Economics (Balance of Payments)

GREASE THOSE WHEELS (ECONOMICS)

#1 BALANCE OF PAYMENTS

The only thing you are expected to know about balance of payments in the AS Level Economics syllabus is...

• Explain the Components of Balance of Payments.

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Well Balance of Payments (BOP) can be thought of as a country's virtual economic logbook. It has the records of all the money that flows into and out of a country. Such movement can occur in in the following ways;
(Credit is inflow of foreign exchange while debit is outflow)

• Exports (Credit)
• Imports (Debit)
• Aid and Funds (Credit)
• Payment for Services, such as banking, advertisements.
• Cross-border dividend and interest rate payments.
• Remittances sent by overseas workers. (Credit)
• Foreign Investments (long term capital inflows)
• Speculative Investments in currency markets and stock exchanges (short term capital inflows).

They are bracketed in the Balance of Trade part of the Current Account which is a component of balance of payment that records all foreign exchange inflows and outflows. Balance of Trade, well, deals with all the monetary transactions that are occurring at a country's outlets (i.e, ports). It is very important in determining the competitiveness of a country in the global market.. Balance of Trade focuses on all types of goods that are transferred between for e.g, Pakistan and the rest of the world.

These are part of the Invisible section of the Current Account and account for the exports and imports of services only. Which include the payment to shareholders of a business (dividend) which reside in other countries, portion of wages transferred by overseas workers to their family back at home (remittances), interest received from money kept in foreign banks and all other transactions which involve intangible goods (goods that cannot be touched) such as transfer of copyrights etc.

These make up the Capital Account part of the Balance of Payments' logbook. Short term capital inflows are purely speculative in which an investor invests a part of his investment in a country's stock exchange or currency market when he/she sees some positive future development, like increase in the value of the currency of that country or growth of an industry that is listed on that specific country's stock exchange. Long term capital inflows are more measured and are the investments in a running business at a country. For example if Japan sets up a water purification/desalination plant in Saudi Arabia. But such inflows come at an opportunity cost, that are the dividends/portion of profits sent back to the Japanese investors. Law and Order situation of a country, tax rates, interest rates, expectations for profits and government policies are some of the factors that affect long term capital investment.

Balance of Payment disequilibrium can be of two types. A deficit and a surplus a surplus (depicted by a -ive sign :-O) is when money inflow exceeds money outflow and the monetary reserves of a country build-up while a deficit (signified by a +-ive) occurs when the opposite occurs. A country, necessarily, likes to have its balance of payment in equilibrium, and it should remain like that, but in real life such a thing doesn't occur and the surplus-equilibrium-deficit cycle rolls on. Let us outline some of the things that result in a balance of payment deficit...

1. When the imports of a country exceeds its imports.
2. When the exchange of services b/w the countries are more inclined towards debit.
3. When there are a large amount of loans taken by the country from other countries/organizations. Until such loans become grants, the foreign exchange used to pay back these loans with interests would result in a current account deficit.
4. Decreased investment in a country due to political \ economical instability or other crisis situations that discourage investors.
5. Appreciation (increase in value) of the country's currency in the international market which results in imports getting cheaper for the citizens while exports getting expensive for foreign buyers thus resulting in increased imports and decreased exports.
6. When a country is on road of technological advancement and economic well-being then it imports more capital goods and machinery which might result in a temporary BOP deficit but will benefit the country in the long run.
7. When a major importer of a good from the country starts imposing heavy tariffs (taxes on imports), quotas or a complete trade embargo on that country then a severe BoP deficit is observed. For example Iran imports, say 90%, of its tea from Kenya but the Iranian government finds the Kenyan tea as of low quality or has found cheaper substitute for it then it will subsequently reduce imports for it and such a move will also leave a negative impact on other Kenyan tea importing countries and effect the overall BoP (deficit) of Kenya.
8. Inflation in a country will also result in its exports being expensive in the foreign market. Which will persuade importing countries to scout for better alternatives and effecting the BoP (deficit) of the country in question.

Some things that result in a balance of payment surplus are...
(most are contrary to the above given statements, exceptions are listed below)

1. Basically, increased exports and decreased imports result in such a phenomenon.
2. A country advances technologically which results in increased quality and quantity of its goods in the international market. Better quality at a the same or lower price is bound to get the importer's attention.

We will be discussing measures to correct balance of payment disequilibrium when we have completed the exchange rates part of the syllabus.