The balance of payments (BoP) is a record of all transactions between a country and the rest of the world over a specified period, typically one year. It includes all transactions involving goods, services, and financial assets between a country\’s residents and non-residents. The BoP is divided into two main components: the current account and the capital and financial account.
The current account of the BoP records all transactions involving the exchange of goods and services between a country and the rest of the world. It includes the following:
- Trade balance: This is the difference between a country\’s exports and imports of goods. A trade surplus occurs when exports exceed imports, while a trade deficit occurs when imports exceed exports.
- Services balance: This is the difference between a country\’s exports and imports of services. It includes items such as travel, transportation, and financial services.
- Income balance: This includes all income earned by a country\’s residents from foreign sources, such as dividends, interest, and wages. It also includes all income earned by foreign residents from sources within the country.
- Current transfers: This includes all transfers of money between a country\’s residents and non-residents that do not involve the exchange of goods or services. Examples include foreign aid, remittances, and gifts.
The capital and financial account of the BoP records all transactions involving the exchange of financial assets between a country and the rest of the world. It includes the following:
- Foreign direct investment: This is when a company from one country invests in a company in another country with the aim of gaining a controlling interest.
- Portfolio investment: This involves the purchase of stocks, bonds, and other financial assets by foreign investors.
- Other investments: This includes loans, deposits, and trade credits between a country and its non-residents.
- Reserve assets: This includes a country\’s holdings of foreign currencies and gold.
The balance of payments is a useful tool for monitoring a country\’s international economic transactions and analyzing its trade relationships with other countries. A surplus in the current account indicates that a country is exporting more goods and services than it is importing, while a deficit indicates the opposite. Similarly, a surplus in the capital and financial account indicates that a country is receiving more foreign investment than it is investing abroad, while a deficit indicates the opposite. By monitoring these balances, policymakers can make informed decisions about their country\’s economic policies and trade relationships with other countries.
At the end of this chapter, students should be able to:
- Identify factors that give rise to payments of money into and out of the home country.
- Explain B.O.P. concepts such as the trade balance, the current account balance and the overall balance.
- Identify the different ways of dealing with the balance of payments disequilibrium.
- Trace developments in Nigeria’s balance of payments.
DEFINITION OF BALANCE OF PAYMENTS
Balance of payments may be defined as the relationship between the sum total of a country’s payment for her imports and receipts for her exports. It is thus a statement of income and expenditure on an international account, for a period of time, usually one year. It can also be referred to as a statement or record showing the relationship between a country’s total payments to other countries and its total receipts from them in a year.
COMPONENTS OF BALANCE OF PAYMENTS
A country’s Balance of payments can be divided into three major components, namely, the current account, capital account and monetary movements account.
- Current Account: This is made up of the total receipts and payments on both visible and invisible goods and services. Invisible services are insurance, banking, transportation, interest payment tourism, etc. While visible goods an automobiles, cocoa and crude oil.
- Capital Account: This account is ma up of the movement or flow of money or capital from one country to another such as investment, international I and loans. There are short and long-term capital movements. A country’s balance of payments is favourable when I received more than the amount she pays out and vice-versa.
- Monetary Movement Account: This account shows how the balance on both current and
capital accounts are settled. It shows how the surplus or def both account is settled
Money plays an important role in international transactions. Both internal and external trades are similar because both are transacted use of money. However, they still differ in many ways. In internal trade, buyers and sellers use
the same currency and so no currency problems arise. In foreign trade, however, this is the case. Countries have different currencies thus, it becomes necessary to change one another for trade to take place. Money also acts as a unit of measurement in which transactions are kept. Just as individuals firms keep records of their sales and purchases in order to know whether or not they are making a profit.
Countries also keep records of the money they spend on imports and the money they earn from exports in order to know whether international trade has been profitable or not in the period. This kind of record-keep, which is done by countries in units of money, is precisely what the balance of payments is all about. Money is also useful in international transactions when involves the foreign exchange market. All exchanges that take place between the residents of one country and another require the use of money.
The foreign exchange market came into existence as a result of the need to resolve the differences between one
’’country‘s currency and that of another.‘country ‘ s currency and that of another.‘’ country‘s currency and that of another.‘country ‘ s currency and that of another.
Money also facilitates economic development by means of foreign exchange, foreign capital and skills are being imported, thereby assisting the development process of the under-developed.
BALANCE OF PAYMENT DIS-EQUILIBRIUM
Definition: Balance of payment disequilibrium may be defined as a situation which occurs when the total receipts of a country on the combined current and capital account are not equal to the payments. In other words, a balance of payment disequilibrium occurs when total receipts are not equal to the total payments of a country.
It should be noted that the balance of payment equilibrium can exist. There is an equilibrium balance of payment it the total receipts from other countries equal total payments to other countries.
Types of Balance Payment Disequilibrium
1. Balance of payment surplus
Definition: There is a balance of payments surplus whose total receipts from all other countries exceed the total payments to other countries during a given trading period. This situation gives rise to what is referred to as a favourable balance of payments. The reporting country in this case is financially strong in its international trade transactions.
Effects of the balance of payments surplus
(1) Increase in economic activities: There will be an increase in economic activities since a surplus enables the citizens of a country to have more funds at their disposal.
(2) Greater net income: A balance of payment surplus means a greater inflow of earnings from abroad. This will lead to a higher level of net income at home through the operation of the multiplier effect.
- Inflationary tendency: The balance of payments surplus must be well managed by the government so that it will not result in inflation.
- Debit retirement: A balance of payments surplus situation can help a country to retire (pay off) previously accumulated debt.
Balance of payments deficit
Definition: A balance of payments deficit may be defined as a situation which occurs when the combined receipts on the current and long-term capital accounts of a country are less than the corresponding payments. In other words, a balance of payments deficit occurs when a country’s expenditure flows are more than the country’s income flows.
Types of balance of payments deficit
- Temporary balance of payment deficit: This type of deficit, also called
a short-term deficit, is the type which can easily be corrected or adjusted within a short term. They do not pose serious problems. They can be financed or paid for by the use of reserves or international borrowing.
- Fundamental or chronic balance of payments deficit: This is also called long-term deficit and this cannot be corrected or adjusted within a short term and it usually has an adverse effect on the country’s reserves.
Causes of Balance of payments deficit
The causes of the balance of payments in Nigeria for example include:
- This makes Nigeria dependent on food
imports and imported inputs for her agro-allied industries.
- A low level of technological development
makes the country a greater importer of advanced technology.
- Inadequacies in export promotion strategies: Export promotion strategies to encourage more earnings for the country are grossly inadequate.
- Political instability: Political instability discourages export drive but encourages massive importation of goods and services.
- This attitude encourages the government
to engage in massive importation of all kinds of goods into the country.
- This can go a long way to deplete the external reserves and use all earnings to settle external debts.
- Existence of import-dependent industries: These industries reduce the country’s earnings as they demand for scarce foreign exchange to enable them to procure machines and raw materials from abroad.
- Poor social and economic infrastructure: Poor social and economic infrastructure contribute
greatly to low capacity utilisation in the industrial sector e.g. bad roads, irregular supply of electricity, water and poor telecommunications.
BALANCE OF PAYMENTS ADJUSTMENTS
Meaning: Balance of payments adjustment refers to the various ways by which balance of payments disequilibrium (especially balance of payment deficits) can be reduced or corrected Balance of payments deficit can either be financed or reduced (corrected).
Ways by which balance of payments deficit can be financed
Some of the means by which balance o
payments deficit of a country can be financed are:
- Running down external reserves and SDRs.
- Drawing (or borrowing) from International Monetary Fund (IMF)
- Short-term credit from various sources (borrowing)
- Purchase of goods and services (export promotion)
- Sale of foreign investments
- Increased export of goods and services (export promotion)
- Grants and aid from friendly countries
Measures to reduce or correct the balance of merit deficit
The balance of payments deficit of a country can be corrected or corrected by the following measures:
- Foreign exchange control: Foreign exchange control involves the rationing of foreign exchange in order to reduce the balance of payment deficit.
- Expenditure reduction: This is used in order to cut down domestic demand and reduce imports.
- Expenditure switching: This involves the manipulation of exchange rates to induce people to patronise locally made goods.
- Fiscal control: This involves the rising of tariffs (i.e. increase in import duties) in order to reduce the balance of payment deficit.
- Raising interest rates: The raising of interest rates is to reduce bank lending
- Devaluation: Devaluation cheapens exports and makes imports expensive, thus improving the balance of payments
- Reduction of imports: The governments can restrict imports by the use of tariffs, quotas and outright embargos on imports.
- Grants and aids: This can be obtained from richer or friendly nations to offsets the deficit that occurs in the balance of payments.
- Borrowing: A country can borrow money from IMF or other richer nations in order to correct her balance of payment
- Promotion of import substitution industries: This is done to replace the commodities that were previously brought from foreign countries
- Selling investments abroad: Selling the country’s investment abroad and using it to pay creditors can also serve as a solution.
- Drawing on foreign reserves: Drawings on the value of the country’s foreign reserves to pay the
- Increase in experts: The encouragement of experts can be promoted through subsidies and concessions.
- Increase in production: With a spectacular rise in production, domestic prices of goods would be brought down and the export of goods stimulated. Demand for imported goods will reduce.
- loans for businesses
- how to establish enterprises
- what is a firm
- price equilibrium
- scale of preference
- concept of economics
- economic tools for nation building
- factors affecting the expansion of industries