INTERNATIONAL

FINANCIAL
MANAGEMENT

Fourth Edition

EUN / RESNICK

3-1 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Balance
of Payments 3
Chapter Three
INTERNATIONAL
Chapter Objective: FINANCIAL
MANAGEMENT
This chapter serves to introduce the student to the
balance of payments. How it is constructed and
Fourth Edition
how balance of payments data may be interpreted.
EUN / RESNICK

3-2 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Three Outline
 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
3-3 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments Accounting
 The Balance of Payments is the statistical record
of a country’s international transactions over a
certain period of time presented in the form of
double-entry bookkeeping.

N.B. when we say “a country’s balance of

payments” we are referring to the transactions of
its citizens and government.

3-4 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 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
Maplewood’s bank account.
 This will lead to a rise in the supply of
dollars and the demand for British pounds.

3-5 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 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

3-6 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 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.

3-7 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Capital Account
 The capital account measures the difference
between U.S. sales of assets to foreigners and U.S.
purchases of foreign assets.
 In 2004, the U.S. enjoyed a $611.2 billion capital
account surplus—absent 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.
3-8 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Statistical Discrepancy
 There’s going to be some omissions and
misrecorded transactions—so we use a “plug”
figure to get things to balance.
 Exhibit 3.1 shows a discrepancy of $51.9 billion
in 2004.

3-9 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 The Official Reserves Account
 Official reserves assets include gold, foreign
currencies, SDRs, reserve positions in the IMF.

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 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
3-11 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-12 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account In 2004, the
1 Exports $1,516.2
U.S. imported
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
more than it
Balance on Current Account ($665.9) exported, thus
Capital Account
running a
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8) current account
6 Other Investments
Balance on Capital Account
$524.3 ($483.7) deficit of
$611.2
7 Statistical Discrepancies 51.9 $665.9 billion.
Overall Balance $2.8
Official Reserve Account $2.8

3-13 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits During the same
Current Account
1 Exports $1,516.2
year, the U.S.
2 Imports ($2,109.1)
attracted net
3 Unilateral Transfers $16.4 ($89.4) investment of
Balance on Current Account ($665.9) $611.2 billion—
Capital Account
4 Direct Investment $115.5 ($248.5)
clearly the rest
5 Portfolio Investment $794.4 ($90.8) of the world
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
found the U.S.
7 Statistical Discrepancies 51.9 to be a good
Overall Balance $2.8
Official Reserve Account $2.8
place to invest.

3-14 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
Under a pure
2 Imports ($2,109.1)
flexible
3 Unilateral Transfers $16.4 ($89.4) exchange rate
Balance on Current Account ($665.9) regime, these
Capital Account
4 Direct Investment $115.5 ($248.5) numbers would
5 Portfolio Investment $794.4 ($90.8) balance each
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
other out.
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-15 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
In the real
2 Imports ($2,109.1)
world, there
3 Unilateral Transfers $16.4 ($89.4) is a statistical
Balance on Current Account ($665.9) discrepancy.
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8

3-16 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,516.2
Including that,
2 Imports ($2,109.1)
the balance of
3 Unilateral Transfers $16.4 ($89.4) payments identity
Balance on Current Account ($665.9) should hold:
Capital Account
4 Direct Investment $115.5 ($248.5) BCA + BKA = – BRA
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8
Official Reserve Account $2.8
($665.9) + $611.2 + $51.9 = ($2.8)
3-17 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8

3-18 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As U.S. citizens import, they are supply dollars to the FOREX market.
3-19 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As U.S. citizens export, others demand dollars at the FOREX market.
3-20 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,516.2 P S
2 Imports ($2,109.1) S1
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)
Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7) D
Balance on Capital Account $611.2
7 Statistical Discrepancies 51.9
Overall Balance $2.8 Q
Official Reserve Account $2.8
As the U.S. government sells dollars, the supply of dollars increases.
3-21 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments Trends
 Since 1982 the U.S. has experienced continuous
deficits on the current account and continuous
surpluses on the capital account.
 During the same period, Japan has experienced the
opposite.

3-22 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of the United States
U.S. Balance of Payments Trend: 1982-2004
800
Balance of Payments ($B)

600
400
200
U.S. BCA
0
U.S. BKA
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
-200
-400
-600
-800
Year

Source: IMF International Financial Statistics Yearbook, various issues

3-23 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of United Kingdom

40
30
20
10
0 UK BCA
1982

1984

1986

1988

1990

1992

1994

1996

1998

2000
-10 UK BKA
-20
-30
-40
-50

Source: IMF International Financial Statistics Yearbook, various issues

3-24 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of Japan
150

100

50

Japan BCA
0
Japan BKA
1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004
-50

-100

-150

Source: IMF International Financial Statistics Yearbook, various issues

3-25 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of Germany
80
60
40
20
0 Germany BCA
1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004
-20 Germany BKA

-40
-60
-80
-100

Source: IMF International Financial Statistics Yearbook, various issues

3-26 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of China

60

50

40

30
China BCA
20
China BKA
10

0
1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004
-10

-20

Source: IMF International Financial Statistics Yearbook, various issues

3-27 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
 Balance of Payments Trends
 Germany traditionally had current account
surpluses.
 From 1991 to 2001Germany experienced current
account deficits.
 This was largely due to German reunification and the
resultant need to absorb more output domestically to
rebuild the former East Germany.
 Since 2001 Germany returned to its earlier pattern.
 What matters is the nature and causes of the
disequilibrium.
3-28 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Balances on the Current (BCA) and Capital
(BKA) Accounts of Five Major Countries
800
China BCA
600
China BKA
400 Japan BCA
Japan BKA
200 Germany BCA

0 Germany BKA
1980 1985 1990 1995 2000 2005 UK BCA
-200 UK BKA
U.S. BCA
-400
U.S. BKA
-600

Source: IMF International Financial Statistics Yearbook, 2000

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 End Chapter Three

3-30 Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.