Balance of Payments Overview

Balance of Payments (BOP)

• The Balance of Payments (BOP) is a record of all economic transactions between a country and the rest of the world
• It covers a specific time period
• Transactions include trade, services, investments, and capital transfers
• The BOP is divided into three main accounts

Current Account

• Records the flow of goods, services, income, and current transfers
• It includes trade in goods (visible trade)
  • Exports and imports of physical goods (machinery, food, cars)
  • A surplus occurs when exports exceed imports
  • A deficit occurs when imports exceed exports
• Trade in Services (invisible trade):
  • Exports and imports of services (tourism, banking, insurance, shipping)
• Primary Income:
  • Income from investments abroad (dividends, interest, profits)
  • Payment of income to foreign investors
• Secondary Income (Current Transfers):
  • Transfers of money without exchange of goods or services
  • Remittances, foreign aid, and pensions

Capital and Financial Account

• Tracks the flow of funds for investment purposes and other financial transfers
• Capital Account:
  • Records one-off transactions
    • Debt forgiveness
    • Inheritance taxes
    • Transfers of ownership of fixed assets (land)
• Financial Account:
  • Tracks transactions involving financial assets and liabilities
    • Foreign Direct Investment (FDI): Purchase of physical assets in another country
    • Portfolio Investment: Investment in stocks and bonds
    • Reserves: Government holdings of foreign currencies and gold
    • Loans and Banking Flows: Borrowing and lending across borders

Errors and Omissions

• Ensures the BOP balances
• Accounts for data inaccuracies or unrecorded transactions

Key Terms

• Surplus: When inflows (credits) exceed outflows (debits)
• Deficit: When outflows (debits) exceed inflows (credits)

Causes of a Current Account Deficit

• High levels of imports
• Weak export demand
• Appreciation of currency
• Structural issues (lack of investment in productive sectors)

Consequences of a Current Account Deficit

• Depreciation of currency
• Increased borrowing (increasing external debt)
• Impact on economic growth (loss of domestic jobs in export industries)

Policies to Correct a Current Account Deficit

• Expenditure-switching policies:
  • Encourage domestic consumption
    • Tariffs, quotas, subsidies to exporters
• Expenditure-reducing policies:
  • Reduce overall spending
    • Higher taxes, reduced government spending, higher interest rates
• Supply-side policies:
  • Improve competitiveness
    • Training, education, infrastructure investment

Causes of a Current Account Surplus

• High export demand (competitive pricing or high-quality goods)
• Low import levels (protectionist measures or preference for domestic goods)
• Depreciation of currency (making exports cheaper and imports more expensive)

Consequences of a Current Account Surplus

• Appreciation of currency (making exports more expensive)
• Global imbalances (other countries may face deficits, leading to trade tensions)
• Over-reliance on exports (vulnerability to external shocks)

Importance of Balance of Payments

• Indicator of economic health (surpluses show competitiveness; deficits indicate structural issues)
• Affects exchange rates (persistent imbalances influence currency stability)
• Guides economic policy (deficits may prompt corrective measures like currency devaluation)

Example: Kenya's Balance of Payments (BOP)

• Kenya often experiences a current account deficit due to high imports and lower exports.
• To finance this deficit, Kenya relies on foreign investment, loans, and remittances.