We know that the exports and imports of a country are influenced by a number of factors. The financial account describes the change in international ownership of assets. Receipts of such loans and repayment of loans by foreigners are recorded on the positive credit side. Your expected higher future salary is worth the investment. Our tutors are highly qualified and hold advanced degrees. In the short-run, the country may benefit from a higher level of consumption through import of goods and consequently a higher standard of living. According to Bo Sodersten, The balance of payments is merely a way of listing receipts and payments in international transactions for a country.
Or these are the items against which no quid pro quo is demanded. Persistent imbalances indicate that the balance of payments is in fundamental disequilibrium. Deficit in capital account arises when debit items are more than credit items. In the equation, Prefers to national income, C to consumption expenditure, I to investment expenditure, G to government expenditure, X to exports of goods and services and M to imports of goods and services. It must be remembered in this respect that the rate of exchange serves as an equilibrating factor between the balance of payments positions.
It must encourage its residents to spend more. A deficit occurs when a country's government, businesses, and individuals export fewer goods and services than they import. It means that the price of dollar falls in relation to the pound in the foreign exchange market. The first is earned on foreign assets owned by a nation's residents and businesses. The balance of payments is quite disturbed by the factors which affect and change imports and exports continuously. So, it does not have direct effect on income, output and employment of the country.
So, through official financing, the account as a whole is brought into exact balance Fig. Asset Income: This is composed of increases or decreases in assets like bank deposits, central bank and government reserves, securities, and real estate. Balance on Capital Account : The transactions, which lead to inflow of foreign exchange like receipt of loan from abroad, sale of assets or shares in foreign countries, etc. Capital Account is used to: i Finance deficit in current account; or ii Absorb surplus of current account. If a country exports an item a current account credit , it effectively imports foreign capital when that item is paid for a capital account debit. Suppose the dollar depreciates in relation to the pound. As a result, the country imports more and exports less of goods.
Similarly, imports must be discouraged by: i Imposing import duty, ii Prohibiting the product totally or iii Adopting quota system, iv Manufacturing the equivalent product within the country etc. Thus the balance of payments always balances in the accounting sense, according to the basic principle of accounting. Items 2 a and 2 b comprise services balance or balance of invisible trade. In the same way, if India invests in a foreign country, it is a payment and will be recorded on the debit side. Merchandise exports are presented as the plus item and are computed free on board which means that cost of transportation, insurance etc. Public investment, on the other hand, consists of low interest loans to underdeveloped nations i.
Capital Account: The second major account in the balance of payment accounting system is the capital account, which records capital transactions- purchases and sales of assets-between residents of one country and those of other countries. All these create a substantial deficit. The best way to do that is lower the. It means there will be a fall in foreign exchange reserves maintained by a nation and the country can no longer able to attract sufficient capital flows to finance the current account deficit. It will be balanced only when the total of credit items will exactly be equal to the total of debit items which really happens. Capital account shows the net change in ownership of foreign assets and transactions in Marketable Securities Marketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. Thus, if we find any trade deficit, it does not mean that the country is losing its reserves foreign exchange etc.
It is only when all items in the balance of payments are included that there is no possibility of a deficit or surplus. The relationship between these balances is summarised in Table 2 below. Investments to and from abroad: It includes: A. So, it shows the net income generated in the foreign sector. But it is difficult to determine which item is compensatory and which is autonomous. This usually requires the government to undertake remedial measures. Components of Balance of payments: Balance of payments comprises of following three sub accounts : 1.
On the other hand, if X is less than M, the balance of trade is in deficit or is unfavourable. Current account : Current account measures receipts and payments which are related to goods and services. Every transaction is entered on the credit and debit side of the Income Statement and assets and liabilities on the balance sheet. Sodersten and Reed refer to the external wealth account of a country which shows the stocks of foreign assets held by the country positive item and of domestic assets held by foreign investors liabilities or negative item. When a country devalues its currency, the price of foreign currency increases which makes imports dearer and exports cheaper.
These refer to those receipts and payments, which take place without any service in return. The country has to pay more for costly imports and gets less for its cheap exports. Residents include the people, businesses, and government. These transactions consist of and of goods, services and capital, as well as transfer payments such as foreign aid and remittances. Payment for import of goods is written on the negative side debit items and receipt from exports is shown on the positive side credit items.
Such investments to abroad be recorded on the negative debit side as they lead to outflow of foreign exchange. The difference between the totals is known as the Balance of Trade. A long term capital is one whose maturity period is longer than a year, such as long term bonds or physical capital. Online Live Tutor Structure of Balance of Payments Accounts: We have the best tutors in Economics in the industry. They restrict imports and also control and regulate the foreign exchange.