CHAPTER

7
BALANCE OF PAYMENTS
 LEARNING OUTCOMES

 Define Balance of payment

 Calculate balance of payment (BOP), and
discuss the structure of the BOP as well as the
effects and measures to reduce BOP deficit.

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 BALANCE OF PAYMENTS

DEFINITION :

 Balance of payments is the national accounts of a country.

 It measures all financial transactions, flow of currencies into and
out of the economy within a particular period, usually a year.

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 BALANCE OF PAYMENTS (cont.)

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 BALANCE OF PAYMENTS (cont.)

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 BALANCE OF PAYMENTS (cont.)

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 BALANCE OF PAYMENTS (cont.)

Errors and Omissions

Use as a balancing item to bring the final balance of
payments account to zero.
Official Financing Account/Reserve Assets
Shows the balance of monetary movements into and out of
a country.

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 BALANCE OF PAYMENTS (cont.)

Basic Calculation of BOP

(1)Merchandise Trade Balance = Merchandise Export – Merchandise
Import
(2)Service Balance = Service Export – Service Import
(3)Balance in Current Account = Merchandise Trade Balance +
Service Balance + Net Income + Current Transfer
(4)Balance on Capital Account = Capital Account + Financial Account
(5)Overall Balance = Balance in Current Account + Balance in Capital
Account + Errors and Omissions
(6)Reserve Assets = –(Overall Balance)
(7)Basic Balance = Balance in Current Account + Long-term Capital
Account

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 Economic Effects of a
BOP
• A Trade deficit in BOP means inflow of currency
into the nation is less than the outflow of currency
to other nations
• The country is burdened with a foreign debt. It is
unfavourable condition.
• The reasons are :
i. Imports is greater than exports
ii. The country is unable to attract foreign
investments.
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 Economic Effects of a
BOP

• A Trade surplus in BOP means inflow of currency

into the nation is greater than the outflow of
currency to other nations
• The is more favourable condition in the short run.
• However a prolonged surplus for a country means a
deficit for another nation as the country having
deficit may retaliate by imposing protectionism.

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 Disequilibrium in BOP
(Deficit)
 Measures to correct :
1. Export promotion
2. Discourage imports
3. Control inflation
4. Use government reserves
5. Devaluation

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 MEASURES TO REDUCE BOP
DEFICIT
 Export promotion - The government can
encourage exports by giving subsidies or
granting tax holidays or abolishing export duties
for local exporters.

 Discourage imports - This can be achieved by

imposing high tariff rates or quotas for imported
products. Thus their imports prices will increase
and the quantity demanded will decrease.

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 Inflation - The government should control
the problem of inflation by tight monetary or
fiscal policy, in order to reduce money
supply in the economy. Thus, this will
reduce the pressure of inflation.
 Using the government’s reserves - The
government’s reserves are in the form of
gold and foreign currencies. However this
measure can only be used in a short period
only as the reserves will deplete if it is been
using in a long run.
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