How well can we account or the part of direct Investment that occurs through over- seas borrowing, yet affects the home country’s international economic position? Even more simply, how well can we measure “International” transactions that are simply transfers of funds from the account of an importer to the account of a foreign exporter in the same bank? The realistic answer to these questions Is: not very well. National governments create elaborate accounts for the transactions between their residents and foreign residents, but It is often very difficult to obtain full and accurate information.
Putting hat problem aside for the moment, let us consider the methods that governments use to record each country’s international transactions. The most widely-used measure of International economic transactions for any country Is the balance of payments (BOP). This record attempts to measure the full value of the trans- actions between residents of one country and residents of the rest of the world for some time period, typically one year.
The balance of payments is a flow concept, in that it records flows of goods, services, and claims between countries over a period of time, ether than a stock of accumulated funds or products. It is a value concept, in that all the items recorded receive a monetary value. Denominated in the given country’s currency at the time of those transactions. The balance of payments thus is a record of the value of all the economic transactions between residents of one country and residents of all other countries during a given time period. Why do countries worry about measuring these transactions?
According to Griffin and Pastas (2010) Country do so because If a country records a substantial Imbalance between Inflows and outflows of goods and services for an extended period of time, some means of financing or adjusting away the Imbalance must be found. For example, If the Euro zone countries record a persistent trade deficit with China for several years, there will be pressure to either devalue the Euro relative to the Chinese currency, the Remind, or for Chinese investors to place large and continuing investments into Euro-denominated securities.
This pressure presents both a political outcome (pressure on the Chinese government to revalue the Remind) and an economic costs, perhaps by producing in China). So, the importance of the balance of payments is not only macroeconomic, in the domain of government accountants, but also managerial, since an imbalance provides guidance to managers about expected government policies as well as about opportunities to take advantage of currency opportunities.
Since the relatively open foreign exchange markets of many countries today leave the exchange rate substantially to supply and demand, the balance of payments is an indicator of exactly that supply and demand for a country’s currency that will lead to changes in the exchange rate. The supply and demand for a currency come from both trade flows (exports and imports) and capital flows (investments and borrowing). So, the balance of payments implications for exchange rates must include both sides of the story, the “real” flows and the financial flows.
Since the balance of payments is an accounting statement it will always balance— that is, the sum of all debits or payments must equal the sum of all credits or receipts. This is guaranteed by the principles of double-entry bookkeeping. As a result, countries that are net importers of capital (exporters of securities) and have costive capital account balances will necessarily have equal negative balances on current account. A country with a current account deficit will necessarily have a capital account surplus, and one with a current account surplus will have a deficit in its capital account.
Running a deficit on the current account means that an economy is not paying its way in the global economy. There is a net outflow of demand and income from the circular flow of income and spending. Spending on imported goods and services exceeds the income from exports. In principle, there is nothing wrong with a trade deficit. It simply means that a country must rely on foreign direct investment or borrow money to make up the difference. In the short term, if a country is importing a high volume of goods and services this is a boost to living standards because it allows consumers to buy more consumer durables.
On other hand, when there is a current account deficit – this means that there is a net outflow of demand and income from a country’s circular flow. In other words, trade in goods and services and net flows from transfers and investment income are taking more money out of the economy than is flowing in. Aggregate demand will fall. When there is a current account surplus there is a net inflow of money into the circular flow and aggregate demand will rise.
When a country suffers a persistent balance of trade deficit, the nation will also suffer from a depreciating currency and will find it difficult to borrow in the international capital market Each country devise means of dealing with the deficit in the balance of payment, according to Kim and Kim (2006) , the alternatives to deal with the balance-of-payments problems include: I. Deflate the economy through tight monetary and fiscal policies, The government an adopt export promotion measures to correct disequilibrium in the balance of payments.
This includes substitutes, tax concessions to exporters, marketing facilities, credit and incentives to exporters, etc. The government may also help to promote export through exhibition, trade fairs; conducting marketing research & by providing the required administrative and diplomatic help to tap the potential imports and make it self-reliant. Fiscal and monetary measures may be adopted to encourage industries producing import substitutes. Industries which produce import bustiest require special attention in the form of various concessions, which include tax concession, technical assistance, subsidies, providing scarce inputs, etc.
Non-monetary methods are more effective than monetary methods and are normally applicable in correcting an adverse balance of payments. There are drawbacks to these fiscal policies. Such industries may lose the spirit of competitiveness. Domestic industries enjoying various incentives will develop vested interests and ask for such concessions all the time. Deliberate promotion of import substitute industries go against the principle of comparative advantage. It. Continue foreign borrowing and continue to attract foreign investment, There is a strong relationship between foreign investment and economic growth.
Larger inflows of foreign investments are needed for the country to achieve a sustainable high trajectory of economic growth. Foreign investment comes in several forms. Portfolio investment, foreign loans and foreign direct investment are the three important types. Of these foreign direct investments in industry and services are the most useful. Foreign loans are generally used for investment in infrastructure. This is important as a serious bottleneck for domestic as well as foreign investment is the poor state of infrastructure.
However the development of infrastructure alone would not suffice. Iii. Institute strict exchange controls, It is an extreme step taken by the monetary authority to enjoy complete control over the exchange dealings. Under such a measure, the central bank directs all exporters to surrender their foreign exchange to the central authority. Thus it leads to concentration of exchange reserves in the hands of central authority. At the same time, the supply of foreign exchange is restricted only for essential goods.
It can only help controlling situation from turning worse. In short it is only a temporary measure and not permanent remedy. In the other hand, the central bank of a country might decide that a lower exchange rate provides a suitable way of improving competitiveness, reducing the overseas price of exports and making imports more expensive For those countries operating with a managed exchange rate, the government may decide to authorities intervention in the currency markets to manipulate the value of the currency ‘v. Country could allow floating the currency.