Balance of Payment

Balance of Payment Basics about A Country’s Balance Sheet

FEBRUARY 2010 MANOJ KUMAR AGRAWAL

Balance of payment is defined as “Balance of Payments of a country is a record of its monetary transactions over a period with the rest of the world”. Balance of Payment consists of Current Account and Capital Account. Current Account: Shows all the money flows to and from a country arising from exports and imports or Goods and Services, plus transfers of income and other net transfers. Balance of payments on current account =

Visible trade + Invisible trade + Transfers of funds

Trade Balance (Visible trade): Show the sum of visible export revenue minus the sum of visible Import expenditure. Invisible Balance: (Intangible goods) Net flows in Services: (Tourism, Professional services, Transport, etc.) Net Flows in Income: (Wages, Returns of Investment, Profits of Firms, Interest payment) Net transfers: (Subsidies from other Governments to locals, Transfers from donations and remittances (presents, gifts to families, prizes, etc.), and Government transfers (received and sent)...

Curious to know about balance of payments. How the deficits are calculated? Then give a look to this document.

• Current Account

• Trade Balance

• Invisible Balance

• Capital Account

• Disequilibrium in BoP

• Causes of Disequilibrium

• Measures for Correction

Capital Account: If Capital Account is positive (+), assets of the country decrease. If Capital Account is negative (-), assets of the country increase. Direct Investment: Long Term. A foreign firm building a plant or buying an existing factory in local economy is FDI (Foreign Direct Investment). Credit in Capital account. Portfolio Investment: Short Term. Purchase of foreign currency. Buying stocks, shares, bills or bonds abroad or foreigners buying local bonds, stocks, shares, bills, bonds, etc. Net balance of current account. Other financial flows: Savings Abroad. (Outflow of foreign currency $). Loans to foreigners mean that K account is decreasing but there is an asset that is going to be recovered in the future. Gold and Foreign Reserves: are the foreign currency deposits held by Central Banks and monetary authorities. These are assets of the central banks which are held in different reserve currencies, such as the dollar, euro and yen, and which are used to back its liabilities. E.g. the local currency issued. Balancing item (or statistical error) Parallel Markets Illegal trade (not reported flow of capital, illegal trade, smuggling, etc.)

NOTE: Balance of payments should be always in equilibrium. A deficit in Current Account has to be covered by a Surplus in the Capital Account. Economically healthy nations that provide good investment opportunities tend to run trade deficits and capital account surpluses. Note: In fixed exchange rate system govt. ensures BOP is zero, whereas in floating exchange rate surplus / deficit influence the exchange rate. Clarification: some says BOP consists of Current a/c, Capital a/c, IMF, SDR Allocation, Errors and omission, reserve and surplus. While many merge all in capital a/c except current a/c.


Disequilibrium in BOP

Following are the types of disequilibrium: Cyclic disequilibrium: It occurs on account of trade cycle. Caused by demand fluctuation due to changes in output, price, employment and income Structural disequilibrium: Caused by demand fluctuation due to change in fashion, habits, economic progress, crop failure, labor strikes, raw material supplies etc.

Short run disequilibrium: Short term International loan or lending. Export Import imbalance. Long run or Secular disequilibrium: aka Fundamental disequilibrium. Accumulation of deficits of surpluses,

Causes of Disequilibrium:

Trade Cycle

Huge development & investment programs

National output and national spending

Population growth

Huge external borrowing

Inflation

Demonstration effect

Exchange rates

Money supply

Interest rates

Tariffs and Quotas

Is deficit a burden on Government?



Measures for disequilibrium correction

Monetary measures: v Monetary contraction or expansion: Money

supply is regulated. Thus by affecting purchasing power, local demand is reduced, which ultimately increases exports. This includes changing interest rates etc.

v Devaluation / Revaluation: Currency is devaluated to promote exports and discourage imports.

v Exchange Control: Governing the currency

exchange tightly. Trade measures: v Export promotions: Reduction in export duties,

Export subsidies, Export incentives.

v Import control: Import duties, Import quota, and Import prohibition.

Other measures: v Foreign loans. v Incentive for investments. v Tourism development. v Import subsidization. v Incentive for inward remittance.

Exchange rate matters

Documents

Balance of Payment