The Balance of Payments

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The Balance of Payments• Balance of Payments (BOP):

measures all international economic transactions between residents & foreign residents.

• Monetary and fiscal policy must take the BOP into account at the national level • BOP data may be important

• Indicates pressure on exchange rate• May signal imposition/ removal of controls over payments,

dividends, interest. • Helps forecast country’s market potential

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For example…• BOP transactions (US side)• Daimler-Chrysler purchases manufacturer in Chicago.• GM China pays dividends to parent in US.• An American tourist purchases a necklace in India.• A Mexican lawyer purchases US bond via investment

broker in Cleveland.

• Rule of thumb: “follow the cash flow”

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B of PA. Current Account

A. Net exports/imports goods&services (Balance of Trade)

B. Net Income (investment income from direct portfolio investment plus employee compensation

C. Net transfers (sums sent home by migrant abroad)

B. Capital Account

Capital transfers related to purchase and sale of fixed assets such as real estate

C. Financial Account

A. Net foreign direct investment

B. Net portfolio investment

C. Other financial items

D. Net Errors and Omissions

Missing data such as illegal transfers

E. Reserves and Related Items

Changes in official monetary reserves including gold and foreign exchange reserves

Σ (A:E) = Overall Balance

Basic Balance = A+B+C

Overall Balance = A+B+C+D

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BOP Accounting• The BOP must balance• How to measure international economic activity?• Is it an international economic transaction?• How do flow of goods/services/assets/money translate in

debits & credits?• Bookkeeping procedures for BOP?

• Mistakes are common…

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The Current Account

• Goods Trade or Balance of Trade (BOT) – export/import of goods. • Services Trade – export/import of services (financial, construction, and tourism).• Income – predominately current income associated with investments made in

previous periods, + wages & salaries paid to non-resident workers.• Current Transfers – financial settlements due to change in ownership of real

resources or financial items. Any transfer b/n countries which is one-way, a gift or a grant.• CA typically dominated by export/import of goods, for this reason Balance of

Trade (BOT) is widely quoted.

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For example…•Trade balance

• Debit: Sun Microsystems buys LCDs from Hong Kong.• Credit: Singapore Airlines buys Boeing jet.

•Trade in services• Debit: American rents an apartment in Singapore.• Credit: TUI - Germany places an ad in the NYT.

•Income payments• Debit: Honda US pays dividend to Honda Japan.• Credit: Bank Austria pays salary to rep in NY office.

•Unilateral Current Transactions• Debit: Peace Corps pays US volunteer teachers in Bosnia.• Credit: TotalFina pays tuition of employee for Stern MBA.

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The Current Account1997 1998 1999

Goods exports 682 672 687Goods imports (876) (917) (1030)

Goods trade balance (BOT) (194) (245) (343)

Services exports 255 261 270Services imports (167) (183) (191)

Services trade balance 88 78 79

Income receipts 257 258 276Income payments (251) (265) (295)

Income balance 6 (7) (19)

Current transfers, credits 8 9 9Current transfers, debits (49) (53) (57)

Net transfers (41) (44) (48)

US Current Account, 1997-1999 (US$ bn)

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U.S. Trade Balance vs. Balance on Services & Income, 1985-99 (US$ bn)

-$350

-$300

-$250

-$200

-$150

-$100

-$50

$0

$50

$100

$150

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Balance on goods Services & income

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

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The Capital/Financial Account• Capital account: transfers of fixed assets, real estate,

acquisitions/disposal of non-produced/non-financial assets• Financial account: three components; classified by

degree of control, • Direct Investment – Net balance of capital which is

dispersed from and into US for the purpose of exerting control over assets. • E.g. US company acquires foreign company stake (-)• Foreign company acquires US company stake (+)• foreign direct investment (FDI): 10%+ of voting shares acquired.

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The Capital/Financial Account

• Portfolio Investment – Net balance of capital which flows in/out of US but does not reach 10% ownership.• No voting or control rights over the asset. • Purchase/sale of equity securities.• Purchase/sale of debt securities.

• E.g. T-bill purchases by foreigners (net portfolio investment)• E.g. US$ debt issues by foreign companies/ governments.

• Risk/Return motivated.• Far more volatile than FDI.

• Other Investment Assets/Liabilities –Short & long-term trade credits, cross-border loans, currency & bank deposits, & other accounts receivable and payable in cross-border trade.

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Direct Investment Concerns

• How much shall the country control the direct investments?• What can foreigners buy?

• Land, real estate sale to foreigners limited (Eastern Europe)• Certain stock can not be purchased (China, Russia)

• How shall profit be distributed?• Profit drain?• Many foreign firms in US reinvest most of their profits.

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The Capital/Financial Account

Direct investment abroad (105) (146) (151)Direct investment in the US 106 186 276

Net direct investment 1 40 125

Portfolio InvestmentAssets purchased by US residents, net (119) (136) (129)Assets purchased by foreign residents, net 386 269 342

Net portfolio investment 267 133 213

Other InvestmentOther investment assets (264) (47) (159)Other investment liabilities 265 27 136

Net other investment 1 (20) (23)

Financial Account Balance 269 153 315

US Capital/Financial Account, 1997-1999 (billions of US$)

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For example…•Direct Investment

• Debit: Ford builds factory in Australia.• Credit: Ford sells its factory in UK.

•Portfolio Investment• Debit: US investor buys BASF stock @ Frankfurt Stock Exchange• Credit: Korean gov’t buys US T-bills to hold as forex reserves.

•Other investment• Debit: HP deposits $10m in a bank account in London.• Credit: HP generates accounts receivable in Canada.

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US Financial Account, 1985-99 (US$ bn)

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

-$100

-$50

$0

$50

$100

$150

$200

$250

$300

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Net direct investment Net portfolio investment Net other investment

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Current & Financial/Capital Account Balances, US, 1992 - 1999 (US$ bn)

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

-$400

-$300

-$200

-$100

$0

$100

$200

$300

$400

1992 1993 1994 1995 1996 1997 1998 1999

Current account Financial/capital account

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The Other Accounts• Net Errors and Omissions – Account is used to

account for statistical errors and/or untraceable monies within a country• Official Reserves (ORA) – total reserves held by official

monetary authorities within a country. • Comprised of major currencies used in international trade

and financial transactions, & reserve accounts (SDR) held @ IMF.

.

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The Balance of Payments in Total1997 1998 1999

A. Current Account (140.55) (217.13) (331.48)

Goods exports FOB 681.65 672.29 686.66Goods imports FOB (876.37) (917.19) (1029.92)

Goods trade balance (BOT) (194.72) (244.90) (343.26)Services exports 255.29 260.69 269.58Services imports (166.51) (182.68) (191.30)

Services trade balance 88.78 78.01 78.28Income credit 257.35 258.45 276.17Income debit (251.16) (264.66) (294.65)

Balance on Goods, Services & Income 6.19 (6.21) (18.48)Current transfers, credits 8.47 9.33 9.41Current transfers, debits (49.27) (53.36) (57.43)

B. Capital Account 0.35 0.64 (3.50)

Capital account credit 0.35 0.64 0.49Capital account debit 0.00 0.00 (3.99)

Total, Groups A plus B (140.20) (216.49) (334.98)

C. Financial Account 269.04 153.59 314.64Direct invesment 1.02 40.27 124.64

Direct investment abroad (105.02) (146.05) (150.90)Direct investment in the US 106.04 186.32 275.54

Portfolio investment assets (118.98) (136.00) (128.59)Equity securities (57.58) (101.24) (114.40)Debt securities (61.40) (34.76) (14.19)

Portfolio investment liabilities 385.60 269.33 342.19Equity securities 67.85 41.95 98.07Debt securities 317.75 227.38 244.12

Other investment assets (263.94) (46.60) (159.45)Monetary authorities 0.00 0.00 0.00General government 0.07 (0.42) 2.75Banks (141.12) (35.57) (69.86)Other sectors (122.89) (10.61) (92.34)

Other investment liabilites 265.34 26.59 135.85Monetary authorities (18.85) 6.88 24.71General government (2.86) (3.48) (1.37)Banks 171.31 30.27 80.10Other sectors 115.74 (7.08) 32.41

Total, Groups A through C 128.84 (62.90) (20.34)

D. Net Errors and Ommisions (127.83) 69.65 11.63

Total, Groups A through D 1.01 6.75 (8.71)

E. Reserves and Related Items (1.01) (6.73) 8.73

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What if…?• BOP shows surplus:• D > S for that currency. • Allow currency value to increase,• Or accumulate foreign reserves.

• BOP shows deficit:• S > D for that currency.• Devalue currency,• Or use official reserves to support currency.

Balance of payment account

Current accountEX & IM of goods

EX & IM of Services

Factor income/payments(Profit/dividend/Interest)

Other Transactions(gifts/grants)

Capital AccountDirect foreign investment

portfolio invesment(shares)

Other trade items(bank accounts)

Foreign reservesChange in official reserves

• Import a mobile phone CHY 1500 @22 =33000 LKR

Balance of payment account

Current account

Import of Mobile Phone -33000

Total-33000 0 -33000

Capital Account

Export LKR (bank account) 33000

Import CHY (bank account) -33000

export CHY (bank account) 33000

Total -33000 66000 33000

Foreign reserves

• Buy shares in Sri Lanka(by Chinese) worth CHY 1000 -22000LKR

Balance of payment account

Current account

0 0 0

Capital Account

Export Securities 22000

Import LKR -22000

-22000 22000 0

Foreign reserves

• Export tea to USA worth 100USD @133 - 133000LKR

Balance of payment account

Current accountExporting tea 13300

0 13300 13300

Capital AccountImporting(bank account) -13300

-13300 0 -13300

Foreign reserves

• Deficit in BOP• Excess supply of domestic currency

• Surplus in BOP• Excess demand of domestic currency

Current accountImport of Mobile Phone -33000Export tea 13300

-33000 13300 -19700

Capital AccountExport LKR (bank account) 33000Import CHY (bank account) -33000export CHY (bank account) 33000Export Securities 22000Import LKR -22000Importing(bank account) -13300

-68300 88000 19700

Foreign reserves

0

Current accountImport of Mobile Phone -33000Export tea 13300

-33000 13300 -19700Capital Account

Export LKR (bank account) 33000Import CHY (bank account) -33000export CHY (bank account) 33000Export Securities 22000Import LKR -22000Importing(bank account) -13300Importing(bank account) -3000

-71300 88000 16700Foreign reserves

Export Foreign currency 3000 30000