The Balance of Payment (BOP) is the financial record of a country’s transactions with the rest of the world for a given period of time usually one year. This primarily includes the country’s trade in goods and services with other countries.
The balance of payment is made up of three accounts, which are:
- Current Account
- Capital Account
- Financial Account
The largest component of BOP is Current Account, as it records all exports and imports of goods and services, investment incomes and transfer payments.
Components of Current Account
- Trade in Goods: This shows the record of all imports and exports of goods of a country. These can be traded in its raw, and manufactured state of production such as shoes, bags, cars. It is further categorised as Visible export (A physical product sold overseas)and Visible Import (A physical product brought from overseas).
- Trade in Services: This shows the record of all imports and exports of services of a country. Examples include Skill acquisition, Banking, Tourism, Coding. It is further categorised as Invisible export (A service sold overseas resident)and Invisible Import (A service brought from overseas resident).
- Investment Income: This is also known as Primary income. This is a record that shows what a country earns from investment abroad. Examples are: dividends, interests, profits earned by MNCs abroad.
- Net Income Transfers: This shows the income transfer between residents and non residents which could be as a result of financial gifts between residents from different countries which are not limited to the following: donations to charities, international aid, payments of taxes and excise duties by visiting residents, pensions to retired people living abroad.
Current Account deficit occurs when a country spends more money than it earns i.e. imports exceed exports while a Current Account surplus occurs when a country earns more via exports than it spends on import. i.e exports exceeds import.
Causes of Current Account Deficit
A deficit on the current account due to a combination of two factors:
Lower demand for Exports:
- this could be facilitated by a fall in manufacturing competitiveness, perhaps due to higher labour costs in the domestic economy.
- Declining incomes in foreign market owing to economic recession which means that consumers or firms have less money available to spend on another country’s export.
- Another factor that influences low demand for export is a higher exchange rate which makes exports more expensive for foreign buyers which in-turn reduces the volume and value of exports
Higher demand for Imports: Consumers will tend to purchase more foreign goods if they are of better quality or cheaper than the local product. So also, if the cost of producing of local goods increases, consumers might be forced to import foreign goods in a bid to reduce spending on expensive items.
Consequences of Current Account Deficits
- Increased Borrowing: The government of the country would have to keep borrowing to ensure that there is stability within the economy and it comes with an opportunity cost, money that could be used to maintain the economy would be used to finance debt repayment.
- Unemployment: A fall in demand from sunset or sunrise industries would cause cyclical unemployment since labour is a derived demand. They may have to undergo pay cut to stabilize the economy.
- Reduced Demand: A trade deficit means the economy is spending more on imports than imports, this would mean that the demand of locally made goods would reduce which can effortlessly lead to a recession.