Why is a balance of payment important and why does it balance?

Answer 1

Given that it reflects all payments and liabilities to foreigners and all payments and obligations received from foreigners, the balance of payments is one of the major indicators of a country's status in international trade. It has the potential to influence the prices of free-floating currencies, because free-floating currencies are affected not only by political events or governmentpolicies but also by the economic events represented by the BOP. As every country strives to a have a favorable balance of payments, the trends in, and the position of, the balance of payments will significantly influence the nature and types of regulation of export and import business in particular.

BOPS statistics (at least estimates of major items) are regularly compiled, published and are continuously monitored by companies, banks and government agencies. Often we find a news head line like "announcement of provisional US balance of payment figures sends the dollar tumbling down".

Obviously the BOP statement contains useful information for financial decision matters.

In the short run, BOP deficits or surpluses may have an immediate impact on the exchange rate. Basically BOP records all transactions that create demand for and supply of a currency and the possible impact on the exchange rate. Further they may signal a policy shift on the part of the monetary authorities of the country, unilaterally or in concert with the trading partners. For example a country facing a current account deficit may raise interest rates to attract short-term capital inflow to prevent depreciation of its currency. Or it may tighten credit and money supply to make it difficult for domestic banks and firms to borrow the home currency to make investments abroad. It may force exporters to realize their export earnings quickly and bring the foreign currency home. Countries suffering from chronic deficits may find their ratings being downgraded because the markets interpret the data as evidence that the country may have difficulties in servicing its debt. Finally BOP accounts are intimately connected with the overall saving -investment balance in a country's national accounts. Continuing deficits and surpluses may lead to fiscal and monetary actions designed to correct the balance, which in turn will affect exchange rates and interest rates in the country.

Therefore BOP accounting serves to highlight a country's competitive strengths and weaknesses, and helps in achieving balanced economic-growth. It can significantly affect the economic policies of a government, and the economy itself