Balance of Payment

Balance of Payment
❖Balance of payments is systematic record of total transactions of a
country with rest of the world in a given period of time usually a year.
❖These transactions include payments for the country's exports and
imports of goods & services, financial capital, and financial transfers.
❖The Balance of payment is a comprehensive record of all the
transaction of a country with rest of the country during a particular year.
• Nations continually carry out economic, commercial and financial
transactions between residents of one nation and rest of world in the
form of :
•exchange of goods for goods
•goods for services
•services for services
•goods and services for money etc.
• Summary of these transactions for a period carries great economic
significance for the nation.
• The systematic record of all economic transactions between residents
of a country and rest of world in a given period is called the Balance
of Payment.
•BOP is a double entry system statement of followings :
•all receipts for goods exported
•all services rendered
•capital received by residents* of the nation and payments made by
residents for goods imported and services received in addition to
capital transferred to non-residents and foreigners.
•Residents mean individuals , businesses and govt. agencies.
• Military personnel, diplomats, tourists and workers who emigrate
temporarily are considered residents of the country of their
citizenship.
Balance of Trade
• On the other hand, Balance of Trade considers the value of exports
and imports of visible items i.e. merchandise only.
•It does not take into account trade of invisible items.
•Thus ‘Balance of Trade’ is a sub-set of ‘Balance of Payment’.
Types of Balance Of Payments
• Surplus/favorable Balance Of Payment:
• If the receipts of a countryare greater than its
payments the result is Surplus.
• Receipts > Payments
•Deficit/adverse/unfavorable balance of payments:
If the receipts of a country are less than its payments the result
is Deficit.
Receipts < Payments
Components of Balance of Payment
* B.O.P. on Current account
* B.O.P. on Capital account
* Unilateral Payment accounts
* Official Settlement accounts
• Balance Of Payment on Current Account
• It includes value of exports and imports of visible items and receipts and payments
on invisibles i.e. services like banking, insurance, travel, tourism, transportation etc.
• Balance of Payment on current account is added to determine nations’ Gross
Domestic Product (GDP).
• Balance of Payment on Capital Account
• It comprises of
i) Private capital (both long and short-term) :
• Long- term with maturity period of more than one year and short-term with
maturity of one year or less.
• Long-term private capital includes Foreign Investments ( both Direct and
Portfolio), long term loans, foreign currency deposits and unclassified capital
account receipts of foreign currency, SDRs etc
 ii) Banking capital covers the external financial assets and liabilities
of commercial and co-operative banks who deal in foreign
exchange.
iii) Official capital are SBP’s holding of foreign currency, SDRs etc. on
behalf of Govt. of Pakistan’s in the form of loan, miscellaneous
receipts, payments etc.
• -- Capital outflow from home country to foreign countries is
treated as debit and inflow of capital from foreign countries to
home country is treated as credit
• Special drawing rights (SDR) are an artificial currency
instrument created by the International Monetary Fund, which
uses them for internal accounting purposes
* Unilateral Transfers Account
• It comprises of uni-directional transactions like ‘giving of gifts’. Disaster
relief, foreign aids, govt. grants, pension paid to and received by
Pakistani citizens for services rendered abroad.
* Official Reserve Account
• It represents official sales of foreign currencies and other reserves to
foreign countries or official purchase of foreign currencies or other
reserves from foreign countries.
•-- Credits here are money received from official sale of foreign
currencies and reserves. Similarly, debits comprise of official purchases
of foreign currencies and other assets.
• Balance on Current Account consist of exports and imports of goods
and services plus net unilateral transfers
•Equilibrium in Balance of Payment of Nations

•When demand for and supply of foreign currency in a nation in a

given period are equal – it is viewed as equilibrium position in
BOP.
•But in case of most of nations, it is not so i.e. they either enjoy a
surplus BOP or deficit. It represents disequilibrium in Balance of
Nations.
Types of BOPs Equilibrium
1. Static Equilibrium
2. Dynamic Equilibrium
• Static Equilibrium
• The distinction between static and dynamic equilibrium depends upon the time
period. In static equilibrium, export 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. Not only should the
BOPs be in equilibrium. But also national money incomes should be in an
equilibrium vis-à-vis money income abroad. The foreign exchange rate must also
be in equilibrium.
• 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 and
there are no longer destabilizing short run capital movements.
• The condition of dynamic equilibrium in the long run is that exports and imports
differs by the amount of long term autonomous capital movements made in a
normal direction, from the low interest rate contrary to those with high rates.
Economic Factors may cause in disequilibrium
1) Development Disequilibrium
2) Cyclical Disequilibrium
3) Secular disequilibrium and
4) Structural Disequilibrium
1. Development Disequilibrium
• Developing countries mostly take up activities like establishment of
industries, infrastructure etc. which require greater imports of capital goods,
machinery etc. In addition it also shoots up imports of consumer goods on
account of increase in per capita income and aggregate demands.
• Thus increased developmental activities result in greater outflow of
foreign currency leading to deficit in BOP
2. Cyclical Disequilibrium
• Due to fluctuations in business cycle in a country , value of
imports of consumer goods and then consumer goods go up or
down periodically, both of which lead to disequilibrium in BOP.
3. Secular Disequilibrium
• It mostly happens in developed countries where disposable income
of people are very high. It raises in turn the cost of production and
price of goods and services.
• Consequently, developed countries prefer to outsource goods and
services from other countries where quality of goods is high and
cost of production is low.
• It may lead to secular disequilibrium in BOP of nation.
• Structural Disequilibrium
• Sometimes notable shift comes in nature of economy of countries
e.g. from agricultural to manufacturing or services.
• These may call for structural changes in developing alternative
items, sources of supply, changes in transport channels and also
costs.
•These structural changes may enhance imports of capital goods and
consumer goods resulting in deficits in BOP.
•Political Factors
• Political uncertainties, instability, internal disturbances, external wars
etc. create threatening situation for local industry and investments. In
such cases domestic production declines leading to increase in
imports and outflow of capital
• It results in deficit in BOP as it happened in Sri Lanka, Pakistan etc.
• Social Factors
• Changes in culture, taste, preference, fashion etc. bring about
changes in nature of import of consumer items first, followed by
capital goods leading to deficit in BOP.
•Correction of BOP Disequilibrium
• When BOP becomes surplus, nations enjoy the same as it offers a
number of desirable situation like increased purchasing power and
influence in global market.
•In cases of disequilibrium due to deficit, countries adopt measures to
eliminate the same completely, if not possible at least reduce it.
1. Automatic Correction of BOP Disequilibrium
•Deficit in BOP indicates that demand for foreign exchange is higher
than its supply in the nation.
•It leads to devaluation of local currency in relation to the foreign currency.
Thereby imports become costlier and exports cheaper. So imports get
reduced and exports are increased. Thereby outflow of FE is reduced and
income is increased leading to automatic restoration of equilibrium
•Deliberate Measures
• Govt. also adopts certain measures to control deficit BOP called ‘Deliberate
Measures’ as indicated.
• Monetary Measures
• Reduction in Money Supply:
• SBP takes to control credit so that money supply in the country is reduced which
leads to decline in income, purchasing power, aggregate demand and consumption.
• Thus imports decline and hence outflow of foreign currency. In turn exports
grow and inflow of foreign currency to set right BOP disequilibrium.
• Interest Rate Adjustment :
• Inflow of FE in deficit BOP nation falls, so liquidity falls. So on short term basis
‘Interest rate’ is raised leading to investments and loans coming from foreign
nations for improving BOP scenario.
•Devaluation
• In case of deficit BOP, purchasing power of local currency reduces, the Govt.
deliberately devalues currency. Thus imports become costlier and exports
cheaper. Hence increased exports and reduced imports balance the disequilibrium
of BOP.
•Exchange Control
• Exporters are to surrender the foreign exchange earned to SBP through authorized
dealers and importers are to draw foreign exchange from authorized dealers.
• Through suitable policies from time to time, Govt. of Pakistan and SBP control
imports to reduce deficit of BOP.
• Trade Measures
• These measures try to restore equilibrium through increasing export and
decreasing import.
Causes of Deficit In The Bop
❖ Increase in imports:
• The heavy import of capital goods and machinery has considerable increased
the import bill.
❖ Decrease in Exports:
•Pakistan’s major exports are rice, cotton, raw wool, leather, fish etc so our export
base is narrow. It is concentrated in relatively low value added products.
❖ Less Modernization of Machinery:
• There have been less modernization, balancing and replacement of machinery in
the private industrial sector. The fall in production and decline in the quality of
products has adversely affected exports.
❖ Consumption Oriented Society:
• Due to rapid rise in population and increased consumption habits, the domestic
manufactured goods are mostly consumed in the country .
❖ Increase in Prices of Inputs:
•The costs of both imported capital goods and industrial raw material, the
inflationary impact of the rise in the prices of inputs are not helping in
achieving the export targets.
❖ Tough Competition:
• There is availability of higher standard goods at lower prices in international market. It
causes reduction in exports, which result in deficit in BOP.
❖Political Uncertainty:
• Due to political uncertainties the efficiency of the industries and the fall in the
volume of production, has reduced export earnings. So BOP is unfavorable.
• Defense Needs:
• We have to purchase modern weapons for our defense at a very high cost like
275 billion, which increases burden on our BOP and it becomes adverse
❖Foreign Debts Servicing:
• Pakistan pays interest on these loans regularly. It paid $ 112 billion as
debts services charges during 2020-2021 . The interest payment has
adversely affected the balance of payment.
 Measures To Correct Deficit in the BOP
❖ Increase the Exports:
• By giving subsidies to the exporters and granting of loans at reduced rates to the
exporters as well as providing insurance facilities and shipment services etc.
❖ Decrease the imports:
• By imposing restrictions on imports, by increasing the import duties, imposition of
exchange control etc
❖Manufactured Goods:
• Instead of exporting primary goods like raw cotton, Pakistan should export
manufactured goods like textiles and garments, leather goods, food products and
electrical goods.
❖Reduction in Export Duties:
•If we reduce export duties the foreigners will prefer to import from Pakistan because
of low prices.
❖ Quality Products:
• Pakistan is needed to improve the quality of its products like electric fans, cycles,
electric motors, shoes, ball pens, crockery etc according to international standard.
❖ Deflation:
• By adopting tight fiscal policy by decreasing Govt. expenditures and increasing taxes
income and expenditures of people will decrease. In this way, there will be a deflation
in the economy. As a result the imports will decrease and exports will increase.
❖ Packing:
• High quality packing is essential for promoting exports.
❖ Import of Only Essential Items:
• Only essential items should be imported which are needed for our industrial
production. Import of luxuries should be banned.
❖ Population Control:
• Many of our problems are arising due to fast increase in population. Sincere efforts
should be made to decrease growth rate of population.
❖ Decrease in Consumption:
• Taxes should be imposed to reduce the consumption of many items. Rich people in
our country are spending freely on unnecessary imported consumer items.
❖ Labor Intensive Industries:
• Labor intensive industries should be established, because labor is cheaper in
Pakistan, these industries can be set up at lower cost.
❖ Devaluation:
• Devaluation refers to deliberate attempt made by monetary authorities to bring
down the value of home currency against foreign currency. When a country devalues
its currency, exports becomes cheaper and imports become expensive which causes
a reduction in the BOP deficit.
❖ International Monetary Fund (I.M.F):

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