Balance of Payments (BoP)
The Balance of Payments (BoP), commonly referred to as the balance of international payments, is a list of all economic transactions that take place between entities in one nation and the rest of the world within a specific time period.
In other words, Balance of Payment is a balance sheet of the nation’s systematic accounting that includes both debit and credit activities. All international monetary transactions are observed by the Balance of Payment. The BoP calculates the amount of money coming into and out of the nation by accounting for all transactions made in both public and private sectors.
The primary goal of BoP is to identify an economy’s strengths and shortcomings. One can determine the overall revenues and losses from international commerce by analyzing the BoP accounts from the previous year.
Features of Balance of Payment
- BoP is a systematic record of all the economic transactions of a country with the rest of the world
- It includes all the transactions, visible and invisible.
- It relates to a period of time.
- It follows a double entry system of book- keeping.
Current and Capital Account of Balance of Payment
The balance of payments is divided into two parts: the current account and the capital account. The capital account shows the net change in ownership of national assets, while the current account shows a country’s net revenue.
When a distinct, typically a very moderate capital account is reported separately, the capital account is occasionally referred to as the financial account. The current account covers transactions involving products, services, investment income, and current transfers. In a broad sense, the capital account comprises financial instrument transactions as well as central bank reserves. When used strictly, it solely refers to financial instrument transactions.
While the capital account is not taken into account when calculating national production, it is the current account. From an accounting point of view, the balance of payments is always positive. Moreover, in the accounting process, a current account deficit is balanced by a capital account surplus brought on by either borrowing from overseas or depleting the country’s gold and foreign exchange reserves. Similarly, a surplus in the current account is balanced by a similar deficit in the capital account brought on by debtor country loans and bills or by a drop in the country’s gold and foreign exchange reserves.
Disequilibrium in Balance of Payment
However, total receipts for the reference period need not always be equal to total payments, which leads to disequilibrium in the balance of payments. An imbalance in the balance of payments exists when the total receipts and total payments for the accounting period do not match. There are a few factors that cause disequilibrium in balance of payments, which we will discuss below.
Most countries undergo population growth. Countries like India and China not only have a large population, but they also have a rapid population growth rate. In order to meet the demands of the growing population, the volume of imports may also rise accordingly.
Developing nations, like Nepal, have multiple development projects that require the import of capital goods, raw materials (that are not readily available), and highly skilled and specialized labor. As development is a continual process, these countries’ long-term reliance on imports of these goods leave them with a balance of payment deficit.
Unexpected Natural Calamities
Natural calamities, like landslides and flooding, negatively impact the nation’s agricultural and industrial productivity. These unexpected events can quickly throw the balance of payments of a nation out of balance. Hence, the country’s balance of payments becomes disbalanced resulting in rise of imports and declining exports.
Imitating Developed Countries’ Strategies
When citizens of developing nations imitate the consumption habits of citizens of developed nations, imports from such nations will increase as the required resources may not be easily available in their country. This will result in a sudden increase or decrease of export, throwing the balance of payments out of balance.
Fluctuations Caused in Trade Cycles
The country’s balance of payments may become out of equilibrium due to business fluctuations brought on by the functioning of trade cycles. For instance, if a business recession strikes in another nation, it may quickly result in a decline in exports and exchange earnings for the nation in question leading to an imbalance in the balance of payments.
A rise in income and price levels brought on by the rapid economic development of developing nations will result in higher imports and lower exports, which will result in a balance of payments deficit.
Globalization has created a more open and free environment for the exchange of capital, goods, and services worldwide. The globalization of international commercial transactions also increases competition. Hence, some nations face difficulties as a result of the new and emerging global economic order. This leads to an imbalance in their balance of payments.
Poor Marketing Strategies
Developed nations often formulate and practice superior marketing strategies resulting in an increase in their surplus whereas developing countries often have limited resources to implement these sorts of marketing activities. Hence, due to these limitations, developing countries often suffer huge deficits because of their need to import resources for the implementation of such marketing strategies.
Transfer of Capital to Developed Nations
Countries may lose their gold reserves or foreign currency due to speculative motives. To protect themselves against political uncertainties, people in underdeveloped or developing nations may transfer their capital to wealthier nations. The situation of the balance of payments becomes negatively impacted due to such capital movements.
Correction of Adverse Balance of Payment
Deficits and surpluses, in a country’s balance of payments can either be cyclical, where the deficit or surplus is short and tied to fluctuations in the business cycle, or structural, where there is a tendency for the account to be in deficit or surplus over a long period of time. Hence, countries may adopt a number of policies in order to correct the adverse effects on the balance of payments. These are discussed in detail below.
Monetary Policies Focused on Deflection
A country’s balance of payments imbalance may be addressed through monetary policy. The high import and export levels are one of the main reasons for the deficit in their BoP. Reversing this effect is necessary. Hence, by increasing the bank rate and limiting credit, the nation may adopt a deflationary or “dear money” policy in this regard. Here, the price declines during a deflationary period making exports more appealing and imports more expensive overall. Eventually, this causes imports to decline and exports to increase.
Currency depreciation is the decrease in a country’s exchange rate compared to another. For instance, if the EUR-USD exchange rate changes from 1.15 to 1.00, it indicates a 13% decline in the value of the Euro relative to the US dollar. Considering all other factors constant, home currency depreciation can increase exporters’ profits as their sales become worth more when converted to the home currency. Exporters in such circumstances could be able to cut their pricing abroad since their profit margins rise when faced with a weakening currency. In addition to that, local businesses will also see reduced competition from international sellers as a result of currency depreciation. However, persistent currency depreciation is expected to lead to higher interest rates and inflation expectations. Plus, this method is also not feasible under the current system of the International Monetary Fund (IMF), which prescribes a fixed exchange rate system.
Devaluation of the currency is another strategy used for boosting export interest. A decrease in the official rate at which one currency is exchanged for another is referred to as devaluation. When a currency is determined to be excessively overvalued, devaluation is implemented. For foreigners, devaluation lowers the cost of commodities. Imports will decrease as exports increase.
This strategy imposes import traffic tariff taxes to increase the cost of the import with the main goal of controlling imports. As a result, imports decline and the balance of payments improves.
In order to lower the imbalance in the balance of payments, the government may potentially obtain loans from overseas banks or foreign governments. As a result of the lengthy repayment period for these loans, the government is able to eliminate the balance of payments deficit. The government can also make efforts to strengthen its foreign exchange position during this period.
Encourage International Tourism
The government can potentially attract more foreign tourists to their nation by providing them with a range of amenities and attractive travel packages. This boosts the nation’s earnings in terms of foreign exchange, which helps to reduce the deficit in the balance of payments.