Balance of Payments Account - Essay Example

Balance of Payments Account and of the Introduction A majority of countries have made concerted efforts of reporting transactions that happen between the residents of the home country and that of the foreigners; the recording of various economic transactions are normally executed within a predetermined period. The methodical recording of various economic transactions between the home country and other foreign countries is defined as the balance of payments accounting. The balance of payments accounting is normally recorded on the balance of payments account. The balance of payments account is amongst the important financial statements of a country since it reveals the true economic situation of a given nation. The balance of payments account also reflects whether a country is a debtor or creditor. Additionally, it indicates whether the currency of the home country is gaining strength or weakening in relation to other foreign currencies (Yan, 2007). In particular, the balance of payments account is an account that records various international flows of goods and services, as well as money. The exchange is normally recorded as either a negative or positive value. Various types of exports are usually assigned positive values; aspects that are assigned a positive value in the balance of payments account include the exports of financial assets, currency, products and services. On the other hand, imports are normally assigned negative values. Aspects of the balance of payments account that are assigned negative values include the imports of financial assets, currency, goods and services. Generally, the balance of payments account typically distinguishes between financial assets and products. In this regard, products refer to goods and services that are either imported or exported outside a country. Conversely, the financial assets imply the money that is ether imported or exported outside a country. The Components of the Balance of the Payments Account Current account The current account is normally divided into two parts: these consist of invisible imports and exports, and Merchandise imports and exports. Merchandise Imports and Exports Merchandise exports refer to the goods that are sold outside a country; the selling of goods to a foreign country leads to the creation of a credit entry on the balance of payments account. This is because the transaction arising from the merchandise exports normally leads to monetary claims among the foreign residents and governments (Sinn and Wollmershäuser, 2012). Conversely, the transactions involving the purchase of goods from a foreign nation are treated as a debit entry on the balance of payments account. This is because the purchase of goods from abroad normally leads monetary claims by foreigners on the home nation. Among a large number of countries in the world, merchandise exports and imports are considered to form the fundamental international transactions (Debelle and Galati, 2007, p.991). Invisible Imports and Exports The invisible export refers to the sale of services to other foreign countries. On the other hand, the purchase of services from other countries is considered as an invisible import. The sale of various types of services is recorded as credit entries on the balance of payments accounts. Conversely, the purchase of services from abroad are normally treated as debit entries on the balance of payments account (Vandevyvere, 2012). There are a number of services that a country normally sells to foreigners. Among them include, insurance, medical services, transport and accommodation services (Financial account, 2008). The sale of these services forms the fundamental component of invisible exports. The spending of money by foreign tourists abroad, as well as the income paid on debts and other investments in the home nation, is normally treated as an invisible import; it is traditionally entered on the balance of payments account as a debit entry (White, 2011). The service sector has been growing immensely in the 21st century; however, the growth of the service sector began in the late 20th century (Financial account, 2010). This denotes that the service sector plays a major role in the current account. Growth in the service sector have been realized in diverse areas including tourism, the computers’ software, concert performers, technical guidance, as well as the financial services (Pettis, 2013). For instance, Boeing, an aircraft company, has been involved in sending its training professionals to different parts of the world with an aim of providing training to individuals of diverse nationalities. Similarly, the sale of the computer software has been on the rise in the last two decades. Among the software that are purchased include, anti-virus software, windows and Microsoft office. Capital Account The capital account is usually associated with various capital transactions relating to short-term and long-term perspectives. A debit entry is always is represented by a capital outflow: conversely, a credit entry is always represented by a capital inflow. For example, if an Australian company invests one billion sterling pounds in the UK, the transaction would be represented as a credit on the balance of payments accounts of the UK and a debit on the Australian’s balance of payments account. Sinn (2012) claims that the dividends or interests received with respect to various investments are recorded on the current account. The dividends that are received by the home country residents as a result of investing abroad are typically recorded as a credit entry; interest received on extension of loans to foreigners are also treated as credit entries. In contrast, the interests that are paid to foreigners are entered on the balance of payments account of the home country as a debit entry; similarly, the dividends that are paid to foreigners as a result of investing in the home country’s assets are treated as debit entries (Financial account, 2010). The interests and dividends are never recorded as a debit or credit entry on the capital account because they represent services paid as far as various types of investments are concerned. The Unilateral Transfers Account The unilateral transfers refer to: the remittances made by the private sectors; grants extended by governments; and, the calamity relief among others. The unilateral transfers represent all transactions that are done without seeking compensation of any manner with respect to the payments made or products provided (Yan, 2003, p.297). On the balance of payments account, payments that are made to foreign countries are treated as debit entries, while the payments that are received from abroad are treated as credit entries. For instance, the donations made by the citizens of the US in saving Africans that were facing famine are private transfers. On the other hand, the extension of a grant to save the lives of Africans that was suffering or susceptible to experiencing malaria by the former US’ President, George Bush, is a form of a government grant. The Official Settlement Accounts: The holdings by a government or official agency of the means of compensation that are usually acknowledged for the payment of international claims are represented by official reserves (Atoyan and Manning, 2013). Does The Balance Of Payments Account Balance? The balance of payments account always balance (Catalán and Magud, 2012). The reason behind the balancing of the balance of payments account is due to the fact that the goods and services, which are traded at the international market, normally experience a monetary compensation. This implies that the movement of goods and services are always offset by an equal movement of money. For instance, if a Canadian businessperson imports Chinese computers worth $100,000 there would be a balancing movement of money to the Chinese manufacturer. It is accepted among the economists, financiers, accountants, governments and business practitioners that a deficit in the current account would always be offset by a surplus in the capital account (Nelson, 2011). This denotes that if the UK businessperson imports vehicles from a German manufacturer, the United Kingdom importer should export financial assets to the German exporter. Similarly, a surplus in the current account should be offset by a surplus in the capital account. For instance, if an individual exports certain goods or services, it would mean that the financial assets of the foreign purchaser are being imported (Regional Economic Outlook, 2013). Despite the fact that the balance of payments account is always balanced, there have been major attentions being paid to the deficit of current accounts. The deficit of the current account has specifically received criticisms from the public (Lane and Pels, 2012). However, it is established that a large number of the citizens are not aware of the fact that the current account deficit is always accompanied by the capital account surplus. In any circumstance, if all the transactions between the home country and foreign residents are taken into consideration, there would be no reason as to why a balance of payments account should not balance. This explains the reason why the importation of foreign products would always result in the exportation of the home country currency. This denotes that a given trade of goods and services is always accompanied by the transfer of financial assets. Since the ancient times, individuals and corporate firms that have been engaging in the trading of goods and services are always paid in foreign country’s currency or currency-dominated assets, including office buildings and treasury bills (Black, 2011). However, even though the total receipts and payments essentially balance, there would be inequalities. These comprise of an excess of a receipt or payment; this is normally referred to as a deficit or surplus in a given type of transaction. This denotes that there can be a surplus or deficit in the following trades: the goods trade, income on foreign investment, the service trade, unilateral transfers, the movement of currency and money between treasuries and central banks of various countries, as well as the private investment. Conclusively, when a country experiences a surplus or deficit with respect to its balance of payments account, a reference should be made to a specific type of transaction (Lee and Wang, 2012). Nevertheless, in contrast to the general believe, the existence of the deficit of a current account does imply a weak economic policies or bad economic situation of a country. For instance, if the UK is experiencing deficits in its current account, it may imply that the UK is importing capital. In the modern world, importing a commodity such as tea is not lesser risky than importing capital. In addition, Lanau and Wieladek (2012) provide that the existence of deficit may occur as a result of response to a certain condition in an economy. For instance, a deficit may occur as a response to increased levels of inflation, reduced levels of productivity, as well as decreased levels of savings. For instance, there must be an expectation of a deficit of the UK current account if the UK investments are deemed to be safe and lucrative. However, according to Hallett and Oliva (2013), it is not always the case that a situation which a deficit responds to is not always good. In a number of circumstances, countries report bad deficit responses. Whether an economy experiences a good or bad condition response may be due to bad or good policies. Actual scenarios regarding the deficit of the current accounts in the world have been experienced; these deficits elicited diverse reactions among scholars, business people and the entire public. For instance, in the US, the current account, which realized a surplus of five billion dollars in 1981, experienced a deficit of one-hundred and sixty-one billion dollars in 1987. A majority of the US citizens claimed that the high levels of deficit had resulted in significant losses of jobs: however, this was untrue. Statistics indicated that the period between 1981 and 1987 the employment increased by 2.5%; the employment stood at 62.5% in 1981 as opposed to 60% in 1987 (Mcgrattan and Prescott, 2010, pp.1493-1522). The 2.5% increase was a representation of about twelve million new employees. Although there were fears among the US’ officials and citizens regarding the capital inflow to the US as a result of the current account deficit, records indicated that the ownership of assets by the Americans was not reduced by the increased foreign capital inflow. The effect of the increasing foreign capital inflow led to the increased levels of capital in the US. Later, in 1988, there were concerns about the capital inflow reducing or stopping. There were also fears with respect to its corresponding effects to the economy. After 1988, the capital inflow began to reduce gradually; however, the current account adjusted by experiencing decreases with respect to the deficits (Mcgrattan and Prescott, 2010, pp.1493-1522). What Should be Done to Bring the Account into Balance If the Account Is in Disequilibrium Given that the balance of payments account would always face disequilibrium as explained above, there need to be various measures and methods of correcting the inequality. According to Chang and Tsai (2006), a nation that experiences periodically instances of deficits in its balance of payments account can realize economical progress by establishing and implementing various measures of correcting the disequilibrium of an account. Firstly, a nation can consider restricting imports. The restriction of imports can be carried out by executing various import quotas; the restriction can also be realized by barring the importation of dispensable goods and services. Although this method is considered practical in various economies, this measure can bar a country from receiving fundamental foreign commodities. It may also lead to problems of raw materials supply which are fundamental for the production of various products in diverse industries (Darku, 2010, 2608). Secondly, a country can opt to establish measures that would encourage exports. This can be made successful by establishing industries that are associated with products and services of exportation. A government can stimulate the exportation sector by providing monetary and non-monetary support to participating individuals and firms. The increase of exports has the ability to correct the deficit given that there would be an increased level in the earnings of foreign exchange (Kang and Shambaugh, 2013). A nation that is experiencing the balance of payments account deficit may opt to borrow from foreign countries. A nation can borrow from friendly governments or international financial institutions. The international financial institutions include the International Monetary Fund, and the World Bank. However, this measure is not considered to be sustainable in the long term; the strategy is used as a short-term measure (Bulut, 2013, p.698). A nation that is seeking to provide solution to its long-term problems of balance of payments disequilibrium should consider other measures. Alternatively, a nation may receive outright gifts from rich counties. For instance, the Afghanistan received outright aid from various western countries following the war between the terrorist group and the US which left a number of individuals homeless and starving. A number of countries that are underdeveloped also receive outright aid from economic able countries. Although this method is characterized by lesser problems relating to reimbursement, this method is not considered appropriate given the small quantities of aid. In addition, outright aids by various able governments are characterized by uncertainty, hence unreliable. Finally, but by no chance the least, a nation may resolve to devalue its currency. The devaluation of a currency helps to encourage exports. The devaluation of a currency results in the low prices of a country’s exports in relations to that of other countries. However, this measure is deemed to be unsustainable in certain circumstances. Bank (2013) argues that a different country may resolve to devalue its currency to experience high levels of exports. If this happens, devaluation may not be very significant in correcting the disequilibrium that occurs in various class of the balance of payments transactions. Conclusion The balance of payments accounts are important in determining the economic position of a country. The balance of payments account also details the transactions that are experienced between one country and others. Majorly, a balance of payments account enables a government to understand whether a nation is a creditor or debtor. However, it should be noticed that the balance of payments account would always balance. This means that the deficit of the current account would automatically be offset by a surplus of a capital account. On the other hand, a deficit on a capital account would always be offset by surplus in the current account. As a result, there are no circumstances where a country would experience unbalancing of its balance of payments account (Bush, 2013). Although the balance of payments account balances, the specific class of transactions with respect to the balance of payments account would frequently face inequalities. These inequalities can be paid attention to and various ways of correcting the disequilibrium can be devised. For instance, deficits in the merchandise goods can be corrected by devaluing the currency of a country. Other measures such as stimulating the exports via financial and non-monetary support can be implemented. Although these measures are believed to be important, inequalities with respect to current or capital account and its associated components does not always imply that economy is weak (Kim and Kim, 2011). For instance, current account deficit may mean that there were responses triggered such increased capital inflows. In the present world, the financial assets and goods and services are all deemed to be characterized by similar features of risk and benefits. This explains the reason why countries with huge current account deficits experience positive growth in various sectors, including employment. List of references Atoyan, R. and Manning, J., 2013. Rebalancing evidence from current account adjustment in Europe. Washington, D.C.: International Monetary Fund. Bank, W., 2013. Africa Development Indicators 2012. New York: Taylor and Francis. Black, A., 2011. Good Small Business Guide 2012 How to start and grow your own business.. London: A & C Black. Bulut, L., 2013. Current account dynamics and degree of capital mobility. Applied Economics Letters, 20(7), pp.697-701. Bush, G., 2013. Indonesia staff report for the 2013 Article IV consultation. Washington, D.C.: International Monetary Fund. Catalán, M. and Magud, N., 2012. A tradeoff between the output and current account effects of pension reform. Washington, D.C.: International Monetary Fund. Chang, W. and Tsai, H., 2006. Devaluation, Capital Formation, and the Current Account. Open Economies Review, 17(3), pp.341-357. Darku, A., 2010. Consumption smoothing, capital controls and the current account in Ghana. Applied Economics, 42(20), pp.2601-2616. Debelle, G. and Galati, G., 2007. Current Account Adjustment and Capital Flows. Review of International Economics, 15(5), pp.989-1013. Financial account, 2008. 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Lane, P. and Pels, 2012. Current account imbalances in Europe. London: Centre for Economic Policy Research. Lee, Y. and Wang, K., 2012. Capital Mobility and Current Account Imbalance: Nonlinear Threshold Vector Autoregression Approach. International Interactions, 38(2), pp.182- 217. Mcgrattan, E. and Prescott, E., 2010. Technology Capital and the US Current Account. American Economic Review, 100(4), pp.1493-1522. Nelson, S., 2011. Quicken 2012 For Dummies. Hoboken: John Wiley & Sons. Pettis, M., 2013. The Great Rebalancing Trade, Conflict, and the Perilous Road Ahead for the World Economy. Princeton: Princeton University Press. Regional Economic Outlook, October 2013. (2013). Washington: International Monetary Fund. Sinn, H., 2012. The European balance of payments crisis. Hoboken: Palgrave Macmillan. Sinn, H. and Wollmershäuser, T., 2012. Target balances and the German financial account in light of the European balance-of-payments crisis. Munich: CESifo. Vandevyvere, W., 2012. The Dutch current account balance and net international investment position. New York: Taylor and Francis. White, A., 2011. Financial account. United Kingdom Balance of Payments: The Pink Book, 2011(1), pp.65-78. Yan, H., 2003. Capital mobility, inter-temporal current account balance and currency crisis. Global Business and Economics Review, 5(2), p.297. Yan, H., 2007. Does capital mobility finance or cause a current account imbalance? The Quarterly Review of Economics and Finance, 47(1), pp.1-25. Read More