Difference between Balance of Trade and Balance of Payment

Like a balance sheet is made to recognize the profit and loss of the company, similarly, a balance of payment and balance of trade is used to measure the economic transactions, i.e., imports & exports which happen from one country to another in a particular period. India's imports & exports show the transactions of goods & services which are taking place with foreign countries. The financial status of a country is depicted by this only.

Balance of Trade:

Balance of Trade is a statement that shows the difference between export and import of a country. It is a constituent of the balance of payment. It shows the imports & exports which have been done by one country with foreign one. In this, the transaction of visible goods takes place and not the services. It tells the net profit or loss which a particular country has incurred. As it is a part of the balance of payment (BOP), its scope is narrower. The BOP doesn't consider capital transactions.

Balance of Trade (BOT) only helps recognize a country's economic & financial power. It depicts if a country has imported or exported whether the trade balance is deficits, surplus or equal. When the surplus is higher, it is called positive balance trade.

Features of Balance of Trade (BOT)

1) Export and Import

The trade balance should involve trade between two countries, indicating the goods moved from domestic to foreign countries, or vice versa.

2) Visible Goods

In the trade balance, only visible goods are considered and not invisible.

3) Material Goods

Only material goods will be treated in the balance of trade. Non-material goods are not considered in the balance of trade.

Types of Balance of Trade

1. Trade Equilibrium

It is a situation in which the amount invested in imports and obtained from exports are equal. The amount spent on imports of goods & services is compensated with the amount gained from exports. Thus, it has no harm. When the balance of trade is unfavorable. It is definitely a great concern. However, if it stays for a short period then it causes no harm, as it does not affect economic transactions.

Equilibrium: Import is equal to Export (X=M)

2. Trade Deficit

When a country imports more than exports, it is termed a trade deficit. The trade deficit is a situation in which imports are greater than export. When imports are more and exports are less, it is considered negative as more money will be used to buy products, which may down a country's economic status.

Trade deficit: Import is greater than Export (X<M)

3. Trade Surplus

The trade surplus is the opposite of the trade deficit. In a trade deficit, the imports are more than the exports, whereas, in a trade surplus, the imports are less, and exports are more. It is considered positive as more money will be obtained from other countries while exporting. It strengthens the financial status of a country.

Trade Surplus and Its Importance

As we all know, surplus trade is when a country's export is more than its import. It is considered to be positive trade. Its benefits are as follows:

• Employment and growth are generated when there is a trade surplus, but the interest rate increases.
• Trade surplus can influence the currency value of a country. When there will be more exports of goods, this trade will give power to a country to control currency.
• Trade surplus helps in transferring technology as a nation with a trade surplus will have the opportunity to make an investment in technology which will further help a country to interact with international branches.
• It can be observed if there is more export, the nation will have more control over its currency,

Factors Affecting BOT

1. Government Policies

The balance of trade can get affected by government policies as government policies may put restrictions on imports and subsidizing exporters.

2. Impact of Exchange Rate

The balance of trade will also get affected by the exchange rate. If a country's exchange rate increases, the price of goods & services will increase, leading to a decrease in export and import.

3. Foreign Currency Reserves

When a country indulges in international marketing, that particular country purchases machines to enhance the productivity of goods & services. For this import, sufficient forex reserves are needed. But if it is not there, then it becomes difficult to trade. Thus, the balance of trade is also gets affected by foreign currency reserves.

4. Inflation

If there is inflation in a country, the product price will increase, leading to higher prices for producing goods & services. Then, the export will be less due to higher prices, again leading to a trade imbalance.

Balance of Payment:

Balance of payment is also a statement showing all the transactions between countries. But it is broader than the balance of trade because the balance of trade is a constituent of the balance of payment. The difference between the total receipts of foreign exchange and the total payment of foreign exchange is also called BOP. Balance of Payment records goods and services, including invisible items. Capital, gold, and investment are considered while making BOP. The inflow & outflow of all goods & services and the economic transaction are included in the balance of trade. It records the transactions of both accounts, considering current and capital account transactions. If the balance of payment is not good, which is a situation of imports being higher than exports, then it is a big deal. Because higher imports than exports will lead to the outflow of cash which will further cause a reduction in the money supply.

Transactions that BOP Includes

a) Current Account

In this account, the transactions of all goods and services are considered. It includes both tangible and intangible items.

b) Capital Account

In this account, the capital expenditure and investments which are made are included. Examples are a foreign direct investment, government loans to foreign countries, etc.

c) Financial Accounts

In this account, the investment made in real estate, foreign direct investment and business ventures are recorded.

Components of BOP

1) Export & Import

In the balance of payment, the transactions made on imports & exports are recorded.

2) Services Rendered and Received

In the BOP, not only goods are considered but also services. The services include banking, shipping, investment etc. Further, it also considers two incomes.

A) Non-Factor Income

Income received from services like shipping and tourism is included in non-factor income.

B) Factor Income (Investment)

The income earned by a citizen on investments is known as factor income. It may include money earned on an investment or if a person owns land abroad.

3) Unilateral Transfer

When a citizen receives gifts and remittances, it is termed a unilateral transfer. As it is for free and no payment is made on it.

4) Capital Receipts and Payments

When the domestic country's assets and liabilities get affected by international transactions, it is recorded in BOP. It includes if a government has taken a loan from another country or has invested in a foreign country.

Features of BOP

1. Systematic Record

Balance of payment (BOP) is systematic. It records payment and receipt of goods & services made during import and export.

2. Fixed Period

This account is made for a fixed period. It shows the particular period in which it is made. For example - For a year.

3. Comprehensive

It is more comprehensive as it considers all the visible and invisible items. The capital transfers are taken into account while making the balance of payment.

4. Double Entry System

The economic transactions that are done include receipts and payments. It is recorded on the basis of a double-entry system.

5. Debited or Credited

The transaction entries are debited when money is paid and credited when money is received.

Importance of BOP

1. It sees the transaction of exports & imports related to goods & services for a particular period.
2. It helps the government recognize the potential of industries based on which the government formulates policies.
3. The government decides whether the tax should be increased or decreased based on imports & export.
4. Economic status is revealed by BOP. The government decides monetary and fiscal policies based on this economic status.
5. When the fund flows, and investments are made, financial accounts track it. The changes that occur in the ownership of assets are then thoroughly analyzed.

Difference between Balance of Trade and Balance of Payment