Balance of payment

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Explain the international balance of payments (BOP) and the reason for its use.

The international balance of payments (BOP) is a summary of a country’s record of all economic transactions made between the country’s residents and the world within a specific period. The economic transactions can be made by governmental bodies, firms, as well as individuals. The balance of payment transactions includes all the visible and non visible transactions within a country at a certain period of time. It accounts for all the demand and supply on foreign currency from foreign claims on a country’s currency. The records of transactions made within a country must be equal since any inequality shows that one country has acquired more assets than the other. However the international trade allows countries to acquire more than they sell or more than they can buy. This therefore allows countries to run into deficit or into surplus. A country that borrows more from the world runs into deficit while the one that lends more to the world runs into surplus (IMF, 2005).

Examine how surpluses and deficits in the balance of payments (BOP) affect exchange rates

The word balance of payments normally refers to the following sum: A country’s balance of payments is believed to be in surplus when consistently, the balance of payments is positive by a particular amount if sources of funds such as bonds sold and export of goods sold are exceeding uses of funds such as money used paying for imported goods and paying for foreign bonds bought by that amount. The BOP deficit occurs when the balance of payments is negatives thus when the former are less than the latter. The BOP surplus / deficit is accompanied by an accrual / loss of foreign exchange reserves by the government central bank. Current accounts are said to be dealing with the exchange of goods and services within two countries. The current account provides a measurement of monetary value for exports from a country and imports into a country. Whenever a country’s exports value exceeds the rate of the goods and services as well as it imports, then the country is said to have made a trade surplus. The current account is known to measures the value of an import and an export monetarily.

On the other hand the capital account is said to be measuring monetary flows within countries that purchase financial assets such as real estate, bonds, stocks as well as other related items. The summation of both the current and capital accounts adds up to zero. This entails that a country which runs a current account exchange deficit shall have an equalized capital account trade surplus. When a country spends more money on foreign goods/services then it is said to have a current account deficit. Net surplus of the domestic money that flows overseas finally returns in the capital account.

When a country increases domestic growth it is said to be holding its economic growth rate constant. Higher domestic growth rates, increases a country’s consumption of goods and services, and its income including imports. An increase in domestic inflation rate, and thus holding foreign inflation rates stable, shows that there are moderately higher prices for domestic goods which makes imports to be cheaper in comparison since their prices are not changed. In the capital account a country allows for interest rate which is the return on savings to differ and examine at how changes affect monetary flows. Higher domestic interest rates is said to increase the pleasant appearance of the nation’s financial assets to foreigners as they can make a moderately higher return by sending money abroad.

Summary accounts

Balance of payments is divided into two accounts thus the current account and the capital account. A deficit with in one account is coordinated by a surplus within the other account. The balance of trade is one part of the general balance of payments position of accounts. A Balance of payments surpluses / deficits can be attained by setting up the exchange rate. Surplus occurs when the balance of payment is greater than zero which means that the country is experiencing net inflow payments. When a country fixes the currency exchange rate to be lower than the flexible exchange rate equilibrium level will not only generate a balance of trade surplus but will temporarily generate a balance of payments surplus (Dwivedi, 2005).

Deficit occurs when the balance of payment is less than zero which means that country has a net outflow of payments. In case a country fixes its currency exchange rate higher than the flexible exchange rate equilibrium level will not generate a balance of trade deficit but will temporarily generate a balance of payments deficit. BOP surpluses and deficits are short lived since they are accomplished through forcing an imbalance in the currency flow of either into/out of the country. Below is an example of Balance of Payments for Northwest Queoldiola with deficit and surpluses tracked on current and capital accounts.

References

Balance of Payments Manual. (2005). Washington, D.C.: International Monetary Fund(IMF).

Dwivedi, D. (2005). International macroeconomics: Theory, policy, and applications (2nd ed.).

Hound mills, Basingstoke, Hampshire: MacGraw- hill