Eun Resnick Balance of Payment

The Balance of PaymentsChapter Objective: Chapter Three INTERNATIONAL FINANCIAL MANAGEMENT 3 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. Second Edition EUN / RESNICK Chapter Three Outline   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 3-1 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights McGraw-Hill/Irwin reserved. Balance of Payments Accounting  The Balance of Payments is the statistical record of a country¶s international transactions over a certain period of time presented in the form of double-entry bookkeeping. N.B. when we say ³a country¶s balance of payments´ we are referring to the transactions of its citizens and government. McGraw-Hill/Irwin reserved. 3-2 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights USA imports $100.000 credit recorded by Mercian that offsets a $100. .Balance of Payments Example    Suppose that Maplewood Bicycle in Maplewood Missouri.000 debit at Maplewood¶s bank account. There will exist a $100. This will lead to a rise in the supply of dollars and the demand for British pounds. Inc. All rights McGraw-Hill/Irwin reserved.000 worth of bicycle frames from Mercian Bicycles in Darby England. 3-3 Copyright © 2001 by The McGraw-Hill Companies. All rights McGraw-Hill/Irwin reserved. They are composed of the following:     The Current Account The Capital Account Statistical Discrepancy The Official Reserves Account 3-4 Copyright © 2001 by The McGraw-Hill Companies. .Balance of Payments Accounts   The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. Inc. then a country is running a trade deficit. If the debits exceed the credits.The Current Account    Includes all imports and exports of goods and services. Inc. 3-5 Copyright © 2001 by The McGraw-Hill Companies. All rights . McGraw-Hill/Irwin reserved. Includes unilateral transfers of foreign aid. All rights McGraw-Hill/Irwin reserved. portfolio investments and other investments. The U. borrowing from foreigners. sales of assets to foreigners and U.000 capital account surplus²absent of U. . purchases of foreign assets.S.S. enjoys about a $150.000. The capital account is composed of Foreign Direct Investment (FDI).S.The Capital Account    The capital account measures the difference between U. 3-6 Copyright © 2001 by The McGraw-Hill Companies.000. this ³finances´ our trade deficit. Inc.S. Statistical Discrepancy   There¶s going to be some omissions and misrecorded transactions²so we use a ³plug´ figure to get things to balance. All rights .1 shows a discrepancy of $96. McGraw-Hill/Irwin reserved. Exhibit 3. 3-7 Copyright © 2001 by The McGraw-Hill Companies. Inc.76 billion in 1997. SDRs. McGraw-Hill/Irwin reserved.The Official Reserves Account  Official reserves assets include gold. 3-8 Copyright © 2001 by The McGraw-Hill Companies. reserve positions in the IMF. foreign currencies. Inc. All rights . 3-9 Copyright © 2001 by The McGraw-Hill Companies. Inc. BCA + BKA = 0 McGraw-Hill/Irwin reserved. All rights .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. 58 Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.61 ($1. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6.95 $264.80) ($119. 3-10 . All rights Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.U.28) ($227.01) ($166.93 $387.S.76) $1.02 ($1.44) ($79.13 $1.53) ($45.62 $194.167. Inc.295.02) Copyright © 2001 by The McGraw-Hill Companies.2) ($96. 61 ($1.295.62 $194.28) ($227.U.01) ($166. All rights Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.8 billion.76) $1.53) ($45.80) ($119.95 $264. imported more than it exported. In 1997. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6. thus running a current account deficit of $166. Inc. the U.58 Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.93 $387.2) ($96. 3-11 .13 $1.02) Copyright © 2001 by The McGraw-Hill Companies.S.S.44) ($79.167.02 ($1. 295. During the same year.13 $1.U. attracted net investment of $264. the U.S. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6.93 $387.S.S.02) Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.02 ($1.28) ($227. All rights .2) ($96.62 $194.58 Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.167.95 $264.58 billion²clearly the rest of the world found the U.53) ($45. 3-12 Copyright © 2001 by The McGraw-Hill Companies. to be a good place to invest.01) ($166.44) ($79.61 ($1.80) ($119. Inc.76) $1. 80) ($119.93 $387.02 ($1.01) ($166.61 ($1.62 $194.13 $1. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6.2) ($96. 3-13 .295.S.U.95 $264. Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved. these numbers would balance each other out.02) Copyright © 2001 by The McGraw-Hill Companies.44) ($79.58 Under a pure flexible exchange rate regime. Inc.53) ($45.28) ($227.167.76) $1. All rights Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107. 80) ($119.167. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6.76) $1. 3-14 .95 $264.01) ($166.28) ($227.58 Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.53) ($45.62 $194.93 $387.2) ($96. there is a statistical discrepancy.02) Copyright © 2001 by The McGraw-Hill Companies.295.61 ($1. Inc.S.U. All rights Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account In the real world.13 $1.44) ($79. $107.02 ($1. 62 $194.02) Debits Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account Including that.U.80) + $264.80) ($119.01) ($166. Inc.02) 3-15 Copyright © 2001 by The McGraw-Hill Companies.13 $1.295.167.76) = $1.53) ($45.02 ($1.44) ($79.58 Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.58 + ($96. Balance of Payments Data Credits Current Account 1 2 3 Exports Imports $6.28) ($227. ($166. All rights .2) ($96.93 $387.BRA $107.S.76) $1.02= ±($1.61 ($1. the balance of payments identity should hold: BCA + BKA = .95 $264. Inc.61 ($1.53) ($45.295.80) ($119.28) ($227.Balance of Payments and the Exchange Rate Credits Current Account 1 2 3 Exports Imports $6. All rights .62 $194.76) $1. 3-16 Copyright © 2001 by The McGraw-Hill Companies.167.95 $264.01) ($166.02 ($1.2) ($96.93 $387.58 D Q Exchange rate $ Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.13 $1.02) Debits P S Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.44) ($79. As U.167.53) ($45.76) $1.80) ($119.93 $387. All rights .95 $264.295.2) ($96. they are supply dollars to the FOREX market.S.Balance of Payments and the Exchange Rate Credits Current Account 1 2 3 Exports Imports $6.02 ($1.01) ($166. citizens import.13 $1.62 $194.58 D Q Exchange rate $ Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.28) ($227. Inc. 3-17 Copyright © 2001 by The McGraw-Hill Companies.44) ($79.61 ($1.02) Debits P S Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107. 53) ($45.2) ($96. All rights .61 ($1. 3-18 Copyright © 2001 by The McGraw-Hill Companies.58 D Q Exchange rate $ Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.167.295.02 ($1. citizens export.S.01) ($166. others demand dollars at the FOREX market.76) $1.80) ($119.28) ($227.Balance of Payments and the Exchange Rate Credits Current Account 1 2 3 Exports Imports $6. Inc.93 $387.13 $1.62 $194. As U.95 $264.02) Debits P S Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.44) ($79. 95 $264.02) Debits P SS 1 Unilateral Transfers Balance on Current Account Capital Account 4 5 6 7 Direct Investment Portfolio Investment Other Investments Balance on Capital Account $107.02 ($1.93 $387.S.28) ($227. Inc. All rights .Balance of Payments and the Exchange Rate Credits Current Account 1 2 3 Exports Imports $6.2) ($96.80) ($119.13 $1.01) ($166. the supply of dollars increases.58 D Q Exchange rate $ Statistical Discrepancies Overall Balance Official Reserve Account McGraw-Hill/Irwin reserved.76) $1.44) ($79.62 $194.167.61 ($1. government sells dollars. 3-19 Copyright © 2001 by The McGraw-Hill Companies.53) ($45.295. As the U. S. During the same period. has experienced continuous deficits on the current account and continuous surpluses on the capital account. Inc. 3-20 Copyright © 2001 by The McGraw-Hill Companies. Japan has experienced the opposite.Balance of Payments Trends   Since 1982 the U. McGraw-Hill/Irwin reserved. All rights . All rights Current Account Capital Account 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 -50 . Inc. 3-21 Copyright © 2001 by The McGraw-Hill Companies. Balance of Payments Trends Balance of Payments ($b) 200 150 100 50 0 -100 -150 -200 Year McGraw-Hill/Irwin reserved.Balance of Payments Trends U.S. Inc. All rights .Balance of Payments Trends Japan's Balance of Payments Trend Balance of Payments ($b) 150 100 50 0 -50 Current Account Capital Account -100 -150 Year McGraw-Hill/Irwin reserved. 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 3-22 Copyright © 2001 by The McGraw-Hill Companies. . All rights McGraw-Hill/Irwin reserved. This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany. What matters is the nature and causes of the disequilibrium. Inc.Balance of Payments Trends     Germany traditionally had current account surpluses. 3-23 Copyright © 2001 by The McGraw-Hill Companies. Since 1991 Germany has been experiencing current account deficits. 3-24 Copyright © 2001 by The McGraw-Hill Companies.Balance of Payments Trends Germany's Balance of Payments Trend Balance of Payments ($b) 80 60 40 20 0 -40 -60 -80 Year McGraw-Hill/Irwin reserved. All rights Current Account Capital Account 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 -20 . Inc. 3-25 Copyright © 2001 by The McGraw-Hill Companies.Continuous fall in country¶s foreign exchange reserves due to supply inelasticity of exports and excessive demand for foreign goods and services. McGraw-Hill/Irwin reserved. This may be due to factors like : .Changes in consumer tastes within the country or abroad which reduces exports and increases imports of a country. . All rights .REASONS OF DISEQUILIBRIUM IN BALANCE OF PAYMENT  Fundamental Disequilibrium ± long run BOP disequilibrium of a country. Inc. Technological Changes . .  Structural Changes . Inc.Deficit in BOP due to import of resources 3-26 Copyright © 2001 by The McGraw-Hill Companies. .Import restrictions .Excessive capital outflows to high imports.Low competitive strength in world markets. . All rights McGraw-Hill/Irwin reserved..Inflationary pressures which makes exports dearer. Change in Exchange Rates Capital Movements Political and Economic Conditions McGraw-Hill/Irwin reserved. All rights . 3-27 Copyright © 2001 by The McGraw-Hill Companies.     Cyclical Fluctuations Change in National Income which increase imports and thus deficit in BOP. Inc. All rights McGraw-Hill/Irwin reserved. . Adjustment through Capital Inflow by increasing the domestic rate of interest. Devaluation / Expenditure or Switching Policy Direct Control by introducing tariff and nontariff barriers. 3-28 Copyright © 2001 by The McGraw-Hill Companies. Inc.Measures to Correct BOP Deficit     Adjustments through Depreciation of Country¶s currency. import duty and excise duty etc. 3-29 Copyright © 2001 by The McGraw-Hill Companies. .   Adjustment through Income Changes by increasing the demand for and exports. Simulation of Export and Import Substitutes Expenditure reducing policies like contractionary monetary and fiscal policies which leads to increase in domestic interest rate to reduce money supply and reduction government expenditure and or increase in taxes. All rights McGraw-Hill/Irwin reserved. Inc. All rights . 3-30 Copyright © 2001 by The McGraw-Hill Companies.End Chapter Three McGraw-Hill/Irwin reserved. Inc.