Bekaert and Hedrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Lecture Three
The Balance of Payment (BoP)

SIMAD University

2021
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Balance of Payments: Concept and Terminology

Balance of Payments (BOP);

• Accounting statement that summarizes all the economic
transactions between residents of the home country and
residents of all other countries.
• Balance of payments summarizes the international flows of goods
and services and changes in the ownership of assets across
countries.

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Balance of Payments: Concept and Terminology

Major Accounts in the BoP;
• Current Account;
• Goods and services transactions - imports/exports
• Investment Income flows (dividends and interest paid to
domestic residents who own foreign assets as well as dividends
and interest paid to foreign residents who own domestic
assets)
• Transfers (foreign aid, gifts, and grants given by the residents or
governments of one country to those of another)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Balance of Payments: Concept and Terminology

Major Accounts in the BoP;
• Capital Account;
• Purchases of foreign assets by domestic residents as well as the
purchases and sales of domestic assets by foreign residents
• Sales of foreign assets by domestic residents as well as the
purchases and sales of domestic assets by foreign residents
• Official settlements/reserves account (Gold and assets
denominated in foreign currency are the typical international
reserves)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Balance of Payments: Concept and Terminology

Major Accounts in the BoP;
• Double-entry accounting system;
• Each transaction gives rise to a credit (inflows) and a debit
(outflows), both of equal value.
• Credit transactions give rise to conceptual inflows or sources of
foreign exchange
• The purchases of goods and assets by foreign residents from
domestic residents are credits because they are a source of
foreign exchange

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Balance of Payments: Concept and Terminology

Major Accounts in the BoP;
• Double-entry accounting system;
• Each transaction gives rise to a credit (inflows) and a debit
(outflows), both of equal value.
• Debit transactions give rise to conceptual outflows or uses of
foreign exchange
• The purchases of goods and assets by domestic residents from
foreign residents are debits because they cause an outflow of
foreign exchange

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Summary of the Accounts of the Balance of Payments

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Surplus and Deficit in the BoP Accounts

Surplus/deficit;
• Surplus results when the credit exceed the debit transactions
• Deficit results when the debits exceed the credit transactions
An important Balance of Payments identity
• Current Account + Capital Account = 0
• Current account + Regular capital account + Official settlements
account = 0
• Implication is current account deficits (of which the U.S. suers)
MUST have a capital account surplus
• Now, Can you explain why the U.S doesn’t have problem with the
long-lasting trade deficit?
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Surplus and Deficit in the BoP Accounts

The U.S. Current Account ($M)
• Goods/Services; levels and balances
• Investment income
• Unilateral current transfers, Net (Current transfers are unilateral
transfers with nothing received in return)
• Balance on current account
M

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

• Suppose the U.S. computer maker Dell sells $20 million of
computers to Komatsu, a Japanese manufacturer of
construction and mining equipment. Komatsu pays Dell by
transferring dollars from its dollar-denominated bank account
at Citibank in New York to Dell’s bank account.
• What are the credit and debit items on the U.S. balance of
payments?
• What are the credit and debit items on the Japanese balance of
payments?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

• Suppose the U.S. computer maker Dell sells $20 million of
computers to Komatsu, a Japanese manufacturer of
construction and mining equipment. Komatsu pays Dell by
transferring dollars from its dollar-denominated bank account
at Citibank in New York to Dell’s bank account.
• What are the credit and debit items on the U.S. balance of
payments?
• What are the credit and debit items on the Japanese balance of
payments?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

U.S Balance of Payment Credit Debit

Computer purchase by +20 million

foreign (Export of Goods)

Decrease in foreign -20 million

ownership of U.S Assets
(Capital Outflow)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

Japanese Balance of Credit Debit
Payment

Computer purchase by -20 million

Domestic (Import of
Goods)
Decrease in foreign +20 million
ownership of Japanese
(Capital Inflow)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

• Suppose LVMH, a French luxury goods company, buys 1.5
million of consulting services from the British subsidiary of the
Boston Consulting Group (BCG). LVMH pays by writing a check
on its euro-denominated bank account at its Paris bank, Société
Générale, and BCG deposits the check in its euro-denominated
bank account at a different Paris bank, BNP Paribas.
• What are the credit and debit items on the French balance of
payments?
• What are the credit and debit items on the British balance of
payments?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

French Balance of Credit Debit
Payment

Purchase of Consulting -€1.5 million

service (Import)

Increase in foreign +€1.5 million

ownership of French
assets (Capital Inflow)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

British Balance of Credit Debit
Payment

Sale of Consulting service +€1.5 million

(Export)

Increase in foreign -€1.5 million

ownership of British
Company (Capital
Outflow)
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

• Consider an Indonesian resident who in previous years invested
in Japanese government bonds. Each year, the Indonesian
receives ¥500,000 of coupon payments from her Japanese
bonds. Suppose that these payments are paid to her Tokyo
bank, where she keeps a yen-denominated bank account.
• What are the credit and debit items on the Indonesian balance
of payments?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

Indonesian Balance of Credit Debit
Payment

Receipt of Coupon +¥500,000

payments (Income
Account)
Increase in foreign -¥500,000
ownership of Indonesian
(Capital Outflow)

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

• Consider the effect on the Japanese BOP of a gift of $2 million
by a Japanese firm to a U.S. university to create an endowed
chair. Suppose, also, that the Japanese firm finances the gift by
selling U.S. Treasury bonds in which it had previously invested.
• What should we record as credit and debit items on Japan’s
balance of payments?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

BoP Recording Examples

Japanese Balance of Credit Debit
Payment

Gift by Japanese fi rm to -¥200 million

U.S. university
(Import of Goodwill)
Sale of U.S Treasury Bond +¥200 million
(Capital Inflow) for Japan

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Capital Account Summary

• Capital Inflow;
• When foreigners increase their ownership of our assets by
purchase and acquisition
• When our citizens decrease their ownership of foreign assets
by sale and other disposal methods.
• Capital Outflow;
• When our citizens increase their ownership of foreign assets
by purchase and acquisition
• When foreigners decrease their ownership of our assets by
sale and other disposal methods.
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Dynamic of BoP

• What is the economic importance of surpluses and deficits?

• How do current account deficits today affect the balance of
payments in the future and ultimately the country’s debt
position relative to the rest of the world?

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Dynamic of BoP
• What is the economic importance of surpluses and deficits?
• How do current account deficits today affect the balance of
payments in the future and ultimately the country’s debt
position relative to the rest of the world?
• To understand this dynamic, we need to rewrite the current
account as;

Current account = Trade account + International investment

income account

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Dynamic of BoP
• Countries as Net Creditors or Net Debtors!
• A country’s net international investment position, or net
foreign assets helps us make this classification.
• Positive international investment position means that the
country is net creditor
• Negative international investment position means that the
country is net debtor.
NB: The indebtedness doesn’t mean that the country has more
debt securities investment, it means that host more investments
from foreigners than foreigners host from it.
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Dynamic of BoP
• Countries as Net Creditors or Net Debtors!
• A country’s net international investment position, or net
foreign assets helps us make this classification.
• Positive international investment position means that the
country is net creditor
• Negative international investment position means that the
country is net debtor.
NB: The indebtedness doesn’t mean that the country has more
debt securities investment, it means that host more investments
from foreigners than foreigners host from it.
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

U.S Net International Investment Position

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

U.S Net International Investment Position

• Many economists worry about the large negative international
investment position of the United States because they worry
about its implications for the U.S. current account.
• However, we see that the United States had a surplus of $121
billion on its investment income account in 2009, which is
surplus.
• Why is it so?
• It is because of “Composition” and “Return” effects

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Saving, Investment, Income and the BoP

𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺, for closed economy
𝐺𝐷𝑃 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋, for open economy
We can then define Gross-National Income as follows;
𝐺𝑁𝐼 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋 + 𝑁𝐹𝐼➔ 𝐺𝑁𝐼 = 𝐺𝐷𝑃 + 𝑁𝐹𝐼
Where NFI represent the “Net Foreign Income”.
• Subtracting expenditures from both sides, you have;
• 𝐺𝑁𝐼 − 𝑁𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑟𝑢𝑟𝑒𝑠 = 𝑁𝑋 + 𝑁𝐹𝐼
• If a country has a CA surplus, it's income exceeds its
expenditures
• If a country has a CA deficit, expenditures exceed income
3/28/2021 International Finance Slides Lecturer: Adam H. Roble
Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Saving, Investment, Income and the BoP

• Current account = Change in net foreign assets

• If country has a CA surplus, it is acquiring assets
• If country has a CA deficit it is losing assets

3/28/2021 International Finance Slides Lecturer: Adam H. Roble

Bekaert and Hodrick, 2nd Edition SIMAD UNIVERSITY, Mogadishu, Somalia

Saving, Investment, Income and the BoP

National Savings, Investment, and the Current Account;
• National savings = Gross National Income - Consumption
(by both its citizens and the government)
• If a country spends more than its income, its savings
are negative
• Using the dentitions of GNI and GDP we can rearrange
terms to find that National Saving -National Investment
= Current Account
• 𝑆 − 𝐼 = 𝐶𝐴
• What relationship do you think exist between CA deficit
and government deficit?
3/28/2021 International Finance Slides Lecturer: Adam H. Roble