Balance of Payments (BOP) and Exchange Rates
A Balance of Payments, which is also referred to as BOP, is a type of accounting record whereby all of a country’s monetary transactions associated with the rest of the world are recorded. The types of transactions included on the BOP sheet include export and import payments for goods, services, capital, and even financial transfers. In other words, the Balance of Payments sheet is used to summarize all international transactions that take place within a designated amount of time, which is typically 12 months.
The transactions would also be recorded as a single currency, which is usually the domestic currency that the country using the BOP uses. In addition, the Balance of Payments sheet is used to keep track of investments and loans, as well as exports, which are listed as surplus. Then, the BOP sheet would provide detail on the way in which funds are used, which might be as investment in one or more foreign countries or imports. In this case, the entries are listed as a deficit.
Once the BOP sheet has been completed, the next step is balancing the sheet. In this case, the sum to zero must be determined so ultimately, no surplus or deficit would exist. Let us say that a particular country was importing a greater amount of goods than what it exports. Using this scenario, the Balance of Payments accounting record would show a deficit, which would then need to be balanced out in some way. This might be accomplished by reducing reserves, earning funds from investments in foreign countries, or perhaps receiving loans from foreign countries.
Keep in mind that the Balance of Payment sheet will always balance once every type of payment has been added. With this, an imbalance on the sheet would be possible for one specific element listed on the sheet. When this happens, surplus countries would actually build a tremendous amount of wealth. On the other hand, any deficit countries would fall further and further into debt.
Regarding the right way to correct imbalances that show up on the Balance of Payment sheet, several suggestions have been made throughout history but there is still debate whether country governments should have issues with this or be concerned. When looking at the world financial crisis that started in 2007 and is still affecting society today, it all began when all-time imbalances existed. Because of this, finding out the right way to handle these global imbalances has become a top priority of policymakers.
The Balance of Payment sheet has been comprised of two divisions since 1973 to include the current account and the capital account. For the current account, a country’s net amount would be listed but only if it is surplus or in the case of spending if the entry were a deficit. The sum of the current account includes any net earnings on exports but also any payments made on exports.
Then for the capital account on the BOP sheet, this is a record of net change in ownership of foreign assets. In this case, the record would include the reserve account, which is the nation’s central bank operations internationally, plus investments and loans between one country and other countries in the world. The only exclusion would be future regular repayments, loan dividends, and investment yield, which would actually be recorded on the BOP current account sheet.
To re-balance the Balance of Payment sheet, several options exist, one being with the change of the exchange rate. As a country’s currency increases in value when compared to currencies from other countries, a nation’s exports would become less competitive. With that, imports would be less expensive, which then helps correct the current account surplus. In addition, when this occurs, investments that flow into the capital account would not be as appealing, which helps balance the surplus.
On the other hand, when a country’s currency sees a decline in value, buying imports would be more expensive and level of competitiveness of exports would increase. With this, the deficit is corrected. Of course, the government must make changes to exchange rates using rules that are based on or managed by currency regime. Therefore, when currency is allowed to float freely within the foreign exchange market, rates will also change to help restore balance to the BOP.
