BALANCE OF PAYMENTS (PART I)

Yvonne Harvey, Contributor HELLO. I will begin today's lesson by giving you the learning objectives for this topic. The candidate should be able to: * Differentiate between balance of trade and balance of payments. * Discuss the impact of balance of trade, balance of payments and devaluation. * Discuss the internal measures which a country may adopt to address an adverse balance of payments problem. * Discuss the external strategies which a country may adopt to address adverse balance of payments. These objectives will be covered in the two lessons, starting today. Ready? International trade refers to trade among different countries of the world. When countries trade with each other, a record is kept of the financial transactions between them. This record is known as the 'balance of payments'. It is a statement of the trade which takes place between a country's residents (individuals, businesses and the government) and the residents of all foreign countries. Therefore, Jamaica's balance of payments shows all the payments we receive from other countries and all payments which we make to them. There are three components of the balance of payments account: the current account, the capital account and the official financing account. Now, we are going to analyse each account in turn. Please note that in all parts of the balance of payments account, exports and income and are, therefore, given a plus (+) sign and imports and payments are given a minus (-) sign. THE CURRENT ACCOUNT This section of the balance of payments is divided into two parts: part (a), the visible trade account, and part (b), the invisible trade account. The visible trade account records the tangible items, i.e., the imports and exports of goods only. The difference between the money value of goods imported and goods exported is known as the visible trade balance, or the balance of trade. This balance may be a plus (+) surplus or a minus (-) deficit. If exports exceed imports, the result will be a surplus or a favourable balance of trade. On the other hand, if imports exceed exports there will be a deficit, or unfavourable balance of trade. The invisible trade account records the intangible items, i.e., the imports and exports of services, tourist expenditure and income, income from investments abroad and paid to investments abroad. The services include shipping, aviation and financial services. The balance on this account is known as the invisible balance and it will be a plus (+) favourable if exports (income) of the intangible items exceeds the imports. Now, you can work out for yourselves what will result in a minus (-) on this account. The overall current balance is the difference between our exports of goods and services and the imports of goods and services. As with the visible and invisiblebalances, the overall current balance may be favourable or unfavourable.

THE CAPITAL ACCOUNT This account records capital flows, i.e., loans and grants to and from other countries, investments bought and sold (note that the income from investments is recorded in the invisibles of the current account). As with the current account balance, the capital account balance may be favourable or unfavourable. Now, we need to consider the overall balance of payments figure. This takes into account the current account balance and the capital account balance. If, overall, the exports exceed the imports, the overall balance of payments will be a surplus (+) and if overall the imports exceed the exports, the overall balance will be a deficit (-). This means that the country spent more than it earned. THE BALANCE OF PAYMENTS MUST BALANCE Ultimately, this must happen since every export becomes an import and every import was an export. Balancing the balance of payments means that there must neither be a surplus nor a deficit in the end. A way must be found to finance the surplus or deficit through external strategies which are shown in the official financing account. Next week, we will take a look at this part of the balance of payments account. We will also look at ways of financing an adverse balance of payments and ways of correcting an adverse balance of payments. Now, for your assignment, to reinforce what we have covered. Try this question. (a) Define the term 'balance of payments' (2 marks). (b) (I) What is meant by a country's balance of trade? (2 marks). (II) Calculate the balance of trade for the country shown below: Visible trade in US$m Exports Imports Invisible Exports Imports 26,000 29,000 (net) 20,000 15,000 (2 marks).

(c ) Name two items that are regarded as invisibles (2 marks). (d) Calculate the cucurrent account balance (2 marks). Total: (10 marks).

Balance of payments (Part II) HELLO EVERYONE. I know you all remembered to do your assignment and you are eager to see if you got parts (b) (11) and (d) correct. For part (b) (11) you were asked to calculate the BALANCE OF TRADE from the information given. The answer you should have arrived at is US $M -3,000. The balance of trade remember involves the exports and imports of visibles and since the imports exceed the exports, the balance is

negative (unfavourable). The answer to the part which asked you to calculate the CURRENT ACCOUNT BALANCE is US $M -8,000. To arrive at this figure, you must first calculate the invisible balance which is US $M -5,000. The current account balance takes in the visible and the invisible balance and since they were both unfavourable, the overall current account balance is also unfavourable. I hope you got those answers. Now let us move on to the meat of this lesson. First, we are going to look at the final part of the balance of payments account THE OFFICIAL FINANCING ACCOUNT. THE OFFICIAL FINANCING ACCOUNT This account shows how the balance of payments is financed i.e. it shows what is done with the surplus or the deficit on the balance of payments. Let us look at some ways of financing a balance of payments deficit. FINANCING A BALANCE OF PAYMENTS DEFICIT - Borrowing from international financial institutions e.g. The International Monetary Fund and The World Bank - Borrowing locally - Drawing down on the official reserves of foreign exchange - Selling an asset locally or overseas - Borrowing from other countries - Receiving gifts and grants - Rescheduling of the debt. What if the balance of payments showed a surplus? This surplus could be financed in the following ways. FINANCING A BALANCE OF PAYMENTS SURPLUS The surplus may be used in the following ways: - Lend money, for e.g. to other countries - Purchase an asset locally or overseas - Increase the official reserves of foreign exchange - Pay outstanding debts - Invest the surplus - Give gifts and grants to other countries Below is an example of the official financing account. Assume that the balance of payments figure is US $M -1500. THE OFFICIAL FINANCING ACCOUNT

US $M Foreign currency borrowing Official reserves Total +800 +700 +1500

Now we have balanced the balance of payments by eliminating the deficit of US $M 1500. What though if a country continues to have an adverse balance of payments, year after year? Well, that country must find ways of correcting that adverse balance of payments. The country has a balance of payments problem and must therefore earn more by: (a) Increasing exports through - Offering incentives and subsidies to local manufacturers - Encouraging foreign investment - Extending credit facilities - Reducing spending - Improving marketing skills and sponsoring exhibitions - Devaluing the local currency, which makes exports cheaper. (b) Reducing imports by: - Increasing tariffs (duties) on imported goods and services - Setting quotas to limit the physical amount imported - Requiring special licenses to import - Devaluation, which makes imports dearer - Foreign exchange controls, which limit the amount of foreign currency available to individuals. The question below will test how much you have grasped of this lesson.
(a) What is the Official Financing Account? (2 marks). (b) (1) List TWO ways of financing a balance of payments surplus (2 marks). (11) List TWO ways of financing a balance of payments deficit (2 marks). (c) A country has a balance of payments of US $M + 300, draw up the Official Financing Account to show how this may be financed (2 marks). (d) Explain TWO ways of CORRECTING an adverse balance of payments. Total: 10 marks.