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Abigail Sta.

Ana
INMUFIN K31
Balance of Payments
I. Introduction
One’s national currency in terms of foreign currency is usually the price of
exchange rate in the market. Since, exchange rate has close links to the general price
levels of the economies of their respective countries, it shows its importance for it
affects the real income and wealth of those economies. One of the major objectives of
the exchange rate based stabilizations is to improve the Balance of Payment (BOP)
performance through international competitiveness. Countries have been using this
strategy for a considerable period of time producing varying results. Past research
studies have shown that some countries were successful in following the particular
strategy while some countries producing disastrous results. Under these
circumstances the obvious question that has to be answered is “What are the reasons
for producing such varying results?” The objective of this paper is to understand how
BOP performance of each country varies.

II. Background
The Balance of Payments or BoP is a country’s official settlement balance,
otherwise known as the balance of official financing. More simply, the BoP is the
measure of a country’s total international trade. It is a systematic statement of all the
economic transactions between the country and the rest of the world. The payments
or proceeds into a country are entered as positive numbers and the deficits or
payments out of the country are entered as negative numbers. Its major components
are capital account, current account, and financial account.
The term balance applies because the trade of goods and services in one direction
will be balanced by the transfer of money in the opposite direction. More accurately,
the trade of these goods and services as they are measured by the current account will
be balanced by the transfer of money as it is measured by the capital account (Heakal,
2011).
In relation to the foreign exchange market, which keeps account of the values of
the major currencies of the world, the balance of payment has the potential to
influence the prices of free-floating currencies. That is because free-floating
currencies are effected not only by political events or government policies but also by
the economic events represented by the BoP and even by the speculation of individual
traders (Akrani, 2010).
III. Issues
Over the years since Balance of payments has been implemented several issues
have appeared. During Pre-1820 to early 19th century there was the mercantilism
issues at the same time at 1820-1914 mercantilism was challenged by the free trade.
At 1914-1945 deglobalisation happened and there were approximately 16 BoP crises
and 15 twin crises. After World War II, Bretton Woods system was used which
caused imbalances. In 1997 the Asian BoP crisis also happened which cause the re-
assessment of the free market. Since BoP has to balance overall, the surplus and
deficit that happens in trading causes the imbalance in the different countries. This
shows that BoP performance for countries vary since there are also different causes
of imbalances that occurs. This paper would discuss why there are imbalances issues
in balance of payments.
IV. Methodology
In order to derive the answers to the research question mentioned above and
interpret the effectiveness of Balance of payments, heavy research was done to
provide trustworthy results coming from past research papers with depth and
reliability about balance of payments. Research papers written by people who have
great knowledge background regarding the topic were the one’s considered for the
analysis. The results and information gathered from the research are presented and
discussed below. Accordingly, from the several papers that has been written about
balance of payments, the information obtained showed the different views and
opinions of the researchers regarding the different issues present in balance of
payments.
V. Review of Related Literature
According to Riley (2012) there are several reasons why countries experience surpluses
and deficits that’s why each country also experiences different circumstances. First, some
countries increase their capacity of export industries as growth strategy which shows their
export-oriented growth. Second, others would focus on foreign direct investment which can
happen after export growth. Third is that having surplus can cause the country to undervalue
its exchange rate for them to be able to boost their competitiveness.
Moreover, Riley (2012) states that high domestic saving rates can be attributed to
surpluses and a closed economy could mean that a small portion of national income is taken
by imports. Lastly, strong investment income from overseas investments could cause trade
surpluses.
Because the current account and the capital account add up to the total account, which is
necessarily balanced, a deficit in the current account is always accompanied by an equal
surplus in the capital account, and vice versa. According to Herbert Stein (2008) a deficit or
surplus in the current account cannot be explained or evaluated without simultaneous
explanation and evaluation of an equal surplus or deficit in the capital account.

From research it states that a country is more likely to have a deficit in its current account
the higher its price level, the higher its gross national product, the higher its interest rates, the
lower its barriers to imports, and the more attractive its investment opportunities—all
compared with conditions in other countries—and the higher its exchange rate. The effects of
a change in one of these factors on the current account balance cannot be predicted without
considering the effect on the other causal factors (Stein, 2008).
In a floating exchange rate, the two components of the Balance of Payments should
balance each other out. This is because financial outflows must be matched by financial
inflows. When a country has a fixed exchange rate, there is more likely to be a balance of
payments problem (Pettinger, 2014). A country is said to have balance-of-payments
constraint if it cannot sell financial claims sufficient to cover its shortfall in production of
tradeables, relative to desired consumption of tradeables. For a country to finance its
spending on tradeables it would mean that people should spend less. The reduction in
spending on non-tradeables will result in unemployment, while the reduction in spending on
tradeables will reduce the trade deficit. As the economy adjusts to the inability of previously
creditworthy residents to finance earlier purchases of tradeables, one will also see a
downward spiral of spending on non-tradeables (Wolf, 2012).
VI. Analysis and Conclusion
Though the credit and debit are written balanced in the balance of payment account, it
may not remain balanced always. Very often, debit exceeds credit or the credit exceeds debit
causing an imbalance in the balance of payment account. This means that imbalance happens
in the Balance of payments which is called disequilibrium. Disequilibrium may take place
either in the form of deficit or in the form of surplus.
Disequilibrium of Deficit arises when our receipts from the foreigners fall below our payment
to foreigners. While, Disequilibrium of Surplus arises when the receipts of the country exceed
its payments. In conclusion, there are many reasons why disequilibrium happens in balance of
payments and some of the reasons are the following: population growth, development
programs, demonstration effect, natural factors, cyclical fluctuations, inflation, poor
marketing strategies, flight of capital, and globalization. Overall, Balance-of-payments
constraints have not been removed, in any way, inside a currency union. They are exactly as
before. The difference is that one adjustment mechanism; the currency, has been removed.
But an adjustment mechanism may also be a source imbalance of disequilibrium.
VII. References
Akrani, G. (2010, December 1). Disequilibrium in the Balance of Payment - Meaning , Causes. Retrieved
from Kalyan Economics: http://kalyan-city.blogspot.com/2010/12/disequilibrium-in-balance-of-
payment.html
Heakal, R. (2011). What Is The Balance Of Payments? . Retrieved from Investopedia:
http://www.investopedia.com/articles/03/060403.asp
Pettinger, T. (2014, February 10). Balance of Payments Disequilibrium. Retrieved from Economics Help:
http://www.economicshelp.org/blog/185/economics/balance-of-payments-disequilibrium/
Riley, G. (2012, September 23). Balance of Payments - Deficits and Surpluses. Retrieved from Tutor2u:
http://tutor2u.net/economics/revision-notes/a2-macro-balance-of-payments-deficits.html
Stein, H. (2008). Balance of Payments. Retrieved from Library of Economics and Liberty:
http://www.econlib.org/library/Enc/BalanceofPayments.html
Wolf, M. (2012, February 16). Can one have balance of payments crises in a currency union? . Retrieved
from Matin Wolf Exchange: http://blogs.ft.com/martin-wolf-exchange/2012/02/16/can-one-have-
balance-of-payments-crises-in-a-currency-union/