One of the six government economic objectives is to keep Balance of Payment at the appropriate healthy level.
To start with, Balance of Payment records value of all the transactions between a country and all the rest of the world during a particular period of time, usually one year.
Specifically, Balance of Payment includes three components:
1. Current Account:
– Imports and Exports of goods and services.
2. Capital Account:
– Lending to and borrowing from other countries.
– Foreign Direct Investments (FDI).
3. Official Settlements Account:
– Holdings of gold.
– Reserves of foreign currencies.
The value of nation’s export earnings and its import spending extracted from the Current Account in Balance of Payment is called Balance of Trade. Balance of Trade is the difference between the value of exports and imports of goods and services of a country over a year.
Balance of Trade = Exports – Imports
Exports
Exports are all the goods and services sold to consumers and business in other countries. Consumers and businesses in other countries will be using the country’s currency. Exports involve money coming into the country.
Imports
Imports are all the goods and services purchased from businesses in other countries. Consumers and businesses in the country will be using a foreign currency. Imports involve money flowing out of the country.
International trade should be balanced
Governments should strive to avoid a deficit on their international trade balance (imports spending exceeding exports earnings). It is because countries, the same as individual people, are not able to spend more than they earn in the long run to sustain themselves without borrowing.
Trade Surplus: Exports > Imports
Trade Balance is positive.
A trade surplus means that the value of goods and services exported to other countries exceeds the value of goods and services imported from other countries.
A trade surplus occurs when a country does produce everything it needs and even more, so it sells surplus of its own home products to other foreign countries that pay for the exports.
The government could appreciate home currency to achieve trade balance (exports = imports).
Trade Deficit: Exports < Imports
Trade Balance is negative.
A trade deficit means that the value of goods and services imported from other countries exceeds the value of goods and services exported to other countries.
A trade deficit occurs when a country does not produce everything, and needs to buy products from foreign countries and pay for those imports. If a country does not have enough earnings from exports, it will need to borrow from other countries to pay for those imports.
The government could depreciate home currency to achieve trade balance (exports = imports).
It is usually better for a country to have a positive Trade Balance and Balance of Payment as more money enters into the country than leaves it.
