Balance of payments
What is the price of a country’s What is the price of a country’s currency?currency?
If we know the factors affecting If we know the factors affecting demand & supply, then we shall demand & supply, then we shall know the factors influencing know the factors influencing exchange ratesexchange rates
Hence, the considerable interest inHence, the considerable interest inmaintaining a record of the factorsmaintaining a record of the factorsbehind the supply & demand of abehind the supply & demand of acountry’s currencycountry’s currency
Can be visualised as an itemisation of the Can be visualised as an itemisation of the factors behind the demand & supply of a factors behind the demand & supply of a currencycurrency
Why is the BOP account published?
To report the country’s To report the country’s international performance in international performance in trading with other nationstrading with other nations
Factors affecting exports & hence the demand for home currency
Home prices v/s comparable goods Home prices v/s comparable goods abroadabroad
Foreign incomeForeign income
Foreign import duties & quotasForeign import duties & quotas
Principles of BOP accounting
Double entry bookkeepingDouble entry bookkeeping It is a cash flow statementIt is a cash flow statement Designed to always balance; rules Designed to always balance; rules
for debits and creditsfor debits and credits The way it is balanced tells us how The way it is balanced tells us how
a country is doing in its transactions a country is doing in its transactions with other countrieswith other countries
Components of BOP
Current accountCurrent account
Capital/financial accountCapital/financial account
Net errors and omissionsNet errors and omissions
Official reserves accountOfficial reserves account
Current account balance
Fair indicator of a country’s Fair indicator of a country’s international competitivenessinternational competitiveness
A current account surplus will A current account surplus will strengthen the currencystrengthen the currency
Current account balance
Affected by:Affected by:
InflationInflation
A comparatively high economic A comparatively high economic growth- increase in imports while growth- increase in imports while demand for exports lag behinddemand for exports lag behind
Capital / Financial Account
Capital accountCapital account
Transfers of financial assets and Transfers of financial assets and
the acquisition and disposal ofthe acquisition and disposal of
non-produced/ non-financial non-produced/ non-financial
assetsassets
Financial Account
Direct investmentDirect investment
Portfolio investmentPortfolio investment
Other investment assets/ liabilitiesOther investment assets/ liabilities
Current & Capital Account Relationship
Inverse relation between the Inverse relation between the current and capital accountcurrent and capital account
Countries experiencing large Countries experiencing large current account deficits “ finance” current account deficits “ finance” these purchases through equally these purchases through equally large surpluses in the capital large surpluses in the capital accountaccount
Official Reserves Account
Total reserves held by official Total reserves held by official monetary authorities within the monetary authorities within the country.country.
Normally composed of the major Normally composed of the major currencies used in international currencies used in international trade and financial transactionstrade and financial transactions
Net Errors & Omissions
Reasons?Reasons?
Capital MobilityCapital Mobility
Capital FlightCapital Flight
Link Between Current & CapitalAccount
National Income = Consumption + SavingsNational Income = Consumption + Savings
National spending= Consumption+InvestmentNational spending= Consumption+Investment
National Income- National spending =National Income- National spending =
Savings – InvestmentsSavings – Investments
Savings – Investments = surplus capital Savings – Investments = surplus capital
( that must be invested overseas)( that must be invested overseas)
i.e Savings = Domestic Inv + Net Foreign Inv Net Foreign Inv= Nation’s net public & private capital flows = capital account deficit
Alternatively,A national savings deficit = capital account surplus( net borrowing from abroad)This borrowing finances the excess of national spending over income.
If we subtract expenses on domestic goods & services from National Product,the remaining goods & services must be exports
Similarly, subtracting spending domestic goods & services from total expenditure, the remaining goods & services must be imports
We have now another national income identity:
National Income – National spending = Exports – Imports = Net Foreign Investment
Thus, in a freely floating exchange rate system,
The current account balance & the capital account balance must exactly offset each other
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