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Imports and exports may seem like prosaic terms that have little bearing on

everyday life, but they exert a profound influence on the consumer and the
economy. In todays interlinked global economy, consumers are used to seeing
products and produce from every corner of the world in their local malls and
stores. These overseas products or imports provide more choices to
consumers and help them manage strained household budgets. But too many
imports in relation to exports which are products shipped from a country to
foreign destinations can distort a nations balance of trade and devalue its
currency. The value of a currency, in turn, is one of the biggest determinants of a
nations economic performance. Read on to learn how these mundane staples of
international trade have a more far-reaching influence than most people imagine.
Effects on the Economy
According to the expenditures method of calculating gross domestic product, an
economys annual GDP is the sum total of C + I + G + (X M), where C, I and G
represent consumer spending, capital investment and government spending,
respectively.
While all those terms are important in the context of an economy, lets look closer
at the term (X M), which represents exports minus imports, or net exports. If
exports exceed imports, the net exports figure would be positive, indicating that
the nation has a trade surplus. If exports are less than imports, the net exports
figure would be negative, and the nation has a trade deficit.
Positive net exports contribute to economic growth, something that is intuitively
easy to understand. More exports mean more output from factories and industrial
facilities, as well as a greater number of people employed to keep these factories
running. The receipt of export proceeds also represents an inflow of funds into
the country, which stimulates consumer spending and contributes to economic
growth.
Conversely, imports are considered to be a drag on the economy, as can be
gauged from the GDP equation. Imports represent an outflow of funds from a
country, since they are payments made by local companies (the importers) to
overseas entities (the exporters).
However, imports per se are not necessarily detrimental to economic
performance, and in fact, are a vital component of the economy. A high level of
imports indicates robust domestic demand and a growing economy. Its even
better if these imports are mainly of productive assets like machinery and
equipment, since they will improve productivity over the long run.
A healthy economy, then, is one where both exports and imports are growing,
since this typically indicates economic strength and a sustainable trade surplus
or deficit. If exports are growing nicely but imports have declined significantly, it
may indicate that the rest of the world is in better shape than the domestic
economy. Conversely, if exports fall sharply but imports surge, this may indicate
that the domestic economy is faring better than overseas markets. The U.S.
trade deficit, for instance, tends to worsen when the economy is growing
strongly. The countrys chronic trade deficit has not impeded it from continuing to
be one of the most productive nations in the world.
But a rising level of imports and a growing trade deficit do have a negative effect
on a key economic variable the level of the domestic currency versus foreign
currencies, or the exchange rate.
Effect of Exchange Rates
The inter-relationship between a nations imports and exports, and its exchange
rate, is a complicated one because of the feedback loop between them. The
exchange rate has an effect on the trade surplus (or deficit), which in turn affects
the exchange rate, and so on. In general, however, a weaker domestic currency
stimulates exports and makes imports more expensive. Conversely, a strong
domestic currency hampers exports and makes imports cheaper.
Lets use an example to illustrate this concept. Consider an electronic component
priced at $10 in the U.S. that will be exported to India. Assume the exchange rate
is 50 rupees to the U.S. dollar. Ignoring shipping and other transaction costs
such as import duties for the moment, the $10 item would cost the Indian
importer 500 rupees. Now, if the dollar strengthens against the Indian rupee to a
level of 55, assuming that the U.S. exporter leaves the $10 price for the
component unchanged, its price would increase to 550 rupees ($10 x 55) for the
Indian importer. This may force the Indian importer to look for cheaper
components from other locations. The 10% appreciation in the dollar versus the
rupee has thus diminished the U.S. exporters competitiveness in the Indian
market.
At the same time, consider a garment exporter in India whose primary market is
the U.S. A shirt that the exporter sells for $10 in the U.S. market would fetch her
500 rupees when the export proceeds are received (again ignoring shipping and
other costs), assuming an exchange rate of 50 rupees to the dollar. But if the
rupee weakens to 55 versus the dollar, to receive the same amount of rupees
(500), the exporter can now sell the shirt for $9.09. The 10% depreciation in the
rupee versus the dollar has therefore improved the Indian exporters
competitiveness in the U.S. market.
To summarize, a 10% appreciation of the dollar versus the rupee has rendered
U.S. exports of electronic components uncompetitive, but has made imported
Indian shirts cheaper for U.S. consumers. The flip side of the coin is that a 10%
depreciation of the rupee has improved the competitiveness of Indian garment
exports, but has made imports of electronic components more expensive for
Indian buyers.
Multiply the above simplistic scenario by millions of transactions, and you may
get an idea of the extent to which currency moves can affect imports and exports.
Countries occasionally try to resolve their economic problems by resorting to
methods that artificially depress their currencies in an effort to gain an advantage
in international trade. One such technique is competitive devaluation, which
refers to the strategic and large-scale depreciation of a domestic currency to
boost export volumes. Another method is to suppress the domestic currency and
keep it at an abnormally low level. This is the route preferred by China, which
held its yuan steady for a full decade from 1994 to 2004, and subsequently
allowed it to appreciate only gradually against the U.S. dollar, despite having the
worlds biggest trade surpluses and foreign exchange reserves for years.
Effect of Inflation and Interest Rates
Inflation and interest rates affect imports and exports primarily through their
influence on the exchange rate. Higher inflation typically leads to higher interest
rates, but does this lead to a stronger currency or a weaker currency? The
evidence is somewhat mixed in this regard.
Conventional currency theory holds that a currency with a higher inflation rate
(and consequently a higher interest rate) will depreciate against a currency with
lower inflation and a lower interest rate. According to the theory of uncovered
interest rate parity, the difference in interest rates between two countries equals
the expected change in their exchange rate. So if the interest rate differential
between two nations is 2%, the currency of the higher-interest-rate nation would
be expected to depreciate 2% against the currency of the lower-interest-rate
nation.
In reality, however, the low-interest-rate environment that has been the norm
around most of the world since the 2008-09 global credit crisis has resulted in
investors and speculators chasing the better yields offered by currencies with
higher interest rates. This has had the effect of strengthening currencies that
offer higher interest rates. Of course, since such hot money investors have to
be confident that currency depreciation will not offset higher yields, this strategy
is generally restricted to stable currencies of nations with strong economic
fundamentals.
As discussed earlier, a stronger domestic currency can have an adverse effect
on exports and on the trade balance. Higher inflation can also affect exports by
having a direct impact on input costs such as materials and labor. These higher
costs can have a substantial impact on the competitiveness of exports in the
international trade environment.
Economic Reports
A nations merchandise trade balance report is the best source of information to
track its imports and exports. This report is released monthly by most major
nations. The U.S. and Canada trade balance reports are generally released
within the first 10 days of the month, with a one-month lag, by the Commerce
Department and Statistics Canada, respectively. These reports contain a wealth
of information, including details on the biggest trading partners, the largest
product categories for imports and exports, trends over time, etc.
Conclusion
Imports and exports exert a major influence on the consumer and the economy
directly, as well as through their impact on the domestic currency level, which is
one of the biggest determinants of a nations economic performance.

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The balance of trade of a nation is the difference between values of its exports and
imports. When exports are greater than imports, the nation is said to have a balance of
trade surplus. On the other hand, if imports are greater than exports, the nation is said
to have a balance of trade deficit. Exports and imports that figure in the balance of trade
concept arise in the context of trade with other countries. Exports are the value of goods
and services produced in the United States and sold to other countriesin other words,
exports are expenditures on American goods and services by the residents of foreign
countries. A Jeep Cherokee produced in Detroit and sold to a Canadian resident in
Toronto is an example of a U.S. export. Imports, on the other hand, are the value of
goods and services produced in other countries and bought by the United Statesin
other words, imports are expenditures by the residents of the United States on goods
and services produced by foreign countries. ASony television manufactured in Japan
and bought by an American living in Los Angeles is an example of a U.S. import. Since
the balance of trade arises in the context of foreign trade, the balance of trade surplus is
also called the foreign trade surplus and the balance of trade deficit is also called the
foreign trade deficit. Also, since the balance of trade surplus or deficit is defined as the
difference between exports and imports, it as also called net exports.
The foreign trade surplus or deficit is considered to play an important part in the
economic growth of a nation, and thus it has implications for jobs created within the
country or jobs lost to other nations. As a result, this topic is often debated in an
emotionally charged atmosphere. Below is a brief history of balance of trade in the
United States, as well as a summary of the economic implications of running a foreign
trade surplus or deficit.
THE RISE AND FALL OF THE U.S. TRADE
DEFICIT
Up until 1982, the foreign trade deficit was not a serious problem for the United States.
The trade deficit started rising dramatically in 1983, from about $38 billion in 1982 to a
peak of approximately $170 billion in 1987. Moreover, the trade deficit has remained at
relatively high levels since 1982hovering well over $100 billion per year for most of the
1988-98 period.
One of the reasons for the emergence of the balance of trade deficit in 1983-84 was the
increase in interest rates in the United States. The early 1980s experienced higher
nominal interest rates (the ordinary interest rates as quoted by financial
institutions) and higher real interest rates (nominal interest rates when adjusted
forinflation). The interest rate is one of the major determinants of the exchange rate.
The exchange rate, in turn, is the value of the U.S. dollar in relation to the currencies of
other countriesoften, it is expressed as the value of one U.S. dollar in terms of the
number of units of the currency of another nation. For example, if one U.S. dollar is
equal to 100 Japanese yen (the Japanese currency), then the exchange rate between the
U.S. dollar and the Japanese yen is 1:100. Of course, the exchange rate of the U.S. dollar
can also be expressed the other way aroundthat is, the number of U.S. dollars equal to
one Japanese yen. The U.S. dollar will be characterized as being strong in relation to the
Japanese yen if a large number of yens are equal to one U.S. dollar, whereas the dollar
will be considered weak if one U.S. dollar equals fewer yens.
The exchange rate is like the price of any commodity that responds to forces of demand
and supply. If the demand for the U.S. dollar rises relative to another currency, its price
in terms of that currency risesthat is, the exchange rate (of the dollar) appreciates. On
the other hand, if the supply for the U.S. dollar rises relative to another currency, its
price in terms of that currency fallsthat is, the exchange rate (of the dollar)
depreciates. The rise in interest rates experienced in the United States during the early
1980s made investment in the United States more attractive, relative to investments in
other countries. As a result, foreign residents rushed to convert their financial assets
(held in their own domestic currencies) into U.S. dollars for investment in the United
States. This raised the demand for the U.S. dollar and the supply of foreign currencies,
raising the value of the U.S. dollar. This appreciation in the U.S. dollar had adverse
effects on the U.S. foreign trade deficit, since it reduced U.S. exports to other countries
and increased imports from these countries.
The way changes in the exchange rate affect exports and imports can be briefly
explained as follows. When the U.S. dollar appreciates, foreign goods (expressed in U.S.
dollars) become cheaper and U.S. goods (expressed in foreign currencies) become more
expensive. Assume, for example, that one U.S. dollar was equal to 100 Japanese yen and
a Sony television is priced at 15,000 yen in Japanimplying that the television is worth
$150 in the United States. Now, assume that the U.S. dollar appreciates so that one
dollar equals to 150 yen. The stronger dollar implies that the Sony television set will now
cost only $100 in the United States. The lower price of the television set (in terms of the
U.S. dollar) leads to increased sales of Sony television sets in the United Statesthat is,
an increase in imports into the United States. Now, consider an item that the United
States exports, for example, a Jeep Cherokee. Suppose that the Jeep costs $10,000 in
the United States. When one dollar equals to 100 yen, a Jeep Cherokee will sell for
1,000,000 yen in Japan. When the U.S. dollar appreciates to 150 yen to a dollar, the
Jeep will sell for 1,500,000 yen in Japan. Thus, due to the appreciation of the U.S.
dollar, a Jeep Cherokee becomes more expensive in Japan, reducing its demandthis
translates into reduced exports from the United States. The exchange rate appreciation
thus serves as the double-edged swordreducing exports and increasing imports
simultaneously. This is what happened in the 1980s; the rise in the value of the U.S.
dollar was the main culprit behind the dramatic rise in the U.S. foreign trade deficit. The
U.S. dollar has gradually declined in value(with significant fluctuations) since then, as
has the trade deficit, but not to the level that existed in 1982.


Read more: http://www.referenceforbusiness.com/encyclopedia/Assem-Braz/Balance-
of-Trade.html#ixzz3FjdpTy2X
http://www.friendsmania.net/forum/b-com-part-2-ii-economics-pakistan-
notes/28442.htm
http://www.tdap.gov.pk/tdap-statistics.php
https://www.scribd.com/doc/53186535/A-Report-on-Balance-of-Payments-of-
Pakistan-and-their-problems
The Balance of Payments
EconoTip
The U.S. balance of payments includes a current account, which summarizes imports and exports and a
capital account, which summarizes forgiveness of debts, transfers of goods or financial assets
accompanying migrants, and other transfers of assets. It also includes a financial account, which
summarizes U.S. and foreign investment in fixed assets, securities, and other financial assets, and
intangible assets. The current account should balance out to zero against the sum of the capital and the
financial accounts.
The balance of international payments, commonly known as the balance of payments, is the overall
accounting of a nation's international economic activity. It is a statement summarizing the transactions
that took place between a nation and the rest of the world, usually over a calendar quarter or year. It
shows the sum of all the transactions between the individuals, businesses, and government agencies of
the nation and those of the rest of the world.
Transactions are recorded as debits and credits in the balance of payments. Transactions that cause
money to flow into the country (inflows) are credits, and those that cause money to leave the country
(outflows) are debits.
For example, if the U.S. exports a cement mixer to Brazil, the transaction is a credit to the U.S. balance of
payments and a debit to Brazil's balance of payments. If Malaysia borrows $1.5 billion from the U.S.
government, the transaction is a debit to the U.S. balance of payments and a credit to Malaysia's.
However, when Malaysia makes its first payment on the principal and interest on the loan, it is a credit to
the U.S. balance of payments and a debit to Malaysia's.
The balance of payments statement divides international transactions into three accounts: the current
account, capital account, and financial account, as follows:
The current account includes trade in goods and services; income receipts, such as dividends
and interest; and unilateral transfers of assets, such as foreign aid.
The capital account includes forgiveness of international debt, migrant transfers (goods or
financial assets accompanying migrants into or out of the country), transfers of funds arising from
gift and inheritance taxes, and uninsured damage to fixed assets.
The financial account records trade in fixed assets such as companies and real estate; in
financial assets such as stocks and bonds; in government-owned assets and foreign-owned
assets in the United States; and in rights and intangible assets, such as mineral rights,
copyrights, patents, trademarks, franchises, and leases.
EconoTip
Although economists used to point out that services generally were not exportedhaircuts were the
favorite examplethat has changed. The vast majority of international trade is still in goods, but trade in
services has grown considerably over the past two decades. Categories of services exported and
imported include transportation, financial, consulting, engineering, and telecommunications services.
Each of these three accountsthe current account, the capital account, and the financial accountis
summed separately. The sum of the current account should balance with the sum of the capital account
plus the financial account. Thus, the current account should balance out to zero against the capital and
financial accounts. In practice, the balance is close to zero relative to the sums involved, but is rarely
exactly zero. This is due to statistical discrepancies, accounting conventions, and exchange rate
movements that change the recorded value of transactions.
Why should the current account balance out to zero against the capital and financial accounts?
Because when the United States imports more goods and services than it exports, the result is a current
account deficit. The United States must finance that current account deficit, either by international
borrowing or by selling more capital assets than it buys internationally. Conversely, when the United
States exports more that it imports, its trading partners must finance their current account deficits, either
by borrowing or by selling more capital assets than they purchased.
Table 18.2 shows the U.S. balance of payments for 2001.
Table 18.2 U.S. Balance of Payments, December 31, 2001(billions of dollars)
Inflows Outflows Net
Current Account
Merchandise Account (Exports/Imports)
Goods $719 -$1,146
Services 279 -210
Total Merchandise Account $998 -$1,356 -$358
Income Account 284 -269 15
Transfers -50
Balance on Current Account -$393
Capital Account 1
Financial Account
Foreign Investment in the United States 753
U.S. Investment Abroad -371
Balance on Financial Account $382
Statistical Discrepancy 10
Balance on Capital and Financial Accounts

$393
Source: Bureau of Economic Analysis, International Accounts Data
The deficit on the merchandise account, commonly known as the trade deficit, accounts for almost all of
the deficit on the capital account. It is a deficit in exports of goods that causes the U.S. trade deficit. In
2001, the United States imported almost 60 percent more goods than it exported (because $1,146 - $719
= $427 and $427 $719 = .59). However, the United States runs a surplus in services, exporting $279
billion and importing $210 billion of services in 2001.
EconoTalk
A trade deficit occurs when, during a certain period, a nation imports more goods and services than it
exports. A trade surplus occurs when a nation exports more goods and services than it imports.
As the financial account shows, the current account deficit is offset by the amount of foreign investment in
the United States, which exceeds U.S. foreign investment. While America does a lot of foreign
investmentplacing $371 billion abroad in 2001the rest of the world invests very heavily in the United
States, to the tune of $753 billion in that year. So America's ability to attract foreign investment helps to
finance its appetite for imports.
The United States has run a merchandise trade deficit since 1976, although it typically runs a surplus in
services. The merchandise trade deficit rose from $36 billion in 1982 to a peak of $160 billion in 1987. In
the recession year of 1991, the trade deficit stood at $71 billion, but the run-up during the 1990s was
particularly strong. During that period, the United States enjoyed a vigorous economic expansion while
the economies of Europe and Asia languished. By 2000, the merchandise trade deficit had grown to $434
billion. In 2001, which included three quarters of contraction, the trade deficit still reached $358 billion.


Read more: International Finance: Effect on Imports, Exports, and GDP |
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Balance of trade (BOT) / Trade balance

What is a balance of trade (BOT) / trade balance?
A country's trade balance, or balance of trade (BOT), is the difference in value
between its exports and imports over a given period of time.
If the value of a country's imports exceeds that of its exports (a negative balance), it is
said to have a 'trade deficit'. If the reverse is true (a positive balance), it is said to have
a 'trade surplus'.
The trade balance forms part of a country's overall current account, which calculates
the difference between a country's total savings and investments.
It is also referred to as 'balance of trade (BOT)', 'commercial balance and 'net exports
(NX)'.
How does a trade deficit or surplus affect an economy?
Depending on the economic conditions, a trade deficit is not always a bad thing. For
example, if a country's economy is booming, increasing imports can help to meet
demand for goods and services, or introduce greater competition on prices.
During a recession, however, countries generally prefer to increase exports with a view
to generating jobs domestically and increasing demand for domestic goods and
services. A trade deficit in this climate would be negative for the economy overall.
Likewise, a trade surplus is not always positive and could indicate that the country is
under-utilising the means at its disposal i.e. hoarding funds that could be used to
further contribute to the total wealth of that country.
Developing countries in particular can struggle to maintain a positive trade balance
(surplus) in tough economic times. This is usually because they have to pay a high price
to import finished goods but receive a much lower price for the raw materials that they
export.
Current-Account Deficits
The current account is the balance of trade between a country and its trading
partners, reflecting all payments between countries for goods, services, interest
and dividends. A deficit in the current account shows the country is spending
more on foreign trade than it is earning, and that it is borrowing capital from
foreign sources to make up the deficit. In other words, the country requires more
foreign currency than it receives through sales of exports, and it supplies more of
its own currency than foreigners demand for its products. The excess demand for
foreign currency lowers the country's exchange rate until domestic goods and
services are cheap enough for foreigners, and foreign assets are too expensive
to generate sales for domestic interests.

Balance of Payments: Categories and Definitions

The Balance of Payments (BoP) records all transactions that cross a countrys borders. The
simplest way to think about it is as a record of all payments going out to foreigners (with the
reasons for those payments), and all payments coming into the country from foreigners (with
the reasons for those payments). We give the payments coming in a plus sign, and the payments
going out a minus sign.

There are various ways that these payments can be categorized and organized. This discussion
is revised to reflect the categories on your spreadsheets, which use IMF data.

Most BoP presentations give you two large categories: a Current Account, which includes trade,
and a Capital Account, which includes sales and purchases of assets. Several other kinds of
payments are usually stuck in the Current Account. For an example of a typical textbook
presentation, see our e-reserve reading on the BoP or this Wikipedia article.

The IMF uses this basic division, but they call the Capital Account the Financial Account, so
they have a Current Account and a Financial Account. Fair enough. Whats not fair is that
they have named one of the more obscure sub-categories of the Financial Account the Capital
Account. So what the IMF calls the capital account is not what most textbooks call the capital
account. Worse, they keep moving it -- in the very latest set of figures, their little "capital
account" moves out of the large "financial account" category and into its own space between
current and financial account. Sigh. Happily, the stuff captured in the IMF's "Capital account"
category is typically very small in proportion to the overall BoP, so for this class, you can almost
certainly ignore it. (This is funny: since the last time I checked the link the Wikipedia article has
been updated to a reflect the IMF's divergent usage, and now cites this humble page.)

So below Im going to follow the presentation on your spreadsheets, but add
explanation. There are a couple of documents out there on the web that provide clear
explanations of BoP items, so when they have nice wording I quote them.


Current Account

The current account measures all transactions (other than those in financial assets and liabilities)
that involve economic values and occur between resident and non-resident entities. It also includes
offsets to current economic values provided or acquired without something of economic value in
exchange. (Central Bank of New Zealand p. 6)


Goods are tangible, real stuff like wheat and steel and cars. The term merchandise is also used for
goods.



Goods: Exports f.o.b.

Goods sold to foreigners.
(+) They require that foreigners make payments to us so they take a plus sign.
Macro Note: since exports are a source of total aggregate demand for nationally-produced
goods, changes in exports will produce corresponding changes in national income. If other
countries incomes rise, they will likely import more of our goods, raising our exports. If
your country's exports are dominated by commodities like oil or coffee, they will be affected
by swings in the prices of those things. This means that in the short run, the volume of a
country's exports depends mainly on foreign events. Over the longer run, look for patterns
of capital investment in export industries.
Always remember that most exports are produced by private firms. We may say "the United
States exports wheat" but what is actually going on is that a private seller of wheat in the
U.S. hooks up with a private buyer in another country.
(FOB means "free on board, meaning what it costs to get the goods to the boat (or
equivalent). The alternative is CIF which means "cost, insurance, freight, and includes
additional costs to get the good to the foreign customer.)



Goods: Imports f.o.b.

Goods purchased from foreigners.

(-) They require that we make payments to foreigners so they take a minus sign.

Macro Note: Generally imports will rise or fall as total national income rises or falls, since
they will represent part of national demand for goods. When income rises, both demand for
imports and demand for locally-made goods will rise. Additionally, some countries may have
export industries that require significant amounts of imports. Always remember that imports
are imported because particular people or firms within your country decide to buy them from
particular sellers located abroad.


Services are purchases and sales of intangible items like tourism or transportation. You dont have
to ship them and you cant store them.

In a broad sense services are products other than physical goods. There are two differences
between goods and services:
there is no physical object over which ownership rights can be established
a service cannot be traded separately from its production.
The production of a service is linked to an arrangement made between a producer in one economy
and a consumer in another economy prior to the time that production occurs. (Central Bank of New
Zealand p. 45)

Usually, when people talk about exports they mean goods exports plus service exports, and then
they say imports they mean goods plus service imports. Trade balances are usually computed for
both goods and services trade. But sometimes you will see people writing about the merchandise
trade balance, and then theyre not including services.



Services: Credit (service exports)

Services sold to foreigners.

(+) They require that foreigners make payments to us so they take a plus
sign. (Credit is accounting terminology meaning someones gotta pay us for
this.)



Services: Debit (service imports)

Services bought from foreigners.

(-) They require that we make payments to foreigners so they take a minus
sign. (Debit is accounting terminology meaning weve gotta pay someone for
this.)


Income covers two types of transactions between residents and non-residents: (i) those
involvingcompensation of employees, which is paid to non-resident workers or received from non-
resident employers and (ii) those involving investment income receipts and payments on external
financial assets and liabilities. ... Investment income ... is income derived from ownership of external
financial assets and payable by residents of one economy to residents of another economy. It includes
interest, dividends, remittances of branch profits, and direct investors shares of the retained
earnings of direct investment enterprises. (European Union)

In some presentations, income is called factor services or factor income. Thats factor in the
sense of factor of production, i.e. land, labor, or capital, so you can think of it as a payment in
exchange for the use of physical capital or the use of the principal on a loan. You may think its
weird that interest payments on a loan go into the current account while principal payments go into
the financial account. But thats how accountants see the world.



Income: Credit (inflows)

Payments to us from foreigners that are interest on loans that we made to them,
profits from physical capital (like factories) owned by our citizens in foreign
countries, and income received by our workers from foreign employers.

(+) This requires that foreigners make payments to us and so takes a plus sign.



Income: Debit (outflows)

Payments by us to foreigners that are interest on loans to us or profits from physical
capital that they own in our country, and income paid to foreign workers.

(-) This requires that we make payments to foreigners so takes a minus sign.

Macro Note: Countries that borrow a lot will show very large amounts of interest
payments going out, sometimes to the extent that half of their exports are going to
pay interest on loans. (One reason why interest payments may balloon is that when a
country has trouble making payments on debt, it may enter into a "rescheduling"
agreement that postpones payments of loan principal (see below) while continuing
interest payments. That lets lenders keep the loans on their books as "performing."
The macro effect of this debt burden, however, is that the country consumes a lot less
than it makes, and this can tend to reduce gross fixed capital formation, crippling
prospects for future growth. Not to mention lowering overall consumption, which
often hits the poor hardest.


A transfer is a payment that is not made in exchange for anything. Basically, a gift. Youre not
getting a good or service for it, and youre not making it to be released from an obligation, like with
an interest payment on a loan. Sometimes youll see the words unrequited transfer or unilateral
transfer used for this category. (For accounting geeks: the transfer is actually the offsetting entry
for the payment, a sort of imaginary thing that the accountant imagines as whatever the payment
was made for.)

Current transfers are transfers that directly affect the level of disposable income of the ... donor or
recipient. in the words of the European Union. The New Zealand Central Bank says: Current
transfers directly affect the level of disposable income and influence the consumption of goods and
services for the donor and the recipient economies. Capital transfers consist of the transfer of
ownership of a fixed asset, the forgiveness of a liability, and the transfer of cash that is linked to, or
conditional on, the acquisition or disposal of a fixed asset. The transfers made by migrants as they
move to a new country are an example of a capital transfer.

In some presentations of the data, transfers are divided into official transfers and private
transfers.

Official transfers are government-to-government payments, though some may go through
international agencies like the United Nations. This can be termed "aid" of various kinds;
when the United States, for example, got large payments from Japan and other countries to
defray costs involved in the Gulf War, those represented large positive official transfers in the
U.S.BoP. For only a few countries, however, are official transfers likely to be a significant part
of the overall BoP.

Private (i.e. made at individual initiative) transfers are made by workers who go abroad and
send part of their earnings home, e.g. Salvadorans in the U.S., Turks in Germany, Filipinos in
Singapore. So you would expect the United States to show net negative private
transfers, andIndia to show net positive private transfers. For most countries transfers are
insignificant compared to trade, but for a few, like El Salvador, they are quite important.



Current Transfers, n.i.e.: Credit (Inflows)

Official Transfers into our country mean that foreign governments (or multilateral
agencies) make payments to us.

Private Transfers into our country mean that foreigners make payments to us.
(Suppose your uncle in Japan sends you a check.)

(+) They require that foreigners make payments to us so they take a plus sign.

Macro note: Large incoming transfers will enable a country to import more -- in fact thats
often the intent of foreign aid, and many donors insist that their "aid" be spent on their
exports, and the United States has, as a matter of policy, tried to use aid programs to promote
consumption of U.S.-grown products, especially wheat. Some have argued that by
stimulating imports into the aided country, large aid programs may actually hurt local
producers.



Current Transfers: Debit (Outflows)

Official Transfers to other countries are simply payments by our government to
other countries.

Private Transfers to other countries are simply payments to people in those
countries. Suppose you help support your grandparents in Mexico

(-) They require that we make payments to foreigners so they take a minus sign.



Total Current Account, n.i.e.

You add up everything above.

(N.i.e. means not including exceptional financing. Dont worry about it.)

Financial Account

The financial account covers all transactions, including the creation and liquidation of financial
claims, associated with change of ownership in international financial assets and liabilities. (Central
Bank of New Zealand)


See my note at the top on the potential for confusion around the term Capital Account, which
means different things to different people. In the IMFs presentation, capital account is
mainlycapital transfers, which means unrequited transfers of an asset of some kind. See my note
above under current transfers. In the World Bank's definition, capital account includes
government debt forgiveness, investment grants in cash or in kind by a government entity, and taxes
on capital transfers. Also included are migrants' capital transfers and debt forgiveness and
investment grants by nongovernmental entities. So basically you have both private capital transfers
and public capital transfers. For most countries this category will be extremely small, if they are
reported at all, so its highly unlikely that these will be important for any of your research memos.



Capital Account, n.i.e.: Credit



Capital Account: Debit


Direct Investment means acquiring a significant ownership stake in a foreign business.

Direct investment is investment undertaken by an entity resident in one economy in an
enterprise resident in another economy. The purpose of the investment is to obtain or sustain a
lasting interest in the enterprise and exercise a significant degree of influence in its
management. (Central Bank of New Zealand)

According to the IMFs current criteria, owning ten percent or more of a business qualifies as having
a lasting interest and a significant degree of influence in its management If you own less than
ten percent, youre treated as a portfolio investor.

Direct Investment is divided directionally: foreigners investing in businesses in our country, and our
residents investing in businesses abroad.



Direct Investment Abroad

Our residents buying (or selling) ownership stake in foreign businesses in other
countries.
When our residents buy ownership stakes in foreign firms from foreigners,
they have to make payments to those foreigners, so that will take a minus
sign.
When our residents sell ownership stakes in foreign firms to foreigners, those
foreigners have to make payments to us, so that takes a plus sign.



Direct Investment in Reporting Economy, n.i.e.

Foreigners buying (or selling) ownership stake in businesses in our country.
When foreigners buy ownership stakes in domestic firms, they have to make
payments to us, so that will take a plus sign.
When foreigners sell ownership stakes, we make payments to them, so that
will take a minus sign.


Think of portfolio investment as the kind of securities that small investors might acquire: stocks,
corporate or government bonds. Youre acquiring these as part of a portfolio of assets, but youre not
buying enough shares in a company to have a significant ownership stake, in particular the kind of
stake that would give you a say in management.

Portfolio investment consists of equity and debt securities that are not classified to either direct
investment or reserve assets. Equity securities include shares, stocks, ... or similar documents that
usually denote ownership of equity. The level of equity ownership that denotes portfolio investment is
taken as being less than 10 percent ownership in an entity. ... Debt securities include tradable
instruments such as bonds and notes, debentures (long-term instruments) and money market
instruments (short-term instruments such as treasury bills, commercial and financial paper).
(Central Bank of New Zealand)

Portfolio Investment is divided directionally: foreigners investing in businesses in our country, and
our residents investing in businesses abroad.



Portfolio Investment Assets

Our residents portfolio investment abroad.
When our residents buy foreign securities, we have to make payments to
foreigners, so this will take a minus sign.
When they sell those securities, foreigners have to make payments to us, so
that takes a plus sign.
Because those securities are our assets and their liabilities, theyre called assets here.



Portfolio Investment Liabilities, n.i.e.

Foreigners portfolio investment in our country.
When foreigners buy securities, they have to make payments to us, so that
will take a plus sign.
When foreigners sell those securities, we make payments to them, so that
will take a minus sign.
Because these securities are our liabilities and their assets, theyre called liabilities
here.


The IMF says: Financial derivatives are financial instruments that are linked to a specific financial
instrument or indicator or commodity, and through which specific financial risks can be traded in
financial markets in their own right. Basically, they are a category of more complex financial
instruments, and they are often individually tailored to the needs of particular borrowers or
lenders. For the most part, however, its unlikely that you will have much data for this category.


Financial Derivatives Assets

Our residents purchases or sales of financial derivatives abroad.


Financial Derivatives Liabilities

Foreign residents purchases or sales of financial derivatives in our country.

The major component in Other investment is usually bank loans specifically, the principal of
loans. The interest goes under income in the current account.

The other investment item is a residual category that includes all financial transactions not covered
under direct investment, portfolio investment, financial derivatives or reserve assets ... Other
investment can be further subdivided into (i) trade credits, (ii) loans/currency and deposits and (iii)
other assets/other liabilities. (European Union)



Other Investment Assets

Assuming this is bank lending, this would consist of our banks making loans to
foreigners.
When our bank makes the loan, it would have to make a payment to the
foreigner, so that would take a negative sign.
When a foreigner repays the principal on the loan, they would be paying us,
so that takes a plus sign.
The loan is our banks asset and the foreigners liability.



Other Investment Liabilities, n.i.e.

Assuming this is bank lending, this would consist of our foreign banks making loans
to anyone in our country.
When the foreign bank makes the loan, it would have to make a payment to
our domestic borrower, so that would take a plus sign.
When our resident repays the principal on a loan, they make a payment to a
foreigner, so that takes a minus sign.
The loan is our liability and the foreigners asset.



Total Financial Account, n.i.e.

Add all the Financial Account items up.


The Current Account plus Financial Account plus Reserve Changes should sum to zero, because they
should capture the totality of all transactions across our borders. If they dont, somebody missed
counting something. This may mean smuggling of goods in or out. Sometimes a large negative
figure will indicate capital flight -- a lot of domestic residents buying foreign assets without telling
their government.

Net Errors and Omissions

Overall Balance is Current Account plus Financial Account plus net Errors and Omissions

Overall Balance

Finally we get to changes in the quantity of foreign assets held by the Central Bank.
Whats left over after we sum up the Current Account and Financial Account should be the change in
the reserves held by the Central Bank. If all these activities bring in more foreign exchange than they
use, the balance should be accounted for by additional foreign assets held by the central bank. We
call these assets reserves, so total reserves rise. If all these activities use up more foreign exchange
than they bring in, the Central Bank has to fill the gap by selling some of the foreign assets it owns, so
total reserves fall. So:
Current Account + Financial Account = Change in Reserves
This is a useful way to look at it because using the reserves is a policy choice made by the
government. Reserves can be seen as a "savings account" or "war chest" (sometimes literally) of a
government; it can spend accumulated reserves to but things abroad that it needs. For example if the
harvest of a key export crop is bad, a government can dip into its reserves to maintain imports of
essential goods.
Plus and minus signs: This is a rich source of confusion. By accounting convention, the reserve
account is treated as a stash of assets outside the country that you either spend money on (when you
increase reserves) or draw money from (when you sell some of those assets, thereby running down
your reserves). That means that when reserves rise, they are a net use of funds (you're spending
money to buy reserves, just like you spend money to buy imports) and take a minus sign. And when
you draw on your reserves they are a net source of funds, and take a plus sign. It's totally
counterintuitive, because the minus sign corresponds to a situation when reserves rise, and the plus
sign corresponds to a situation when reserves fall. We're so used to thinking "plus sign good" that
it's hard to wrap the brain around the fact that a big positive number in "changes in reserves" means
your country is burning through its precious stash of reserve assets.
One way to reduce cognitive dissonance is to look at "Overall balance" on the spreadsheet just
above. A big negative number means reserves were used up that year, a big positive number means
there was money left over to buy more reserve assets.


In economics, a country's current account is one of the two components of its balance of payments,
the other being the capital account. The current account consists of the balance of trade, net factor
income(earnings on foreign investments minus payments made to foreign investors) and net cash
transfers.
The current account balance is one of two major measures of a country's foreign trade (the other
being thenet capital outflow). A current account surplus increases a country's net foreign assets by
the corresponding amount, and a current account deficit does the reverse. Both government and
private payments are included in the calculation. It is called the current account because goods and
services are generally consumed in the current period.
[1][2]

Contents
[hide]
1 Overview
2 Calculation
3 Reducing current account deficits
4 Interrelationships in the balance of payments
5 U.S. account deficits
6 See also
7 References
8 External links
Overview[edit]
A country's balance of trade is the net or difference between the
country's exports of goods and services and its imports of goods and services, ignoring all financial
transfers, investments and other components. A country is said to have a trade surplus if its exports
exceed its imports, and a trade deficit if its imports exceed its exports.
Positive net sales abroad generally contributes to a current account surplus; negative net sales
abroad generally contributes to a current account deficit. Because exports generate positive net
sales, and because the trade balance is typically the largest component of the current account, a
current account surplus is usually associated with positive net exports.
In the net factor income or income account, income payments are outflows, and income receipts are
inflows. Income are receipts from investments made abroad (note: investments are recorded in
the capital account but income from investments is recorded in the current account) and money sent
by individuals working abroad, known asremittances, to their families back home. If the income
account is negative, the country is paying more than it is taking in interest, dividends, etc.
The various subcategories in the income account are linked to specific respective subcategories in
the capital account, as income is often composed of factor payments from the ownership of capital
(assets) or the negative capital (debts) abroad. From the capital account, economists and central
banks determine implied rates of return on the different types of capital. The United States, for
example, gleans a substantially larger rate of return from foreign capital than foreigners do from
owning United States capital.
In the traditional accounting of balance of payments, the current account equals the change in net
foreign assets. A current account deficit implies a paralleled reduction of the net foreign assets.
Current account = changes in net foreign assets
If an economy is running a current account deficit, it is absorbing (absorption = domestic
consumption + investment + government spending) more than that it is producing. This can only
happen if some other economies are lending their savings to it (in the form of debt to or direct/
portfolio investment in the economy) or the economy is running down its foreign assets such as
official foreign currency reserve.
On the other hand, if an economy is running a current account surplus it is absorbing less than
that it is producing. This means it is saving. As the economy is open, this saving is being
invested abroad and thus foreign assets are being created.
Calculation[edit]
Normally, the current account is calculated by adding up the 4 components of current account:
goods, services, income and current transfers.
[3]

Goods
Being movable and physical in nature, goods are often traded by countries all over the world.
When a transaction of certain good's ownership from a local country to a foreign country
takes place, this is called an "export." The other way around, when a good's owner changes
to a local inhabitant from a foreigner, is defined to be an "import." In calculating current
account, exports are marked as credit (the inflow of money) and imports as debit. (the
outflow of money.)
Services
When an intangible service (e.g. tourism) is used by a foreigner in a local land and the local
resident receives the money from a foreigner, this is also counted as an export, thus a credit.
Income
A credit of income happens when an individual or a company of domestic nationality receives
money from a company or individual with foreign identity. A foreign company's investment
upon a domestic company or a local government is considered as a credit.
Current transfers
Current transfers take place when a certain foreign country simply provides currency to
another country with nothing received as a return. Typically, such transfers are done in the
form of donations, aids, or official assistance.
A country's current account can be calculated by the following formula:

When CA is the current account, X and M the export and import of goods and
services respectively, NY the net income from abroad, and NCT the net current
transfers.
Reducing current account deficits[edit]
The quarterly current account of Australia ($A million) since 1959
Action to reduce a substantial current account deficit usually involves increasing
exports (goods going out of a country and entering abroad countries) or
decreasing imports (goods coming from a foreign country into a country). Firstly,
this is generally accomplished directly through import restrictions, quotas, or
duties (though these may indirectly limit exports as well), or by promoting
exports (through subsidies, custom duty exemptions etc.). Influencing the
exchange rate to make exports cheaper for foreign buyers will indirectly
increase the balance of payments. Also, Currency wars, a phenomenon evident
in post recessionary markets is a protectionist policy, whereby countries
devalue their currencies to ensure export competitiveness. Secondly, adjusting
government spending to favor domestic suppliers is also effective.
Less obvious methods to reduce a current account deficit include measures that
increase domestic savings (or reduced domestic borrowing), including a
reduction in borrowing by the national government.
A current account deficit is not always a problem. The Pitchford thesis states
that a current account deficit does not matter if it is driven by the private sector.
It is also known as the "consenting adults" view of the current account, as it
holds that deficits are not a problem if they result from private sector agents
engaging in mutually beneficial trade. A current account deficit creates an
obligation of repayments of foreign capital, and that capital consists of many
individual transactions. Pitchford asserts that since each of these transactions
were individually considered financially sound when they were made, their
aggregate effect (the current account deficit) is also sound.
Interrelationships in the balance of
payments[edit]
Main article: Balance of payments
Absent changes in official reserves, the current account is the mirror image of
the sum of the capital and financial accounts. One might then ask: Is the current
account driven by the capital and financial accounts or is it vice versa? The
traditional response is that the current account is the main causal factor, with
capital and financial accounts simply reflecting financing of a deficit or
investment of funds arising as a result of a surplus. However, more recently
some observers have suggested that the opposite causal relationship may be
important in some cases. In particular, it has controversially been suggested
that the United States current account deficit is driven by the desire of
international investors to acquire U.S. assets (See Ben Bernanke,
[4]
William
Poole links below). However, the main viewpoint undoubtedly remains that the
causative factor is the current account and that the positive financial account
reflects the need to finance the country's current account deficit.
U.S. account deficits[edit]

Current account: Balance of Payments Structure [1]
Since 1989, the current account deficit of the US has been increasingly large,
reaching close to 7% of the GDP in 2006. In 2011, it was the highest deficit in
the world.
[5]
New evidences, however, suggest that the U.S. current account
deficits are being mitigated by positivevaluation effects.
[6]
That is, the U.S.
assets overseas are gaining in value relative to the domestic assets held by
foreign investors. The U.S. net foreign assets therefore is not deteriorating one
to one with the current account deficits. The most recent experience has
reversed this positive valuation effect, however, with the US net foreign asset
position deteriorating by more than two trillion dollars in 2008.
[7]
This was due
primarily to the relative under-performance of domestic ownership of foreign
assets (largely foreign equities) compared to foreign ownership of domestic
assets (largely US treasuries and bonds).
The balance of payments (BOP) is the place where countries record their
monetary transactions with the rest of the world. Transactions are either marked
as a credit or a debit. Within the BOP there are three separate categories under
which different transactions are categorized: the current account, thecapital
account and the financial account. In the current account, goods, services,
income and current transfers are recorded. In the capital account, physical
assets such as a building or a factory are recorded. And in the financial account,
assets pertaining to international monetary flows of, for example, business or
portfolio investments, are noted. In this article, we will focus on analyzing the
current account and how it reflects an economy's overall position.
The Current Account
The balance of the current account tells us if a country has a deficit or a surplus.
If there is a deficit, does that mean the economy is weak? Does a surplus
automatically mean that the economy is strong? Not necessarily. But to
understand the significance of this part of the BOP, we should start by looking at
the components of the current account: goods, services, income and current
transfers.
1. Goods - These are movable and physical in nature, and in order for a
transaction to be recorded under "goods", 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).
2. Services - These transactions result from an intangible action such as
transportation, business services, tourism, royalties or licensing. If money is
being paid for a service it is recorded like an import (a debit), and if money is
received it is recorded like an export (credit).
3. 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.
4. Current Transfers - Current transfers are unilateral transfers with nothing
received in return. These include workers' remittances, donations, aids and
grants, official assistance and pensions. Due to their nature, current transfers are
not considered real resources that affect economic production.
Now that we have covered the four basic components, we need to look at the
mathematical equation that allows us to determine whether the current account is
in deficit or surplus (whether it has more credit or debit). This will help us
understand where any discrepancies may stem from, and how resources may be
restructured in order to allow for a better functioning economy.
The following variables go into the calculation of the current account balance
(CAB):
X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers
The formula is:
The balance of payments accounts of a country record the payments and receipts of
the residents of the country in their transactions with residents of other countries. If
all transactions are included, the payments and receipts of each country are, and
must be, equal. Any apparent inequality simply leaves one country acquiring assets
in the others. For example, if Americans buy automobiles from Japan, and have no
other transactions with Japan, the Japanese must end up holding dollars, which they
may hold in the form of bank deposits in the United States or in some other U.S.
investment. The payments of Americans to Japan for automobiles are balanced by
the payments of Japanese to U.S. individuals and institutions, including banks, for
the acquisition of dollar assets. Put another way, Japan sold the United States
automobiles, and the United States sold Japan dollars or dollar-denominated assets
such as Treasury bills and New York office buildings....

Although the totals of payments and receipts are necessarily equal, there will be
inequalitiesexcesses of payments or receipts, calleddeficits or surplusesin
particular kinds of transactions. Thus, there can be a deficit or surplus in any of the
following: merchandise trade (goods), services trade, foreign investment income,
unilateral transfers (foreign aid), private investment, the flow of gold and money
between central banks and treasuries, or any combination of these or other
international transactions.
Imports, from AmosWEB's Economics Gloss*arama.
IMPORTS: Goods and services produced by the foreign sector and purchased by the
domestic economy. In other words, imports are goods purchased from other
countries. The United States, for example, buys a lot of the stuff produced within the
boundaries of other countries, including bananas, coffee, cars, chocolate, computers,
and, well, a lot of other products. Imports, together with exports, are the essence of
foreign trade--goods and services that are traded among the citizens of different
nations. Imports and exports are frequently combined into a single term, net exports
(exports minus imports)....
Exports, from AmosWEB's Economics Gloss*arama.
EXPORTS: The sale of goods to a foreign country. The United States, for example,
sells a lot of the stuff produced within our boundaries to other countries, including
wheat, beef, cars, furniture, and, well, almost every variety of product you care to
name. In general, domestic producers (and their workers) are elated with the
prospect of selling their goods to foreign countries--leading to more buyers, a higher
price, and more profit. The higher price, however, is bad for domestic consumers. In
that domestic consumers tend to have far less political clout than producers, very
few criticisms of exports can be heard....
Balance of Trade, from AmosWEB's Economics Gloss*arama.
BALANCE OF TRADE: The difference between the value of goods and services
exported out of a country and the value of goods and services imported into the
country. The balance of trade is the official term for net exports that makes up the
balance of payments. The balance of trade can be a "favorable" surplus (exports
exceed imports) or an "unfavorable" deficit (imports exceed exports). The official
balance of trade is separated into the balance of merchandise trade for tangible
goods and the balance of services....

A balance of trade surplus is most favorable to domestic producers responsible for
the exports. However, this is also likely to be unfavorable to domestic consumers of
the exports who pay higher prices.

Alternatively, a balance of trade deficit is most unfavorable to domestic producers in
competition with the imports, but it can also be favorable to domestic consumers of
the exports who pay lower prices....
http://www.academia.edu/1577971/Balance_of_Payment_of_Bangladesh
BALANCE OF PAYMENTS:
A comprehensive set of accounts that tracks the flow of currency and other monetary assets
coming in to and going out of a nation. These payments are used for international trade,
foreign investments, and other financial activities. The balance of payments is divided into
two accounts -- current account (which includes payments for imports, exports, services,
and transfers) and capital account (which includes payments for physical and financial
assets). A deficit in one account is matched by a surplus in the other account. The balance
of trade is only one part of the overall balance of payments set of accounts.
The balance of payments provides a country with a record of international payment flows.
While the balance of trade is one important part of the balance of payments account it is
only part. The balance of payments is a comprehensive set of accounts that track all sorts of
payments coming in to and going out of a nation for a wide variety of reasons.
Specifically the balance of payments is the difference between all payments coming into a
nation and those going out of the nation. It is the balance of international monetary
transactions for a nation.
The balance of payments is effectively the difference between the funds received by a
country and those paid by a country for all international transactions. These international
transactions include (1) the exchange of merchandise (exports and imports), which is the
balance on merchandise trade, (2) the exchange of services, summarized as the balance on
services, (3) any gifts or transfer payments that do not involve the exchange of goods and
services, and the (4) the purchase of physical or financial capital assets.
The balance of payments is divided into two accounts -- current account (which includes
payments for imports, exports, services, and transfers) and capital account (which includes
payments for physical and financial assets).
Balance of Payments for Northwest Queoldiola
Balance of Payments
To illustrate the balance of
payments system of accounts,
consider the Republic of
Northwest Queoldiola, a
hypothetical country that is well
suited for this task. Other real
world countries, such as the
United States, Brazil, or
Lichenstein, have similar accounts
(albeit with different numbers).
The chart to the right presents
the hypothetical balance of
payments for Northwest
Queoldiola stated in terms of
queolds, the hypothetical
Queoldiolancurrency. The balance
of payments for real world
countries is generally stated in
terms of their domestic currencies
(such as dollars for the United
States or reals for Brazil).
First note that this chart contains
two major sections, Current
Account and Capital Account.
Details about both are
forthcoming. Near the bottom of
the chart is then a summary
Balance of the Current and
Capital Accounts,which combines
the two sections. At the very
bottom is finally the overall
Balance of Payments. Why the
overall balance is zero but the
summary balance is not is worthy
of further discussion and is also
forthcoming.
Current Account
The Northwest Queoldiola balance
of payments chart at the right
highlights the current account.
The current account is a record of
all trade between one nation and other nations. It includes payments for imports and
exports of both goods and services. It also includes monetary gifts or transfer payments to
and from other nations. This account is divided into three categories -- balance on
merchandise trade, balance on services, and unilateral transfers.

Current Account





Balance on Merchandise Trade: A click of the [MerBal] button highlights the first
portion of the Current Account. This is the difference between the payments received
for exports of goods to other nations and the payments made for the imports of
goods from other nations. The goods included are physical or tangible goods, but not
intangible services. The balance merchandise is thus appropriately divided into
Merchandise Exported and Merchandise Imported. Note Northwest Queoldiola
exports more merchandise that it imports, hence the balance is a positive number.

Balance on Services: A click of the [SerBal] button highlights the second portion of
the Current Account. This is the difference between the payments received for
exports of services to other nations and the payments made for the imports of
services from other nations. This includes only intangible services. Once again a
summary balance is provided for the trade in services, which for Northwest
Queoldiola is negative, meaning that it exports fewer services than it imports.

Unilateral Transfers: A click of the [Un Tran] button highlights the last portion of the
Current Account. This is the difference between gifts or transfers received from other
nations and transfers sent to other nations. In includes gifts or transfers between
individuals, and perhaps more important, it includes transfers between governments.
For Northwest Queoldiola transfers are positive because it receives more gifts from
other countries than it gives out.
Note that the sum of the balance on merchandise trade and the balance on services is
technically termed the balance on goods and services, or more commonly just the balance
of trade. Click the [TradBal] button for a look. This value is positive if the exports of goods
and services exceeds the imports of goods and services, which is a balance of trade surplus.
Abalance of trade deficit occurs if the exports of goods and services falls short of the
imports of goods and services, and the resulting value is negative.
Including unilateral transfers with the balance on goods and services provides a summary
value of the balances of the current account, the last line in this section. Highlighting this
can be done by clicking the [Cur Bal] button. For Northwest Queoldiola, this value is
positive.
Capital Account
Capital Account
In the middle of the Northwest
Queoldiola balance of payments
chart is the capital account, as
highlighted in the chart to the
right. The capital account includes
the flow of payments used to
purchase financial and physical
assets. Some folks in the foreign
sector purchase assets in the
domestic economy. And some in
the domestic economy purchase
assets in the foreign sector.
These purchases are be made by
individuals, business, and even
governments.
Domestic Investment in
Foreign Sector: A click of
the [Dom Inv] button
highlights this portion of
the Capital Account. This is
the net flow of payments
used by those in the
domestic economy to
purchase financial and
physical assets in other
nations. The bulk of this
category is purchases of
foreign assets, especially
physical capital, made by
private domestic
businesses. However, it
also includes purchases of
foreign assets, primarily
financial assets, made by
the domestic government
(usually the central bank
and usually in the conduct
of exchange rate policies).

Foreign Investment in
Domestic Sector: A click of
the [For Inv] button highlights this portion of the Capital Account. This is the net flow
of payments used by those in the foreign sector to purchase financial and physical
assets in the domestic economy. Once again, the majority of these payments is for
the purchase of domestic physical capital by foreign sector businesses. However,
purchases of financial capital issued by the domestic government, especially
currency, is notable.





A Balance

Summing the outflow of payments by the domestic sector for foreign assets and the inflow
of payments by the foreign sector for domestic assets generates the balance on the capital
account. For Northwest Queoldiola, this value is negative, as can be highlighted with a
simple click of the [Cap Bal] button.
A Balance of Accounts
This chart of the Northwest Queoldiola balance of payments highlights the summary balance
portion of the statement. Interestingly, the balance on the current account for Northwest
Queoldiola is a positive value and the balance on capital account is (almost) and equal
negative value. Is this mere coincidence?
Hardly. Summing the balance on the current account and the balance on the capital should,
in theory at least, equal zero. That's what the "balance" in balance of payments is all about.
Any net flow of payments for goods and services is offset by an equal but opposite net flow
of payments for capital investments. In the balance of payments, the current account and
capital account balance out to zero (in theory).
This arises because the payments are made with the domestic currency of the nation (in
this case, queolds used by Northwest Queoldiola). This currency is typically only the legal
tender for the domestic economy and is, of course, limited in supply. Thus, any domestic
currency that flows out of the country to purchase imports or invest in foreign assets must
return (eventually) to the domestic economy to purchase exports or invest in domestic
assets.
What else could those in the foreign sector do with this currency?
Let's look at this in other terms. A current account deficit arises if imports exceed exports
(with adjustments for net transfers abroad). In this case, the domestic economy is sending
more money out for these activities than it is receiving. A capital account surplus then
arises if the foreign sector is buying relatively more domestic assets than the domestic
sector is buying foreign assets. That is, the money flowing out of the domestic economy
from the current account due to imports and exports is flowing back in to purchase domestic
assets.
This has an important implication. If the current account has a deficit, then the capital
account has a matching surplus. Or if the current account has a surplus then the capital
account has a matching deficit.
While, in theory, the balance of payments is zero, in practice, measurement errors prevent
an absolute balance. Note that while the summary Balance on Current and Capital Accounts
is close to zero, it is NOT zero. It should be, but it is not.
For this reason a "statistical discrepancy" is included that is exactly equal to be opposite of
the Balance on Current and Capital Accounts. When combined, the Overall Balance is zero,
exactly as it should be.
Surplus or Deficit?
The balance of payments account for a country, in theory, and thanks to the statistical
discrepancy, in practice, achieve a balance. However, it is possible for a country to have a
balance of payments surplus or deficit -- at least temporarily. Balance of payments
surpluses or deficits can be achieved by fixing the currency exchange rate.
A Surplus: A balance of payments surplus would occur if the balance is greater than
zero. This means that the country has a net inflow of payments. More payments are
coming in to the country for exports, transfers, or investments than are going out.
Fixing the currency exchange rate below the flexible exchange rate equilibrium level
not only generates a balance of trade surplus (as the relatively low exchange rate
encourages exports and discourages imports), but it can also temporarily generate a
balance of payments surplus (as more payments come in for exports than go out for
imports).

A Deficit: Alternatively, a balance of payments deficit would occur if the balance is
less than zero. This means that the country has a net outflow of payments. More
payments are going of the country for imports, transfers, or investments than are
coming in. Fixing the currency exchange rate above the flexible exchange rate
equilibrium level not only generates a balance of trade deficit (as the relatively high
exchange rate discourages exports and encourages imports), but it can also
temporarily generate a balance of payments deficit (as fewer payments come in for
exports than go out for imports).
Balance of payments surpluses and deficits are short lived. They are achieved by forcing an
imbalance in the flow of currency either into or out of the country. Eventually this currency
will begin to flow in the other direction. Of course the policy efforts to maintain the
imbalance can be intensified to offset the natural counter-balancing flow.
But such efforts cannot be maintained indefinitely. Eventually the country will pay out all of
its domestic currency to other countries (with a balance of payments deficit) or domestically
control all of the currency of other countries (with a balance of payments surplus). Neither
of this options can actually occur.








FACTORSAFFECTING BALANCE OF PAYMENTS
Export of Goods and Services
The Prevailing Exchange Rate of the Domestic Currency:
A lower value of the domestic currency results in the domestic price getting translated into a lower
international price. This increases the demand for domestic goods and services and hence their
export. This is likely to result in a higher demand for the domestic currency. A higher exchange rate
would have an exactly opposite effect.
Inflation Rate:
The inflation rate in an economy vis--vis other economies affects the international competitiveness
of the domestic goods and hence their demand. Higher the inflation, lower the competitiveness and
lower the demand for domestic goods. Yet, a lower demand for domestic goods and services need
not necessarily mean a lower demand for the domestic currency. If the demand for domestic goods
is relatively inelastic, then the fall in demand may not offset the rise in price completely, resulting in
an increase in the value of exports. This would end up increasing the demand for the local currency.
For example, suppose India exports 100 quintals of wheat to the US at a price of Rs.500 per quintal.
Further, assume that due to domestic inflation, the price increases to Rs.530 per quintal and there is
a resultant fall in the quantity demanded to 96 quintals. The exports would increase fromRs.50,000
to Rs.52,800 instead of falling.
World Prices of a Commodity
: If the price of a commodity increases in the world market, the value of exports for that particular
product shows a corresponding increase. This would result in an increase in the demand for the
domestic currency. A fall in the demand for domestic currency would be experienced in case of a
reduction in the international price of a commodity. This impact is different from the previous one.
The previous example considered an increase in the domestic prices of all goods produced in an
economy simultaneously, while this one considers a change in the international price of a single
commodity due to some exogenous reasons.
Incomes of Foreigners:
There is a positive correlation between the incomes of theresidents of an economy to which the
domestic goods are exported, and exports. Hence, other things remaining the same, an increase in
the standard of living (and hence, an increase in the incomes of the residents) of such an economy
will result in an increase in the exports of the domestic economy Once again, this would increase the
demand for the local currency.
Trade Barriers:
Higher the trade barriers erected by other economies against the exports from a country, lower will
be the demand for its exports a hence, for its currency.

Imports of Goods and Services
Imports of goods and services are affected by the same factors that affect the exports. While some
factors have the same effect on imports as on exports, so of them have an exactly opposite effect.
Value of the Domestic Currency:
An appreciation of the domestic currency results in making imported goods and services cheaper in
terms of domestic currency, hence increasing their demand. The increased demand imports results
in an increased supply of the domestic currency depreciation of the domestic currency have an
opposite effect.
Level of Domestic Income
: An increase in the level of domestic income increases the demand for all goods and services,
including imports and it results in an increased supply of the domestic currency.
International Prices:
The International demand and supply positions deter the international price of a commodity. A higher
international price would translate into a higher domestic price. If the demand for imported goods is
inelastic, this would result in a higher domestic currency value of in increasing the supply of the
domestic currency. In case of the demand elastic, the effect on the supply of the domestic currency
would depend the effect on the domestic currency value of imports.
Inflation Rate:
A domestic inflation rate that is higher than the inflation of other economies, would result in imported
goods and services bee relatively cheaper than domestically produced goods and services would
increase the demand for the former, and hence, the supply domestic currency.
Trade Barriers:
Trade barriers have the same effect on imports exports - higher the barriers, lower the imports, and
hence, lower the supply of the domestic currency.
Income on Investments
Both payments and receipts on account of interest, dividends, profits etc., depend on the level of
past investments and the current rates of return that can be earned in an economy. For payments, it
is the level of past foreign investments and the current domestic rates of return; while for the receipts
it is the past domestic investments in foreign economies and the current foreign rates of return,
which are relevant.
Transfer Payments
Transfer payments are broadly affected by two factors. One is the number of migrants to or from a
country, who may receive money from or send money to relatives. The second is the desire of a
country to generate goodwill by granting aids to other countries along with the economic capability to
do so, or its need to take aids and grants from other countries to tide over difficulties.

Capital Account Transactions
Four major factors affect international capital transactions. The foremost is the rate of return which
can be earned on the investments as compared to the returns that can be earned on domestic
investments. The higher the differential returns offered by a country, the higher will be the capital
inflows. Another factor is the additional risk thataccompanies these returns. More the risk, lower the
capital inflows. Diversification across countries may offer some extra benefit in addition to the returns
offered by a particular investment. This benefit arises from the fact that different economies may be
at different stages of economic cycle at a given time, thus making their performance unrelated.
Higher the diversification benefits, higher the inflows. One more factor, which has a very significant
affect on these transactions, is the expected movement in the exchange rates. If the exchange rates
are quite stable, or the movement is expected to be in the investors' favor, the capital inflows will be
higher

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