Effect of Balance of Payments on Currency Value
One of the fundamental indicators of forex trading is the balance of payments which can be said as a summary of transactions carried out by residents of a country with residents of other countries for a certain period of time which is usually calculated within one year. Balance of payments includes the purchase and sale of goods and services, grants from individuals and foreign governments, and financial transactions. Generally the balance of payments is divided into a current account balance (which consists of the trade balance, service balance and transfer payment) and the capital and financial traffic balance, and financial items.
Types of transactions in the balance of payments:
- Debit transactions, which are transactions that cause the flow of money (foreign exchange) from domestic to overseas. This transaction is called a negative transaction (-) or is recorded as a debit, which is a transaction that causes a reduction in the position of foreign exchange reserves.
- Credit transactions are transactions that cause the flow of money (foreign exchange) from abroad into the country. This transaction is also called a positive transaction (+) or is recorded as a credit, which is a transaction that causes an increase in the country’s foreign exchange reserve position.
Now in this case we will discuss one of the balance of payments, namely the trade balance. When a country is said to have a surplus recorded as a positive transaction or credit and means that the country is able to produce and sell its products with a total value more than the total value bought from other countries or it can be said that the income derived from total exports is greater than the expenditure for imports .
From these conditions it can be said that the country’s economy is relatively stronger than the countries that are trading partners. As a result, the currency exchange rate tends to strengthen against its trading partner countries. Strengthening this currency exchange rate will result in the price of exported products more expensive than products imported from their trading partner countries. And a country’s currency exchange rate will tend to strengthen if the country is able to maintain its trade balance surplus condition .
The opposite is true when a country is said to experience a deficit recorded as a negative or debit transaction and means that the country is more importing than exporting its domestic products so that its trading partner country is more profitable than the country itself.
And these conditions can be said that the economy of its trading partner countries is relatively stronger than the country, as a result the exchange rate of the trading partner countries tends to strengthen, or the exchange rate of the country’s currencies tends to weaken against the currencies of trading partner countries. The weakening of the exchange rate resulted in the price of imported products more expensive than products exported to trading partner countries.Countries that experience a trade balance deficit continuously, in the long run the currency exchange rate tends to weaken.
So a country with a surplus trade balance will encourage a trading partner country that has a deficit to weaken (devaluate) its currency exchange rate to make its export products more competitive so that it will increase export volume and ultimately narrow the trade balance deficit. If later the condition of the country returns to surplus then in the long run the currency exchange rate will tend to strengthen.