Lecture Business economics - Lecture 31: Balance of payments

This chapter explain how currencies of different nations are exchanged when international transactions take place, analyze the balance sheet the United States uses to account for the international payments it makes and receives, discuss how exchange rates are determined in currency markets, describe the difference between flexible exchange rates and fixed exchange rates, Identify the causes and consequences of recent record-high U.S. trade deficits.

Balance of payments

Instructor: Prof.Dr.Qaisar Abbas

Course code: ECO 400

Lecture 31

Lecture Outline

1 Composition of BOP

2 Pakistan’s BOP

3 Causes of BOP imbalance

Some theoretical Aspects

• It’s a comprehensive record of eco transactions of the residents of a country with the rest of the world during a given time period

• It’s a tabulation of the credit and debit transactions of a country with foreign countries and international institutions

• Statistics Department of State Bank of Pakistan is responsible to compile Pakistan’s Balance of Payments Statistics (BOP) as per IMF format (BPM5)

Why is it important ?

• Its main aim is to provide the government information about the international eco position of the country and to help make decisions about monetary and fiscal issues, on one hand, and about trade and payments on the other

• Government authorities are constant users of balance of payments and other statistics in carrying out their responsibilities of monitoring economic activity, formulating recommendations an appropriate balance of payments and domestic economic policies and evaluating various economic strategies

• Regional balance of payments statistics are used both by the Pakistan’s authorities and by the authorities of partner countries to monitor developments in economic relations between Pakistan and those countries

or specific country grouping

• Pakistan’s balance of payments is used by academic and business observers as well as by policy maker around the world in monitoring developments in the worldwide payments position and in comparative studies of trends in the balance of payments of various countries

• BOP data is also used by international bodies such as IMF, World Bank and other external stakeholders etc

Why is it important ?

Composition of BOP

• Current Account: deals with the trade transactions of goods and services,

international services (tourism, transportation) and unilateral transfers (gifts and foreign aid)

• Capital Account: consists of direct investment and purchases of

interest-bearing financial instruments, non-interest interest-bearing demand deposits, gold

• Official Reserve Asset Account: measures the change in the nation’s

liquid and non liquid liabilities to foreign official holders and the change in the official reserve assets during a year

•Pakistan’s BOP situation has not been satisfactory since independence The

country with the exception of three years has been running a persistent deficit

in her BOP on current account

•These years are as follows:

• 1947-1948

• 1950-1951 (due to Korean War exports increased)

• 1972-1973 ( Devaluation of PKR)

Pakistan’s BOP

Pakistan’s BOP

• We have been having a trade balance in almost all years except for the three years i.e 1947-48, 1950-51 and 1972-73

• 1947-48: exports were Rs 444 million, imports were Rs 319 million and trade surplus of Rs 125 million

• 1950-51:Trade surplus was of Rs 176 million It was due to excess exports

of cotton and jute

• 1972-73: trade surplus was of Rs 153 million Reason was massive

currency devaluation in 1972, rupee was depreciated from 4.76 to 11

rupees per dollar Exports share in GDP rose to 14.9%

• 1982-83:After witnessing a significant improvement in 1982-83, the BOP deteriorated sharply in 1983-84 and this trend continued in 1984-85 Lower growth in merchandise exports and a decline in home remittances contributed to this situation

• 1987-88: Pakistan’s balance of payments position which had deteriorated sharply in 1987-88 with draw-down of $462 million on the foreign exchange reserves, received a terms of trade shock in 1988-89

• 1989-90:The BOP has shown improved performance during 1989-90 with reduction in current account deficit and increase in net international reserves

Pakistan’s BOP

Pakistan’s BOP Problem

• Merchandise and services account has been showing poor performance over the years since 1972-73

• Combined deficit over the years are.

• 1972-73, Rs 12.8 billion, 1975-76, Rs 25.84 billion, 1978-79, Rs 30.05 billion and 1979-80, Rs 31.62 billion

• Economy was temporary depending on external factors i.e foreign

remittances and foreign aid in 1980-81

• BOP deteriorated sharply in 1983 to 1985 because of lower growth in merchandise exports

• Trade deficit increased in1989 due to floods in punjab and sind and

disturbances in karachi

Pakistan’s BOP Problem

• Govt implemented SAP to remove imbalances in BOP Key elements were flexible exchange rates, trade and tariff reforms and viable fiscal balance

• Because of all these measures, trade deficit declined from US$1.93 billion in 1988-89 to US$ 1.70 billion in 1989-90

• Worker’s remittances were showing some declining and rising trend from 1982-83 to 2003-04

Current Position

• Pakistan is still suffering a BOP problem mainly because foreign exchange earning capacity depends on primary goods which being cheaper fetch lesser foreign exchange and for which market is unstable

• Development program require import of equipment which also cause trade deficit

Trade and Payments Growth (%)

Average (Annual)

1980s 1990s 2000s 1999-00 2006-07

2009-10(R)

Exports

(fob)

Imports

(fob)

4.5 3.2 13.7 -0.1 8.0 -1.7

Trade

Deficit

0.9 0.6 6.2 -32.3 15.0 -8.6

Workers

Remittan

ces

1.9 -5.3 26.8 -7.2 19.4 14.0

Current

A/c deficit

21.2 12.2 -4.6 -52.9 -30.3 -57.4

Trade and Payments Growth (%) Average (Annual) (%) of GDP (MP)

1980s 1990s 2000s 1999-00 2006-07

2009-10(R)

Exports

(fob)

9.8 13.0 12.4 11.2 11.9 11.1

Imports

(fob)

18.7 17.4 16.7 13.1 18.5 17.6

Trade

Deficit

Current

A/c deficit 3.9 4.5 1.5 1.6 5.1 2.2

Causes of Imbalance in BOP

• Slow growth of production: the scope for increasing the export of fruit,

vegetable and livestock products was very high in middle east, but the potential for increasing the prod of these items was not properly realized

• Marketable portion of agri prod was very small part of total prod

• Underutilization of existing capacity is there.

• Political Uncertainty: the events started with the dissolution of assembly in

1988, it greatly affected psychology of business communities

Causes of Imbalance in BOP

• Fiscal policies: heavy import duties on raw material are so high that high cost of prod makes the goods uncompetitive in the world market

• These import duties work like export duties.

• Approach of tax rebate was adopted on production of export, but this

procedure was very time consuming and complex So it greatly reduced the impact of tax rebate

• The approach should be to tax consumption not prod.

• Trade restrictions of developed countries: it has a huge impact on Pakistan's export of cotton and textile

Causes of Imbalance in BOP

• Import substitution policy of Pakistan: it is causing higher domestic prices, inefficient industries because in absence of foreign competition there is no incentive for reducing the prod cost

• Heavy import of food-grains and energy

• Inflation

• Pricing policy

• Foreign exchange remittances:

Policy Options

• Make exports more elastic.

• Reduce inflation

• Reduction in import of luxury items

• Import of raw material available in country should be disallowed

• Enhance production

• High quality exportable goods should be produced at competitive cost

• Reduction in export duties, allowing export incentives

• Establish joint ventures with friendly countries to encourage prod

Policy Options

• Floating exchange rate can also correct BOP disequilibrium

• Fully utilize idle capacity

• Encourage export of manufactured goods, particularly engineering goods.

• Export oriented industries should be exempted from sales and excise duties

Recommended Books

•

• Ishrat Husain, “Pakistan: The economy of an elitist state”, Oxford

University Press

• Zaidi, S Akbar,(1999),“Issues in Pakistan Economy”, Oxford University Press

• Saeed, K Amjad,(2007)“Economy of Pakistan, Institute of Business

Management, Lahore

• Economics Survey of Pakistan (Latest Issues), Economic Advisor’s Wing, Ministry of Finance, Government of Pakistan