The Balance of Payments

1. The Balance of Payments Definition and structure

2. Balance of payments • overall view of transactions with the rest of the world. • Made up of three separate accounts • Current Account • Capital Account • Financial Account

5. Balance of Payments – Current Account • It is a record of all money flows from international transactions between the Kz and the rest of the world • Trade in Goods • Trade in Services • Investment Income • Capital Transfers

6. Trade in Goods (visibles) • Consumer Durables • Capital Goods • Commodities • Components • Foodstuffs and Beverages

7. Services (invisibles) • Tourism • Financial Services • Insurance • Music and entertainment • Banking

8. Financial Account: Investment Income • Investment in companies overseas, • And their investment in us • FDI Foreign Direct Investment. • Other investments e.g. Loans to banks.

9. Capital Transfers • Transfer of money between individuals • Kazakhs working overseas • Grants to overseas countries • Contributions to International organisations e.g. IMF, World Bank and WTO.

10. Capital Account • Acquisition or disposal of Non produced or non financial assets. • Capital transfer credits • Donation from Canada to Tanzania for schools • Dr from Canada Cr to Tanzania • Capital transfer debits • UK to finance an Airport St. Helena.

11. Debt forgiveness • If Rwanda relieved of its debts = Cr in Rwanda’s capital account. • If a bank in Switzerland , which made a loan to government of Sierra Leone waived that debt = Dr in Switzerland’s Capital Account.

12. Foreign Exchange Reserves • If there is a deficit in the Balance of Payments the government will draw on reserves to rectify the deficit and support the exchange rate.

13. Current Account

17. UK Deficit Narrows of which: EU  £3.2    non-EU  -£10.9

18. Trade in Goods Deficit Widens

26. Consequences for Japan Balance of Payments Surplus • Positive Current Account balance. • Country has a high demand for exports • High demand for local currency • Leads to appreciation of currency value • Makes M cheaper

27. Consequences for USA of a Balance of Payments Deficit • Negative Current Account Balance • Means that another part of the account must be in surplus to create a balance of money. • The magnitude of the deficit is important, measured as a % of GDP

28. How to fix a large Current Account Deficit • Encouraging people to buy locally produced products. • Devalue currency • Reduce AD.

29. Demand & Supply side causes of deficit • Short-term factors eg Strong consumer demand – • Leads to a very high level of demand for imported goods and services • UK consumers have a high income elasticity of demand for overseas-produced goods

30. Demand & Supply side causes of deficit • The strong sterling exchange rate in the past has helped to reduce the UK price of imports causing expenditure-switching effect • weakness of the global economy and in particular the very slow growth in the Euro Zone has damaged UK export growth.

31. causes of deficit in UK • 55% of all UK X go to EU • shifts in comparative advantage (China) • The availability of cheaper M inevitably causes a substitution effect from British consumers

32. Causes of deficit • Weak product innovation and R & D • The UK manufacturing sector has been in long-term decline for more than twenty years. • Lack of productivity, inflexible labour market

33. Implications of a deficit • There is a net outflow of demand and income from the circular flow of income and spending. • The currentaccount need not balance as long as the financial account is in surplus – need to attract investment, savings etc • The UK has run large currentaccount deficits in with barely any effect on the overall economy. • Small chance of speculative selling of sterling on the foreign exchange markets

34. Implications of a deficit • If the deficit is due to very strong consumer demand, it automatically self corrects when the economic cycle turns • increased imports of new capital & technology which improves productivity in LR could cause deficit – not a problem • A widening trade deficit may result in lost output & employment because it represents a net leakage.

35. Implications of a deficit • Foreign investors may eventually take fright, lose confidence and take their money out. • Deficit represents an S>D of the currency in the foreign exchange market • can lead to a  Price therefore exchange rate

37. WILL A DEPRECIATION OF THE CURRENCY LEAD TO THE ELIMINATION OF A BALANCE OF TRADE DEFICIT? Surplus on the current account Time Deficit on the current account Net improvement Point when currency depreciates

39. terms of trade • = the rate of exchange of one good or service for another when two countries trade with each other. 

40. Terms of Trade Index • ToT = 100 x Average export price index / Average import price index • If export prices  faster than M prices, . •  D X  and D M  • If import prices   faster than export prices, the terms of trade have deteriorated

41. Plenary • On your boards write two important things you have learned about the Balance of Payments.