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The Balance of Payments: Chapter Objective

The document provides an overview of a country's balance of payments (BOP). It defines the BOP as a statistical record of a country's international transactions over time. It discusses the key components of the BOP - the current account, capital account, and reserve account. The current account records trade in goods/services and investment income. The capital account records flows of financial capital. Together these must net to zero. BOP data can provide insights into a country's trade competitiveness and capital flows over time.

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Bigbi Kumar
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50 views

The Balance of Payments: Chapter Objective

The document provides an overview of a country's balance of payments (BOP). It defines the BOP as a statistical record of a country's international transactions over time. It discusses the key components of the BOP - the current account, capital account, and reserve account. The current account records trade in goods/services and investment income. The capital account records flows of financial capital. Together these must net to zero. BOP data can provide insights into a country's trade competitiveness and capital flows over time.

Uploaded by

Bigbi Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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The Balance of

Payments

Chapter 3

Chapter Objective:
This chapter serves to introduce the student to the balance of
payments, how it is constructed and how balance of payments
data may be interpreted.

Chapter Outline
Balance of Payments Accounts

The Current Account


The Capital Account

External Balance and the Exchange Rate


Balance of Payments Trends in Major Countries
1

Balance of Payments
The Balance of Payments is the statistical record of a countrys
international transactions over a certain period of time
presented in the form of double-entry bookkeeping.
Why is it useful to examine a countrys BOP?
The BOP provides detailed information about the supply and
demand of the countrys currency.

The trade statistics in the Current Account, for example, show the
composition of trade what a country imports and what it exports.
The Capital Account shows inflows and outflows of capital in various
categories.

Viewed over time, BOP data can shed light on important


developments in a countrys comparative advantage and
international competitiveness.
2

Balance of Payments
Accounts
They are composed of the following:

The Current Account


The Capital Account
The Official Reserve Account

Balance of Payments
Accounts
Current Account
Records flows of exports, imports, investment income, and international
financial transfers.
Merchandise trade export and import of tangible goods
Services payments and receipts for legal and consulting fees,
royalties, tourist expenditures
Investment income payments and receipts of interest, dividends, and
other income on foreign investments
Unilateral Transfers unrequited payments (e.g. 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.

Balance of Payments
Accounts
The capital account
Records sales to foreigners of Canadian financial assets and
Canadian purchases of foreign financial assets.
The capital account is composed of Foreign Direct Investment
(FDI), portfolio investments, and other investment.

Direct investment involves acquisitions of controlling interests in


foreign businesses.
Portfolio investment represents investment in foreign shares and bonds
that do not involve acquisitions of control.
Other investment includes bank deposits, currency investment, trade
credit and the like.
5

Balance of Payments
Accounts
The Reserve Account
The Reserve Account of BOP records changes in the amount
of official reserve assets held by the Bank of Canada.
Official reserves assets include gold, foreign currencies,
SDRs, reserve positions in the IMF.
If a country must make net payment to foreigners because of
BOP deficit, the country could either run down its official
reserve assets or borrow anew from foreigners.

Balance of Payments
Accounts
Statistical Discrepancy
Theres going to be some omissions and misrecorded
transactionsso we use a plug figure to get things to
balance.
Exhibit 3.4 shows a discrepancy of $0.8 billion in 2002.
How to calculate?
BP = 0 when all known transactions are accounted for, so
the SD is the "residual" value that will balance the books.

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, where the CB does


not maintain any official reserves, a CA surplus or deficit must be
matched by KA deficit or surplus:
BCA + BKA = 0
Under the fixed exchange rate regime, the combined balance on
the current and capital accounts will be equal in size, but opposite
in sign, to the change in the official reserves:
BCA + BKA = -BRA
8

Balance of Payments
Fixed Exchange Rate

BOP determines necessity of government intervention


Can help forecast devaluation/revaluation of currencies

Floating Exchange Rate

Government has no responsibility as FX rates are


determined by market forces

Managed Floats

Focus of government is on interest rates


9

Balance of Payments Trends


in Major Countries
From 1982-2000, U.S. has had continual annual trade deficits (CA) with the rest of the world (ROW), along with annual capital
surpluses (+KA), in roughly equal annual amounts. U.S. has
been a "net debtor" nation over this period.
Over the same period, Japan has had annual trade surpluses with
ROW, along with annual capital outflows, also in roughly equal
amounts. Japan is a "net creditor" nation, investing its trade
surplus in foreign stocks, bonds, real estate, government debt (Tbonds, etc.), businesses (FDI), art, etc. Japan has been accused
of "mercantilism," i.e. erecting trade barriers, or protectionist
trade policies to restrict or limit imports.
10

Balances on the Current (BCA) and


Capital (BKA) Accounts of the U.S.

Source: IMF International Financial Statistics Yearbook, 2000


11

Balances on the Current (BCA) and


Capital (BKA) Accounts of Japan

Source: IMF International Financial Statistics Yearbook, 2000


12

Balances on the Current (BCA) and Capital


(BKA) Accounts of United Kingdom

Source: IMF International Financial Statistics Yearbook, 2000


13

Balances on the Current (BCA) and


Capital (BKA) Accounts of China

Source: IMF International Financial Statistics Yearbook, 2000


14

Balance of Payments Trends


in Major Countries
Like the U.S., the United Kingdom recently experienced continuous
current account deficits, coupled with capital account surpluses. The
magnitude, however, is far less that that of the United States.
Germany traditionally had current account surpluses. Since 1991
Germany has been experiencing current account deficits. This is
largely due to German reunification and the resultant need to absorb
more output domestically to rebuild the former East Germany. This
has left less output available for exports.
China has been running trade surpluses AND capital account
surpluses. For example, in 2002 China had a $35.4B trade surpluses
and a $6.4B capital inflow. Reason: Official reserve holdings of
dollars has increased. Chinese govt. buys up dollars with Yuan, to
keep the dollar strong and the Yuan low, and the Yuan/$ rate stable.
15

Impact on Currency
CA: All the other factors constant, a deficit balance
on a countrys current account implies that there is
excess supply of its currency in the foreign markets.
Hence, its currency should depreciate.
KA: All other factors constant, a surplus balance in
a countrys financial account implies that there is
excess demand for assets denominated in its
currency. Hence, its currency should appreciate.
16

Affects on the Economy


Is a nations current account balance, by itself, a good measure
of its economic health?
NO; there is no law, economic or political, which states that the
current account balance must be positive. Unlike running a budget
deficit in which a person or institution spends more than it makes,
running a deficit in the current account, simply means a country
imports more than it exports.
Is a current account surplus and financial account deficit by
itself an indication of economic strength?
NO, particularly not if the exodus of the financial capital occurs
because there are a few good investment opportunities in the
country.
Is the net inflow of capital bad?
NO, if the capital is being invested in such a way as to enhance the
productive capacity of the country.
17

Do monetary and fiscal policies affect the


exchange rates and BOP components?
Monetary Policy: An unanticipated shift to expansionary
monetary policy will lead to more rapid economic growth,
accelerated inflation and lower real interest rates
BOP effects: Higher income and higher domestic prices stimulate
imports and discourage exports. Lower real rates discourage
foreign and domestic investment at home.
Exchange rate effects : The adverse impact of the countrys
current account will increase the supply of currency in the fx
markets; causing the currency to depreciate. The adverse impact
of the countrys financial account will decrease demand for the
countrys currency, causing it to depreciate.
18

Do monetary and fiscal policies affect the


exchange rates and BOP components?
Fiscal Policy: An unanticipated shift to more expansive fiscal
policy will result in budget deficits, increase in aggregate demand,
inflation and an increase in real interest rates.
BOP effect:Increase demand will encourage imports & discourage
exports, which moves the current account towards deficit.
Meanwhile, the higher interest rates attract foreign investment and
discourage domestic investment from leaving the country, moving
the financial account surplus.
Exchange rate effects: The adverse impact of the current account
will increase the SUPPLY of the countrys currency, causing the
currency to depreciate.
The positive impact of the KA will increase demand causing the
currency to appreciate.
19

What about monetary and fiscal


policies?
So what do you think is the net effect?
The overall effect is mixed, but the interest
rate effect will likely dominate in the short
term leading the exchange rate appreciation.

20

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