13.the balance of payment
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THE BALANCE OF
PAYMENTS
Definitions
and Concepts
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Definitions
We often hear that the less developed countries
(LDCs) suffer from adverse balance of payment
and consequently experience chronic foreign
exchange gap. Continuous BOP deficits haveforced countries to resort to corrective measures
like currency devaluation, imposition of tariffs,
exchange controls, contractionary monetary and
fiscal policies .Even the so called developedcountries have been no exception to this
tendency.
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Concepts of BOP
Policies of import substitution and export
promotion to achieve external balance have led to
serious problems of growth and trade for the
countries of the world.The BOP is one of the oldest and the most
important statistical statement for any country.
The BOP of a country is a systematic record of
all economic transactions between the residents of
a given country and of the resident of the rest of
the world in an accounting period.
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ACCOUNTING METHOD AND FORMAT
The BOP transactions include all the foreign receiptsof and payment by a country during a given year.
The receipts include all the earning and borrowing of
foreign exchange, and they are recorded as credit
items. The payment include all the spending and
lending's of foreign exchange, and they are recorded
as debit items.
In the purely accounting or book keeping sense thebalance of payment must always balance, because
the BOP is a schedule of debit and credit transactions
which must necessarily be equal.
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BOP accounts
The BOP statements basically includesix major accounts which are as follows:
1. Goods Account
2. Services Account
3. Unilateral Transfers Account
4. Long Term Capital Account
5. Short Term Capital Account
6. International Liquidity Account.
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GOODS ACCOUNT
It includes the value of the merchandise exports andthe value of the merchandise imports. These items of
foreign exchange earnings & spendings are called as
visible items in the BOP. If the receipts from
exports of goods happen to be equal to the payments
for the imports of goods, we describe the situation as
one of zero" goods balance.
Otherwise there would be either a positive or negativegoods balance depending on whether we have
receipts exceeding payments (positive) or payments
exceeding receipts (negative).
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SERVICE ACCOUNT
Just as a country exports goods and import goods a
country also exports and imports what are called as
services. The Service Account records all the service
exported and imported by a country in a year. Unlikegoods which are tangible or visible, services are
intangible. Accordingly, services transactions are
regarded as invisible items in the BOP. They are
invisible in the sense that service receipts andpayments are not recorded at the port of entry or exit
as is the case with the merchandise imports and
exports receipts.
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SERVICE ACCOUNTThe service transactions take various forms. They basicallyinclude
(a) transportation, banking and insurance receipts andpayments from and to the foreign countries,
(b) tourism, travel services and tourist purchases of goods andservices received from foreign visitors to home country andpaid out in foreign countries by home country citizens,
(c) expenses of students studying abroad and receipts fromforeign students studying in the home country,
(d) expenses of diplomatic and military personnel's stationedoverseas as well as the receipts from similar personnel fromoverseas who are stationed in the home country, and
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SERVICE ACCOUNT
(e) interest, profits, dividends and royalties received
from foreign countries and paid out to foreign
countries.These items are generally termed as investment
income or receipts and payment arising out of what
are called as capital services
A positive sum is regarded as favorable to a
country and a negative sum is considered as
unfavourable.
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Unilateral Transfer Account
The third account in the BOP schedule is the UnilateralTransfer Account . This account includes all gifts, grants and
reparation receipts and payments to foreign countries.
Unilateral transfer consist of two types of transfers: (a)
government transfers and (b) private transfers.
Foreign economic aid or assistance and foreign military aid or
assistance received by the home countrys government
constitute government to government transfers.
Private transfers, on the other hand, are funds received from or
remitted to foreign countries on person-to-person basis. AMalaysian settled in the United States remitting $100 a month
to his aged parents in Malaysia , is a private transfer inflow
item in the Malaysian BOP.
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Long-Term Capital Accounts
It includes the amount of capital that has moved out orinto the country in a year. Any capital that has movedin or out of the country for a period of one year ormore is regarded as long-term capital movement. Thelong-term capital account includes the following
categories.
Private Direct Investment
Private Portfolio Investment
Government loans to Foreign Governments.
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Private Direct Investment
These investments are done byhome country citizens and firms inforeign countries (debit) and byforeigners in the home country(credit). This type of capitalmovement is induced by differencein profit rate between the homecountry and the rest of the world.
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Private Portfolio Investment
These investments are done by home
country citizens and firms in foreign securities or
stocks or bonds or shares (debit) and by foreigners
in home country securities, stocks, bonds ,shares,etc. (credit)
This type of movement in and out of a
country is induced by differences in interest rates,
dividends or rate of return on capital between thehome countrys financial assets and those of
the foreign nations.
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Government loans to Foreign
Governments
These loans are given by
home countrys government(debit) and to the home
countrys government byforeign governments (credit).
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If the foreign multinational corporations areinvesting heavily in our country, we receive
capital inflow in the form of direct private
investment. It has a favorable effect on our
BOP. But when the foreign investors in our
country starts repatriating profits to their home
country, there will be a capital outflow from our
country to foreign countries. This goes in to ourservice account as investment income outflow
(debit).
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Short-Term Capital Account
The Fifth main account in the BOP, is the Short-Term
Capital Account. Bank deposits and other short
term payments fall into this category. Short term
capital items fall due on demand or in less thanone year, as opposed to long term capital flows
which have maturity after one year or thereafter.
The vast majority of Short-Term Capitaltransactions basically represents bank transfers
that finance trade and commerce.
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Short-Term Capital Account
It is also interesting to note that it is often hard to keeptrack of all the Short-Term Capital movements in and
out of the country. They can at best be rough
estimates. Indeed in some countries the separate
category of Short-Term Capital account does notexist.
In some countries Short-Term Capital transactions are
included in the Unrecorded Transactions as aseparate BOP account in its own right. This
Unrecorded Transactions Account or Errors and
Omissions Account Includes,
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Short-Term Capital Account
Beside short term capital movements, the
following items as well.
Statistical and recording errors
Smuggling
Illegal and secret capital movementsImperfect estimation procedures.
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International Liquidity Account
The sixth and final BOP account is the
International Liquidity Account which simply
record net changes in foreign reserves.
Essentially this account lists internationallyacceptable means of settling international
obligations.
International Liquidity Account is bestunderstood as follows:
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Table 1:Surplus Case ($) MILLION
DebitCredit
2
Goods Account 1,500 800
Service Account500 1400
Unilateral Transfers Accounts 100 120Long Term Capital Account 900 400
Errors & Omissions(including short term capital) A/C 500 630
International Liquidity Account 150
Balance of Payment 3,500 3,500
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Surplus Case
The total receipts are $3,500 million and totalpayments are $3,350 millions. There is a net BPO
surplus amounting to $150 million. This sum of $150
million is entered into International Liquidity Account
as debit. The logic of accountingfor this sum of $150million as debit is that , this sum represents either
Purchase or import of gold worth $150 million
Net addition to accumulation of foreign reserves of$150 million
Capital lending in the sum of $150 million to other
countries on short term or long term basis.
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Table 2:Deficit Case ($) MILLION
DebitCredit
2
Goods Account 800 1500
Service Account1400 500
Unilateral Transfers Accounts 120 100Long Term Capital Account 400 900
Errors & Omissions(including short term capital) A/C 630 500
International Liquidity Account 150
Balance of Payment 3,500 3,500
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Deficit Case
The above table has the exact opposite picture. The
sum of debit payments exceeds the sum of credit
receipts by $150 million which represents the net
deficit in the BOP due to the first five accounts.
The question is, how was this deficit of $150 million
financed? The answer is that it was financed in one ofthe following three ways:
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Deficit Case
Selling or exporting gold worth $150
million; or
Drawing down upon the past accumulated
foreign reserves equal to the sum of $150million; or
Borrowing capital in the sum of $150
million on short term or long term basisfrom friendly countries or international
institutions like IMF
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Balance of Trade
Balance of trade may be defined as the differencebetween the value of goods and services sold to
foreigners by the residents and firms of the home
country and the value of goods and services purchased
by them from foreigners. In others words, the
difference between the value of goods and services
exported and imported by a country is the measure of
balance of trade..In Table there is a balance of trade deficit equal to $130
million.
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Balance of Payment on Current Account
This is a broader concept than the concept of
balance of trade. Balance of payment on current
account includes the sum of three balances,
Merchandise balance, service balance and unilateraltransfers balance.
in other words, it comprises of trade balance and
transfer balance. In table the positive unilateral
transfers balance of $180 million is added on to the
negative trade balance of $130 million which will give
us a current account BOP surplus of $50 million.
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Balance of Payment on Capital Account
For a long time, economist had assumed that factors ofproduction do not move across international
boundaries: the classical economists built models of
trade assuming that only goods and services move
across international boundaries. International capitalmovements viewed in that light, were an impossibility.
Perhaps, for this reason, we do not have a well
developed theory of international capital movement.
Theory or no theory, international capital movements
in and out of countries are a fact of life and very much
a reality in todays world.
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Balance of Payment on Capital Account
Returning to the question of BOP accounting
procedure, all the transactions involving inward or
outward movement of capital and investment areincluded in the capital account of the BOP of the
reporting country. In simple terms, the BOP
capital account comprises of the Long-Term and
Short-Term Capital Accounts. In table the capitalaccount balance shows a net surplus of $40
million.
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Basic Balance
This is a relatively straightforward and simple
concept. Basic balance in the BOP comprises of the
BOP on current account plus Long-Term Capital
Account. The Short-Term capital account balance isnot included in the basic balance. This is perhaps for
two main reasons
Due to short term
Many countries do not have a short term capital
account.
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Overall Balance of Payment
This is a sum of balance on current
account and on capital account puttogether. It includes all international
monetary transactions of the reporting
country vis--vis the rest of the world.
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Accounting Balance of PaymentsThe overall BOP entries in our table show a net surplus of $90
million. This sum of $90 million surplus is entered into the
International Liquidity (debit) Account. The rationale behind
this entry in the debit column is that, this sum of $90 million
constitutes disposal of that BOP surplus in any of the followingways (a) purchase or import of gold worth $90 million; or (b)
adding to the countrys stock of foreign exchange reserves of
$90 million for future use; or (c) extending short term loan of
$90 million to other needy countries or buying some foreignincome earning short term assets. There may be some
combinations of (a), (b) and (c) as well.