What is balance of payments and factors affecting balance of payments?

Answer 1

Balance of payment:The balance of payments (BOP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

FACTORSAFFECTING BALANCE OF PAYMENTS

Export of Goods and Services

The Prevailing Exchange Rate of the Domestic Currency:

A lower value of the domestic currency results in the domestic price getting translated into a lower international price. This increases the demand for domestic goods and services and hence their export. This is likely to result in a higher demand for the domestic currency. A higher exchange rate would have an exactly opposite effect.

Inflation Rate:

The inflation rate in an economy vis-à-vis other economies affects the international competitiveness of the domestic goods and hence their demand. Higher the inflation, lower the competitiveness and lower the demand for domestic goods. Yet, a lower demand for domestic goods and services need not necessarily mean a lower demand for the domestic currency. If the demand for domestic goods is relatively inelastic, then the fall in demand may not offset the rise in price completely, resulting in an increase in the value of exports. This would end up increasing the demand for the local currency. For example, suppose India exports 100 quintals of wheat to the US at a price of Rs.500 per quintal. Further, assume that due to domestic inflation, the price increases to Rs.530 per quintal and there is a resultant fall in the quantity demanded to 96 quintals. The exports would increase fromRs.50,000 to Rs.52,800 instead of falling.

World Prices of a Commodity

: If the price of a commodity increases in the world market, the value of exports for that particular product shows a corresponding increase. This would result in an increase in the demand for the domestic currency. A fall in the demand for domestic currency would be experienced in case of a reduction in the international price of a commodity. This impact is different from the previous one. The previous example considered an increase in the domestic prices of all goods produced in an economy simultaneously, while this one considers a change in the international price of a single commodity due to some exogenous reasons.

Incomes of Foreigners:

There is a positive correlation between the incomes of there sidents of an economy to which the domestic goods are exported, and exports. Hence, other things remaining the same, an increase in the standard of living (and hence, an increase in the incomes of the residents) of such an economy will result in an increase in the exports of the domestic economy Once again, this would increase the demand for the local currency.

Trade Barriers:

Higher the trade barriers erected by other economies against the exports from a country, lower will be the demand for its exports a hence, for its currency.

Imports of Goods and Services

Imports of goods and services are affected by the same factors that affect the exports. While some factors have the same effect on imports as on exports, so of them have an exactly opposite effect.

Value of the Domestic Currency:

An appreciation of the domestic currency results in making imported goods and services cheaper in terms of domestic currency, hence increasing their demand. The increased demand imports results in an increased supply of the domestic currency depreciation of the domestic currency have an opposite effect.

Level of Domestic Income

: An increase in the level of domestic income increases the demand for all goods and services, including imports and it results in an increased supply of the domestic currency.

International Prices:

The International demand and supply positions deter the international price of a commodity. A higher international price would translate into a higher domestic price. If the demand for imported goods is inelastic, this would result in a higher domestic currency value of in increasing the supply of the domestic currency. In case of the demand elastic, the effect on the supply of the domestic currency would depend the effect on the domestic currency value of imports.

Inflation Rate:

A domestic inflation rate that is higher than the inflation of other economies, would result in imported goods and services bee relatively cheaper than domestically produced goods and services would increase the demand for the former, and hence, the supply domestic currency.

Trade Barriers:

Trade barriers have the same effect on imports exports - higher the barriers, lower the imports, and hence, lower the supply of the domestic currency.

Income on Investments

Both payments and receipts on account of interest, dividends, profits etc., depend on the level of past investments and the current rates of return that can be earned in an economy. For payments, it is the level of past foreign investments and the current domestic rates of return; while for the receipts it is the past domestic investments in foreign economies and the current foreign rates of return, which are relevant.

Transfer Payments

Transfer payments are broadly affected by two factors. One is the number of migrants to or from a country, who may receive money from or send money to relatives. The second is the desire of a country to generate goodwill by granting aids to other countries along with the economic capability to do so, or its need to take aids and grants from other countries to tide over difficulties.

Capital Account Transactions

Four major factors affect international capital transactions. The foremost is the rate of return which can be earned on the investments as compared to the returns that can be earned on domestic investments. The higher the differential returns offered by a country, the higher will be the capital inflows. Another factor is the additional risk thataccompanies these returns. More the risk, lower the capital inflows. Diversification across countries may offer some extra benefit in addition to the returns offered by a particular investment. This benefit arises from the fact that different economies may be at different stages of economic cycle at a given time, thus making their performance unrelated. Higher the diversification benefits, higher the inflows. One more factor, which has a very significant affect on these transactions, is the expected movement in the exchange rates. If the exchange rates are quite stable, or the movement is expected to be in the investors' favor, the capital inflows will be higher