It
is a statistical statement which systematically summarises the economic
transactions of a country with rest of the world for a given time period.
Balance of trade and Balance of
payments:
The
balance of trade includes only those transactions arising out of export and
import of visible items (goods). However
it does not include the transaction of invisible item such as shipping,
insurance and banking, payment of interest, dividends or expenditure by
tourists. Balance of payment takes into
account the exchange of both visible and invisible items between the
countries. Hence Bop records all the
economic transactions of a nation with the rest of the world. Bop represents a clear picture of countries
external balance.
Components of Balance of
payments:
All
the transactions that fall under Balance of payments are recorded in standard
double – entry book keeping system.
According to this entry system for a credit entry there should be
equivalent debit entry. As international
transactions are recorded in double – entry book keeping, the balance payments
must always balance (ie) total amount of debits must equal to the total amount
of credits. Sometimes, balancing items
like omissions and errors are added to balance the items.
The Balance of payment usually
consists of following transactions which are grouped under credit and debit
entries.
A Current Account
A Capital Account
A Unilateral payments
account
A Official Reserves
Assets account
A Current account: This
account includes all transactions that arises out of use of national
income. It consists of two major items,
namely, a. Exports and Imports,
b. Invisible exports and imports.
b. Invisible exports and imports.
Merchandise
Exports (ie) sale of goods abroad are credit entries because al transactions
under this heading generates income on the other hand, merchandise exports ie
purchase of goods from abroad are debit entries because all the entries that
comes under this heading gives rise to foreign money claims on the home
country.
Merchandise imports and exports form
the most important international transaction of the most of the countries.
Similarly, sale of services are
credit entries and invisible imports are debit entries.
A Capital Account: The
capital account consists of short term and long torm capital transactions. Capital outflow represents debit whereas
capital inflow represents credit (for example) If an American firm invests 100
million dollars in India, this transaction will be represented as debit in balance
of payment and a credit in the Balance of payment of India.
A Unilateral Transfers
Account: Unilateral transfers is another term for
gifts and includes private remittances, government grants, reparations (sent
back to one’s country) and disaster relief.
Unilateral payments received from
abroad are credits and those made abroad are debits and they are part of
current account.
A Official reserve
Account: This account represents the official holdings
by the government and agencies. Of all
these accounts current account represent the transfer of goods, services,
income and gifts between the home country and foreign countries. When there a surplus (ie) inflows are more
than outflows, the current account is said to be positive and when there is a
deficit (ie) inflows are less than out flows, the current account is said to be
negative.
A current account
surplus means exports are more and imports are less. This means the nation earns more on foreign
exchange and reduced liabilities in its dealing with other countries. A deficit, on the other hand means that the
country must pay other nations in other words the imports are more and exports
are less. This increases the liabilities
of the home countries in its dealing with foreign nations. It is, therefore, said that the current
account balance represents the bottom line on a nation’s income statement. If it is positive, the nation is spending
less than its total income and accumulating assets. If it is negative, domestic expenditure
within the country is more which exceeds income. This results in the increase of borrowings
from the rest of the world.
A Balance of payments
Disequilibrium: The balance of payments in said to be in
equilibrium when there in no surplus or deficit in the balance of payment of a
country. The most common factors which
causes balance of payments disequilibrium are discussed below.
A Development
disequilibrium: This equilibrium is caused due to the various
developmental activities taken by the nation.
Large scale developmental expenditure usually increases purchasing
power, aggregate demand and prices, resulting in large imports and less exports
causing disequilibrium in balance of payment.
A Cyclical
disequilibrium: Cyclical fluctuations of general business
activity is also a prominent reason for balance of payment disequilibrium. A country enjoying a boom in IT for example
will experience more rapid growth which increases its imports than
exports. This causes disequilibrium in
BOP.
A Secular
Disequilibrium: In a developed country for example, the
disposable income is generally very high and hence more demand. At the same time the production cost is also
very high due to higher wages. These two
factors high demand for goods and high production cost when coupled together
will encourage the developed country to look for goods that are cheap outside
their country. This increases the
imports than the exports.
A Political
Factors: Factors like war or changes in world trade routes
causes disequilibrium in BOP.
A Sociological
Factors: Certain
social factors also influence balance of payments. For instance change in the tastes, preference
and fashions, may affect import and export and thereby affect the balance of
payments.
A Correction of
Disequilibrium: A
country may not be bothered about a surplus in the balance of payments, but
every country strives to remove or at least reduce a balance of payment
deficit.
There are a number of measure
available for correcting the balance of payments disequilibrium. They fall in to two categories
A Automatic
Correction
A Deliberate
measure
A Automatic
Correction: Under this, the BOP disequilibrium
will be automatically corrected. (for example) assume that there is a deficit
in the balance of payments. When there
is a deficit, export are less and import of goods are more. This increase the liabilities of the home
country in its dealing with foreign nations.
This causes fall of domestic currency in the international market due to
increase of exchange rate. This makes
the export of goods cheaper. As time
passes, due to the reduction in the price of export goods, its demand in the
international market tend to rise. This
pulls up the BOP from a deficit country. The automatic adjustment of BOP can
happen by adjustment in the following variables-price, interest, income and
capital flows.
A Price
adjustment:
Under the gold standard, gold outflows takes place from a deficit
country to a surplus country. As a
result of this movement of gold, the supply of money in the deficit country
becomes less and supply of money in surplus country becomes more. This will result in rise in the prices in the
surplus country which will encourage imports and discourage exports and fall in
prices in the deficit country which will encourage exports and discourage
imports leading to the restoration of BOP equilibrium in due course.
A Interest rate
adjustment:
The contraction or expansion of money supply resulting from the BOP
deficit or surplus leads to rise or fall in interest rates Due to the outflow
of gold from the deficit country to the surplus country, the supply of money
becomes less in the deficit country. As
a result, interest rates goes up in the deficit country. This will encourage investors in the deficit
country where the interest rate has risen to withdraw their funds from abroad
and invest in the home country. Moreover,
because of fall in rate of interest in the foreign country caused due to BOP
surplus, foreigners will be encouraged to send money to deficit country where
the interest rates has risen. These
changes will also contribute to the restoration of BOP equilibrium.
A Capital Flows: changes in the interest rates as a result of
BOP disequilibrium will encourage capital flows from the surplus nation to the
deficit nation helping in the restoration of BOP equilibrium.
A Deliberate
Measures: However
because of the various problems associated with the policy of automatic
correction, deliberate measures are employed today. Deliberate measures are classified as
A Monetary
Measures
A Trade
Measure
A Miscellaneous
