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International Economics II

International Economics II. CHAPTER I. Balance of Payments. Meaning . The balance of payments is a systematic record of all economic transactions( visible & Invisible goods) which are completed between the residents of a country and the resident of the rest of the world.

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International Economics II

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  1. International Economics II

  2. CHAPTER I Balance of Payments

  3. Meaning The balance of payments is a systematic record of all economic transactions( visible & Invisible goods) which are completed between the residents of a country and the resident of the rest of the world. Visible Goods are the goods such as wheat, rice, machinery, computers etc. Invisible transactions are the services of transportation, insurance, banking etc.

  4. Cont’d General use of BP accounting is more recent, but in 1381 Richard Aylesbury, an Englishman, had not only collected such statistics, but was developing analysis as to why the accounts behaved as the did.

  5. Definition of BOP • According to Bo Souderton: • The BOP is merely a way of listing receipts and payments in international transactions for a country. 2. According to Professor Kindleberger: • It is a systematic record of all economic transactions of a country with the rest of the world in a given period of time.

  6. Explanation of the Definition These economics transactions consists of exports of goods, imports of goods export of services and imports of services, out flow of capital, inflow of foreign capital.

  7. Structure of balance of BOP The BOP accounts of a country is constructed on the principle of double- entry book keeping. Every international transaction automatically enters the balance of payments twice: once as a credit (+) and once as a debit (-). For example: When payments received from a foreign country, it is credit transaction while payments to a foreign country is a debit transaction.

  8. Structure of balance of BOP • Thus in balance of payment we inter the international receipts on the one side, and international payments on the other side • The receipts come into being because of export of goods and services, unilateral transfers and inflow of capital goods • While payments have to be made against import of goods ,unilateral transfers and outflow of capital

  9. The Flow of Currencies: Whisky sold to Italian hotel Export earnings for UK (Credit on Balance of Payments) € changed to £

  10. The Flow of Currencies: Oil from Russia Oil £ changed into Roubles Export earnings for Russia Import expenditure for the UK (Debit on balance of payments)

  11. Import Goods- Money Goes Out of Country

  12. Export Goods- Money Comes Into the Country

  13. Major Components of BOP Accounting system

  14. Major Components of BOP Accounting system

  15. BOP Account Explanation 1) CURRENT ACCOUNT The current account of BOP consists of the receipts and payments against a) exports and imports of goods, b) exports and imports of services c) unilateral transfer ( international grants, gifts and foreign remittances both private and public etc) a) exports and imports of goods, the export and import of goods are concerned with trade items, they are known as visible items and are recorded at the time of exportation and importation at airport or at sea-port .

  16. BOP Account Explanation (cont..) If we sum the receipts and payments of exports of goods and import of goods it will called BOT (balance of trade) b) Exports and imports of services Exports and imports of services are known as invisible items because they are hardly recorded The receipts and payments of services give rise to BOS c) Transfer payment A Government/people receive/pay international grants, gifts ,foreign remittances. on basis of receipts and payments of transfer payment we get BOTP

  17. BOP Account Explanation (cont..) 2) CAPITAL ACCOUNT • Capital account consists transaction in financial assets in form of short and long term lending and borrowings, private and official investments • It is an account which comprises of inflow & outflow of capital • this account shows capital mobility internationally for short and long period of time • Capital transfer may be official as well as unofficial • Receipts and payments regarding foreign loans are considered • Conclusion are drawn about BOC account

  18. BOP Account Explanation (cont..) 3) OFFICAL RESERVE ACCOUNT • ORA include gold stock, holding of foreign currencies • The official reserves account in fact a part of capital account • UK and USA BOP accounts shows it a separate account • Financial reserves account measures the change in nation's liquidity and non-liquid liabilities to foreign official holders

  19. BOP Account Explanation (cont..) • it shows the change in a nation's official reserves during one year • It represents the “Foreign Exchange” position of a country

  20. The Balance of Payments Accounts • Examples of Transactions • A U.S. firm exports $500 of goods to Italy. the Italian company deposits the $500 in its account at Citibank in New York. • That is, the U.S. trades assets for goods. • This transaction creates the following two offsetting entries in the U.S. balance of payments: • It enters the U.S. CA( Debit) with a negative sign ($500). • It shows up as a $500 credit in the U.S. financial account. 20

  21. The Balance of Payments Accounts

  22. The Balance of Payments Accounts • A U.S. citizen pays $200 for dinner at a French restaurant in France by charging his Visa credit card. • That is, the U.S. trades assets for services. • This transaction creates the following two offsetting entries in the U.S. balance of payments: • It enters the U.S. CA with a negative sign (-$200). • It shows up as a $200 credit in the U.S. financial account. 22

  23. The Balance of Payments Accounts

  24. The Balance of Payments Accounts • U.S resident purchases foreign stock for $400 • The purchase of foreign stock increase U.S asset abroad • This shows capital outflow from U.S and is recorded as a capital debit of $400 in BOP of U.S • Foreign assets of U.S is increase by $400 • This shows Capital inflow to U.S and recorded as a Credit in U.S BOP

  25. The Balance of Payments Accounts

  26. The Balance of Payments Accounts • Suppose U.S govt gives a $100 to the government of a developing nation as a part of the U.S aid program. • U.S debits unilateral transfer for the $100 gift given (payment made) • This represents an increase in foreign claim ,or in foreign asset • This transaction is recorded as a capital inflow or credit

  27. The Balance of Payments Accounts

  28. Is BOP always in Equilibrium BOP always balance means that the algebraic sum of the net credit and debits balances of current, capital and official reserves account must be equal to ZERO, BOP is written as B= Rf - Pf Where B represents the BOP Rf receipts from foreigners Pf payments made to foreigners

  29. Explanation • When • When Rf – Pf > 0, it is known surplus, receipts from foreigners exceeds than payments to foreigners • And when Rf – Pf < 0 there is deficit in the BOP, as the payments made to foreigners exceeds receipts from foreigners. B= Rf – Pf = 0 , there the BOP is equilibrium

  30. Disequilibrium in BOP A disequilibrium in the BOP of a country may be either a deficit or a surplus. A deficit or a surplus BOP of a country appears when, Its receipts( Credits) do not match its payments ( Debits). If credits or receipts exceed debit payments, there is surplus in BOP and it is also called Favorable. On the other hand, if debits payments exceed credit receipts, there is Deficit in the BOP and this is known Unfavorable or Adverse

  31. Example of Surplus of favorable BOP

  32. Causes of Disequilibrium • TEMPORARY CHANGES or ( Disequilibrium) There may a temporary changes in BOP by random variation in trade, seasonal fluctuations, the effect of weather on agriculture production etc. normally its occur for a short period of time. 2. Fundamental Disequilibrium: Fundamental disequilibrium refers to continuous and long run BOP disequilibrium of a country. According to IMF current Report it may cause to, • Changes in consumer tastes within the country or abroad which reduce the country exports and increase the country imports

  33. Causes of Disequilibrium (cont..) • Continuous fall in the country’s foreign exchange reserves due to supply inelasticity of exports and excessive demand of for foreign goods and services • Excessive capital out flow due to massive imports of capital goods, raw-materials, consumer goods and technology • Low competitive strength in world market • Inflationary pressure which make the exports dearer

  34. Causes of Disequilibrium (cont..) 3. Structural Changes: Such type of disequilibrium rises because of the structural changes which occur in a country, • increase in Population • Technological changes in method of production of products in domestic industries or in industries of other countries. They may affect the cost, price and qualities of products • Restrictions of all kind imports of machinery, and technology etc • Deficiency of resources which increase exports and decrease imports

  35. Causes of Disequilibrium (cont..) 4. Changes in National Income: an increase in national income increase the imports of country , sometime it increase the exports if there is unemployment in a country 5. Price changes; inflation and deflation affects the BOP position of a country, in case of inflation exports decreases and in case of deflation export increase

  36. Causes of Disequilibrium (cont..) 6.Capital movements: • Borrowings and lending or movements of capital by countries result in disequilibrium in BOP • A country which gives loans and grants on a large scale to other countries has deficit in BOP on capital account • A country borrowing large funds from other country and international institutions may have favorable BOP

  37. Causes of Disequilibrium (cont..) 7. Political conditions • it creates certainty and uncertainty among foreigner investors • political instability creates uncertainty which leads to out flow of capital and retards its inflow of capital and vice versa 8. Stage of economic development • stage of economic development affects BOP • Developing countries will have deficit in BOP • it imports capital equipments ,petroleum products and technology and export usually raw materials and primary products

  38. Causes of Disequilibrium (cont..) • Changes in Exchange rate: • Overvaluation and undervaluation of foreign currency lead to BOP disequilibrium • When the value of currency is higher in relation to other currency, it is said to be overvalued ,opposite is the case of an undervalued. • Overvaluation of domestic currency makes foreign goods cheaper and exports dearer in foreign market • As result export decrease and imports increase • It increase outflow of capital • Unfavorable BOP

  39. Causes of Disequilibrium (cont..) • Cyclical fluctuations: • Cyclical fluctuation in business activities leads to BOP disequilibrium • in case of depression , both exports and imports decreases • In case of boom, both export and imports increases

  40. Measure to correct deficit in BOP • Adjustment through Exchange Depreciation( Price Effect) : Under flexible exchange rates, the disequilibrium in the BOP is automatically solved by the forces of demand and supply for foreign exchange. Exchange rate is the price of currency which is determined by demand and supply forces It varies with demand and supply equilibrium rate of exchange is to be find in order to clear the foreign exchange market Depreciation of currency is important for rectifying the deficit in BOP Depreciation of currency increase the export and decrease imports

  41. Measure to correct deficit in BOP (cont..) 2. Devaluation: Devaluation rises the prices of domestic prices of imports and reduce the foreign price of exports of a country. devaluation increase exports and reduce the imports 3. Direct Control: To correct the disequilibrium in the BOP, Govt. also adopts direct controls which aim at limiting the volume of imports. the following are the ways for correcting the BOP a) Heavy imports duties b) quotas c) allow free imports off essential inputs d) free imports of machinery

  42. Measure to correct deficit in BOP (cont..) • 4) Adjustment through capital Movements: • Rate of interest is main reason for capital inflow or capital outflow • BOP is in equilibrium when domestic rate of interest is equals to world rate • low domestic rate attracts capital and vice versa • 5) Stimulation of Exports and imports : • BOP is corrected by encouraging exports and by finding imports substitution

  43. Measure to correct deficit in BOP (cont..) • 6) Adjustment through income changes • Given the foreign exchange and prices in the country, increase in the value of exports increase the income of all persons associated with the export industries • Demand for other goods and services within country increase • Income of people related industries increases • This process will rectify BOP position of a country

  44. Measure to correct deficit in BOP (cont..) • 7) Expenditure –reducing policies; • Deficit in BOP means an excess of expenditure over income • Equality between expenditure and income should be bring • Expenditure reducing monetary and fiscal policies should be use • Expenditure reducing policies reduce aggregate demand through higher tax and rate of interest

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