BALANCE OF PAYMENTS:
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The Balance of payments accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

According to ‘American Heritage Dictionary’:
Balance of payments is a systematic record of a nation's total payments to foreign countries, including the price of imports and the outflow of capital and gold, along with the total receipts from abroad, including the price of exports and the inflow of capital and gold.

According to ‘Oxford Dictionary of Geography’:
Balance of payments is a comparison between the payments made by one country to other nations of the world and the revenue it receives from them. If receipts exceed outgoings, the balance is positive. The capital account records payments made in settlement of old debts or establishment of new ones; the current account shows payments made on goods and services, including interest payments. The balance of trade is a similar record, but registers only visible exports and imports.

According to ‘Investopedia Financial Dictionary’:
Balance of payments is a record of all transactions made between one particular country and all other countries during a specified period of time. Balance of payments compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa.

So we can say that, Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. Balance of payments positions indicate various signals to businesses. Balance of payments comprises current account, capital account and financial account.

Balance of Payments Equation

One of the ways we can express the functional form of equation [ Md /P = f (Y, r, II)] is as follows:

md/md = Y Y/Y + r r/r + II/II ……………………………..(i)

Where, md = Md/P is the real money demand

and for a given variable K, K = K t - K t-1

In Equation (i), Y, r, II are the elasticities of the demand for money with respect to real income, interest rate, and inflation respectively. Their expected signs are as follows:

Y > 0 , r < 0 , II < 0

The money demand function in nominal terms is equivalent to Equation (i) and may be expressed as follows:

Md/Md = P/P + Y Y/Y + r r/r + II II/II

On the other hand, money supply equation can be written as:

MS / MS = a/a + R/(R+DC) + DC/(R+DC) ………… (ii)

Or, MS / MS = a/a + R/H + DC/H

Where, the monetary base, H = R + DC

Rearrangements of the terms results in the following:

R/H= MS / MS - a/a -DC/H …………………………. (iii)

The equilibrium condition is:

MS = Md

Or, Md/Md = MS / MS …………………………………….(vi)

Now setting the equilibrium condition in equation (iii) and using the values from equation
(ii) we get, the Balance of Payments Equation as follows:

R/H =  P/P + YY/Y+ r r/r + II II/II- a/a - DC/H

Types of Balance of Payments

Current account: Current account is a detailed financial statement representing the debit and credit relationship between two parties that has not been finally settled or paid because of the continuous, ongoing dealings of the parties.

Capital account: An account stating the amount of funds and assets invested in a business by the owners or stockholders, including retained earnings.

Approaches to the Balance of Payment

There are three analytical approaches to the balance of payment :
(i) The elasticity approaches (ii) The absorption approach and (iii) The monetary approach.

(i) The Elasticity Approach
Robinson developed this approach originally in 1930’s. It concentrates on the elasticity condition necessary for a devaluation to improve the current account component of balance of payment. It is a partial equilibrium model, which focus on the response of exports and imports to charges in relative prices and ignores income effects, capital flow, and the money market.

(ii) The Absorption Approach
This approach emphasizes the fact that payments imbalances are characterized by ex ante divergences between aggregate income receipts and aggregate domestic expenditures (absorption). This approach focuses specific attention upon the product market, rather less on the exchange rate market and appears to ignore completely the money market.

(iii) The Monetary Approach
According to this approach it would appear that what is happening to a country’s balance of payments will depend, given the demand for money in that country and in the rest of the world, upon the rate of the growth of the money supply in the country vis-à-vis the rate of growth of the money supply in the rest of the world. The key feature of the monetary approach is the automatic balance of payments adjustment mechanism i.e., a balance of payment surplus or deficit is removed by adjustment of money supply to money demand.

Current statistics of balance of payment in Bangladesh

(In million US$)
Items 2010-11
July-Nov 2011-12
July-Oct 2011-12
July-Nov % Changes
4 over 2
1 2 3 4 5 Trade balance -2754 -2421 -3645 Export f.o.b.(including EPZ) 8297 8180 9785 17.93 Of which : Readymade garments 6417 6315 7563 17.86 Import f.o.b (including EPZ) 11051 10601 13430 21.53 Services -968 -909 -1166 Credit 1039 947 1142 9.91 Debit 2007 1856 2308 15 Primary income -614 -612 -729 Credit 46 28 30 -34.78 Debit 660 640 759 15 Of which : Official interest payments 132 154 188 Secondary income 5098 4372 5526 Official transfers 44 34 34 Private transfers 5054 4338 5492 8.67 Of which : Workers' remittances 4581 4012 4921 7.42 Current Account Balance 762 430 -14 Capital account 146 114 116 Capital transfers 146 114 116 Others 0 0 0 Financial account -1269 -1103 -844 Foreign direct investment (net) 285 324 377 32.28 Portfolio investment (net) 56 31 86 Other investment (net) -1610 -1458 -1307 Medium and long-term (MLT) loans 424 192 264 -37.74 MLT amortization payments 291 256 341 17.18 Other long term loans (net) -69 -44 32 Other short term loans (net) 25 -212 -373 Trade credit (net) -1083 156 370 Other assets -335 -1199 -1298 DMBs and NBDCs (net) -281 -95 39 Assets 350 175 -7 Liabilities 69 80 32 Errors and omissions -223 175 -236 Overall Balance -584 -384 -978 Reserve Assets 584 384 978 Bangladesh Bank (net) 584 384 978 Assets* -767 -515 -1527 Liabilities -183 -131 -549 Memorandum Items : Gross reserves (before valuation adjustments) 11417 10398 9145 Valuation Adjustment During the Period -717 -60 140 Gross reserves (after valuation adjustments) 10700 10338 9285 In months of imports of goods and services 4.1 3.32 2.95 ODs to ADs and Reserve held at OBUs 0 -119 41

It is clear that Bangladesh is facing continuous Balance of Payment Deficit.

Causes of Balance of Payment deficit
A current account deficit occurs when the value of imports (of goods, services and investment incomes) is greater than the value of exports.
There are various factors which could cause a current account deficit:
1. Fixed Exchange Rate
If the currency is overvalued, imports will be cheaper and therefore there will be a higher Q of imports. Exports will become uncompetitive and therefore there will be a fall in the quantity of exports.
2. Economic Growth
If there is an increase in national income, people will tend to have more disposable income to consume goods. If domestic producers can not meet the domestic demand, consumers will have to import goods from abroad.
3. Decline in Competitiveness.
In Bangladesh there has been a decline in the exporting manufacturing sector, because it has struggled to compete with developing countries in the far east. This has led to a persistent deficit in the balance of trade.
4. Higher inflation
This makes exports less competitive and imports more competitive.
5. Recession in other countries.
If Bangladesh’s main trading partners experience negative economic growth then they will buy less of our exports, worsening the current account.
6. Borrowing money
If countries are borrowing money to invest e.g third world countries like Bangladesh.

7. Deterioration in the current account This means that the value of exports has increased at a slower rate than the value of imports. Therefore there could have been an increase in the deficit or the surplus could have changed into a deficit.

Balance of Payments problem in developing countries, especially in Bangladesh has been very important and burning issue of the recent days. It tells how many goods and services a country has been exporting and importing and how much a country is borrowing or lending. In this way BALANCE OF PAYMENTS accounts are the statistical record of all transactions taking place between its residents and rest of the world and would help to formulate a country’s future strategy. This is the time of competition and technology. The one who will opt new methods of living, new methods of economic stability will get his share from the rest of the world, otherwise will remain behind. Bangladesh being a developing country should go forward to enter in the circle of developed countries. For this purpose we have to correct our BALANCE OF PAYMENTS situation.

Steps to Reduce Continuous Balance of Payment Deficit
1. Devaluation
Devaluation is the decision to reduce the value of a currency in a fixed exchange rate. This involves reducing the value of the currency against others.
Advantages of Devaluation
1. Exports become cheaper, more competitive to foreign buyers. Therefore, this provides a boost for domestic demand.
2. Higher level of exports should lead to an improvement in the current account deficit. This was important in the case of the UK who had a large current account deficit of over 3% of GDP in 2008
3. Higher exports and aggregate demand can lead to higher rates of economic growth.
The Marshall Learner Condition
This states that a devaluation will improve the balance on the current account, on the condition that the combined elasticity’s of demand for imports and exports is greater than one.
• If (PED x + PED m > 1) then a devaluation will improve current account
• If (PED x + PED m > 1) then an appreciation will worsen current account
This is because the effect on the current account depends on the total value and not just the quantity of exports.
The J Curve effect
In short term demand for imports and exports tends to be inelastic. Therefore, after a devaluation, the current account tends to get worse before it gets better. Over time, demand becomes more price elastic.

Another problem with devaluation is that it can lead to imported inflation. This is a problem if it leads to cost push inflation. This means the improvement in the current account might only be temporary.
2. Deflation
If govt reduces Aggregate Demand by raising interest rates or increasing taxes then people will have less money to spend so they reduce consumption of imports.
• The Bangladesh has a high marginal propensity to import therefore a reduction in Aggregate Demand improves the current account significantly.
• Deflationary policies will also put pressure on manufacturers to reduce costs and this will lead to more competitive exports and so exports will increase
• The success of this policy depends on the elasticity of demand for imports
• However this policy will conflict with other macroeconomic objectives with lower Aggregate Demand, growth is likely to fall causing higher unemployment.

3. Supply Side Policies
These can improve the competitiveness of the economy and exporters, but this will take time to have effect.
Most supply side policies aim to enable the free market to work more efficiently by reducing govt interference.
1. Privatisation.

This involves selling state owned assets to the private sector. It is argued that the private sector is more efficient in running business because they have a profit motive to reduce costs and develop better services.
2. Deregulation

This involves reducing barriers to entry in order to make the market more competitive. For example BT used to be a Monopoly but now telecommunications is quite competitive. Competition tends to lead to lower prices and better quality of goods / service.
3. Reducing Income Taxes.

It is argued that lower taxes (income and corporation) increase the incentives for people to work harder, leading to more output.
However this is not necessarily true, lower taxes do not always increase work incentives (e.g. if income effect outweighs substitution effect)
4. Increased education and training

Better education can improve labour productivity and increase aggregate supply.
Often there is under-provision of education in a free market, leading to market failure. Therefore the govt may need to subsidies suitable education and training schemes.
However govt intervention will cost money, requiring higher taxes, it will take time to have effect and govt may subsidies the wrong types of training
5. Reducing the power of Trades Unions

This should
a) Increase efficiency of firms e.g. less time lost to strikes
b) reduce unemployment ( if labour markets are competitive)

6. Reducing State Welfare Benefits
This may encourage unemployed to take jobs.
7. Providing better information about jobs
This may also help reduce frictional unemployment
8. Deregulate financial markets to allow more competition and lower borrowing costs for consumers and firms.
9. Lower Tariff barriers will increase trade
10. Removing unnecessary red tape and bureaucracy which add to a firms costs
11. Improving Transport and infrastructure.
Due to market failure this is likely to need govt intervention to improve transport and reduce congestion. This will help reduce firm’s costs.
12 Deregulate Labour Markets
This is said to be an important objective for Bangladesh to increase competitiveness. E.g. make it easier to hire and fire workers.
4. Protectionism
Increased tariffs of quotas will reduce imports and improve the current acc
However: 1) Protectionism leads to retaliation so exports will decrease 2) Domestic industries may become uncompetitive, because there is no incentive.

Policy measures for Reducing BALANCE OF PAYMENTS Deficit in Bangladesh

Various measures may be taken for improving the different components Of the BALANCE OF PAYMENTS which are listed below:

1. Appropriate use of Fiscal and Monetary Policies, income and wage policies, and exchange rate policies

2. Improving the domestic political environment and law and order situation.

3. Measures to increase agricultural productivities and to maintain appropriate price for agricultural produce and setting up of agriculture based industries.

4. Facilitating the foreign investors in Bangladesh with improved infrastructural to increase export.

5. Encouraging the setting up of fruit processing industries

6. Encouraging the competitive behaviour of Bangladeshi investors with rest of the world.

7. Improvement of R&D facilities and level of education in the country.

8. Encourage Bangladeshis to use domestic products, which will reduce the import bill.

9. Exemption for exporters and domestic investors from excise duties and sales taxes and encouraging the high value added industries.

10. Arrangement of provision of credit to small and medium size investors and farmers.

11. Allowing duty-free import of textile machinery and duty-free import of other old machinery.

12. Setting up of more export processing zones in the country and supplying infrastructural facilities for the investors. The Journal of Commerce

13. Making arrangements for export of skilled manpower rather than unskilled ones on high wages and setting up of polytechnic colleges or institutes and training centers for the manpower going abroad.

14. Opening up of saving schemes for low-income groups to encourage savings out of their income.

15. Making arrangement to strengthen oil and gas and technology sectors.

16. Financing the educational activities and improving the quality of higher education.

17. Policies may be made to facilitate indirect exports and small and medium enterprises and ban on any type of export may be lifted.

18. Exporter of all level may be educated about the latest international rules and regulations to compete the international market.

19. Free import of high tech. Machinery such as computers may be allowed.

20. Policy measures to face the debt problems of Bangladesh, e.g., to improve external debt, policy to increase country’s export may be strengthened by developing the domestic production.

21. Restoring the donor’s and investor’s (both external and internal) confidence.

22. Most of the producers, exporters and policy makers are not aware of Uruguay Round Trade Agreement on Agriculture. There is an urgent need to pursue public awareness program on the impact of trade liberalization on agriculture, including trade policy developments, priorities and strategies of the major trading partners of Bangladesh.