UNIT II.

ANALYSIS ON THE INTERNATIONAL BALANCE OF PAYMENT

Introduction

The balance of payment in any country is very important in the sense that it
will keep them updated with how money flows into and out of the country in a
particular period of time.

The Balance of Payment will keep them notified if it’s time for them to slow
down on their importation of goods and services or urge them to focus on
exportation.

Learning Outcomes:

At the end of the lesson, you are expected to:

1. Understand what Balance of Payment.

2. Know the important composition of the Balance of Payment.
3. Appreciate the significance of studying Balance of payment.
4. Evaluate the causes of deficits and surpluses.
5. Learn the remedies of avoiding deficits.

Lesson 1. The Balance of Payment

The statement of foreign transactions, often known as the balance of payment,

is a record of a country's international transactions that take place between firms,
governments, or individuals. The BOP calculates the entire amount of money coming
into a country from overseas minus the total amount of money leaving the country for
any other country within the same time period.

All Balance of Payment transactions have an offsetting receipt, according to the

basic concept of balance. For example, a country may declare a surplus in merchandise
trade (showing that it exports more than it imports), but a deficit in another sector, such
as investment income. Managers use BOP as a comprehensive indicator of a country’s
economic activity.

Why is Balance of Payment an important issue to study?

1. The Balance of Payments gives detailed information on a country's currency

demand and supply. If the Philippines imports more than it exports, the supplyof its
peso is likely to exceed in the foreign exchange market, putting the peso under
pressure to depreciate against other currencies; conversely, if it exports more than
it buys, the supply of its peso is likely to surpass.
 2. BOP data could indicate the country's potential as a global business partner. In order
to ameliorate the BOP situation, a government may not be tempted to implement
policies to restrict imports and discourage capital outflows, and vice versa. Foreign
currency restrictions would be more likely if the BOP surplus was higher.
3. Data from the BOP can be utilized to assess a country's success in international
economic rivalry.

Shortfalls (deficits) will be compensated for in various ways, such as:

 Funds generated by investments
 Currency reserves are being depleted.
 Obtaining loans from other nations

There are two main accounts of BOP:

1. CURRENT ACCOUNT, It keeps track of all merchandise trade transactions: Physical

goods imports and exports, such as oil, cereals, and computers (also known as visible
trade) Receipts and payments for intangible products suchas copyrights, cross-border
dividends, and interest payments, as well as receipts and payments for services such
as banking or advertising (also known as invisible trade)
2. CAPITAL AND FINANCIAL ACCOUNT, which records loans to foreigners as well as
loans to citizens.
 Long-term capital investment (money invested in foreign enterprisesas well as profits
earned from selling those assets and returning the money to the home country)
 Short-term capital investment(funds transported throughout the world for business
purposes by organizations with international operations, as well as money invested in
foreign currency by international speculators)
 Debt forgiveness (when the country borrow too much that they cannot anymore pay may
be given conditions), when a certain country borrowtoo much to another country that it
cannot anymore pay its debts, the lending country may cancel or reschedule a foreign
debt to lessen their pain of debt burden. Countries have to pay much interest that they
have small money left to pay for the long term debts to foreign lenders, the foreign
lenders have to give them economic reforms to have some debt forgiven.
 Sale of tangible assets ( like office space abroad)
 Sale of intangible assets (include; patents, copyright, trademarks, etc.)
 Debt duties(On financial account)
 Portfolio investment transactions (Buying and selling of stocks, bonds,derivatives like
options, swaps,)
 FDIs (Foreign Direct Investment), open business in other countries, orforeign
business settling in home country
 Reserves (currency, gold reserve, SDR (Special Drawing rights),foreign reserves
with IMF

LESSON 2. CURRENT ACCOUNT DEFICITS

A. Current Account Deficits and Their Importance

 Negative multiplier effects due to job losses in the export industry andindustries
affected by growing imports.
For example, a drop in foreign exchange reserves can be troublesome for smaller
developing countries that struggle to attract financial capital, and can result in
exchange wealth eroding real living standards.
 A current account deficit is not always detrimental to a nation’s economy- external debt
may be used to finance lucrative investments.

B. Causes of Current Account Deficits

1. Lower aggregate demand (biggest component of current account balance is the trade):
 Low growth due to low productivity in the supply side
 Higher unemployment due to low investment
2. Debt burdens – when a country is over borrowing from the rest of the world:
 Currency crisis
 Economic crisis (more imports, that is, when there is strong domestic economic growth
income of the resident’s growth or is higher thus drives import or when standards of
living goes up therefore import is increased. Or when a country is importing more the
increased money supply goes down)

 There is the tendency of a borrower to not immediately pay because the borrowing
country does not have income streamline, (no concrete purpose of the borrowed
money).
 Depletion of resources (if exporting resources sooner these resources will be depleted
in the long run
3. Exchange rate is decreasing
 When exchange rate is devalued (WIDEC: (W) when exchange rate (I)Import is (D)
dear/expensive (E) export becomes ( C ) Cheap
 Lack of competitiveness – high cost of raw materials thus price of purchased goods will
 be high that competitiveness is at stake. Or there is inadequate research and
Development innovation
 High cost of imported goods and services

Or we can simplify these by stating on the causes and consequences of a current

Account deficits:

Demand side:

 Strong domestic growth. When there is strong domestic growth , the income increases
and thus standard of living is increased and drives importation of goods and services
 Recession overseas. ( recession in key export market)
 Strong exchange rate. Thus, imports become cheap. Strong currency makes imports
cheap and export expensive.

Supply side:

Low investment, low productivity, high relative inflation, high unit level costs, poor
quality reliability, and resource depletion are all factors to consider. If resources are
exported, they will be depleted sooner rather than later.

Policies to rectify a Current Account deficit:

1. Contractionary monetary and fiscal policies

 Monetary policies – the Central Bank’s management of money, credit and interest rate
thus when interest rate is increased there would be less borrowers and depositors will
not be saving their money as it isnot wise for borrowers to borrow money during times
that interest rate

is high and when this happens residents are not driven to import thus growth decreases
and so is employment decreases.
 On fiscal policies – Government tax and expenditure policies usually formulated by
elected officials, thus policy makers decreases money supply.
2. Protectionists measures
 Tariffs are increased
 Quotas are controlled on imported products/ services
 Subsidies to domestic producers
 Embargo (official suspension of imports. Exports)BUT:
 Retaliation: closing doors of other country’s to our exports
 WTO rules to be followed
 Inflation as importation is controlled
3. Allow currencies to depreciate
 Interest rate is decreased, money supply is increased, sell currency reserves
BUT: (Marshall-Lerner condition)
o If exports expand faster than imports, total revenue from net export rises; if imports grow
faster than exports, total revenue from net export falls.
o When a country's currency depreciates, its current accountbalance improves, or moves
closer to a surplus.
o Imported inflation
o Retaliation if currency soars
4. Supply side policies to boost international competitiveness
BUT: It will take a long time, it might not work well and it is very expensive especially to
the underdeveloped countries whose resources are scarce so there is no guarantee of
success

Causes of Current account Surplus:

Structural:

 a significant long-run competitive advantage

 a long-run rise in global prices of main exports
 a structural increase in net investment income (OFWs remittance to theirhome
countries)
 Factor production is on the rise.

Germany, for example, is a manufacturer of household goods and electronics

that is successful in innovating and R&D. As a country that will spend a lot on R&D,
many companies have an advantage over others because of their success in innovation

Cyclical:

 Strong consumer demand and a significant export market have led to adepreciation of
the currency.
 cyclical improvement in trade terms
 drop in [imported energy/components
 costs increase in net inflows of remittance/profits
 Exports of goods and services from China are an example. Enabling the country
to amass vast gold and foreign-currency reserves.

Importance of success in the current Account

 Contributor to the Gross Domestic Product (GDP). (the rationale for positivenet
external demand)
 Could result in demand-pull inflationary pressure.
 Developing a foreign exchange reserve
 To get a currency to appreciate, put pressure on it.

 Allow a currency to be a net capital exporter.

 Huge surpluses could lead to a protectionist reaction.
 Investor risk is increasing as a result of the new standards, which result inhigher
returns on government debt.

ASSESSMENT

1. Differentiate the current account and capital account.

2. Is it a good option to increase the supply of money in order for a
country to buy foreign reserves? Why and Why not?
3. In your own understanding, discuss marshall-lerner condition.
4. Define balance of payment. Discuss its importance.