THE INTERNATIONAL ECONOMIC ACTIVITY OF THE NATION

•The balance of payments

•Fundamentals of balance of payment accounting

•Defining international economic transactions

•Double entry book – keeping

•The accounts of bop

•Kenya’s international trade with other countries; East Africa countries, Africa continent countries and others.

BALANCE OF PAYMENTS• Balance of Payment (BOP) is a record of a country’s

transactions with the rest of the world.or Balance of payment of a country is a record of all financial transactions between residents of that country and residents of foreign countries.

• Residents include companies, co-operations and the government. All transactions are recorded whether they drive from trade in goods and services or transfer of capital.Or BOP is the difference between receipts from all visible and invisible exports and payments for all visible and invisible imports.

• Visible – tangible e.g. coffee, tea, machinery. • Invisible –intangible e.g. services-bank, tourism,

insurance.

Importance of Bop Data

• BOP reveals demand for the country’s currency. i.e. if a country is exporting more than it imports, there will be a high demand for the currency in other countries in order to pay for the exported good.

• BOP trend helps managers predict what sort of economic environment may develop in the country. This impacts their choice of strategic risks to take in specific countries.

• To inform Government about their international economic position in order to enable them make sound decisions on the policy.

BOP Accounts• Just like an individual or a firm has statements of

accounts a country can have a statement of accounts which shows the position of a country’s trade with the rest of the world.

• The BOP accounts are usually for a period of one year. Each transaction involves a credit and a debit entry.

• The accounts are maintained according to double entry concept. E.g. All payments to other countries, funds flowing out, are tracked as debits (-)

• While transactions that are payment from other countries, funds flowing in are tracked as credits (+). The total debts and total credits are always equal.

• The BOP account is divided into two major accounts namely:- Current account, Capital account.

Current Account• This records all transactions in both visible and invisible

trade. The visible and invisible imports are entered on the debit side. While the visible and invisible exports are entered on the credit side as shown below.Items Recorded In Current Account

Current accountDebit (DR) Credit account

(CR)

Import of goods XX Export of goods

XX Import of Services XX Export

of services XX Unilateral transfer payments XX

Unilateral transfer receipts XX Balance (Surplus)

XX Balance (Deficit) XX

XX XX

• The current account can help a country identity whether it has a favourable balance of payment or unfavourable balance of payment

• A deficit in the current account (trade deficit) will occur when imports are greater than exports while a surplus (trade surplus will occur when exports are than imports)

• When a country has a trade surplus it is said to have a favourable balance of payment but when it has a trade deficit it has unfavourable balance of payment. When there is a balance between exports and imports, a country has a balance of payment.

Capital Account

• This includes both long-term and short-term capital movements between the home country and all other countries.

• Long term capital movements will include the following:-

• Direct investments-actual set up and control of an enterprise in a foreign country.

• Portifolio investments- Purchase of securities of a foreign country of government

• Intergovernmental loans.

Short term capital movements include:-• Short-term private lending• Short-term investment.• Both (short-term lending and investment) mostly

exploit interest rate differentials. • There also those transactions necessary to cover any

overall deficit or surplus in the rest of the accounts (Balancing items). These will include:-

• Charges in official reserves- deals with good imports and exports

• Increases or decreased in foreign exchange held by the government.

• Decreases or increases in the liabilities to foreign central banks.

Items Recorded In Capital Account

Dr Capital AccountCr

Capital Payments Capital ReceiptsDirect investments by domestic Direct investment from foreigners

residents abroad XX XX

Portifolio Investment abroad XX Porfitolio investment from foreigners

XX

Short term capital (net) abroad XX Short term (net) capital from abroad

dXX

XX XX

Balance of Payment Disequilibrium

• The BOP current and capital account add up to the total account which is given a double entry approach, is balanced.

• A deficit in the current account is always accompanied by an equal surplus in the capital account and vice versa.

• Balance of payment can further be divided into private and government accounts. Private accounts show the balance between the receipts and payments regarding foreign transactions made by private sector; while Government accounts show the balance between receipts and payments of those transactions made by the Government of a country within a given year.

Balance of Payment Disequilibrium

• The balance of payments (on the current account is said to balance when the total of credit items is exactly equal to the total of debit items. Hardly does this occur. There is either a deficit or a surplus in the current accounts of the balance of payments. The balance of payment disequilibrium is a situation whereby payments of visible exports or receipts from invisible exports exceed the payments fro visible and invisible imports.

Causes of Balance of Payments Disequilibrium

• There are many factors that cause a deficit or surplus in the balance of payment. They are as follows:-

• Temporary causes e.g. seasonal fluctuations, effect of weather on agricultural production which are temporal an convert themselves within a short time.

• Chronic or fundamental disequilibrium this may be due to changes in consumer tastes within a country or abroad.

• Technological changes in methods of production• A country’s national income• Inflation i.e increase in prices of exports.• The stage of economic development of a country.

Correcting Balance Of Payments Disequilibrium

• The corrective measure include:-

• Various adjustment through exchange deprecation (price effect)i.e forces of demand and supply for foreign exchange.

Devaluation of currency

This involves decision made by monetary authorities in Government. Devaluation makes exports cheaper and imports expensive as a result export increase and import decrease thereby correcting BOP disequilibrium.

• Direct controls on imports by fixing quotas , imposing exchange controls, tariffs, subsides taxes, concepts

• Adjust through capital movements.• Adjustment through income changes • Stimulation of export through :-• Export compensation, customers’ drawback, better

marketing and reducing imports (can be done through increased production and productivity)

TYPES OF INTERNATIONAL TRADE TRANSACTIONSAll The transactions involved in international trade can be divided into two:-

i) Accommodating transactionsThese are transactions which exist only because of a deficit or a surplus (balancing items)

ii) Autonomous transactionsThese exist independent of all other items.

NB: Normally when reference is made a balance of payment deficit or surplus, it refers to the balance of payment on current account.

KENYA’S INTERNATIONAL TRADE WITH OTHER COUNTRIES

Kenya has continued to trade with other countries either by forming Bi-lateral agreements and multilateral agreements.

Bi-lateral agreements refer to agreement between two countries especially through diplomatic relations. This is the oldest from of diplomatic relations where states maintain bi-lateral political relationship. This is used to foster trade and resolution of disputes.

This later resulted to Kenya being involved in forming a regional trade block which is a grouping of member states of a certain region that have agreed to form a regional trading block e.g. Kenya is a member of COMESA, EAC

She is also a member of multilateral organizations formed by world governments which include UNO, OECD, Commonwealth countries, Indian ocean council e.t.c

Other multilateral private based organizations like OPEC countries, ILO, Woelrd economic forum, East African Executive Forum e.t.c. which Kenya is a member.

Kenya is an agricultural based country and exporters flowers, coffee, tea, sugar, pyrethrum e.t.c. she imports machinery, vehicles and industrial products from most of the countries she trades with.

Questions.

1. Why should mangers monitor the BOP of the country in which their business operates?

2. Discuss the major BOP accounts

THE END

INTERNATIONAL MONETARY SYSTEM PRINCIPLES AND HISTORY.

Since ancient times, gold has been trusted as a way of people to share value, exchange value and measure value.

From 1200 A.D. to the present, the price of gold has generally been going up. In ancient trading, international traders used both gold and silver coins until 1875.During the world war.

In 1717, Sir Isaac Newton, the great mathematician, established the price of Gold at 3 pounds, 17 shillings 10.5 pence per ounce, putting England defacto on the gold standard.

England was willing to convert gold to currency or vice versa, until world war I. during those two centuries, London was the dominant center of international finance. Estimates hold that 90% of world trade was financed by London.

Most trading or industrial countries followed England’s move adopted the gold standard . each country set a certain number of units of its currency for ounce of gold and the ratios of their gold equivalence established the exchange rate between any two currencies on the gold standard.During world war II, the countries of the world were much too involved with the hostilities to consider the gold standard or any other monetary system. However, many officials realized some system had to be established to operate when peace returned.In 1944, representatives of the 44 allied nations met at the mount Washington Hotel in Bretton Woods, New Hampsire, to plan for the future. The meeting resulted in the first negotiated agreement to support trade through the establishment of monetary institutions among independent nations

They resolved the following• Stable exchange rates were desirable but experience

might dictate adjustments.• Floating or fluctuating exchange rates had proved

unsatisfactory, through the reasons for these opinions were little discussed.

• The government controls of trade, exchange, production e.t.c that had developed from 1931 through World War II were wasteful, discriminatory and detrimental to expansion of world trade and investments.To achieve its goals, the Bretton Woods conference established two international monetary institutions.

• International monetary fund (IMF)• International Bank for reconstruction and development

(IBRD) i.e. world bank.

The IMF articles of Agreement contained rules for International monetary policies and their enforcement. The agreement went to effect in December 1945.The main purpose of IMF include:-

• To promote international monetary cooperation.• To facilitate the expansion and balanced growth of

international trade.• To promote exchange stability and orderly exchange

arrangements among members.• To assist in the establishment of a multilateral system

of payments.• To make the funds resources available for balance of

payment corrections.• To shorten the duration and lessen the disequilibrium

of members balances of payment.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD)Also known as World Bank was established along with IMF in 1945. It is made of 184 member countries. To be a member a country has to be a member of the IMF.FUNCTIONS OF WORLD BANK

• To assist in construction and development by facilitating investment of capital for productive purposes.

• To promote foreign private investment by guarantee of or through participation in loans.

• To provide loans for productive. Purposes out of its resources or out of funds borrowed by it.

• To promote the long-range growth of international trade. It also helps in the maintenance of equilibrium in members’ International investment for the development of the productive resources of members.

• It encourages private enterprises in develop countries through finance Development corporation.

MONEY SYSTEMS OF THE 20TH CENTURY

IMF and World Bank influence international monetary system in various regions of the world and individual countries.From 1945 to 1990, World Bank has transformed its objectives and assistance given to countries. It has included giving advice and assistance in balance of payments. Countries that borrowed money from IMF were advised to look for natural resources in their countries under the structural adjustment program. (S.A.P.S).S.A.Ps came as a result of Latin America experiencing a gain under the Washington consensus.Washington consensus was an agreement between Washington based IMF and World Bank on common approach to advice and assistance given to Latin American countries. IMF & World Bank brought this idea to other developed countries and called it S.A.P.S. it refers to internal mobilization of resources and effective use of existing financial resources into a country.

REGIONAL MONETARY SYSTEMS

Regional monetary systems refers to the monetary system prevailing in the regions of the world.

• It is usually formed under the regional economic blocks. Examples include: NAFTA i.e. North American free trade Association, South America free trade Association, European Union, Asian countries, Comesa, Ecowas, South Africa development economic council.

• Most of these regions trade organizations are trading on one currency system that can be used by most member countries.

• So far European Union have money to introduce one single currency acceptable to all members (Euro). In NAFTA us dollar is dominant.

• There is competition world wide between the Euro and US dollar as the main currency for international transactions e.g. at inception in January 1999 Euro began trading at 1 Euro for US$ 1.14, 2001, 1$ to 0.845 Euro 2002 1 Euro and dollar were trading at par Jan 2004 1 Euro $1.3635, May 2006 1Euro $ 1.2739.

• There is now psychological war between Europe and America because of completion of the two currencies.

• French speaking African countries have been assisted by France to establish a uniform currency (C.F.A). This currency is used in transactions between French speaking countries and France.

• Great Britain is still sticking to their British pound (Sterling Pound) for historical reasons and prestige but they are constantly losing ground.

STRONG CURRENCIES THAT INFLUENCE WORLD ECONOMIES.

• Strong currencies are backed by strong national economies of various countries. Strong economies today include US economy, European economies, Japanese, Indian, Mexican and Chinese economies.

• It follows therefore that the currencies of strong economies will continue playing an important role in developing of economies of many countries of the world. The leading currencies today are US dollar and the European Euro. This is followed by Japanese Yen and Chinese Yuan (Renminbi)

EXCHANGE RATES• Also known as foreign exchange rates. They refer to

the price of one currency in terms of another. An exchange rate measures the amount of foreign currency that can be obtained with one unit of another currency. Example; the exchange rate between the Kenyan shilling and the US dollar refers to the number of Kenyan shillings required to purchase one US dollar.

• It could also refer to the number of Kenyan shillings that cam be bought using one US dollar.

• A rise in the exchange rate means that there is a reduction in the value of one currency in relation to another. The reduction is known as depreciation. A fall in exchange rate implies there is an increase in the value of one currency in relation to another. This increase in the value of a currency is known as appreciation.

PURPOSE OF AN EXCHANGE RATE SYSTEM

• It facilitates the purchase and sale of international currencies

• It makes it possible for international costs and prices to be compared to catty out international trade.

• It is a link between different national currencies.

The rates at which foreign currencies are exchanges can be determined through three systems.

• Market rate system• Fixed exchange rate system• Flexible rate systems

MARKET RATE SYSTEM

Also referred to as free exchange rate. In a free market, the rate at which currencies are exchanged is determined by the intersection of the market demand and supply curves of foreign currency at any given point in time. This is referred to as the equilibrium foreign exchange rate. There is no government influence in the fixing of the exchange rate.

II. FIXED EXCHANGE RATE SYSTEM

This is a system where the government or the central Bank fixes the exchange rate of its currency at a particular , value e.g. gold standard when the rate is fixed, the respective government has an international obligation to prevent its fluctuations.

III. FLEXIBLE EXCHANGE RATE SYSTEM

This is a system of determining the exchange rate of currencies by permitting the forces of demand and supply to interact and fluctuate within a specified range.

The government here influences the rates of monetary expansion or the size of its budgetary deficit.

THE END