Assignment :-“ECONOMICS”

Submitted by :-AFZAAL ALIROLL NO 322SECTION “E”

Submitted To:-MISS NABEELA ASGHAR

-: -:CONTENTS:- :-

Balance of Payment Difference between BOT and BOP

Balance of Payment Equilibrium

Types of BOP Equilibrium Balance of payments in Pakistan, past and present

Summary of Balance Of Payment

Causes for negative balance of payments

Solution Conclusion

Balance of Payment:-“It is a systematic record of all the economic transactions betweendomestic country and rest of the world is known as Balance ofPayment.”

It includes the payments and receipts during exports, imports, Foreign remittances, inward or outward investments etc… Balance of Payment is the difference between Current Account and Capital account of a country.

The Current Account further includes Trading Account, ServiceAccount, Income Account and unilateral transfers and other relateditems.

The Capital account includes Loan transactions, inward or outward Investments, short-term capital and other related items.

Transactions are generally between residents and non-residents. The exceptions are the exchange of transferable foreign financial assets between residents and transferable foreign financial liabilities between non-residents. For the purposes of the Balance of Payments, residency relates to the economic territory of a country, not nationality. An international unit is resident unit when it has a centre of economic interest in the economic territory of a country. The Balance of Payments methodology uses a double- entry accounting system. This means that every recorded item should have a debit and a credit, and there should be a net balance of zero.

Positive and Negative effects on Balance of Payments Accounts

Positive effects (Credit)

Negative effects Debit

1. Any sale of goods and servicesabroad (exports).

1. Any purchase of goods andservices from abroad (Imports)

2. Any earning on investment in a foreign country.

2. Any investment in a foreign country .

3. Income receivable from abroad 3. Income payable abroad

4. Transfers from abroad 4. Transfers to abroad

5. Any receipt of foreign money. 5. . Any payment of a foreigncountry.

6. Increases in external liabilities 6. Any gift or aid given abroad.

7.Any gift or aid from a foreign country. 7. Decreases in external liabilities

8.Decrease in external assets 8. Increases in external assets

9. Any foreign sale of stocks or bonds. 9. Any purchase of stock or bondsfrom abroad.

In practice, the figures rarely balance to the point where they cancel each other out. This is the result of errors or omissions in the compilation of statements. A separate balancing item is used to offset the credit or debit.

Balance of Payments credits show a decrease in assets or an increase in liabilities; debits show an increase in assets or decrease in liabilities, summarized in the table below:

Difference between BOT and BOP:Balance of trade refers only to the merchandise balance or balance on ‘visible transactions’ alone. Visible items refer to the commodity exports and imports entering the balance of trade. They are visible because they are recorded at the customs barriers of the country.

On the other hand, the balance of payments refers to the sum of both the balance on ‘visible transactions’ as well as ‘invisible items’. It also includes capital and financial accounts. Invisible items refer to the imports and exports of services. Such services may be of various kinds for which payments have to be made or received, for example, transport charges, shipping freight, passenger fares, harbor and canal dues, commercial services (fees and commissions), financial services (brokers’ fees) and services connected with the tourist traffic and payment of interest on external debt. As against the commodity or merchandise transactions, which are visible, these services are called invisible items of the balance of payments as they are not recorded at the customs barriers.

Balance of Payment Equilibrium:Equilibrium is that state of balance of payment over the relevant time period which makes it possible to sustain an open economy without severe unemployment on a continuing basis.

In BOP equilibrium, we have to make certain assumptions for the simplicity of our analysis. These assumptions are:

(a) A given supply curve,

(b) No change in price expectations,

(c) Internal capital flows depend on the level of the interest rate at home and abroad,

(d) No accumulation of real capital.

It is evident that the balance of payments depends on both the level of domestic economic activity and the level of domestic interest rate.

FE curve is the set of all transactions of income and interest rate levels for which the overall payments balance is in equilibrium, i.e. neither in surplus nor in deficit (as shown in the following figure).

In the above figure, FE curve showing equilibrium in BOP. All the points above FE curve show surpluses in BOP and all the points below FE show deficits. B is the target point of policy at which the nation has achieved both internal balance (full employment without excessive inflation) and external balance.

Types of BOP Equilibrium:There are two types of BOP equilibrium, i.e., static equilibrium and dynamic equilibrium:

(a) Static Equilibrium: The distinction between static and dynamic equilibrium depends upon the time period. In static equilibrium, exports equal imports including exports and imports of services as well as goods and the other items on the BOPs – short term capital, long term capital and monetary gold are on balance, zero. Not only should the BOPs be in equilibrium, but also national money incomes should be in equilibrium vis-à-vis money incomes abroad. The foreign exchange rate must also be in equilibrium.

(b) Dynamic Equilibrium: The condition of dynamic equilibrium for short periods of time is that exports and imports differ by the amount of short-term capital movements and gold (net) and there are no large destabilising short-term capital movements.

The condition for dynamic equilibrium in the long run is that exports and imports differ by the amount of long term autonomous capital movements made in a normal direction, i.e. from the low-interest rate country to those with high rates. When the BOP of a country is in equilibrium, the demand for domestic currency is equal to its supply. The demand and supply situation is thus neither favourable nor unfavourable. If the BOP moves against a country, adjustments must be made by encouraging exports of goods, services or other forms of exports or by discouraging imports of all kinds. No country can have a permanently unfavourable BOP, though it is possible – and is quite common for some countries – to have a permanently unfavourable balance of trade. Total liabilities and total assets of nations, as of individuals, must balance in the long-run.

Balance of payments in Pakistan, past and present :-Pakistan was caught in vicious deficit balance of payments trap after the pre- plan period. During pre-plan period (1948-49 to 1954-55), Pakistan's performance in the foreign trade sector was reasonably good. Its exports exceeded the imports and formed 114 per cent of total imports. It had surplus BoT up to 1954-55. The year 1955-56 was the last year in which Pakistan had a favorable balance of trade. Since that time, Pakistan has been facing a serious problem of deficit in her BoT and BoP.

The BoP position deteriorated during Zia's regime (1978-79 to 1984-85). A deficit in BoT increased to $2958 million on an average from 1978-79 to 1984-85. Current account deficit in BoP increased to $993 million on an average during 1978-79 to 1984-85.

The BoP position witnessed a significant improvement during first tenures of both Ms. Benazir Bhutto (1988-89 to 1990-91) and Mohammad Nawaz Sharif (1991-92 to 1993-94). The deficit in BoT decreased to $2728 million on an average between 1988-89 to 1990-91 and to $2501million on an average between 1991-92 to 1993-94.

The current account deficit in BoP fell to $1998 million on an average between 1988-89 to 1990-91and to $2333 million on average between 1991- 92 and 1993-94. This reveals that BoP and BoT remained stabilized during the first tenures of both- Benazir and Nawaz Sharif - (1988-89 to 1993-94). Trade deficit as a percentage of GDP stabilized on an average around 4.7 per cent during Benazir's and Nawaz's tenures. The current account BoP as a percentage of GDP on an average was 4.7 per cent in Benazir's period while 4.6 % in Nawaz’s period.

Pakistan's external balance of payment deteriorated in the second tenure of Ms. Benazir (1994-95 to 1996-97). The deficit in BoT and current account deficit in BoP increased to $3128 million and $3635 million on an average between 1994-95 and 1996-97 respectively.

The overall balance of payment position during the second tenure of Nawaz Sharif (1997-98 to 1999-00) witnessed a significant improvement despite the adverse external environment.

Both current account deficit in BoP and BoT decreased in this period. Thedeficit in the balance of trade decreased to $1788 million while currentaccount in the BoP decreased to $1833 million during 1997-98 and 1999-00despite the sanctions imposed by the G-8 countries on bilateral andmultilateral lending as a consequence of Pakistan's nuclear tests in May1998.

The deficit in the balance of trade as a percentage of GDP and currentaccount deficit in balance of payments as a percentage of GDP also showedthe same trend.

The deficit in the balance of trade as percentage of GDP on an averagedeclined to 2.5 per cent while current account deficit in balance of paymentsdeclined to 2.9 per cent on an average during 1997-98 and 1999-00. Workers'remittances exhibited a declining trend during these years. The magnitude ofworkers remittance on an average was $1178 million.

The economy started showing signs of improvement with the start of Musharaf's regime. His government launched a comprehensive set of economic stabilization and structural reform measures.

Pakistan's exports increased from $7.8 billion in 1999-00 to $9.2 billion inFY00-01. The deficit in BoT decreased to $1269 million while currentaccount BoP decreased to $513 million in FY00-01.

The real improvement in BoP started after the event of September 11, FY01. The post-September 11 events helped a great deal in ameliorating Pakistan's chronic external deficit in balance of payments.

Significant reduction in the trade deficit, more than doubling of foreignremittances, and budgetary support from coalition partners in the war againstterror enabled Pakistan to run a current account surplus for the first timesince 1956-57.

There was a sharp decline in trade deficit in FY01-02. The trade deficit fellby 75.5 per cent to $286 million over the level of $ 1338 million of FY00-01. The current account deficit in balance of payment emerged with asurplus of $913 million in FY01-02.

The current account BoP remained in surplus from FY01-02 to FY03-04.Themagnitude of surplus in current account BoP for FY01-02 was $1338million, for FY02-03 $ 3165 million and for FY03-04 (July-March FY03-04)was $1369 million.

The conclusion drawn from the analysis of the BoT and BoP behavior duringdifferent governments between 1971-74 and FY03-04 envisaged that BoTand BoP improved during the governments of Bhutto and Junejo (1971-72 to1977-78 and 1985-86-1987-88) while BoT and BoP deteriorated during Zia'sregime (1978-79 to 1984-85.

The BoT and current account BoP stabilized during the first tenure of bothBenazir and Nawaz Sharif while deteriorated in her second tenure while BoTand BoP stabilized in Nawaz Sharif's second period.

The performance of Benazir in first tenure was better than in her second era despite the workers remittances from abroad increased considerably during her second tenure. Performance of Musharaf's government is much better than the previous governments either military or democratic since 1971-72.

The actual figures for balance of payment can be obtained at the year end therefore it is projected based on the previous data and assisting facts and figures.

Pakistan’s current account balance in the fiscal year 2008-2009 wasUSD 8,547 unfavorable, debit or negative. In the same year thecapital and financial account balance was USD 3,608 favorable orpositive which lead to the Balance of payment to be USD 4,939deficit. In fiscal year 2009-10, current account balance is projected to beUSD 4,911 unfavorable or negative. This means that we are going toface deficit balance of payment this year as well.

Causes for negative balance of payments :-1.Pakistan's balance of payments is highly dependent on workers remittances but these remittances cannot be sustained over a long period of time.

2.One major structural problem of exports is that it is based on relatively low value added products. Pakistan's exports are highly concentrated in cotton group, leather group, rice, synthetic textiles and sports goods.

3.Although Pakistan is trading with large number of countries but her

exports are highly concentrated in few countries. More than half of Pakistan's exports are concentrated in USA, Germany, Japan, UK, Hong Kong, Dubai and Saudi Arabia. Such a high degree of geographic concentration of exports is dangerous as it renders the economy vulnerable to the manipulation of the importing countries.

4.Imports are concentrated on a limited number of commodities namely machinery, petroleum & petroleum products, chemicals, transport equipments, edible oil, iron and steel, fertilizer and tea.

5.Agriculture-related exports constitute a high ratio of the total exports. In

FY02-03, 73 per cent of export earnings came from the export of cotton and cotton products, leather and rice. Such a high degree of dependency on agriculture-related products is an element of uncertainty in export earnings.

6.Although Pakistan is trading with a large number of countries, yet major

portion of imports comes from a few selected countries. Almost 50 per cent of imports come from USA, Japan, Kuwait, Saudi Arabia, Germany, the UK and Malaysia. Such a high degree of geographic concentration of imports is undesirable and is in favor of exporting countries.

7.Pakistani societies make heavy expenditure on their rituals, weddings etc which are useless.

8.The main cause or we can say that the biggest problem is political uncertainty.

9.Sick industries in Pakistan are increasing while at the same time Pakistan is facing tough competition in the world market.

10.Pakistan import oil which is the main resource in producing all the products.

Solution :-1.Government should formulate a strategy to be free of the country’s dependency on workers’ remittances.

2.The emphasis should be on the export of the high value goods and the services.

3.Pakistan should expand its international market.

4.The country has to expand its export base that is too narrow.

5.The industrial sector should be the major sector of the economy.

6.The trend of saving should be promoted.

7.Economic system has to change.

8.Political stability should exist.

9.Market imperfection should be removed

10. Foreign investments should be encouraged.

Conclusion:-When we look at the figures of Balance of Payment, we observe thatthe Exports are decreasing and Imports are increasing. The incomefrom service sector has also declined in recent times for somereasons. The foreign remittances or unilateral transfers has alsodecreased as the people have no more trust on the Pakistan andincreasing rates of taxes are also a reason for people to avoidsending money back to Pakistan instead invest it in foreign country.The FDI has trembled down as the law and order condition is gettingworse day by day. Our current account balance is apparently betterthan the previous year but we should not ignore that fact that it isprojected data and real figures could shuffle around due to severalreasons.

THANK YOU