Pakistan Economy MGT-322

Lec # 7 Balance of Payment Instructor: Ms. Moniba sana

Introduction
Balance of payment (BOP) is systematic record of all economic transactions completed between the residence of a country with the rest of the rest of the world during a specific time period. There are two types of transactions
Credit transactions Debit Transactions

Credit Transactions are those transaction in which economies receives payments from other countries. Debit Transactions are those in which economies make payments to other countries.

Credit Transactions

Debit Transactions

The followings are the examples of credit transactions: i. Export ii. Transfer receipts like gifts, loans etc iii. borrowings from other countries iv. Foreign Direct Investment (FDI) v. Official sale of reserves vi. Worker remittances vii. interest earnings on lending

The following are the examples of debit transactions: i. Imports ii. Transfer payments to foreigners iii. Lending to other countries iv. Investment in foreign v. Official purchase of assets and resaves vi. Interest payment on debt

Accounts of Balance of Payments

Accounts are those parts that record all transactions between resident of a country with the rest of the world. There are three accounts of BOP.
Current account balance Capital and financial account Official reserve account

Current account balance It keeps the record of all international transactions of goods and service, transfer payments and income accounts

 Capital & financial account balance

The Capital account includes Loan transactions, inward or outward Investments, short-term capital and other related items. Official reserve account It keeps the record of transaction and movement in foreign exchange reserves and domestic assets (gold, silver and SDRs) to minimize the deficit in balance of payment.

Balance of Payments Equilibrium

is defined as a condition where the sum of debits and credits from the Current Account and the Financial Account equal zero; Current Account + Financial Account = 0 BOP Deficit where the sum of debits and credits from the Current Account and the Financial Account is negative BOP Surplus where the sum of debits and credits from the Current Account and the Financial Account greater than zero

Balance of Payment Equilibrium

In BOP equilibrium, we have to make certain assumptions for the simplicity of our analysis. These assumptions are: A given supply curve of real capital. No change in price expectations, Internal capital flows depend on the level of the interest rate at home and abroad, There are two types of BOP equilibrium i.e., static equilibrium and dynamic equilibrium

Static Equilibrium

The distinction between static and dynamic equilibrium depends upon the time period In static equilibrium, exports equal imports including exports and imports of services as well as goods and the other items on the BOPs short term capital, long term capital and monetary gold are on balance, zero.

Dynamic Equilibrium
The condition of dynamic equilibrium for short periods of time is that exports and imports differ by the amount of short-term capital movements and gold (net). The condition for dynamic equilibrium in the long run is that exports and imports differ by the amount of long term autonomous capital movements made in a normal direction, i.e. from the low-interest rate country to those with high rates. If the BOP moves against a country, adjustments must be made by encouraging exports of goods, services or other forms of exports or by discouraging imports of all kinds. No country can have a permanently unfavourable BOP though it is possible to have a permanently unfavourable balance of trade.

Causes of Deficit in (BOP)

Income Type of Disequilibrium because of rise in incomes the consumption in the country will increase and the exports will decrease. In this way foreign receipts will come down and deficit in BOP occurs. Price Type of Disequilibrium If in a country due to demand-pull inflation or cost-push inflation, the price level rises, the domestic products will become expensive. In this way, the exports of a country may fall and the imports of a country may increase. In this way, receipts will come down and payments will increase and caused for deficit in BOP.

 Capital Movement: As due to political instability the domestic capital is flowing out then the foreign payments of a country may increase. If the foreign capital is not coming to the country, the receipts of a country may also go down. Thus the changes in capital movement at capital accounts of BOP are also responsible for deficit in BOP. Structural Changes: i. If in a country, the population increases, the exports will decrease and imports will increase and leads to BOP in Deficit ii. If in a country, the natural resources are depleted the exports may come down. iii. If in the world, the substitutes are developed, they may have the effect of reducing the exports of a country. iv. If a country is engaged in the process of economic development, it has to import machinery, raw material and a variety of goods. In this way the country will have to spend foreign exchange on their importation.

Measures to Remove Deficit in BOP

There are different measures that can be used to eliminate the deficit in BOP. Some of these are given in below To Give Subsidies to Exporters: Restrictions on Imports Deflation Devaluation Due to the devaluation of currency, exports become cheaper and imports become expensive and improve the BOP situation International Monetary Fund (I.M.F): As the international level, the institution named as IMF has been set up. This institution has been assigned to perform the following functions:
i. ii. iii. To serve as a pool of international reserves. To keep an eye on exchange rates of currencies. To provide assistance to those countries who face persistent deficit in their BOP.

In this respect IMF has initiated a lot of and with the help of these farcicalities the member of IMF who faces deficit in BOP, can get loan from IMF and use it to remove its deficit.

Balance of Trade (BOT)

The record of only visible goods transaction completed between the residence of a country and the residence of the rest of the world, is known as Balance of Trade Terms of Trade (TOT) Ratio between the value of exports and value of imports is known as terms of trade TOT = Value of exports / value of imports Surplus/Favorable TOT: Value of exports > Value of imports OR Receipts > Payments Deficit/Unfavorable TOT Value of imports > Value of exports OR Payments > Receipts

Current situation of BOP in Pakistan

BOP = Current account + capital account + net errors & omissions Current account Pakistan has suffered a persistent current account deficit which is important indicator to pressurize the economy`s external sector It was in deficit continuously from last few years and current account deficit was $3394 million during July-April 2011-12.

Conti..
Trade deficit expanded mainly due to the 14.5% growth in imports and 0.1% increase in exports. Widening of the trade deficit was also credited to rise in import bill. Pakistan witnessed a strong growth of 25.8% in remittances during FY2011-12 & become 5th largest remittances receiving developing country in 2011.

Capital and Financial Account

The financial account posted a surplus of $ 1200 million during 2011-12 compared to last years surplus of $690. Foreign direct investment declined by $625mn. During FY201112 FDI declined by 48.3%. FDI declined due to the worse law and order situation, energy crises and political instability. Over all external sector of the country showed a surplus of 1210$ million during July-April FY10 against to the 730$ mn in the corresponding last year. This growth of external sector is due to the strong growth of current account and surplus in capital and financial account.