THE BALANCE OF PAYMENTS MUST BALANCE

Ultimately, the balance of payments must balance since every export becomes an import and every import 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.

(a) Define the term balance of payments.

(a) What is meant by a country’s balance of trade?

(b) Calculate the BALANCE OF TRADE for the country

shown below:

Visible trade US ($ M)
Exports 26,000
Imports 29,000
Invisible (net)
Exports 20,000
Imports 15,000

(d) Name TWO items that are regarded as invisibles.

(e) Calculate the current account balance.

THE OFFICIAL FINANCING ACCOUNT

This account shows how the balance of payments is financed; that is, 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 like 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
  • Importing on credit. Permission must be granted from the exporting country.

What if the balance of payments showed a surplus? This surplus could be financed or used in the following ways.

FINANCING A BALANCE OF PAYMENTS SURPLUS

  • lend money, for example 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$1,500m.

THE OFFICIAL FINANCING ACCOUNT

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

Now we have balanced the balance of payments by eliminating the deficit of US $1,500m.

What 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: 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

Reducing imports by:

  • increasing tariffs (duties) on imported goods and services
  • setting quotas to limit the physical amount imported
  • requiring special licences to import
  • devaluation, which makes imports dearer
  • foreign-exchange controls, which limit the amount of foreign currency available to individuals

The questions below will test how much you have grasped of this lessons.

(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$ + 300m, 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

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