrictions that would otherwise be unlawful. The Foreign Trade (Development and Regulation) Act 1992 is the statute through which most of it is administered.

The figures are the Reserve Bank's for one quarter, April to June 2025, and must always be quoted with that period. The running total in step 4 is arithmetic on the published components and does not reconcile exactly to the published current account deficit, because the release does not itemise every line; that is stated openly above rather than smoothed over.

1. BoP = a systematic double-entry record of all economic transactions between residents and the rest of the world in a period. It always balances in the accounting sense; surplus and deficit are economic statements about part of it.
2. Current account: merchandise (visible, Customs-verifiable), services (invisible — non-factor income and investment income), unilateral transfers (unrequited; in India treated as part of invisible trade). Capital account: borrowings, repayments, asset sales, reserve changes.
3. India Q1 2025-26: current account deficit US$ 2.4 bn (0.2 per cent of GDP); goods deficit 68.5; net services 47.9; personal transfers 33.2; primary income outgo 12.8; FDI 5.7, FPI 1.6, ECB 3.7, NRI deposits 3.6; reserves accretion 4.5.
4. Shape: a goods deficit covered by services and remittances. FDI stays, FPI leaves — financing matters as much as size, and primary income outgo is the price of past inflows.
5. Absorption: A = C + I + G against Y = C + S + T, so X greater than M requires S greater than I — a current account deficit is an excess of investment over domestic saving.