The balance of payments: WASSCE Economics

When Sierra Leone imports more than it exports, how does it pay the difference? Every payment between Sierra Leone and the rest of the world, from a cargo of fuel to a remittance from a relative in London, is recorded in one set of accounts: the balance of payments. WASSCE expects you to read it, calculate its balances and explain how a deficit is corrected.

Learning objectives

By the end of this lesson you should be able to:

define the balance of trade and the balance of payments
describe the parts of the balance of payments
calculate the balance of trade and the current account balance
explain the causes of a balance of payments deficit
explain the measures used to correct a deficit

Balance of trade and balance of payments

Definition

The balance of trade (visible balance) is the difference between the value of a country's exports and imports of goods.
The balance of payments (BOP) is a systematic record of all economic transactions between the residents of a country and the rest of the world over a period, usually a year.

The balance of trade is only one part of the balance of payments.

The structure of the balance of payments

Three boxes: the current account, covering goods, services, primary income and secondary income; the capital and financial account, covering direct investment, portfolio investment and loans; and official reserves of foreign currency and gold held by the central bank

Figure 1. The three main parts of the balance of payments. WASSCE Tutor diagram.

Account	What it records	Examples
Current account	Trade in goods and services, income and transfers
– Visible trade (goods)	Exports and imports of goods	Iron ore exports; rice and fuel imports
– Invisible trade (services)	Exports and imports of services	Shipping, insurance, tourism, banking
– Primary income	Wages, interest and profits paid to or from abroad	Profits sent home by foreign mining firms
– Secondary income (transfers)	One-way transfers with nothing in return	Remittances from Sierra Leoneans abroad; aid grants
Capital and financial account	Flows of investment and loans	Foreign direct investment in a mine; loans from abroad; portfolio investment
Official reserves	Changes in the central bank's foreign currency and gold	Reserves fall to pay for a deficit

Because every transaction is recorded twice (as a credit and a debit), the balance of payments always balances in an accounting sense. A "deficit" or "surplus" refers to the balance of particular accounts, usually the current account, before official financing.

Calculating the balances

Worked example

A country's transactions in a year (US$ million):

Item	Value
Exports of goods	900
Imports of goods	1,300
Exports of services	150
Imports of services	350
Primary income received	40
Primary income paid (profits sent abroad)	160
Secondary income (remittances and grants) received, net	420

Balance of trade (visible balance) $= 900 - 1300 = -400$ : a deficit of US$400 million.
Balance on services $= 150 - 350 = -200$ .
Net primary income $= 40 - 160 = -120$ .
Current account balance $= -400 - 200 - 120 + 420 = -300$ : a current account deficit of US$300 million.

This deficit must be financed by inflows on the capital and financial account (investment, loans) or by drawing on official reserves.

Causes of a balance of payments deficit

Heavy dependence on imports of food, fuel and manufactured goods.
Low and unstable export earnings from a few primary products.
Worsening terms of trade.
High domestic inflation, which makes exports dear and imports cheap.
Large payments of profits, interest and debt service abroad.
An overvalued exchange rate.
Large government spending abroad (embassies, imports for projects).
Capital flight: residents moving money out of the country.
Natural disasters, epidemics or conflict that cut exports.

Correcting a deficit

Measure	How it works
Devaluation or depreciation	Makes exports cheaper abroad and imports dearer at home
Tariffs, quotas and import controls	Directly reduce imports
Exchange control	Rations foreign currency for essential imports
Deflationary policies (higher interest rates, less government spending, higher taxes)	Reduce total demand, and so imports, and slow inflation
Export promotion	Subsidies, credit, better quality and marketing to raise exports
Import substitution	Produce at home goods that were imported
Attracting foreign investment and remittances	Brings in foreign exchange
Borrowing (including from the IMF)	Finances the deficit in the short run

Measures that cut spending (deflation) are called expenditure-reducing; measures that shift spending from imports to home goods (devaluation, tariffs) are called expenditure-switching.

In Sierra Leone

Sierra Leone usually has a trade deficit: imports of fuel, rice and machinery exceed exports, except in years of very high iron ore output. Remittances from Sierra Leoneans abroad and grants from development partners are an important source of foreign exchange that helps to finance the current account.

Common mistake

Do not use "balance of trade" and "balance of payments" as if they mean the same thing. The balance of trade covers goods only; the balance of payments covers all transactions, including services, income, transfers and capital flows.

Key points

The balance of trade is exports minus imports of goods.
The balance of payments records all transactions with the rest of the world: current account, capital and financial account, and official reserves.
Current account balance = visible + invisible balances + net primary income + net transfers.
Deficits arise from heavy imports, weak exports, inflation and profit outflows.
Corrections are expenditure-reducing (deflation) or expenditure-switching (devaluation, tariffs).

WASSCE examination focus

WAEC tests this

Expect to distinguish the balance of trade from the balance of payments, to state the components of the balance of payments, to calculate the visible balance and current account balance from a table, and to explain the causes and remedies of a deficit. Show each balance separately with its sign.

Quick check

Exports of goods are $500 million and imports of goods $650 million. What is the balance of trade?
In which account are remittances from relatives abroad recorded?
Give two causes of a balance of payments deficit in a West African country.
What is an expenditure-switching policy?

Answers: 1. $500 - 650 = -150$ : a deficit of $150 million. 2. The current account (secondary income / transfers). 3. Any two: dependence on imports, low or unstable export earnings, worsening terms of trade, inflation, profit and debt payments abroad, overvalued currency, capital flight. 4. A policy that shifts spending from imports to home-produced goods, such as devaluation or tariffs.

The balance of payments