The Brief Introduction of Balance of Payments

Table of Contents

The definition of Balance of Payments

The term Balance of Payments (BOP) is used in referring to the methods that countries adopt in monitoring their global monetary transactions that have taken place during a given period. Normally the BOP is calculated once every three months and once in each calendar year. All transactions happening on the part of both the private and public sectors are included in the BOP so that it can be ascertained as to how much funds are going out and coming into the economy. All the money received into the country is referred to as credits while the money that has been paid by the country against receipt of goods and services is referred to as debit in the BOP. In theoretical terms, the BOP must always be balanced out and the final figure should be zero. However in reality such a situation never arises and the BOP position can tell analysts whether a given country is having a surplus or a deficit as also the sectors of the economy from where any given discrepancies are originating.

Three sections

The Balance of Payments (BOP) is bifurcated into three different sections; the financial account, the capital account, and the current account. These three groups are also divided into different categories in accounting for international financial transactions under separate categories. The financial account documents international financial transactions about investments in businesses, stocks, financial instruments, and real estate. All international financial transfers are documented in the capital account. The current account marks the inflows and outflows of goods and services into the economy (Ingham, 2003).

After all, transactions are taken into account the BOP will reveal that the payments and receipts of all economies must necessarily balance. Any imbalance implies that one nation has acquired assets in another. Although receipts and payment disbursals have to be equal, inequalities exist by way of surplus and deficits in some transactions. There are different definitions given of the Balance of Payments deficit which have varied implications. About three decades back BOP deficit was used in connoting a country’s inability to meet its foreign exchange liabilities towards other countries. The decline in gold reserves maintained for this purpose was an indication of a BOP deficit, which gave the impression of poor credibility of a nation’s financial status. There has been a deviation in recent years after countries adopted the practice to reduce reserves of gold as emanating from a shift in global practices. There was a change from maintaining fixed exchange rates to flexible rates and since then BOP deficit has been concerned with the balance being maintained in the current account (Ison et al, 2006).

The economic situation in the country

A country will have chances of a deficit in its current account if the price levels are high which leads to a larger Gross National Product and which further boosts up the rate of interest. This situation further leads to more restrictions on imports, and investment opportunities for the nation become better, all about economic conditions prevailing in other nations, which makes the country enjoy higher exchange rates for its currency. It is not true that a deficit in the current account is a bad sign for the economy and such a deficit is not necessarily indicative of the poor economic condition of the country in question. If a country has a deficit in its current account it implies that it is importing capital in large quantities. In essence, such deficit is the result of economic conditions prevailing in the country such as inflation, low levels of productivity, and insufficient levels of savings. Policymakers have always had problems in ascertaining the extent to which a deficit in the current account is sustainable. In the present times, it is possible to cope with BOP deficits because of the huge amount of capital inflows possible from other countries, but the problem becomes serious at times because in today’s global economy it is very easy to swiftly withdraw the funds by foreign investors (Riley, 2009).

References

  1. Ingham B, International Economics: A European Focus, 2003, Financial Times/ Prentice Hall
  2. Ison S and Wall, S, Economics, 2006, Prentice Hall Riley Geoff, Balance of Payments Deficit.

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