The Balance of Payments

Introduction
The measurement of all international economic transactions between the residents of a country and foreign residents is called the balance of payments (BOP) The two major sub accounts of the balance of payments are: Current account Financial account
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Fundamentals of Balance of Payments Accounting

The balance of payments must balance
Sub accounts may be imbalanced

Three main elements to the process of measuring international economic activity include:
Identifying what is and is not an international economic transaction Understanding how the flow of goods, services, assets, and money creates debits and credits to the overall BOP Understanding the bookkeeping procedures for BOP accounting

Defining International Transactions

Identifying many international transactions is ordinarily not difficult However, some international transactions are not obvious
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The BOP: Business Transactions

There are two types of business transactions that dominate the BOP: Real assets Financial assets

BOP Accounting: DoubleEntry Bookkeeping

BOP employs an accounting technique called double-entry bookkeeping In this age-old method every transaction produces a debit and a credit of the same amount A debit is created whenever:
An asset is increased A liability is decreased An expense is increased

A credit is created whenever:

An asset is decreased A liability is increased An expense is decreased
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BOP Accounting: DoubleEntry Bookkeeping

The measurement of all international transactions in and out of a country over a year is a difficult task Mistakes, errors, and statistical discrepancies will and do occur Current and capital and financial account entries are recorded independent of one another, not together as this accounting method would prescribe
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BOP Pattern
1. Current Account A. Trade in goods and services (merchandise etc) Goods- 1. Exports 2. Imports b. Services-1. Transportation (freight, passenger) 2. Travel 3. other Services (postal, telecom, financial, cultural, IT, Insurance etc)

BOP- Current Account

B. Income a. Compensation of Employees (wages, benefits) b. Investment Income (direct investment, portfolio etc) C. Current Transfers (payments of current taxes on income and wealth)

II- Capital and Financial Account

A. Capital Account a. Capital Transfers (ownership transfer of fixed assets, debt forgiveness etc) b. Acquisition/ disposal of non produced, non financial assets (patents, copyrights, trademarks, franchises, leases etc)

B. Financial Account
a. Direct Investment 1. Abroad (direct investors of reporting country with direct investment enterprises abroad (10% or above) 2. In Reporting Country (for investment in the reporting country)

BOP
b. Portfolio Investment 1. Assets (holdings of residents of reporting country- equities, debentures, money market instruments, financial derivatives) 2. Liabilities (for investments into the reporting country)

BOP
C. Other investments Assets (Held by residents of the reporting country - trade credits, repurchase agreements, deposits and currency) Liabilities ( for liabilities of residents of the reporting country)

BOP
d. Reserve assets (Assets with country s monetary authorities- monetary gold, SDRs, reserve positions in IMF, foreign currency, deposits and securities) e. Errors and Omissions (Balancing Item)

Major Items of India's balance of Payments (April-December, 2008) (In $ million) April-December (2008-09) (P) Exports Imports Trade Balance Invisibles, net Current Account Balance Capital Account* Change in Reserves# (+ indicates increase;- indicates decrease) 133,527 238,864 -105,337 68,868 -36,469 16,089 20,380 April-December (2007-08) (PR) 113,614 182,894 -69280 53772 -15508 82,682 -67,174

Including errors & omissions; # On BoP basis excluding valuation; P: Preliminary, PR: Partially revised. R: revised

The Accounts of the Balance of Payments

The BOP is comprised of two primary sub accounts:
Current Account Financial/Capital Account

Two additional and important sub accounts of the BOP include:

Net Errors and Omissions Account Official Reserves Account
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The Current Account

This account includes all international economic transactions with income or payment flows occurring within the year, the current period It consists of four subcategories:
Goods trade Services trade Income Current transfers

This account is typically dominated by Goods Trade

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The Current Account

The Balance on Trade (BOT) refers specifically to the balance of exports and imports of goods trade only- Flows of income between residents and non residents Merchandise trade is the core of international trade and has three major components:
Manufactured goods Agriculture Fuels
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The Financial/Capital and Financial Account

This account of the BOP measures all international economic transactions of financial assets It is divided into two major components:
Capital Account Financial Account
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The Capital Account

The Capital Account is made up of transfers of:
Financial assets The acquisition and disposal of nonproduced/nonfinancial assets

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The Financial Account

The Financial Account consists of three components:
Direct investment Portfolio investment Other asset investments

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Net Direct Investment

This is the net balance of capital dispersed out of and into the U.S. for the purpose of exerting control over assets Follows the 10% ownership threshold rule The source of concern over foreign investments in any country focuses on two topics:
Control Profit
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Portfolio Investment
This is the net balance of capital that flows in and out of the country but does not reach the 10% ownership threshold of direct investment It is capital invested in activities that are purely profit-motivated rather than ones made in the prospect of controlling or managing the investment These have shown much more volatile behavior than net direct investments over the past decade
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Other Investment Assets/Liabilities

This category consists of:
Short-term trade credits Long-term trade credits Cross-border loans from all types of financial institutions Currency deposits Bank deposits Other accounts receivable Accounts payable
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Official Reserves Account

This is the total currency and metallic reserves held by official monetary authorities within the country Its significance depends on whether the country is operating under:
A fixed exchange rate regime A floating exchange rate system

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The Balance of Payments--Total

The International Monetary Fund (IMF) is the multinational organization that collects the BOP statistics for over 160 different countries around the globe The current, capital, and financial accounts combine to form the basic balance and is one of the most frequently used summary measures of the BOP The current, capital, financial, and net errors and omissions accounts combine to form the summary measure known as the overall balance or official settlements balance
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The Balance of Payments and Economic Crises

The sum of cross-border international economic activity can be used by international managers to forecast economic conditions and in some cases, the likelihood of economic crises The mechanics of international economic crises often follow a similar path of development
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Capital Flight
Capital flight is the sudden and shocking outflow of capital from a nation s economy in which it is perceived there is political, economic, or currency crises forthcoming

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BOP key indices

Trade Balance Merchandise Balance- Difference Between exports and imports of goods Balance of goods and services- Merchandise balance+ algebraic sum of services trade Current-account balance-measure of a country s net borrowing or lending: + balance=net lending abroad - balance= net borrowing from foreigners

Savings and investment

Current-account balance plus the capital account balance measures the difference between what a country saves and what it invests If a country invests more than it saves, it must borrow the difference from abroad, importing capital

Other indictors
Country debt composition, size Composition of imports- whether a country is consuming or investing borrowed funds Payments balance-Reserves- total and changes in reserves