Commerce-7100-balance-of-payment

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Commerce-7100-balance-of-payment

  1. 1. Unit -21 The Balance of Payment The Balance of Payments is part of the national accounts which records payments to, and receipts from the rest of the world. The account is made up of three sections. These record details of inflows and outflows of foreign exchange. • the current account : inflows and outflows generated by international trade • the capital account :inflows and outflows resulting from the movement of capital and money • financing: inflows and outflows that enable the balance of payments to balance Balance of Payments on Current Account This includes all the payments made and receipts earned that result from trade. Hence this part of the accounts allows us to judge the international competitiveness of a country. When Sri lanka exports tea to another country it generates a flow of foreign exchange into Sri lanka and out of the other country. If exports are greater than imports i.e. inflows of funds are greater than outflows of funds then there is a Balance of Payments surplus on current account. If imports are greater than exports i.e. outflows of funds are greater than inflows of funds then there is a Balance of Payments deficit on current account. In the accounts, outflows of foreign currency are denoted with a minus sign. 1
  2. 2. The Balance of Payments on Current Account are broken down into: • the Balance of Trade or the Visible Balance which measures the net flow of funds resulting from trade in goods. If the value is positive then there is an overall inflow of foreign exchange. If negative there is an overall outflow of foreign exchange. • The balance of invisible trade measures the net flow of funds resulting from the trade of services. This balance of invisible trade will include all of the following inflows or outflows of funds: o flows resulting from financial services e.g. banking , insurance , brokerage firms o flows from shipping and aviation services o expenditure by foreign government on embassies and military bases o flows from tourist services o gifts of money from overseas residents to domestic residents o net property income from or paid abroad o payments of interest on official debt. By looking to see if the value of the account item is positive or negative indicates whether there is an inward or outward flow. However, there are many other flows of foreign exchange taking place unrelated directly to trade. These are recorded in the capital account. 2
  3. 3. The Balance of Payments on Capital Account The capital account records inflows and outflows of foreign exchange that result from capital flows. In the case of Sri Lanka the capital account will include flows resulting from: • repaying of debt to foreign commercial banks, foreign governments and multinational agencies such as the IMF. This is referred to as amortization • borrowing from foreign governments and foreign commercial banks • flows of aid into the country from overseas agencies • flows of foreign direct investment such as investment by multinational corporations • resident capital outflow or capital flight as a country's citizens send money out of the country into foreign banks, or to purchase foreign property or financial assets. In addition an outflow of funds occurs where a Sri Lankan resident or firm acquires capital or financial assets in another country. An inflow occurs where a foreign resident from another country acquires capital or financial assets in Sri Lanka. The Overall Balance and the Need for Financing 3
  4. 4. The current account and the capital account are added to obtain the overall balance of payments. Once again the sign will determine whether there is an overall inflow or outflow. If it looks as though there is going to be an imbalance and inflows are less that the outflows, the government or its agent the Central Bank may resort to a number of ways of generating additional inflows of funds. This is referred to Financing. These can be referred to accommodating flows. In the case of Sri Lanka the data shows that the country regularly experiences a balance of payments deficits and needs to generate an inflow to finance it. Normally there are a number of financing options open to countries in this situation. • Use up reserves of foreign currencies held at the Central Bank. • Borrow from foreign central or commercial banks • Borrow from organisations such as the International Monetary Fund • Reschedule its debt or having its debt reduced Foreign Exchange Market The foreign exchange market market is where currency trading takes place. It is where banks and other official institutions facilitate the buying and selling of foreign currencies. Foreign exchange transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. This market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. Exchange rates 4
  5. 5. The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. For example, the higher the exchange rate for one euro in terms of one yen, the lower the relative value of the yen. Factors determining exchange rates 1) Trade (exports/imports) 2) Interest Rates - increasing the interest rate causes 'hot' money to flow into the economy, therefore the demand the domestic currency increases, therefore the currency appreciates. 3) Inflation - relative inflation rates affects the economy's international competitiveness , so if the economy is experiencing higher inflation rate than its trading partners to such a situation that it is less competitive than they are, than there shall be less demand for the domestic currency as foreign markets will demand less goods and services from you, hence the demand for the domestic currency shall drop. 4) Currency Speculation - simply a believe in the path the currency, shall cause speculators to adjust their trades in light of this believe. Currency fluctuation A currency has value, or worth, in relation to other currencies, and those values change constantly. For example, if demand for a particular currency is high because investors want to invest in that country's stock market or buy exports, the price of its currency will increase. Just the opposite will happen if that country suffers an economic slowdown, or investors lose confidence in its markets. Exchange gain/ (loss) 5
  6. 6. A gain (loss) on the exchange of one currency for another due to appreciation (depreciation) in the home currency (for receivables). In Brief • • • • Balance of Trade = Net Export of Goods - Net Import of Goods. Invisible Trade Balance = Net Export of Services(for wages we receive here in return of our services for a foreign company or rents received on property we may hold abroad) + Unilateral Receipts - (Net Import of Services - Unilateral Payments made) Current Account Balance = Export of (Goods + Services) + Unilateral Receipts - (Import of (Goods+ Services) + Unilateral Payments) Capital Account Balance = Capital Receipts (Foreigners investing here + whatever we borrow from outside India) - Capital Payments(Our repayment of loans + Our investment outside). For example, in India, for the year 2005-2006: • Current Account Balance = -9.19 ($Billion). It was negative, therefore called Deficit i.e. we payed more and received less. • Capital Account Balance = 24.24($Billion). It was positive, therefore Surplus mostly due to high foreign investment in our Shares. P.Suthaharan 25/02/2009 6
  7. 7. A gain (loss) on the exchange of one currency for another due to appreciation (depreciation) in the home currency (for receivables). In Brief • • • • Balance of Trade = Net Export of Goods - Net Import of Goods. Invisible Trade Balance = Net Export of Services(for wages we receive here in return of our services for a foreign company or rents received on property we may hold abroad) + Unilateral Receipts - (Net Import of Services - Unilateral Payments made) Current Account Balance = Export of (Goods + Services) + Unilateral Receipts - (Import of (Goods+ Services) + Unilateral Payments) Capital Account Balance = Capital Receipts (Foreigners investing here + whatever we borrow from outside India) - Capital Payments(Our repayment of loans + Our investment outside). For example, in India, for the year 2005-2006: • Current Account Balance = -9.19 ($Billion). It was negative, therefore called Deficit i.e. we payed more and received less. • Capital Account Balance = 24.24($Billion). It was positive, therefore Surplus mostly due to high foreign investment in our Shares. P.Suthaharan 25/02/2009 6

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