The
structure of the Balance of Payments is important to understand the changing
patterns of exports and imports. Balance of payment is the systematic recording of transaction of a
country with the rest of the world. Balance of payments is split into three main parts. They are, 1) current
account 2) the capital account and 3) the financial account.
The
export and import of goods are referred to as visible trade and the difference
between the value of exports and imports of physical items is known as balance of visible trade. Purchase of
foreign oil be recorded in the import side of visible [goods] in current
account of the balance of trade. The
international trade in services is described as invisible trade and the
difference between the value of import and export is known as balance of invisible trade. When
import exceeds export, the balance of
payment is deficit or unfavourable.
There
are different measures to correct the
imbalance. They are; 1)
Deflation: deflation is a
decrease in the general price level of goods and services. It occurs when the
inflation rate falls below 0% (a negative inflation rate). Deflation increases
the real value of money. This allows one to buy more goods with the same amount
of money over time. -
A reduction in aggregate demand by raising taxes and reducing public
expenditure -less money pumped to the circular flow of income –less demand home
leads to more export (Reduction in production may lead to unemployment).2) Government raise interest rates in the
economy attract flow of money into the country. High interest rate make
borrowing expensive and consumers borrow less to spend and firms less to
invest.3) Protectionism refers
to the policies designed to prevent trade between countries, such as tariff,
quota, exchange control, and so on. 4) Devaluation refers to the lowering of the value currency to make
the exports cheaper for foreign countries to buy. At the same time, the
imports will become more expensive
A
country may have a trade in goods (visible trade) deficit but still have a
current account surplus in its balance of payments. This is because another
component or components of the current account (such as trade in
services (invisible balance), income and current transfers) must have a
surplus. Another situation is that the surplus must be greater than the deficit
on the trade in goods balance.
The
large surplus for a country over many years in the current account of the
balance of payments will have some possible problems for other countries The distinction between short-term
and long-term is to be made clear so as to assess the problem. One
country’s surplus is another country’s deficit; the country with the deficit
may introduce protectionist measures (as indicated). The countries with
deficits could face exchange rate problem. The countries with deficits
could face employment problem.
Current account of balance of payment
The
Current account includes all the money paid by the country for imports of goods
and services and all the money received from the exports of goods and
services. It also includes the flow of money in and out of country for
interest payments profits and dividends on loans investments and shares.
Another component is income balance received and paid out for cross-border
employment [wages]. Central government payments overseas such as taxes
and payments to other countries or international organization and receipts from
abroad such as subsidies or aids are recorded as current transfers. Therefore
the balance on current account is equal to the balances of visible trade,
invisible trade, income and current transfers.
Capital Account of Balance of Payment
The
capital account includes the flows of money into and out of the country to pay
for a change of ownership of fixed assets such as houses, machinery and
factories, sale of fixed assets or the cancellation of debts. The size of
capital account transactions are small compared to the current and financial
accounts of the balance of payments.
Financial Account of Balance of Payment
The
financial account records 1) flows the money into and out of the country to pay
for investments in capital, shares and loans. [Any profits, dividends and
interest payments resulting from these investments are recorded as incomes in
the current account]. 2) Direct inward investment received whenever a foreign
firm sets up a factory, office ore retail outlet, any reinvestment of
profits is also included in this. 3) Portfolio investments received from
overseas are purchases of shares of companies (equity) and loans (debt).
Portfolio investments abroad are the purchases of shares or lend money
overseas. 4) Financial account also records government drawing on or additions
to their reserves of foreign currencies.
There
are numerous errors and omissions which are due to payments not being recorded
and to delays in obtaining information. The balancing item represents the total
of the errors and omissions.