The analysis of the country’s ‘Balance of Payment’ is essential while determining whether their currency value is appreciating or depreciating. The Balance of Payment and the Net International Investment Position of a country together form the international accounts. In this article, we will talk about the Balance of Payment:
The Balance of Payment is the difference between the inflow of money into the country for a particular time (e.g., a quarter or a year) and the outflow of funds to other countries during the same period. It is a statement of all transactions entered into by entities in one country with entities of other countries. The ‘entities’ mentioned here comprise individuals, companies and government bodies.
The Balance of Payment statement takes into consideration the payments made for imports and exports of goods (visible trading) and services (invisible trading). The statement is prepared using the domestic currency of the country.
The major components involved here are the current account and capital account.
The current account presents the net income of a country by tracking actual transactions (imports and exports). It includes the country’s:
- Net income from the transfer of goods and services
- Net earnings on foreign investments
- Net transfer payments.
By combining the above three, the current account balance is achieved. The current account forms part of the national output calculations.
The capital account presents the net change in the ownership of assets. It includes the country’s:
- Transactions in financial instruments
- Transactions in central bank reserves.
After all the components are put together, the Balance of Payment statement should sum up to zero. When the total imports of a country are more than its exports, it leads to a Balance of Payment deficit and a vice versa movement leads to a Balance of Payment surplus. However, this deficit is usually counterbalanced with the Divestment in assets, running down of foreign exchange reserves, loans from the World Bank and other countries, etc. If the current account deficit is left unchecked, it can lead to:
- Depreciation of the domestic currency against foreign currency,
- Lack of faith (from foreign companies) to transact with domestic companies,
- Lack of Foreign Direct Investment, etc.
According to the World Bank data of 2019, the top five countries with current account surplus are Germany, Japan, China, Netherlands, and Switzerland. The top five current account deficit countries are the United States, United Kingdom, Brazil, Ireland, and Canada. India had the seventh-largest current account deficit in 2019 of US$ 29.7 Billion.
Although the current account surplus is considered a positive sign for an economy, it can also be a negative indicator in certain situations. Take Japan as an example: Its current account surplus is primarily due to low domestic demand combined with its competitiveness in exports. The low domestic demand has led to stagflation in its economy with interest rates at zero or negative along with low wage growth.
- Balance of Payment is critical for formulating national and economic policy.
- Balance of Payment acts as a factor in the demand and supply analysis of the country’s currency.
- The Balance of Payment position of a country may act as an indicator while deciding the country’s potential to be a business partner (for other countries).
- The Balance of Payment data may be used to evaluate the competitiveness of a country’s domestic industries.
- The Balance of Payment data can be used to identify areas which have the potential for export-oriented growth. This further can help to adopt protective measures to curb imports of non-essential goods and services.