Definition: Every country has to import and export goods and services. Import is the buying from a foreign country and export refers to selling abroad. The difference between import and export bill of a nation during a given period is known as balance of Trade / balance of payment.
Balance of trade includes only flow of goods (visible item), ignoring services (invisible items) into or out of a country.
Balance of trade of a country will be positive or favourable if its exports exceed imports the balance will be negative or unfavourable if its import bill is greater than export.
Note: According to some Indian and most Pakistani authors, balance of trade includes only goods but services are excluded from it. That is, only visible items are taken into account, and not invisible items, in determining balance of trade. But American and British economists and authors include both goods and services (visible and invisible item) in working out the balance of trade ignoring the term balance of payment in this book, however, Pakistani concept has been adopted.
BALANCE OF PAYMENT
The balance of trade of a nation does not truly reflect its overall international economic and business conditions. It is quite possible that a country may have unfavourable balance of trade but favourable balance of payment since it reflects a better and truer picture of an economy
Definition: Balance of payment is an income and expense account of a country during a given period. It includes all flow of goods, services (visible and invisible items), current account and capital account items. It gives a complete and detailed account and record of all types of imports and exports in the light of which a nation formulate its economic, industrial, and business policies greatly affecting its foreign trade and determines or adjusts foreign exchange rate of its currency. If a country’s foreign receipts are greater than payments the balance of payment will be favorable, and if receipts are less than payments, the balance will be unfavorable (negative). The continuous negative balance of payment may cause devaluation of the currency in an effort to bring the balance favorable. On the other hand consistent and stable favorable balance may call for upward revaluation which is a rise in the value of a currency in the foreign exchange market.
To figure out the nature of the balance of payment the flow of following items is taken into account.
Imports and exports of goods and services, short-and long-term foreign loans, aids, gifts, medical, educational, and hotel services, experts fees, interest incomes and expenses, foreign visits and tours of tourists and government delegations.
The outflow of foreign exchange brings negative balance and the inflow positive or favorable balance of payment. The details of items included in the balance of payment are shown in the following chart.
CHART SHOWING ITEMS ON THE BALANCE OF PAYMENT
I. Current account transactions
1. Exports of goods (+)
2. Imports of goods (-)
1. Military (net)
2. Travel and transportation (net)
3. Investment income (net)
Balance of goods and services = A + B
- Unilateral transfers
- Government grants and aids
- Remittances, pensions, gifts, and charity
Balance on current account = A + B + C
II. Capital Account
d. Long-term Capital flows
1. Direct investment
2. Portfolio investment
e. Short-term capital flows
Official reserves transactions balance = A + B + C + D + E
III. Financing (deficit or surplus) Method
f. Official reserve assets (net)
2. Foreign exchange
3. Special Drawing Rights (SDR)
4. Reserve position at the IMF
g. Official Liabilities
1. Liabilities to foreign countries / governments
2. Liabilities to foreign agencies
HOW TO IMPROVE BALANCE OF PAYMENT
Government can exercise their powers to control the balance of payment in their favor only to certain and limited extent beyond which it becomes uncontrollable and they have to act according to the pressure. We will discuss some of the measures that national adopt to improve their balance of payment.
1. Bank Rate Policy: The nation may raise the rate of interest and make necessary arrangements to ensure the safety of investments. Under such conditions foreign investments begins pouring in and the balance of payment starts improving. But this method is limited in scope.
The rate of interest can be raised only to a certain level beyond which it will have damaging effects on the economy and cause inflation, which in turn hinder the inflow of foreign investment. Rate of interest method will also become ineffective when local currency is volatile and unstable in the foreign exchange market. The continuous devaluation will wipe the benefits of high interest rates. Especially, the long-term investment will suffer more than the short term investment which may absorb the shock of devaluation.
2. Devaluation: The second method to avert the negative balance of payment is the devaluating the currency in the foreign exchange open market. As a result, the goods and services will become cheaper in the international markets and exports will bump up. Increased exports will improve balance of payments.
3. Foreign Investment: National try to receive foreign investments. They offer attractive investment climate to foreign investors by such incentives as tax holiday, better infrastructure, free outflow of their incomes, freedom of prices, duty-free flow of raw material and machinery soft labor laws, etc.
5. Science & Technology: The country may endeavour to concentrate on the growth of science and technology through education and aid of the developed countries. In this way standard of production can be raised and goods of advanced technology can be produced to have better position in the foreign markets.