An inside on surplus position of balance of payment

 

Transactions with external sectors are presented by a simple statement known as balance of payments (BOP). In broad categories, it is classified in economic transactions and financial transactions. The methodology followed in preparing the statement is nothing but debit-credit rules of accounting. Economic transactions are reflected in movements of goods and services. Transactions of goods are presented in balance of trade. Under accounting concept, export is credited as income with debit by deposits of currency in bank accounts maintained abroad. In case of export on credit, receivables are recorded as debit entry. In the reserved way, import transactions are recorded as debit and payments from accounts abroad. Payables are, in case of import through loans, as credit entry.

BOP is prepared based on the manual published by International Monetary Fund (IMF). BOP is in linkage with national income accounts calculated as per System of National Accounts (SNA). Under expenditure method, national income accounts are summation of different expenses on account of private and public consumption, private and public investment, trade transactions with external sectors by netting of imports from exports, and flows from services, factors and transfers. Deduction of consumption and investment from total national income results in savings or dissavings in case of negative figure. Savings or dissavings are nothing but economic transactions as presented in BOP statement.

Balance of trade is adjusted with other economic transactions such as income or expenses for services sectors, receipts and payments from different factors, and transfer items. The result brings surplus or deficit. This is current account position. In accordance with national income accounts, surplus means savings and deficit is dissavings.

BOP is always balanced at anyhow. The global economic activities are changing gears. The world was in lockdown stage during Covid-19. This results in disruption in production, impacting shocks to global supply chain. As of April, 2022, the trade balance is in negative territory amounting to US$27.57 billion. On adjustment of different flows like service, primary and secondary incomes, current account balance is recorded a deficit of US$15.32 billion, appearing highest ever.  During the ten-month period of financial year 2021-2022, overall balance is negative amounting to US$3.71 billion. Then there comes a question how deficit of US$15.32 billion was traded off.

BOP is a balance statement, as noted earlier. Does it indicate the summation of current account and financial account is either zero, or surplus, or deficit? Definitely it has bottom line.

In between current account and financial account, there is another account known as capital account. As per IMF, capital account records acquisitions and disposals of nonproduced nonfinancial assets, such as land sold to embassies and sales of leases and licenses, as well as capital transfers between residents and nonresidents. The transactions under these categories are very insignificant. Considering the accounts, BOP equation is current account + capital account + financial account = change in reserve position.

In case of zero position at overall level, deficit in current account balance is offset by loan receipts or inward investment. The surplus position at bottom line is an indication of outward investment or lending abroad.

There is another situation in which current account in deficit may lead to deficit at end position. This is a situation where liquid stock of financial assets is used to pay off imbalanced amount. Alternatively, such deficit is washed out with the liquidity support from central bank.

On the other hand, current account may be in deficit status but overall position is positive. It indicates that inflows on financial accounts such as investment, loans and grants are injected into the economy higher than the deficit. But borrowings from external loans can be a burden unless sufficient cash flows are not generated to service repayments. As such surplus in BOP is not good always.

There needs an ideal situation in which an economy will be free of unseen dangers. How to reach the situation is a question. There is another point to appear whether it is possible in practical situation.

Economies like ours are in deficit territory of fiscal accounts. This helps private savers to invest in the Government instruments, the remainder from banking and external sources. Fiscal deficit may lead current account deficit provided appetite for investment needs are higher.

International reserve works as support for rainy season, which is built up, in addition to purchase from domestic foreign exchange market, by purchase of foreign currency received on account of loans and grants to the Government from external sources.

BOP is rarely innocently balanced. It depends on current account position. As stated earlier, surplus position is balanced by placing funds abroad in different financial assets. Such situation is rare for countries whose investment is greater than income.

On the other side, deficit position is supported by external sources in the form of equity, loans, and grants. Equity is more secure way to balance the position; it generates income in foreign currency or saves foreign currency in case of import substitution production. But investment through equity is not possible always, external credit is needed.

Short term import finance up to 360 days is permissible under supplier’s/buyer’s credit. This is cost effective deal since cost of fund is comparatively lower than cost of local currency. The deficit in current account is adjusted by such finance which is ultimately settled within 360 days. The transactions are based on commitment by banks which are bound to make payments on maturity; default by importers is not a factor. The issue is whether market is liquid or not. The payment size of short term import finance is reasonable; it does not lead to crisis for settlement.

The next line of import is by external term borrowings. The size of borrowings is larger. Domestic banks cannot extend term finance in foreign currency to corporates which arrange from external sources. Repayment of which depends of cash flows and market liquidity. If the output of relevant corporates is not exportable or import substitution, it does not support markets to absorb the needs.

Dry situation in repayment period can make market volatile. Another visible problem is that term loan is obtainable with permission from competent authorities. For repayment crisis, corporates cannot have ability to arrange another loan. As such, term loan from external sector is prone to crisis. Since Taka is not convertible on capital account transactions, term borrowings from external sources need to be completely restricted.

As an alternative to term borrowings, offshore banking operation of domestic banks may be allowed to extend term loans to corporates in foreign currency. This way of financing cannot result in crisis, offshore banking operation will make settlement of payments with their counterparts by arranging another loans. Alternatively, central bank can operate refinance for term lending to ultimate borrowers.

External term borrowings by corporates should be allowed only in the form of short term buyer’s credit for import payments. Term loans to resident corporates may be considered for those having favorable past financial parameters. In this case, external lenders need to extend loans with recourse to borrowers without any exposure on domestic banks against their payment commitments.

Surplus in BOP is not a good indication, rather crisis prone. Disequilibrium in current account needs to be adjusted prudently so as to avoid external shocks.


Mehdi Rahman works in
the development sector.