Balance of payments

By:

James Knight

James is a lead editor for Invezz, where he covers topics from across the financial world, from the stock… read more.

Updated: Aug 20, 2021

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This is, effectively, the income and expenditure account of a nation over a given period. In the U.K. the most important account is that prepared at the end of a fiscal year on which the Chancellor of the Exchequer, guided by the permanent secretaries at the Treasury, bases his official annual budget. Monthly balance of payments accounts arc, however, also published, in two principal parts- the balance of external trade and the movements of capital to and from other countries.

The balance of trade deals with exports invisible. Visible trade is that concerned with buying and selling goods. Invisible trade consists of services provided to (or by) other nations, e.g. by insurance companies. discount houses, currency dealers. shipping firms issuing charters or handling cargoes, etc. It also covers interest charged on foreign loans and income earned or expenditure incurred in expediting foreign trade generally, e.g. in the provision of financial services. In recent years the tourist industry has been an important factor in invisible trade when it involves the transfer of foreign currencies.

Movements of capital, the second ingredient of the balance of payments, relates to the volume of international investment either by or in other countries. The amount of such investment is influenced by many factors, not least of which is the level of interest rates. In the absence of express government interference, and other things being equal, money is attracted to the place where interest rates on low risk capital are greatest. Any government can attempt to regulate the inflow of foreign currencies by the manipulation of the central bank’s base rate, which will, in turn, have a parallel influence on interest rates generally. Naturally, the fact that interest paid will itself have a detrimental effect on the balance of payments must be taken into account in any long-term planning by the State and puts a restraining hand on any tendency to push up too far the rates offered. Additionally, where exchange rates are volatile, the attraction of high interest rates may be counter-balanced by the possibility of losses brought about by depreciation of the capital invested.

There are limits to the power of any government to balance its national accounts by playing with interest rates- at least in the long run. Nevertheless, in that long run. a balance on international payments must be achieved and this is at the root of many currency devaluations. Short- or medium-term imbalances can be covered either in the traditional way by the transfer of gold or foreign exchange reserves or. more commonly nowadays, loans – either direct from one country to another or, indirectly, through one of the international financial bodies, e.g. the International Monetary Fund.

A healthy economy will have little trouble in balancing its payments and a prosperous economy will budget for surpluses on its balance of trade in successive years, thereby building up both its reputation and its reserves. There is a parallel here with the successful public company which, by good management and perhaps a run of good fortune, is able continually to increase its capital by adding annually to its reserves. provided that such additions are real and. not merely a reflection of inflationary costs and prices.

Reference: The Penguin Business Dictionary, 3rd edt.