💾 Archived View for gmi.noulin.net › mobileNews › 3874.gmi captured on 2023-06-16 at 19:11:54. Gemini links have been rewritten to link to archived content
⬅️ Previous capture (2023-01-29)
-=-=-=-=-=-=-
2012-03-13 07:02:18
August 18 2009 | Filed Under Economics , Economy , Financial Theory ,
Insurance , International Markets , Options
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, the capital 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. (For background reading, see What Is The Balance Of
Payments?)
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.
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).
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).
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.
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.
Advertisement - Article continues below.
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:
CAB = X - M + NY + NCT
What Does It Tell Us?
Theoretically, the balance should be zero, but in the real world this is
improbable, so if the current account has a deficit or a surplus, this tells us
something about the state of the economy in question, both on its own and in
comparison to other world markets.
A surplus is indicative of an economy that is a net creditor to the rest of the
world. It shows how much a country is saving as opposed to investing. What this
means is that the country is providing an abundance of resources to other
economies, and is owed money in return. By providing these resources abroad, a
country with a CAB surplus gives other economies the chance to increase their
productivity while running a deficit. This is referred to as financing a
deficit.
A deficit reflects an economy that is a net debtor to the rest of the world. It
is investing more than it is saving and is using resources from other economies
to meet its domestic consumption and investment requirements. For example, let
us say an economy decides that it needs to invest for the future (to receive
investment income in the long run), so instead of saving, it sends the money
abroad into an investment project. This would be marked as a debit in the
financial account of the balance of payments at that period of time, but when
future returns are made, they would be entered as investment income (a credit)
in the current account under the income section. (For more insight, read
Current Account Deficits.)
A current account deficit is usually accompanied by depletion in
foreign-exchange assets because those reserves would be used for investment
abroad. The deficit could also signify increased foreign investment in the
local market, in which case the local economy is liable to pay the foreign
economy investment income in the future.
It is important to understand from where a deficit or a surplus is stemming
because sometimes looking at the current account as a whole could be
misleading.
Analyzing the Current Account
Exports imply demand for a local product while imports point to a need for
supplies to meet local production requirements. As export is a credit to a
local economy while an import is a debit, an import means that the local
economy is liable to pay a foreign economy. Therefore a deficit between exports
and imports (goods and services combined) - otherwise known as a balance of
trade deficit (more imports than exports) - could mean that the country is
importing more in order to increase its productivity and eventually churn out
more exports. This in turn could ultimately finance and alleviate the deficit.
A deficit could also stem from a rise in investments from abroad and increased
obligations by the local economy to pay investment income (a debit under income
in the current account). Investments from abroad usually have a positive effect
on the local economy because, if used wisely, they provide for increased market
value and production for that economy in the future. This can allow the local
economy eventually to increase exports and, again, reverse its deficit.
So, a deficit is not necessarily a bad thing for an economy, especially for an
economy in the developing stages or under reform: an economy sometimes has to
spend money to make money. To run a deficit intentionally, however, an economy
must be prepared to finance this deficit through a combination of means that
will help reduce external liabilities and increase credits from abroad. For
example, a current account deficit that is financed by short-term portfolio
investment or borrowing is likely more risky. This is because a sudden failure
in an emerging capital market or an unexpected suspension of foreign government
assistance, perhaps due to political tensions, will result in an immediate
cessation of credit in the current account.
Conclusion
The volume of a country's current account is a good sign of economic activity.
By scrutinizing the four components of it, we can get a clear picture of the
extent of activity of a country's industries, capital market, services and the
money entering the country from other governments or through remittances.
However, depending on the nation's stage of economic growth, its goals, and of
course the implementation of its economic program, the state of the current
account is relative to the characteristics of the country in question. But when
analyzing a current account deficit or surplus, it is vital to know what is
fueling the extra credit or debit and what is being done to counter the effects
(a surplus financed by a donation may not be the most prudent way to run an
economy). On a separate note, the current account also highlights what is
traded with other countries, and it is a good reflection of each nation's
comparative advantage in the global economy.
by Reem Heakal