BALANCE OF PAYMENTS (B.O.P)
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 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 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, 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 me received is 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 is settled. It shows how the surplus or def both account is settle
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 seller use
the same currency and so no currency problems arise. In foreign trade, however, this is 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 of transactions are kept. Just as individuals firms keep records of their sales and purchases in order to know whether or not they are making 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 period. This kind of record-keep, which is done by countries in units of money, is precisely what balance of payments is all about. Money also useful in international transactions when involves foreign exchange market. All exchanges that take place between the residents of one country and another require the use of money.
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.
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 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 total payments of a country.
It should be noted that the balance of payment equilibrium can exist. There is equilibrium balance of payment it the total receipts from other countries equals total payments to other countries.
Types of Balance Payment Disequilibrium
1. Balance of payment surplus
Definition: There is balance of payments surplus whose the 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 favourable balance of payments. The reporting country in this case is financially strong in its international trade transactions.
Effects of balance of payments surplus
(1) Increase in economic activities: There will be an increase in economic activities, since 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: Balance of payments surplus must be well managed by the government so that it will not result into inflation.
- Debit retirement: Balance of payments surplus situation can help a country to retire (pay-off) previously accumulated debt.
Balance of payments deficit
Definition: 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, 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
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 adverse effect on the country’s reserves.
Causes of Balance of payments deficit
The causes of balance of payments in Nigeria for example include:
- This makes Nigeria dependent on food
imports and imported inputs for her agro-allied industries.
- Low level of technological development
makes the country a greater importer of advance 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 the 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 source (borrowing)
- Purchase of goods and services (export promotion)
- Sale of foreign investments
- Increased export of goods and services (export promotion)
- Grants and aids from friendly countries
Measures to reduce or correct balance of merit deficit
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 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 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 embargo on imports.
- Grants and aids: This can be obtained from richer or friendly nation 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 of the country’s investment abroad using it to pay the creditors can also serves 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 concession.
- Increase in production: With a spectacular rise in production, domestic prices of goods would be brought down and export of goods stimulated. Demand for imported goods will reduce.
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