Balance Of Payments

Sarah Shaikh

What is the Balance of Payments?

The balance of payments (BOP) records all of the many financial transactions that are made between consumers, businesses and the government in the UK with people across the rest of the World. The BOP figures tell us about how much is being spent by British consumers and firms on imported goods and services, and how successful UK firms have been in exporting to other countries and markets.

The Current Account

The balance of the current account tells us if a country has a deficit or a surplus Goods - These are movable and physical in nature, a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out). Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production. Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' payments, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production.

UK Exports and Imports

UKs Import and Export Indicators and Statistics at a Glance (2010) Total value of exports: US$405.6 billion Primary exports - commodities:manufactured goods, fuels, chemicals; food, beverages, tobacco Primary exports partners: US (14.71 percent), Germany (11.06 percent), France (8 percent), Netherlands (7.79 percent), Ireland (6.89 percent), Belgium (4.65 percent), Spain (4 percent) Total value of imports: US$546.5 billion Primary imports - commodities: manufactured goods, machinery, fuels; foodstuffs Primary imports partners: Germany (12.87 percent), US (9.74 percent), China (8.88 percent), Netherlands (6.94 percent), France (6.64 percent), Belgium (4.86 percent), Norway (4.84 percent), Ireland (4.01 percent), Italy (3.99 percent)

The UKs propensity to import

The UK has high porpensity to import - This means that as income rises the amount UK consumers import from other countries increase - A result of a period of sustained economic growth and strong consumer demand for goods and services our manufacturing sector is not large enough to meet all of the demand for consumer goods and durables, so we must import to satisfy this excess demand

Effects of BoP- deficit

Partial auto-correction: If some of the deficit is due to strong consumer demand, the deficit will partially-self correct when the economic cycle turns and there is a slowdown in spending Investment and the supply-side: deficit may be due to increased imports of new capital and technology which will have a beneficial effect on productivity and competitiveness of producers in home and overseas markets Capital inflows balance the books: Providing a country has a stable economy and credible economic policies, it should be possible for the current account deficit to be financed by inflows of capital without the need for a sharp jump in interest rates. Structural weaknesses: The trade / current account deficit may be a symptom of a wider structural economic problem i.e. a loss of competitiveness in overseas markets, insufficient investment in new capital or a shift in comparative advantage towards other countries. An unbalanced economy too much consumption: the consequences of a high level of consumer demand contrasted with a weaker industrial sector.. Consumers cannot carry on spending beyond their means for the danger is that rising demand for imports will be accompanied by a surge in household debt. Potential loss of output and employment: A widening trade deficit may result in lost output and employment because it represents a net leakage from the circular flow of income and spending. Workers who lose their jobs in export industries, or whose jobs are lost because of a rise in import penetration, may find it difficult to find new employment. Potential problems in financing a current account deficit: Countries cannot always rely on inflows of financial capital into an economy to finance a current account deficit. Foreign investors may eventually take fright, lose confidence and take their money out. Or, they may require higher interest rates to persuade them to keep investing in an economy. Higher interest rates then have the effect of depressing domestic consumption and investment. Downward pressure on the exchange rate: A large deficit in trade in goods and services represents an excess supply of the currency in the foreign exchange market and can lead to a sharp fall in the exchange rate. This would then threaten an increase in imported inflation and might also cause a rise in interest rates from the central bank. A declining currency would help stimulate exports but the rise in inflation and interest rates would have a negative effect on demand, output and employment.

How does a change in exchange rate affect the BoP?

Changes in the exchange rate can have a big effect on the balance of payments When sterling is strong then UK exporters found it harder to sell their products overseas and it is cheaper for UK consumers to buy imported goods and services because the pound buys more foreign currency than it did before.

BoP and the aggregate demand curve