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BOP What Is Balance of Payments?: Exam Question

The balance of payments (BOP) is a summary of all trade and financial transactions between a country and its trading partners over a specified period. It consists of three main sections: the current account, the capital or financial account, and changes in official net foreign exchange reserves. Imbalances in the BOP can have significant economic implications, with surpluses potentially leading to currency appreciation and deficits indicating a country consumes more than it produces.

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18 views3 pages

BOP What Is Balance of Payments?: Exam Question

The balance of payments (BOP) is a summary of all trade and financial transactions between a country and its trading partners over a specified period. It consists of three main sections: the current account, the capital or financial account, and changes in official net foreign exchange reserves. Imbalances in the BOP can have significant economic implications, with surpluses potentially leading to currency appreciation and deficits indicating a country consumes more than it produces.

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BOP

What is Balance of payments?


- A summary of all the trade and financial transactions between a country and its trading
partners over a specified period of time

Exam Question

Explain the difference between a “national balance sheet” and a “balance of payments” and describe
how the two concepts are related. (10)

national balance sheet is a summary-aggregated statement of a country’s assets and liabilities, which
is similar to a firm’s balance sheet. The balance of payments is more like a company income statement
than a balance sheet. As such, it is a record of the monetary values of the various flows of

goods, services and financial assets between countries rather than a measure of the existing national
stocks.

How are the two measurers related? – Exam Question


the net flows of foreign exchange resulting from international transactions lead to a change in a
country’s stock of foreign exchange reserves.

The SA’s Balance of payments

Exam question: describe the main elements that are found in the South African BOP?

Three main sections or elements are present:

1. The current account


2. The capital or financial account
3. The change in the official net foreign exchange reserves.

The current account

Can be subdivide into:

1. The trade account


2. Net service receipts
3. Net income receipts
4. Current transfers

The trade account comprises trade in physical goods. The trade balance is not shown explicitly in the
South African balance of payments, but it can easily be calculated by subtracting the value of
merchandise imports from the value of merchandise exports and net gold exports.

A deficit on the current account means in fact that South Africans borrow in order to spend, and this of
course could have the same dire consequences for a country that it has for an individual.

What do services and income consist of?


Services -are transport of goods and passengers between countries; freight and merchandise
insurance; other financial services; various business, professional and technical services; government
services; and foreign travel.
The main income items are interest; dividends; and foreign branch profits. Why are these items included
in the current account and not in the financial account?
- The reason is that interest, dividends and foreign company profits are properly regarded as
ongoing (foreign) investment income flows derived from prior investments of capital abroad.
The financial account
previously referred to as the capital account) records exchanges of international asset claims. Eg a Zim
Bank buys a bond issued buy the SA government. An Sa company purchasing shares in a Zim
company. Etc.
Note that this account DOES NOT record STOCKs of the assets and liabilities, rather it records changes
to the account. ( can be -ve or +ve or zero)

Direct investment
refers to foreign investments in South Africa (changes in foreign liabilities or inflows) and investments
abroad by South African residents (changes in foreign assets or outflows) where the companies or other
organisations concerned have a significant share of such investments.

Portfolio investment
is the purchase and sale of financial claims such as bonds, treasury bills and equities. Unlike direct
investments, there is no intention by the investor to exercise any control over portfolio investments

Why FDI more preferable than portfolio investment

- because it demonstrates a stronger commitment to invest for a longer term.


- It is more stable than speculative hot money

Unrecorded transactions
arise from the use of a double-entry accounting system to reconcile the balance of payments. The net
sum of debit and credit entries arising from balance of payments transactions should equal the change
in the country’s net gold and foreign exchange reserves. But due to errors and omissions from
compilations, this is seldom the case.
The difference between the recorded change in the net gold and foreign exchange reserves and the
sum of the current, capital transfer and financial account balances is classified as unrecorded
transactions

In actual sense unrecorded transactions serves as a residual that ensure that the BOP will always
balances

The official reserves


Net inflow or outflows of foreign exchange are reflected by the changes in the stocks of official gold
and other foreign reserves.
- It would be fascinating to view BOP by imagining their effect on the foreign exchange market
- Any transaction that leads to a derived demand for foreign currency can be thought of as a
debit (-) item or outflow of foreign exchange, importers demand foreign currency in order to
place orders (and thus a corresponding supply of Rands on the FE market)
- Any transaction that results in a supply of Foreign currency in the Foreign Exchange FE market

Changes in the net gold and foreign exchange reserves are sometimes also called accommodating or
below-the-line foreign exchange flows, in contrast to autonomous above-the-line flows.

EXAM QUESTION
Evaluate the significance of imbalances that may occur within the balance of payments. (15)

Note that the imbalances that happen in the BOP have got several economic significances .
This can happen in the form of a surplus or a deficit

Hence in answering this question, one needs to note that current account deficit is not necessarily bad
while current account surplus is not necessarily good.
:
- Large current account surpluses may lead to currency appreciation which reduces the demand
for exports and increasing the demand for imports
- This in turn will lead to a decrease in Aggregate demand, production and employment in the
SR
- A current account deficit implies that a country is consuming more than it is producing.
Imported goods add to consumer welfare, whereas exports represent a sacrifice in the sense
that goods and services are produced, but they are not available for domestic consumption

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