2.1.4 Balance of Payments

• What is balance of payments

  The balance of payments (BoP) is a record of all economic transactions between a country and the rest of the world.

  
  

  It covers all payments and receipts for the country's exports + imports of goods + services, financial assets/ capital, financial transfer payments (foreign aid)
• Balance of payments equation

  BOP= balance of current account + balance of capital account + balance of financial account + balancing item

  
  

  -Balancing item: Net errors and omissions in data
• Records of the BoP

  -If money is received, it will be credited (inflow)

  
  

  -If money is spent, it will be debited (outflow)

  
  

  -If value is positive, balance of payment is surplus

  
  

  -If value is negative, balance of payment is deficit
• BOP components

  The current account, capital account, financial account
• BOP components - current account


  It records all the transactions related to purchase or sales of goods and services
• BOP components - financial account


  Any types of foreign direct investments will be recorded here
• BOP components - capital account


  It records any types of transfer of assets from one country to another
• Define Surplus

  Export > Import
• Define Deficit


  Import > Export
• Components of the Balance of Payments - Current Account (1)

  Balance of Trade in Goods:

  
  

  It measures the difference between the value of a country's exports and imports of tangible goods (e.g machinery, cars)

  
  

  A trade surplus occurs when exports exceed imports, and a trade deficit occurs when imports exceed exports
• Components of the Balance of Payments - Current Account (2)

  Income Balance:

  
  

  This includes earnings from abroad (e.g., dividends, interest, and wages) and payments made to foreign investors.

  
  

  A surplus indicates that a country earns more from its foreign investments than it pays to foreign investors.
• Components of the Balance of Payments - Current Account (3)

  Balance of Trade in Services:

  
  

  It accounts for the value of services traded internationally, such as tourism, financial services, and consulting.

  
  

  A surplus occurs when a country exports more services than it imports
• Components of the Balance of Payments - Current Account (4)

  Current Transfers:

  
  

  This category includes foreign aid, remittances sent by migrant workers, and other unilateral transfers.

  
  

  It can be positive (inflows) or negative (outflows).
• Current Account Deficits

  A Current Account Deficit occurs when a country's imports of goods, services, income, and transfers exceed its exports in those categories.

  
  

  It implies that the country is spending more than it is earning from the rest of the world.
• Causes of deficits

  - Economic growth, as income grows, demand for M increases

  
  

  - Inflation, high domestic inflation, increases M and reduces X
• Current Account Surpluses

  A Current Account Surplus occurs when a country's exports of goods, services, income, and transfers exceed its imports.

  
  

  It implies that the country is earning more than it is spending internationally.
• Causes of surplus - Demand side


  -High incomes abroad -buying more

  -Low incomes at home - less spending from other countries- reduce imports

  -Exchange rate manipulation (kept low) - less exports, import more

  -High interest rates, decreases imports due to more saving
• Causes of surplus - Supply side


  -Low relative inflation

  -Gains in comparative advantage

  -Natural resources i.e oil and gas
• What does financial account include

  Bonds, Shares in foreign companies and FDI
• What does capital account include

  Sales of assets and Debt forgiveness
• What does current account include

  -Trade in goods and services

  
  

  -investment income (from loans/ dividends)

  
  

  -transfers (aid/EU payment)
• Relationship between Current Account Imbalances and Other Macroeconomic Objectives (1)

  Impact on Exchange Rates:

  
  

  A persistent current account deficit may lead to a depreciation of the country's currency, making exports more competitive and imports more expensive.

  
  

  This can help correct the deficit.
• Relationship between Current Account Imbalances and Other Macroeconomic Objectives (2)

  Impact on Economic Growth:

  
  

  A surplus can lead to higher savings and investment, potentially boosting economic growth.

  
  

  However, a persistent deficit may lead to unsustainable borrowing.
• Relationship between Current Account Imbalances and Other Macroeconomic Objectives (3)

  Impact on Employment:

  
  

  A trade surplus may support job creation in export-oriented industries, while a deficit can lead to job losses in import-competing sectors
• Interconnectedness of Economies through International Trade (1)

  International trade fosters economic interdependence among countries. One country's economic policies and developments can have ripple effects globally

  
  

  Supply chain integration: Many products involve components from multiple countries. Disruptions in one country can disrupt global supply chains
• Interconnectedness of Economies through International Trade (2)

  Benefits of trade: International trade allows countries to specialize in producing what they are most efficient at, leading to efficiency gains and a higher standard of living