The Balance of Payments

Learning Objectives
To understand the fundamental principles of how countries measure international business activity, the balance of payments To examine the similarities of the current and capital accounts of the balance of payments To understand the critical differences between trade in merchandise and services and why international investment activity has recently been controversial in the United States To understand how countries with different government policies toward international trade and investments, or different levels of economic development, differ in their balance of payments

Introduction
BOP is a systematic and comprehensive record of all economic transaction between one country and rest of the world during a period of one year.

Components of BOP
1) Current Account

2) Capital Account
3) Official Reserve Account 4) Error and Omission Account
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Defining International Transactions

Identifying many international transactions is ordinarily not difficult However, some international transactions are not obvious
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BOP Accounting: DoubleEntry Bookkeeping

BOP employs an accounting technique called double-entry bookkeeping In this age-old method every transaction produces a debit and a credit of the same amount A debit is created whenever:
An asset is increased A liability is decreased An expense is increased

A credit is created whenever:

An asset is decreased A liability is increased An expense is decreased
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BOP Accounting: DoubleEntry Bookkeeping

The measurement of all international transactions in and out of a country over a year is a difficult task Mistakes, errors, and statistical discrepancies will and do occur

The Current Account

This account includes all payments related to the purchase and sale of goods and services as well as unilateral transfers of funds from one country to another. It consists of Three subcategories:
Exports of Goods and Services Imports of Goods and Services Net Unilateral Transfer Abroad
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The Current Account

Exports/ imports of Goods and services Goods It includes exports of tangible goods like cotton, medicine ,tea, rice etc. Services: Port services, Banking services, Educational service, Health services etc. The Merchandise trade Balance: Difference between the value of goods exported and value of goods imported is known as merchandise trade balance.

If the value of the country's merchandise exports is greater then the value of its merchandise imports the country is said to have trade surplus and if the value of merchandise exports is less than value of imports the country is said to have deficit trade balance.
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Net Unilateral Transfer Abroad

A Unilateral Transfer is a one way money payment from citizens or the government of one country to citizens or the government of other country.

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2.

The Capital Account

This account includes all payments related to the purchase and sale of assets and to borrowing and lending activities.

It is divided into two major components:

Outflow of Capital Inflow of Account
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Official Reserves Account

indicates the payments gap that official reserve transactions need to cover, i.e., Official settlements balance (OSB) = (balance on current account + balance on non-reserve portion of capital account + statistical discrepancy)

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Official reserve transactions

Official reserve transactions refer to central banks purchases or sales of official reserve assets such as gold, U.S. T-bills, and main foreign currencies.

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Summary
Current account deficit reflects a shortage of saving over investment; current account surplus reflects an excess of saving over investment. Current account deficits either run down net foreign wealth or run up foreign debts. Any current account deficit must be matched by an equal capital account surplus, and vice versa.
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4. Error and Omission Account

In addition to the current, capital, and official reserve accounts , the balance of payments also includes a statistical discrepancy to account for unreported transaction.

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Reasons of deficit BOP

Exports of goods and services fall Imports of goods and services rise

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Why Exports of goods and services fall

Agricultural output has fall Trade restriction abroad like tariff High inflation rate Increase in cost of production Poor technology Low quality products Lack of international information Increase in global competition
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Why Imports of goods and services rise

Imports of capital goods for development purposes Poor quality of goods at home To introduce new technology Low in cost of production at home To become familiar about international market
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