Balance of payments

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  • Created by: samadhi
  • Created on: 08-04-13 19:37

The balance of payments

  • The balance of payments is a record of all economic transactions between the residents of the country and the rest of the world.
  • It records transactions in goods and services as well as capital flows.
  • Any item that, from the home country’s point of view, gives rise to a purchase of foreign currency or an outflow of domestic currency [IMPORTS] is recorded as a DEBIT item on the BOP.
  • On the other hand, any item that gives rise to a sale of foreign currency or an inflow of domestic currency [EXPORT] is recorded as a CREDIT item.
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Balance of payments

The balance of payment is split into 3 main parts:

1. Current account

2. Capital account

3. financial account

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Balance of payments - Deficit and surplus

Digram of blance of payment Defict and Surplus 

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Balance of payments - Current account

Current Account:It is divided into 2 sections known as the balance of visible trade and the balance of invisible trade.

  • The former section records only exports and imports of goods 
  • The difference between the value of goods exported and imported is called the Balance of Trade. 
  • In fact, the balance of trade is only a part of the balance of payment. 
  • It is therefore possible to have a deficit on the balance of trade but a surplus on the balance of payment, or vice versa.
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Balance of payments - Current account

  • The invisible trade balance consists of all exports and imports of services, such as insurance, banking, tourist expenditure, transport. For instance, a British tourist coming to Mauritius will be
  • recorded as an invisible export in the Mauritian BOP. On the other hand, if a Mauritian is going abroad as a tourist, this will be recorded as an invisible import.
  • The invisible section also records income flows into and out of the country and transfers of income such as flow of interest, profits and dividends. For example, dividends earned by a foreign resident from shares in a UK company would be an invisible imports for UK.
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Balance of payments - Capital Account

The capital accounts: records the flows of funds into the country and out of the country.

  • associated with the acquisition or disposal of fixed asset or non-financial assets (for example; land purchased or sold by a foreign embassy, purchases and sales of patents, copyrights and trademarks),receipts of funds for capital projects.
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Balance of payments - Financial account

Financial account: This records the flows of money into and out of the country for the purposes of investment or as deposits in banks and other financial institutions.

  • (a) Investment, both direct and portfolio:
  • (b) Other financial flows:
  • (c) Flows to and from the reserve
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Balance of payments - conclusion (account)

  • When all the components of the BOP are taken together, the balance of payments should exactly balance.
  • So when added together, the current, capital and financial accounts balances should add up to zero.
  • However, in practice, because of mistakes and failure to record all items, often due to time delay,there is always a discrepancy.
  • To correct for this, a net error and omissions item is included in theaccounts.
  • The net errors and omissions figure is the amount which is required to bring the recorded BOPinto balance.
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Balance of payments - Equilibrium

.... to be added 

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Balance of payments - Disequilibrium

  • Disequilibrium in BOP exists when there is a tendency for outflows of trade and capital to be significantly greater or smaller than the corresponding inflows.
  • In other words, there is a surplus or a deficit in BOP.
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Causes of Balance of payments deficit

Causes of balance of patments deficit:

  • A deficit in BOP occurs when export earnings fail to cover imports expenditure.
  • Indeed, it isgenerally the developing countries which are faced with a recurrent BOP deficit since they rely much on imported production techniques, know-how and raw materials to develop their economies.
  • A deficit in BOP can be caused by various factors.
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Causes of Balance of payments deficit

  • 1. Relaxed import controls:
  • 2. High domestic inflation:
  • 3. The economic situation within the country:
  • 4. Level of foreign income.
  • 5. Low Interest rate:
  • 6. Capital flows:
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Causes of Balance of payments deficit

1. Relaxed import controls:

  • A deficit, especially in current account, may occur because the government has not taken the appropriate measures to curb imports.
  • Policies might have been relaxed, for example, low custom duties and no imposition of quota.
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Causes of Balance of payments deficit

2. High domestic inflation:

  • If the rate of inflation in the country exceeds world’s inflation, then local consumers would refrain from purchasing locally manufactured goods.
  • Instead they will shift to foreign substitutes since the latter becomes cheaper.
  • As a result, imports will rise.
  • On the other hand, foreigners will demand less of the country’s products as exports become less competitive.
  • As such, exports will fall.
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Causes of Balance of payments deficit

3. The economic situation within the country:

If the country is experiencing an economic boom with rising output and consumption, it isexpected that its imports will rise since imports depend on the level of national income.

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Causes of Balance of payments deficit

4. Level of foreign income:

  • The exports function of a country depends on foreign national income.
  • If the world economy experiences a depression, this will reduce foreign national income.
  • As a result, the country’s exports will be likely to fall, leading to current account deficit.
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Causes of Balance of payments deficit

5. Low Interest rate:

  • If a country’s rate of interest falls below the rate in other countries, it becomes less competitive for savers and other depositors to invest in the country.
  • Hence, more local residents would be likely to deposit their money abroad and fewer people abroad would deposit their money in the country.
  • As a result, “hot” money flows out to earn high interest elsewhere.
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Causes of Balance of payments deficit

6. Capital flows:

  • If during the year, the country has been investing far more than what the foreigners have been investing in local industries, it is clear that the capital account balance will be unfavourable.
  • Hence, the overall deficit in the BOP would occur if the unfavourable capital account offsets any surplus or reinforces any deficit in the current account.
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Consequences of balance of payment on the Domestic

fill in later 

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Consequences of balance of payment on the External

Fill in later 

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Policies to reduce balance of payments Deficit

Suppy side policy

Demand Side policy:

  • Expenditure Switching policy 
  • Expenditure Reducing policy 
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Policies to reduce balance of payments Deficit

Supply side policy:

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Policies to reduce balance of payments Deficit

Demand side - Expenditure Switching 

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Policies to reduce balance of payments Deficit

Demand side - Expenditure Reducing 

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The Marshall Learner conditions and J curve condit

What is it? 

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The J - curve Effect

Discription: 

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Marshall Lerner condition

Discription 

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Reducing balance of payments current account Surpl

  • Reflate to boost deman and so increase imports 
  • Remove import controls 
  • Revalue the currency  
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Problems with current account Surplus

The dutch disease effect 

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Problems with current account Surplus

Fixed exchange rate 

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Problems with current account Surplus

  • One countries surplus is another countries deficit
  • the country with the defict may introduce prtectionist measures 
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