Balance of Payments (Economics CIE A Level) Cheat Sheet

Definition
It records all economic transa­ctions which take place internally and extern­ally; it shows the inflows and outflows of money.
Inflows = CR
Outflows = DR

Components (mainly)
- Current Account
- Capital Account
- Financial Account

Defn: Value of credit entries > value of debit entries

Causes:
- Higher demand of local products in foreign markets
- Greater share of export markets
- Produc­tivity gains and greater trade compet­iti­veness
- Develop import substi­tution industries - reduce expend­iture on imports - weak currency policy - J curve effect
- Inflows of remitt­ances from migrant workers

Conseq­uences:
- Can lead to BOP disequ­ili­brium
- Risk of retali­ation from trading partners eg. USA v/s China
- Increase foreign currency reserve
- Repay external debt
- Shows good economic perfor­mance - attracts multin­ati­onals

It records transa­ctions pertaining to the transfer of ownership, acquis­ition and disposal of assets.
For example, if a government obtains a capital for constr­uction of a college, it is recorded as an inflow of capital (CR)

It records invest­ments made overseas by the residents of a country (domestic ownership of foreign assets) and those carried out by foreigners in the country (foreign ownership of domestic assets)

It refers to the borrowing and reserves of a country. Govern­ments borrow from financial instit­utions and existing reserves. The surplus arising from these is used for payment of external debts.

It is simply a balancing item. The recording of transa­ctions in a BOP is a very complex exercise and therefore, author­ities need to cater for errors and omission that occur under this heading.

It records the flow of goods and services in and out of a country.
Export = inflow = CR entry
Import = outflow = DR entry

The Current Account Balance is obtained from summation of Trade in Goods, Trade in Services, Primary income and Secondary income.

1. Expend­iture Reducing Policy/ Expend­iture Dampening Policy
- Policies implem­ented to reduce expend­iture on imports.
- eg. increase in interest rates, increase in direct taxes.
- However it conflicts with macroe­conomic objective of economic growth and full employ­ment.

2. Expend­iture Switching Policy (ESP)
- Policies to switch consum­ption from imported products to locally produced.
- eg. tariffs, devalu­ation.
- However there is a time lag and prevents economy from benefits of free trade.

3. Weak Current Policy (ESP)
- Makes exports cheaper and imports more expensive
- However if ped of exports is inelastic, economy receives less export revenue

4. Devalu­ation (ESP)
- J curve effect - devalu­ation will worsen current a/c deficit position before it improves at a later stage.
- Marshall Lerner condition: devalu­ation will lead to an improv­ement in the current account as long as the combined peds of exports and imports are greater than one in the long run.
- However it takes time and expend­iture on imports can increase as ped of imports tend to be inelastic in the short run

1. Trade In Goods
It includes the import and export of tangible items. The difference between the two is the Balance of Trade - either Balance of Trade deficit or surplus. Eg an Indian firm paying a Canadian firm for supplying raw materials will be recorded as a DR entry in India and CR entry in Canada.

2. Trade In Services
It includes the export and import of intangible items such as education, accoun­tancy, health services. The difference between the two is the Balance of Invisible Trade. Eg a Canadian firm paying an Indian firm for accoun­tancy services will be recorded as a DR entry in Canada and a CR entry in India.

3. Primary Income
It covers income earned by indivi­duals and firms.

4. Secondary Income
Previously called Current Transfers,

Defn: Value of credit entries < value of debit entries

Causes:
- Fall in export prices - caused by more suppliers leading to greater compet­ition
- Fall in export market share - volume of export decreases eg. trade libera­liz­ation
- Rise in volume and value of imports leading to outflows in current a/c - due to indust­ria­liz­ation and infras­tru­ctural develo­pment importing lots of machinery and know-how - economic growth - rise in GDP per head - rise in marginal propensity to import
- High rate of inflation - price of local products increase - rise in cost of production - decline in export compet­iti­veness of export led industries - consumers demand more imported goods as they are cheaper - decline in export revenue
- Currency apprec­aition

Conseq­uences:
- BOP disequ­ili­brium
- External debt
- Protec­tionist measures - risk of retali­ation - decline in trade flows
- Bad economic perfor­mance
- Currency deprec­iation

In 2021, according to UNCTAD,
- China had the highest current account surplus at US$317B
- USA had the highest current account deficit at -US$822B .