The Nature of the Balance of Payments

The balance of payments is one of the most important concepts of the international economics. Its study provides a generalized estimator of the economic situation of the country, the effectiveness of its international economic relations. Functionally, the balance of payments plays the role of the macroeconomic model that systematically reflect economic transactions which is carried out between the national economy and the economies of other countries. Such a model is established to develop and implement reasonable exchange rate and foreign economic policy; to carry out the analysis and forecasts of the commodity and financial markets, to carry out bilateral and multilateral comparisons; to do scientific researches, etc. On the basis of actual data of the balance of payments, the international financial institutions, particularly the IMF, make a decision on the providing the particular countries with financial assistance for the stabilization of the balance of payments and to deal with its deficit.

The balance of payments is a statistical report that in a systematic way includes a summary of data on economic transactions between residents of a given country and the residents of other countries (non-residents) for a certain period of time.

The balance of payments fulfils the following functions:

- it is a source of information, as it gives an opportunity to get an idea of the country's international relationships, structural changes of international transactions;

- the characteristics of the balance of payments has both the practical and the scientific value, as far as it allows to simulate the processes of macroeconomic development of an open economy;

- it serves as a reference point for the government, which is responsible for the economic policy, since monetary and fiscal measures as well as measures to promote competition, are often the result of the balance of payments, the result of international influence, which is fixed by the balance of payments.

The Compilation Principles of the Balance of Payments

The balance of payments is based on certain principles derived from its purpose, which is to consider foreign trade operations. The economic operation is considered to be a foreign one, if it is carried out between the economy of a particular country and the economies of the rest of the world. Economic transactions that take place between residents and non-residents cover the dealings, the subject of which are goods, services, incomes, external financial assets and liabilities.

Economic transactions, by the definition of IMF, are the economic flows that reflect the transfer of real resources (transactions in goods, services and income), and the creation, liquidation of foreign financial asset or liability and / or the transfer of ownership to the existing external financial asset and liability (transactions with external financial assets and liabilities).

There are exchange and unilateral foreign economic transactions.

Most economic transactions which are recorded in the balance of payments are exchange, and presuppose that one transact or transfers the economic value to another one and receives its value equivalent. There are three types of international exchange transactions: i) the exchange of goods and services for other goods and services (the barter transactions, because both sides of these transactions are real), and 2) the exchange of goods and services for cash or other financial claims, where one side of the transaction is real, the other one is financial, and 3) the exchange of financial instruments for other financial instruments, in other words both of sides are financial transactions.

The transactions whereby one side of an agreement provides economic value to another side without the return of value equivalent are called unilateral. This absence of value on one side is represented by an entry referred to as a transfer - is made as the required of offsets. Transfers act usually in the form of cash or goods. A particular foreign transaction is recorded in the balance of payments depending on which of these species it belongs to.

Defining the subject of the foreign economic transaction is based on such a concept as "economic territory of the country" that is identical to the concept "economy". Economic territory, by IMF definition, is a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely. However, this territory does not always coincide with the geographical boundary of the state, because its boundaries include the territorial enclaves outside the main border: embassies; consulates; military bases; scientific stations; information, immigration or aid agencies, located in other states and used by governments that own or rent them.

The concept of economic territory plays a significant role in determining the first principle of the balance of payments, namely the residence principle. The concept of residence in the system of the balance of payments is not based on the criteria of national identity or the legal criteria for the determination of residents of a particular state.

The economic entity ( the economic unit), the center of economic interest of which is in the economic territory of the country, is a resident of that country. The economic entity has a center of economic interest in a country, if it has already engaged in economic activities and transactions on a significant scale in the country for one year or more, or if the unit intends to do so. The establishment of resident units is crucial in terms of registration and classification of transactions within a particular economy. Position of working one as a resident and nonresident defines different entries in the balance of payments.

According to the classification of the IMF, to the residents of the economy include the following business units:

• households and individuals who make up a household;

• legal and social entities (companies of different legal forms);

• non-profit institutions;

• the public authorities of that country.

The second principle of the balance of payments is the principle of double entry. Since the balance of payments is based on the principles of accounting, each recorded transaction must be represented by two entries with equal values: a credit entry and a debit entry. A credit entry has a positive arithmetic sign (+) and displays the transaction of "export type", due to which foreign currency are received or earned. A debit entry has a negative sign (-) and reflects the transaction of "import type", in which the foreign currency is spent. A credit side shows the foreign exchange earnings (its supply) and a debit side shows the spending of foreign currency (demand for it). So, according to the double-entry system the reduction of international assets of the country or the increase in its foreign liabilities are recorded on the credit side; the increase of international assets or reducing of its external obligations are recorded on the debit side. Each change on the debit side must be accompanied by a corresponding change on the credit side, and vice versa. Thus, the total debit and the total credit of the balance of payments are always equal.

The third principle of the balance of payments is the principle of the uniform system for valuation of transactions, recorded in the balance of payments. The essence is that market prices that are aligned with economic transactions are used for the evaluation of transactions in real recourses and financial assets and liabilities. The market prices, as defined by the IMF, are the amounts of money that willing buyers pay to acquire something from willing sellers. The exchange are made between independent parties and on the basis of commercial considerations only. The market price refers only to the price for one specific transaction. The market price is clearly distinguished from a price quoted in the market, a world market price, a going price, i.e., the price that is not a price actually applying to a specific exchange. There are some situations, when the market price in accordance with the above-mentioned criteria cannot be defined. This occurs in the case of: the barter transactions; a transaction between separate legal entity that are not independent (affiliated enterprises); goods transferred under a financial lease arrangement), etc. In these cases, the valuation of transactions is performed at the prices of similar transactions.

Compliance with the given principle ensures comparability of the balance of payments in different countries, as well as comparability of accounts of the balance of payments of the particular country.

The fourth principle of the balance of payments is the principle of timing. Each transaction should be reflected in the balance of payments on the credit side and on its corresponding debit side at the same time, and both parties of the transaction should record the operation under the same number, which corresponds to the date of its execution. To implement such an approach it is necessary to determine the time of transactions' recording in the balance of payments. Such a moment can be the time of conclusion of the contract or time of transference of legal ownership on the assets. If the moment of the transfer of ownership is difficult to determine, then it is considered to be the time corresponding accounting entry in the accounting of counterparts.

During the compilation of the balance of payments, it is important to establish the monetary unit, in which it should be kept a record, that is, to define the unit of account. The unit of account must be stable enough, in order that the change of its course during the reference period could not reflect on the bottom line, in addition, it should be stable for the largest possible number of accounting periods to ensure comparability and analysis of their dynamics. In the preparation of the balance of payments it should be used the unit of account used by them in the internal payments and accounting. However, it is necessary to note that the balance of payments in most countries is kept in U.S. dollars.

 
< Prev   CONTENTS   Next >