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What Does BoP Mean for an Economy?

As per two months’ data published by Nepal Rastra Bank (Central Bank of Nepal), balance of payment (BoP) deficit for the review period stands at NPR 5,873.8 million (USD 57.46 million)[1]. Put differently, net foreign assets decreased by NPR 5,873.8 million (USD 57.46 million). 

What is BoP and how is it calculated? BoP is the official record of all economic transactions between residents of a country and the rest of the world in a given period. BoP is based on double entry book keeping, thus the summation of current account balance and broad base of capital account (including financial account and official reserve) must equate to zero.

Mathematically,

Current Account Balance+ Capital (Financial) Account Balance+ Official Reserve Balance=0

If the summation of current and capital account is negative or less than zero, official reserves must be positive to satisfy the equation. Negative balance of current and capital account signifies that the country is importing more goods, services and capital than it is exporting, meaning that the central bank needs to export or sell foreign reserves. This economic situation is termed as BoP deficit.

On the other hand, a positive sum of current and capital account indicates that the country is exporting more goods, services and capital than it is importing, in which case the central bank imports or buys foreign currency. This economic situation is termed as BoP surplus.            

What BoP deficit means for an economy: When BoP of an economy is in deficit, the country is a net consumer. This is also termed an unfavorable balance of payment as more currency is flowing out of the country than flowing in. If the BoP deficit continues for long enough, it could drain the foreign currency reserve (as reserves are necessarily limited) and have significant impact on exchange rates. Moreover, in case of currencies with fixed exchange rates, central bank needs to maintain a desired level of foreign reserve to sustain the peg system. The recent BoP deficit in Nepal was triggered by ballooning current account deficit, which stands at NPR -17,877.8 million (USD -174.9 million). The figure was NPR -11,116.4 million (USD -108.75) in the corresponding period of previous fiscal year.

However, in the short run, BoP deficit (as triggered by trade deficit) is not necessarily a bad economic phenomenon given the deficit financing is used for investment purposes.      

What BoP surplus means for an economy: When an economy experiences a BoP surplus, there is a supply glut of foreign currency in the private FOREX market, encouraging the central bank to intervene and buy foreign reserves. In such circumstances, the country is a net producer of goods and services. BoP surplus is generally considered a favorable economic condition, however, over a period of time the impact of such saving imbalance can be negative. For instance, excessive saving could lead to disinvestment and unemployment.   

Conclusion: Neither BoP deficit nor surplus is advisable in the long run as it could yield serious economic consequences. However, in the short run, both can have favorable outcomes.



[1] Exchange rate- 1USD=NPR102.22 

Niraj K.C
Niraj is currently working as an economist beed and has over three years of experience working in the financial sector. He holds a M.sc in International Business and Economics from University of Hohenheim, Stuttgart, Germany with specialization in International Trade and Financial Econometrics. He is also a MBA graduate from Kathmandu University School of Management (KUSOM) with a major in Finance.
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