Balance of Payments

Pankaj Kumar International Business Environment

Part I Balance of Payments Accounting

Balance of Payments Accounting

Records of transactions among nations have not always been kept. Are they very recent?

Balance of Payments Accounting

General use of BP accounting is more recent, but in 1381 Richard Aylesbury, an Englishman, had not only collected such statistics, but was developing analysis as to why the accounts behaved as the did.

Balance of Payments Accounting

It is not clear that they are really necessary!

Balance of Payments Accounting

For example, who keeps track of Californias balance of payments transactions with other US states?

Balance of Payments Accounting

What kind of records should be kept? What do you want to find out? The nature of the record changes by what we are trying to find out.

Balance of Payments Accounting

What kind of things do governments wish to know? What is the international demand for our currency doing to its value? Do we have enough currency reserves, or capacity to pay for our trade? Does our trade promote full employment? And so on.

Balance of Payments Accounting

What kinds of transactions represent the basic focus of balance of payments accounting? All transactions between the citizens of a nation and those of other nations are recorded in the balance of payments for a given period of time.

Recording International Payments

How is information recorded in balance of payments accounting? The basic technique is standard, double-entry accounting, a flow of funds statement that shows changes in assets, liabilities and net worth over time.

Recording International Payments

The balance of payments statement is to inform government authorities of the international position of the country to assist them with monetary-fiscal questions as well as trade and payments policies.

Debits, Credits, and International Payments

What is the meaning of a debit in a balance of payments account? What is a credit? A debit records a transaction increasing assets or reducing liabilities.

Debits, Credits, and International Payments

A debit results from some kind of transaction requiring an immediate out-payment. A debit arises from the purchase of goods, claims, or reserve assets and represents an inflow of value.

Debits, Credits, and International Payments

A credit records a transaction reducing assets or increasing liabilities. It results from some kind of transaction requiring an immediate in-payment. A credit arises from the sale of goods, claims, or reserve assets and represents an outflow of value.

Sources and Uses of Funds

How does a country derive foreign currencies it needs to conduct its international business? The sources of funds, the supply of foreign exchange, are exports, investment income,

Sources and Uses of Funds

The sources of funds, the supply of foreign exchange, are transfer payments received, and long-term and short-term borrowing.

Sources and Uses of Funds

Credit entries reflect the sources, debit entries indicate the uses of foreign exchange.

Part II The Balance of Payments Accounts

BALANCE OF PAYMENTS ACCOUNTS

These accounts are to summarize payments a country receives from other nations and payments it must make to other nations. They consist of the following five categories:

1. MERCHANDISE OR TRADE BALANCE: (Exports minus imports )

BALANCE OF PAYMENTS ACCOUNTS

2. GOODS AND SERVICES BALANCE: (Just add services) 3. NET UNILATERAL TRANSFERS (Gifts) Government transfers to foreigners (E.g., Foreign aid or wheat from stockpiles) Private remittances of wages earned abroad, and Lots of other transfers.

BALANCE OF PAYMENTS ACCOUNTS

To here, we are looking at the CURRENT ACCOUNT BALANCE (Net flows of goods, services and gifts).
Again: 1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS

Balance of Payments
There is also a set of asset flows referred to as the CAPITAL ACCOUNT BALANCE 4. NET CHANGES IN FOREIGN HOLDINGS OF ASSETS Flows of financial assets and similar claims, or Foreign direct and other investments or Private capital flows. (Note that we are talking direct and portfolio investments here).

Balance of Payments
5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION Foreign official holdings of assets, holdings of official reserve (gold and foreign exchange) assets or, Official asset flows.

All Together Now

1. MERCHANDISE OR TRADE BALANCE: 2. GOODS AND SERVICES* BALANCE: 3. NET UNILATERAL TRANSFERS 4. NET CHANGES IN FOREIGN HOLDINGS OF U.S. ASSETS 5. NET OFFICIAL INTERNATIONAL RESERVE TRANSACTION

Balance of Payments

THE BALANCE OF PAYMENTS IS, THEREFORE, THE SUM OF THE CURRENT AND CAPITAL ACCOUNT BALANCES.

Services in the Balance of Payments

Note: *Services include travel and tourism, trade transportation, insurance, education, financial, technical, telecommunications and other business and professional services. In addition there are royalties, payments for capital services besides interest, such as dividends, payments for foreign labor, etc.

Overall Surpluses and Deficits

What is an overall balance of payments surplus? What is an overall deficit? A surplus is when the sum of the current account plus the private capital account is counterbalanced by an accumulation of official net assets, so official reserve assets increase.

Overall Surpluses and Deficits

What is an overall balance of payments surplus? What is an overall deficit? If it is in deficit , the sum is counterbalanced by an accumulation of official net liabilities, so the country sees its official reserve assets decline.

What Drives Large U.S. Current Account Deficits?

See Coughlin & Pollard and the readings suggested in King, if interested. They are very short and reassuring.

The U.S. currently has a huge current account deficit. Why do we have it?

Is it sustainable?

The current account balance is the difference between domestic saving and domestic investment. If domestic saving falls, the US must borrow from abroad to finance domestic investment US foreign indebtedness is not necessarily bad if foreign funds are used towards investment.

Repayment of the debt is potentially a problem if foreign funds are used to purchase consumption goods since future generations will bear the burden of debt.

Poole presents evidence that the rising current account deficit is associated with rising domestic investment, and a significant share of foreign investment in the US is equity investment which does not have to be repaid. He concludes that the US does not have a current account disorder.

Poole reminds us that a capital and financial account surplus is identical to a current account deficit because their dollar values are identical by the rules of accounting.

If a foreign firm builds a production facility in the US, the capital and financial account surplus increases, which, in turn, means that the U.S. current account deficit would increase. The rising current account deficit in recent years has been accompanied by a rising rate of U.S. domestic investment.

MATHEMATICAL INTERPRETAION

Balance of Payments Accounting Balance of Payments Accounts

The Current Account The Capital Account Statistical Discrepancy Official Reserves Account

The Balance of Payments Identity Balance of Payments Trends in Major Countries

BOP Accounting

The Balance of Payments is the statistical record of a countrys international transactions over a certain period of time presented in the form of double-entry bookkeeping. N.B. when we say a countrys balance of payments we are referring to the transactions of its citizens and government.

Balance of Payments Example

Suppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England. There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewoods bank account. This will lead to a rise in the supply of dollars and the demand for British pounds.

Balance of Payments Accounts

The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. They are composed of the following:

The Current Account The Capital Account The Official Reserves Account Statistical Discrepancy

The Current Account

Includes all imports and exports of goods and services. Includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is running a trade deficit. If the credits exceed the debits, then a country is running a trade surplus.

The Capital Account

The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. The U.S. enjoys about a $444,000,000,000 capital account surplusabsent of U.S. borrowing from foreigners, this finances our trade deficit. The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.

Statistical Discrepancy

Theres going to be some omissions and misrecorded transactionsso we use a plug figure to get things to balance. Exhibit 3.1 shows a discrepancy of $0.73 billion in 2000.

The Official Reserves Account

Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.

The Balance of Payments Identity

BCA + BKA + BRA = 0
where BCA = balance on current account BKA = balance on capital account BRA = balance on the reserves account

Under a pure flexible exchange rate regime, BCA + BKA = 0

U.S. Balance of Payments Data

Credits Current Account 1 2 3 Exports Imports $10.24 $1,418.64 ($1,809.18) ($64.39) ($444.69) ($152.44) ($124.94) ($303.27) Debits

Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

($0.30)

U.S. Balance of Payments Data

Credits Debits

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion.

($0.30)

U.S. Balance of Payments Data

Credits Debits

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

($0.30)

During the same year, the U.S. attracted net investment of $444.26 billionclearly the rest of the world found the U.S. to be a good place to invest.

U.S. Balance of Payments Data

Credits Debits

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

Under a pure flexible exchange rate regime, these numbers would balance each other out.

($0.30)

U.S. Balance of Payments Data

Credits Debits

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

In the real world, there is a statistical discrepancy.

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

($0.30)

U.S. Balance of Payments Data

Credits Debits

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Including that, the balance of payments identity should hold:

BCA + BKA = BRA

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

($0.30)

($444.69) + $444.26 + $0.73 = $0.30= ($0.30)

Balance of Payments and the Exchange Rate

Credits Debits

Exchange rate $

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

P
($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

D Q

($0.30)

Balance of Payments and the Exchange Rate

Credits Debits

Exchange rate $

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

P
($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

D Q

($0.30)

As U.S. citizens import, they are supply dollars to the FOREX market.

Balance of Payments and the Exchange Rate

Credits Debits

Exchange rate $

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

P
($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

D Q

($0.30)

Balance of Payments and the Exchange Rate

Credits Debits

Exchange rate $

Current Account
1 2 Exports Imports $1,418.64 ($1,809.18)

P
($64.39) ($444.69) ($152.44) ($124.94) ($303.27)

S S1

Unilateral Transfers Balance on Current Account Capital Account 4 5 6

7

$10.24

Direct Investment Portfolio Investment Other Investments Balance on Capital Account

Statistical Discrepancies Overall Balance Official Reserve Account

$287.68 $474.39 $262.64 $444.26 0.73 $0.30

D Q

($0.30)

As the U.S. government sells dollars, the supply of dollars increases.

Thank you