Pakistan is in the grip of a serious economic crisis and its economy is badly underperforming. The economic position of the people is in peril with many millions pushed down the poverty line. Two aspects of economic distress are the balance of payments and inflation that decisively affect the performance of an economy and much attention is required to be paid to them. Pakistan is faring badly on both these counts and unless they are not adequately addressed the economic downturn will not abate.
Balance of Payment (BoP) is the record of all economic transactions between the residents of the country and the rest of the world in a particular period of time (e.g., a quarter of a year). These transactions are made by individuals, firms and government bodies. Thus the balance of payments includes all external visible and non-visible transactions of a country. It is an important issue to be studied, especially in international financial management field, for a few reasons.
First, the balance of payment provides detailed information concerning the demand and supply of a country’s currency. If a country exports more than its import its currency will hold its value and will maintain its foreign exchange reserves.
Second, a country’s balance of payments data may signal its potential as a business partner for the rest of the world. If a country is grappling with a major balance of payments difficulty, it may not be able to expand imports from the outside world. Instead, the country may be tempted to impose measures to restrict imports and discourage capital outflows in order to improve the balance of payments situation. On the other hand, a country with a significant balance of payments surplus would be more likely to expand imports, offering marketing opportunities for foreign enterprises, and less likely to impose foreign exchange restrictions.
Third, balance of payments data can be used to evaluate the performance of the country in international economic competition. Suppose a country is experiencing trade deficits year after year. This trade data may then signal that the country’s domestic industries lack international competitiveness. To interpret balance of payments data properly, it is necessary to understand how the balance of payments account is constructed.
These transactions include payments for the country’s exports and imports of goods, services, financial capital and financial transfers. It is prepared in a single currency, typically the domestic currency for the country concerned. The balance of payments accounts keep systematic records of all the economic transactions, visible and non-visible, of a country with all other countries in the given time period. In the BoP accounts, all the receipts from abroad are recorded as credit and all payments to abroad are recorded as debits.
Sources of funds for a nation, such as exports or the receipts of loans and investments are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BoP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down currency reserves or by receiving loans from other countries.
While the overall BoP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BoP, such as the current account, the capital account excluding the central bank’s reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term “balance of payments” often refers to this sum: a country’s balance of payments is said to be in surplus (equivalently, the balance of payments is positive) by a specific amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said to be negative) if the former are less than the latter. A BoP surplus (or deficit) is accompanied by an accumulation of foreign exchange reserves by central bank.
Under a fixed exchange rate system the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country’s currency and other currencies. Then the net change per year in the central bank’s foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float the central bank does not intervene at all to protect or devalue its currency allowing the rate to be set by the market, the central bank’s foreign exchange reserves do not change and the balance of payments is always zero.
In economics inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.
The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualised percentage change in a general price index usually the consumer price index, over time. Economists generally believe that very high rates of inflation and hyperinflation are caused by an excessive growth of the money supply.
Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.
Inflation affects economies in various positive and negative ways. The negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity.
Today, most economists favour a low and steady rate of inflation allowing the central bank more leeway in carrying out monetary policy encouraging loans and investment instead of money hoarding, and avoiding the inefficiencies associated with deflation. Low inflation reduces the severity of economic recessions by enabling the labour market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilising the economy.
The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations and through the setting of banking reserve requirements. TW