03 Balance of Payments

8/3/2019 03 Balance of Payments

1/31

INTERNATIONAL

FINANCIAL

MANAGEMENT

EUN / RESNICKSecond Edition

3The Balanceof Payments

Lecture Objective:

This lecture serves to introduce the student to the

balance of payments. How it is constructed and how

balance of payments data may be interpreted.


2/31

Lecture Three Outline

3-1

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


3/31

Balance of Payments Accounting

3-2

The Balance of Payments is the statistical recordof a countrys international transactions over a

certain period of time presented in the form ofdouble-entry bookkeeping.

E.g. export and imports; cross border investmentsin bonds, stocks, real estate etc

Note: When we say a countrys balance of

payments we are referring to the transactions of

its citizens and government.


4/31

3-3

When exports are more than imports, currencyappreciates and vice versa

If BOP is adverse other countries may not want todo business with you; country will be forced to

restrict imports and arrest capital outflows BOP data can be used to evaluate the

performance of the country in internationaleconomic competition


5/31

3-4

Receipts from foreigners are recorded as a creditwith a positive sign

Payments are recorded as a debit with a negativesign


6/31

Balance of Payments Example

3-5

Suppose that Maplewood Bicycle in MaplewoodMissouri, USA imports $100,000 worth of bicycleframes from Mercian Bicycles in Darby England.

There will exist a $100,000 credit recorded byMercian that offsets a $100,000 debit atMaplewoods bank account.

This will lead to a rise in the supply of dollars andthe demand for British pounds.


7/31

Balance of Payments Accounts

3-6

The balance of payments accounts are those thatrecord all transactions between the residents of acountry and residents of all foreign nations.

They are composed of the following:

The Current Account The Capital Account

Statistical Discrepancy

The Official Reserves Account


8/31

The Current Account

3-7

Includes all imports and exports of goods andservices.

Includes unilateral transfers of foreign aid.

If the debits exceed the credits, then a country is

running a trade deficit.


9/31

Current account

3-8

Merchandise trade: exports and imports of goodslike wheat, rice, computers etc; trade balance isthe difference between exports and imports;Japan, Germany have trade surplus whereas the

US has deficit Services: payments and receipts for legal,

consulting, engineering services, royalties forpatents


10/31

3-9

Factor Income: Payments and receipts of interest,dividends, other income on foreign investments

Receipts are credits and payments are debits

Unilateral transfers: Foreign aid, official and

private grants, gifts

One directional flow; country making payment willreceive goodwill in return


11/31

3-10

When currency depreciates, exports rise andimports fall

J curve effect: Trade balance deteriorates for sometime and then improves

J Curve effect exists in 40% of cases involvingcurrency devaluation


12/31

The Capital Account

3-11

The capital account measures the differencebetween U.S. sales of assets to foreigners andU.S. purchases of foreign assets.

The U.S. enjoys about a $150,000,000,000 capital

account surplusabsent of U.S. borrowing fromforeigners, this finances our trade deficit.

The capital account is composed of Foreign DirectInvestment (FDI), portfolio investments and other

investments.


13/31

3-12

FDI: Setting up of capital projects, acquisitions Portfolio Investment: Sales and purchases of

foreign financial assets

Other Investment: transactions in bank deposits,

trade credits, transactions in currency


14/31

Statistical Discrepancy

3-13

Theres going to be some omissions andmisrecorded transactionsso we use a plugfigure to get things to balance.

Exhibit 3.1 shows a discrepancy of $96.76 billion in

1997.


15/31

The Official Reserves Account

3-14

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

When a country must make a net payment toforeigners because of a BOP deficit the central

bank either should run down its official reserves orborrow anew


16/31

The Balance of Payments Identity

3-15

BCA + BKA + BRA = 0where

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


17/31

U.S. Balance of Payments Data

3-16

Credits DebitsCurrent Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)

Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)


18/31


3-17

In 1997, the

U.S. imported

more than itexported, thus

running a

current account

deficit of$166.8 billion.


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account








19/31


3-18

During the same

year, the U.S.

attracted net

investment of$264.58

billionclearly

the rest of the

world found theU.S. to be a

good place to

invest.


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account








20/31


3-19

Under a pure

flexible

exchange rateregime, these

numbers would

balance each

other out.


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account








21/31


3-20

In the real

world, there

is a statisticaldiscrepancy.


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account








22/31


3-21


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account







Including that,

the balance of

payments identityshould hold:

BCA + BKA = - BRA

($166.80) + $264.58+ ($96.76) = $1.02=($1.02)


23/31

Balance of Payments and the ExchangeRate

3-22

Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account








24/31


3-23

Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account







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


26/31


3-25

Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)


Capital Account







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

S1


27/31

Balance of Payments Trends

3-26

Since 1982 the U.S. has experienced continuousdeficits on the current account and continuoussurpluses on the capital account.

During the same period, Japan has experienced

the opposite.


28/31


U.S. Balance of Payments Trends

-200

-150

-100

-50

0

50

100

150

200

1982

1984

1986

1988

1990

1992

1994

1996

Year

B

alanceofPayments($b)

Current Account

Capital Account

3-27


29/31


Japan's Balance of Payments Trend

-150

-100

-50

0

50

100

150

1982

1984

1986

1988

1990

1992

1994

1996

Year

B

alanceofPayments($b)

Current Account

Capital Account

3-28


30/31


3-29

Germany traditionally had current accountsurpluses.

Since 1991 Germany has been experiencingcurrent account deficits.

This is largely due to German reunification and theresultant need to absorb more output domesticallyto rebuild the former East Germany.

What matters is the nature and causes of the

disequilibrium.


31/31


Germany's Balance of Payments Trend

-80

-60

-40

-20

0

20

40

60

80

1982

1984

1986

1988

1990

1992

1994

1996

Year

BalanceofPayments($b

)

Current Account

Capital Account

3-30

Documents

03 Balance of Payments