Why Should Investors Track Balance of Payment?
Published by Sharekhan Education | December 8, 2020
Why Should Investors Track Balance of Payment?
Balance of Payment is a snapshot of the money flowing in and out of the country. It is a combination of the current account and capital account. The current account includes exports, imports, net income abroad, and net current transfers. Calculation of current account balance is as follows:
Current account balance = (Exports – Imports) + Net income abroad + Net current transfers
Where Net income abroad = salaries paid or received to foreigners, interest, and the dividend paid or received from foreign companies, income from FDI and FII, etc
Net current transfers = Donations, gifts, remittances, official assistance, pensions, etc.
Calculation of Capital Account is as follows:
Foreign investments (foreign portfolio investments, foreign direct investments) + Banking capital (NRI deposits, etc) + short term credits, external commercial borrowings, external assistance, other capital accounts & Errors and errors and omissions.
| Example | Amt in USD bn |
| Trade balance eg. Exports – imports | – 130 |
| Invisibles eg. Software and non-software exports, net income and transfers etc. | +108 |
| Current account | -22 |
| Capital account e.g. Foreign portfolio investments, foreign direct investments, NRI deposits, short term credits, external commercial borrowings, external assistance, other capital accounts & Errors and Omissions | |
| Overall Balance | +19 |
Current Account Deficit and Current Account Surplus:
A negative current account is called a current account deficit. It indicates that the country is a net debtor to the world. Meaning it is investing more than saving to meet its domestic consumption and investment requirement. Hence, it will need to attract more foreign investments and borrowings to fill the deficit. A positive current account, on the other hand, is called a current account surplus. It indicates that the country is a net creditor to the world by providing resources and owes money from other countries.
The investor needs to monitor the current account and the impact of capital account that balances the deficit. The current account deficit is funded either through foreign investments or through borrowings. However, excessive borrowing for current account deficits risks credit rating downgrades and high-interest payments. Countries like Africa and Russia have faced such situations in the past.
If the current account deficit gets funded through foreign investments, then foreigners have an increasing claim on the country’s asset and can opt for withdrawing it anytime. For example, a current account deficit funded through foreign portfolio investments is prone to the withdrawal of the investments when foreign investors lose confidence in the capital markets. In such an event, they can sell their investments, which can not only lead to a fall in the markets but also put pressure on the currency of the country. If the investments are made by MNCs to purchase the best fixed assets, then there is a risk of loss of income to the country. But a high current account deficit accompanied by insufficient capital inflows can depreciate the currency of the country, which would make the imports costlier, leading to inflation.
Impact of current account deficit or surplus on the economy:
A high current account deficit can render the economy uncompetitive as it does not invest in local manufacturing and relies highly on imports to cater to its aggregate demand. For example, from 2008 to 2013, countries such as Portugal, Italy, Greece, and Spain saw their economy weaken due to a lack of competitiveness and low level of export demand. However, inward investments do create scope for higher employment in the economy.
A country with a current account surplus will have surplus foreign exchange to invest in other countries. It can purchase assets around the world to earn profits, dividends, and rent. Surplus from more exports than imports boosts employment and currency value. Export dependence leads to currency appreciation, requiring frequent central bank intervention in forex markets. It would buy a large number of dollars in exchange for its local currency to prevent the local currency from appreciating further. Also, if the country is too focused on exports, it might not have good domestic consumption, which can lead to weak growth in its GDP. Such a situation leads to difficulties during a global recession when the exports could become weak, and domestic consumption might fall short of pushing the growth higher. There could be a situation of stagflation in the economy and lower wage growth due to lower domestic demand.
Investing in Knowledge:
If you would like to understand more about the concept of ‘investing’, then register for one of our free “Power Money Workshops”. And join our investing education program called “Stock Investor” to polish your investing skills. We teach you to identify solid stocks and invest like a professional. So, come and experience it yourself!
Learn stocks trading course, derivatives and trading strategies from sharekhan Education’s online Mastering futures and options trading course.
