What are the effects of balance of payments?
Balance of payments has a great impact on the movement of exchange rates and international trade. When a country is faced with trade deficits, it's likely to experience a fall in its reserves and a depreciation of its currency.
- Inflation.
- National Income.
- Government Restrictions.
- Exchange Rate.
A BoP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports or service its external debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency.
The importance of the balance of payment can be calculated from the following points: It examines the transaction of all the exports and imports of goods and services for a given period. It helps the government to analyse the potential of a particular industry export growth and formulate policy to support that growth.
It can indicate a country's ability to pay for imports: A BOP deficit means that a country is spending more on imports than it is earning from exports and other sources. This can lead to a decline in the country's international reserves and a devaluation of its currency.
There are three main components of the BOP: the financial account, the capital account, and the current account. The combination of the first two should balance with the third, but that doesn't always happen.
Importance of the Balance of Payments
The balance of payments helps any country determine if its currency's value is appreciating or depreciating. It provides almost accurate information on the commercial and/or financial performance of the external sector of an economy.
When funds go into a country, a credit is added to the balance of payments (“BOP”). When funds leave a country, a deduction is made. For example, when a country exports 20 shiny red convertibles to another country, a credit is made in the balance of payments.
Causes of BoP Deficit
High outflow of foreign exchange to meet import demands like technology, machines, and equipment can lead to BoP deficit. Sustained rise in a country's prices can often make foreign products cheaper, leading to a high volume of imports. Unstable tax structures, change in government, etc.
In the short-term, a balance of payments deficit isn't necessarily bad or good. It does mean that, in real terms, there is more importation than exportation occurring until the value of money adjusts.
What causes balance of payments surplus?
A "surplus" in the balance of payments occurs when a nation exports more goods and services and obtains more income and capital from abroad than it imports or pays out. Contrarily, a "deficit" occurs when a nation imports more than it exports and pays more income and capital to foreign entities than it receives.
The formula for the balance of payments is a summation of the current account, the capital account, and the financial account balances. The term balance of payments refers to recording all payments and obligations of imports from foreign countries vis-à-vis all payments and obligations of exports to foreign countries.
To correct a balance of payments deficit , a country can devalue its currency, increase exports, reduce imports, or implement fiscal austerity. Devaluing the currency can make a country's exports cheaper and imports more expensive, thereby improving the balance of payments.
- Current account.
- Capital account.
Increasing exports at a rate faster than the imports will reduce imbalance in the trade sector. Invisible balance will be improved by attracting private transfers, especially workers' remittances.
The balance of payments always balances. Goods, services, and resources traded internationally are paid for; thus every movement of products is offset by a balancing movement of money or some other financial asset.
The disequilibrium can be corrected using policies like currency devaluation, trade policy measures, exchange control and demand management. These policies aim at promoting exports, reducing imports and controlling foreign capital flows. However, these policies also have their costs and limitations.
• A disequilibrium in the balance of payment means its condition of Surplus Or deficit. • A Surplus in the BOP occurs when Total Receipts exceeds Total Payments. Thus, BOP= CREDIT>DEBIT.
The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal.
The income earned from the factors of production are called factors of payment, which come in the form of rent for land, wages for labour, interest for capital, and profit for entrepreneurship.
What are the four factors of payment?
- Land: Rent is a reward for the use of land.
- Labour: Wages are the reward for labour.
- Capital: Interest is the reward for capital.
- Entrepreneur: Profit is the reward for an entrepreneur.
These four factor incomes—wages, rent, interest, and profit—represent the main sources of income in an economy and are essential for understanding the distribution of income among different economic agents.
A payment can be made in the form of cash, check, wire transfer, credit card, or debit card. More modern methods of payment types leverage the Internet and digital platforms.
Factor payments are income for the owners, it may include: Raw materials prices for raw materials. Rent for land or buildings. Wages and salaries for labor.
There are three major parts of a balance of payments: current account, financial account and capital account.
