1BALANCE OF PAYMENTS Module 3 Topic 3: Balance of Payments & Exchange Rates

Objectives  Explanation of the balance of payments.  Distinguish between the current account and capital account.  Causes and consequences of balance of payments disequilibria.  Policy measures for correcting balance of payments disequilibria 9/19/20152

Defining Balance of Payments  The balance of payments is a record of all economic transactions conducted between a country and the rest of the world for a given time period, usually one year.  An economic transaction is an exchange of value. It involves a receipt and a payment of money in exchange for economic goods and services. 9/19/20153

Accounting Treatment of Items  In standard accounting double entry book- keeping, each transaction will result in a debit and a credit entry of equal size or amount.  Thus in that sense, a country’s balance of payments accounts for any given year always balances. 9/19/20154

Accounting Treatment of Items  In terms of actual receipts and payments, a country may be faced in any given year with one of two situations. (a)A surplus or favourable balance on the BOP accounts. (b)A deficit or unfavourable balance on the BOP accounts. 9/19/20155

Accounting Treatment of Items (Debit and Credit Items)  Any item which gives rise to a sale of foreign exchange (an inflow) is recorded as a credit item (+) in the accounts e.g. export of goods and services  Any item which gives rise to the purchase of foreign exchange (an outflow) is recorded as a debit item (-) in the accounts e.g imports of goods and services. 9/19/20156

The Components of the BOP Account  The Balance of Payments Account consists of two parts: current account (i)A current account capitalaccount (ii)A capital (and financial) account 9/19/20157

The Components of the BOP Account CURRENT ACCOUNT  The CURRENT ACCOUNT records all items relating to imports and exports of goods and services, net property income and current transfers between a country and the rest of the world. CAPITAL ACCOUNT  The CAPITAL ACCOUNT records all movement from private sources and official sources between a country and the rest of the world. 9/19/20158

The Components of the BOP Account  The Current Account generally comprises two sections:  (a) Visible balance (balance of visible trade): primarily the import and export of merchandise or goods)  (b) Invisible balance (Balance of invisible trade): primarily the import and export of services. balance on the current account N.B. The sum of the two balances is referred to as the balance on the current account. 9/19/20159

The Components of the BOP Account  The Current Account generally comprises four main items:  (a) Merchandise Trade Balance  (b) Services Balance  (c) Net Property Income Balance  (d) Current Transfers Balance 9/19/201510

The Components of the BOP Account  The capital account records all movement of capital from both private sources as well as official government sources between a country and the rest of the world. 9/19/201511

The Components of the BOP Account  The Capital Account deals primarily with short term and long term flows/movements of capital, that is, it is concerned with international loans and investments.  It may consist of borrowing/repayment, transfer of ownership of a fixed asset; foreign direct investments, financial portfolio investments, foreign aid transactions, other investments and reserve assets. 9/19/201512

The Components of the BOP Account  It must be noted that when the balances of both sections are added there can be a surplus or a deficit.  The account must therefore show the treatments of any of these two situations as well as the item to “balance off” the account. This is strictly for accounting purposes. All surplus or deficits must be dealt with. 9/19/201513

Sample BOP Accounts 9/19/201514

Sample BOP Accounts 9/19/201515

Sample BOP Accounts 9/19/201516

Balance of Payments Disequilibrium deficit or an unfavourable balance  A deficit or an unfavourable balance exists when the value of autonomous debit items exceeds the value of autonomous credit items. surplus or a favourable balance  A surplus or a favourable balance exists when the value of autonomous credit items exceeds the value of autonomous debit items. 9/19/201517