Question

1. What is the balance of payments? Please briefly explain the three components.
2. What are the factors affecting International Trade Flows? Please identify three factors and explain.
3. How exchange rates may correct a balance of trade deficit?
4. List three factors that may affect International Portfolio Investment and explain each factor in one sentence.

Answer 1

a. Balance of Payment : Balance of Payment is a comprehensive record of economic transactions of residents of a country with the rest of the world during a given period of time usually one year.

A consistently positive BoP reflects more foreign investment and money coming into country and not much of its currency being exported. On the other hand, adverse or negative BoP indicates more outflows of money compared to inflows.In the BoP sheet currency inflows are recorded as Credits(+),whereas outflows are recorded as debits(-).

Forms of balance of Payment or components of BoP :

Component 1 : Current account = It shows a nations trading strength.If payments are greater than receipts then there is deficit which is undesirable.It is further divided into :

1. Visible trade - trade in goods

2.Invisible trade -trade in services..main invisibles are

Government expenditure,Interest ,profits and dividends,other financial services, Transport,Tourism etc.

Component 2: Capital Account = This account mainly includes investment and other capital movements.For eg.

if an Indian trader purchases a new shop in London,this is an outflow for India. But if USA builds a showroom in India, then there is inflow of capital for India.

Component 3: Official Financing = It is also known as Total currency flow shows the balance of monetary movements into and out of country.A positive figure shows a net inflow and vice versa.

b. Factors affecting International Trade Flows:

1. Inflation= A general increase in prices and fall in purchasing value of money. A relative increase in a country's inflation rare will decrease it's current account as imports increase and exports decrease.

2. Government Restrictions = A government may reduce it's country imports by imposing tarrif on imported goods,or by enforcing a quota. Trade restrictions also affect international trade flows.

3.Exchange rates = If a country currency begins to rise in value, it's current account balance will decrease as imports increase and exports decrease.

c. When a home country is exchanged for a foreign currency to buy foreign goods, then the home country faces downward pressure, leading to increased foreign demand for country's products. Thus ,in this way exchange rates may correct a BoT deficit.

d.Factors affecting International Portfolio Investment:

1. Exchange Rates: When investors invest in securities in an international country,their return is mostly affected by the change in the value of security.Investors usually shift their investment when the value of currency in a nation they invest weakens more than anticipated.

2.Interest Rates = High interest rates are big attraction for investors. Money usually flows to countries that have high interest rates.

3. Tax rates = Investors usually choose to invest in a country where the applied taxes on interest earned or dividend acquired is low.