Balance of trade and balance of payments
Balance of trade is a comparison between visible imports and visible exports of a country. When the value of exported goods of a country is more than that of its imported goods, the country is said to have favourable balance of trade. On the other hand, if the value of imported goods of a country exceeds the value of its exported goods, the country is said to have unfavourable balance of trade or adverse balance of trade. If the value of exports is equal to the value of imports, the country is said to have equilibrium balance of trade.
We have noted that balance of trade deals with the visible imports and exports, but we know that economic transactions between countries include both goods and services. Hence, a comprehensive concept is necessary, which is named as Balance of payments. This is a record of a country’s trade and financial transaction with other countries. The balance of payments is an account of a country’s payments to and receipts from the rest of the world. It includes both visible and invisible items
Structure of balance of payment accounting (BoP)
Balance of payments is a summary of statement of total economic transactions of a country with rest of the world. The transactions are recorded in the double entry book keeping. It has two sides: credit on the right side with plus sign and debit on the left side with a minus sign. Each transaction is entered on the credit and debit side of balance sheet.
The balance of payments account is a balance sheet like other balance sheets, it must balance. The total of credit items must be equal to the total of the debit items. This does not mean that there can be no surplus or deficit. A country may have surplus or deficit. Technically speaking the balance of payments must balance. It simply means that the account contains items which show how the money to pay for a deficit has been obtained, or how any surplus has been distributed. Deficits are balanced by entries which show withdrawals from the foreign currency reserves or borrowing from overseas. Surpluses are balanced by entries which show addition to the foreign currency reserve or the purchase of overseas assets.
BoP on the current account:-When the balance of visible trade is added to the balance of invisible trade, the result is known as the balance of payments on current account. The following table shows how the balance on current account is calculated.
When the value of exports is greater than the value of imports, the account is said to be in surplus. When the value of imports is greater than the value of exports, the account is said to be in deficit.
Surplus and deficit balance of payments
A deficit must be covered by either;
Borrowing from overseas central banks or from organisation such as the International Monetary Fund
Taking money from the official reserves of foreign currency.
However, there has a limit to borrowing or taking reserve, if the deficit is continuing it must take steps to correct the situations
A surplus may be used to;
–increase the nation’s foreign currency reserves
–make loans to other countries or to repay loans which have been obtained from overseas
—make investments overseas
Measures to correct deficit BoP or BoP disequilibrium or Methods of restricting imports or Trade protection Methods
Some important measures to remove deficit in BoP are given below
a) Promotion of export:-Export promotion can be achieved by reduction of export duties, by providing subsidies to export industries, etc.
b) Reduction in imports: Imports can be reduced by adopting the measures like imposition of new import duties and enhancement of existing import duties, introducing of quota system, and production of import substitutes.
c) Devaluation: Devaluation of currency is the strategy of reduce the foreign value of domestic currency
d) Exchange control: Government my impose restrictions on foreign exchange transaction.
e) Foreign loans:-The government can also secure loans from foreign banks or from foreign governments and organisations to reduce deficit in BoP
f) Encouragement to foreign investments: The government can induce the foreigners to make investments in the country offering them all sorts of incentives and concessions.
g) Deflation: It is the policy to reduce the prices of goods produced within the country. It will make exportable goods cheaper in foreign countries and increase the exports
h) Incentives to foreign tourists: The government may also encourage the foreign tourists to visit the country by offering them various facilities and concessions. This increases the foreign exchange earnings of the country
(Q.Discuss what measures a government might take to influence its countries balance of payments.)
Foreign exchange rate and rate of exchange
Each nation has its own unit of currency (eg. Maluti in Lesotho, Dollar in USA, Rand in South Africa)For transactions within the country, the domestic currency is used. When transactions are conducted across national borders, one currency must be converted into another. Payments across the border are international payments. Currency used for such payments is called foreign exchange.
The foreign exchange rate or exchange rate is the rate at which one currency is exchanged for another. It is the price of one currency in terms of another currency. For example, the exchange rate between maluti and US dollar refers to the number of maluti required to purchase a U.S dollar. If 8 maluti is required to purchase one dollar, then the dollar- maluti exchange rate is $1=M8.
Appreciates (Rises) and Depreciates (Falls) of the exchange value of a country.
When the currency of a country falls, the overseas prices of its exports fall and the home prices of its imports increase. When the currency of a country appreciates, the overseas prices of its exports rise and the home prices of its imports fall.
Terms of trade
Terms of trade =Index of export prices ÷ index of import prices × 100