Khoa Tài Chính

School Doanh Nghiệp

of Finance

International Flow of Funds

International Finance
 Contents
 How can balance of payment measure the
flow of international transactions?
 The key components of the balance of
payments
 Current Account
 Capital and Financial Accounts
International flow of funds

The balance of payments is a measure

of international transactions between
domestic and foreign residents over a
specified period of time.
 International flow of funds
The international balance of payments measures
international capital flows through the following
three factors: international transaction (more vague example):
a foreigner visits VN and buys services here
1. Identifying international economic transaction.
2. Understanding the bookkeeping procedures for
the balance of payments accounting.
3. Understanding how the flow of goods, services,
assets and money creates debit and credit to
balance of payments.
 Accounting principles for balance of payment

Suppose that an American corporation sells $2 million

worth of US-manufactured jeans to Britain, and the
British buyer pays from a US dollar account that is kept
in a US bank. We will then have the following double
entry in the US balance of payments: credit: fund inflow (+)
debit: fund outflow (-)

(credits +; debits –)
Millions dollars
Export (of jeans) +2
Foreign assets in the US: US -2
bank liabilities
 Accounting principles for balance of payment
Suppose that an American corporation purchases $5
million worth of denim cloth from a British
manufacturer, and that the British company puts the $5
million it receives into a bank account in the United
States. We then have the double entry in the US
account:
(credits +; debits –)
Millions dollars
Imports (of cloth) -5
Foreign assets in the US: +5
US bank liabilities
Balance of payment Structure

Two main
accounts
 Errors and omissions
The time that current account entries
are made differs from the time for
payments involved.
Many entries are estimates
Illegal transactions
 Current account

The current account is the broadest measure of

international trade in goods and services of a country,
consisting of the following four components:

1. Trade balance
2. Service balance
3. Factor income
4. Current transfer
 Current account

The most influential factors are:

 Inflation

 National income

 Exchange rates

 Government policies
Current account – influential factors:

Impact of inflation

If a country’s inflation rate increases relative to

trade partners, its current account will be
decreased, when other things being equal.
Current account – influential factors:

Impact of National Income

If national income increases by a higher percentage

than those of other countries, its current account is
expected to decrease, other things being equal.
Current account – influential factors :

Impact of Government Policies

If a country’s government imposes a tax on imported

goods (often referred to as a tariff), the prices of
foreign goods to consumers are effectively increased.
In addition to imposing restrictions, government has
other ways of affecting current accounts as well.
Current account – influential factors:

Impact of Exchange Rates

If a country’s currency begins to rise in value against
other currencies, its current account balance should
decrease, other things being equal.
 Capital/Financial account

The capital / financial account measures all

international economic transactions related to
financial assets. It is divided into two main
categories: Capital Account and Financial Account.
 Capital/Financial account

Capital accounts are created by transferring

financial assets or transactions involving the change
of ownership of non-financial assets.
 Capital/Financial account

The financial account is divided into three parts:

• Foreign direct investment (FDI)

• Foreign portfolio investment (FPI)

• Other investment forms

Factors affecting financial account

• The volatility of exchange rates

• Demographic

• Capital control policy

 Capital control policies

Capital control is the implementation of

government interventions in many forms, to
influence (limit) foreign capital flows, in order
to achieve a certain goal of government
Implications of the BOP accounting identity
The BOP accounting identity:
BC + ΔR +Bk + ε ≡ 0 (1)
• BC : Current account
• ΔR: change in official reserves
• Bk : capital account
• ε : statistical discrepancy
Implications of the BOP accounting identity
Flexible rates
There cannot be any changes in official
reserves because central banks do not buy
or sell currencies and gold.
BC +Bk + ε = 0
Assuming without error
BC +Bk = 0 (2)
Implications of the BOP accounting identity
Fixed rates
We can rearrange equation (1) to state:
ΔR = - (BC +Bk ) (3)
The increase/decrease in official reserves
equals the combined surplus/deficit in the
current and capital accounts.
Group discussion
Is a current account deficit
always bad for a country?

If a country is struck by a shock—perhaps a natural disaster—that

temporarily depresses its ability to access productive capacity, rather
than take the full brunt of the shock immediately, the country can
spread out the pain over time by running a current account deficit.
If the deficit reflects an excess of imports over exports, it may be
indicative of competitiveness problems, but because the current
account deficit also implies an excess of investment over savings, it
could equally be pointing to a highly productive, growing economy. If
the deficit reflects low savings rather than high investment, it could be
caused by reckless fiscal policy or a consumption binge. Or it could
reflect perfectly sensible intertemporal trade, perhaps because of a
temporary shock or shifting demographics. Deficits reflect underlying
economic trends, which may be desirable or undesirable for a country
at a particular point in time.
https://www.imf.org/external/pubs/ft/fandd/basics/current.htm
 Objectives of Economic Policy
Considering the national-income accounting identity:
Y ≡ C + I + G + (Ex - Im) (4)
• Y : Gross domestic product (GDP)
• C : Consumption
• I : Gross investment
• G : Government expenditures
• Ex : Exports of goods and services
• Im : Imports of goods and services
The balance of payments on goods and services:
Ex - Im ≡ Y - (C + I + G) (5)
 The relationship between the dollar
exchange rate and the actual US export.
US US Index
dollar
Net export value
(Left axis) 160

140

120
Value of US dollar
(Right axis)
100

80
1975 1977 1979 1981 1983 1985 1987
IMPORTS, AND EXCHANGE RATES

Figure 1 Deriving the supply of pound

IMPORTS, AND EXCHANGE RATES

• The supply curve shows the amount of money

supplied in the foreign exchange market.
• The price of currency is expressed by the
exchange rate.
• The money supply represents the value of
money spent on imports. This figure is
calculated by multiplying the import price by
the quantity of goods imported.
EXPORT, AND EXCHANGE RATES

Figure 2 Deriving the demand for pounds

EXPORT, AND EXCHANGE RATES

• The demand curve for a currency is derived

from the export supply curve.
• The demand for currency to pay for the export
is equal to the value of the export contract.
• Therefore, to construct a demand curve for a
currency, we must calculate the value of
exports at each exchange rate.
THE STABILITY OF EXCHANGE RATES

Figure 8 Currency supply and import elasticity

THE STABILITY OF EXCHANGE RATES

Figure 9 Stability of foreign exchange markets

 THE J CURVE

The phenomenon of an
initial worsening and
subsequent improvement of
the trade balance after a
depreciation is known as
the J-curve effect.

Figure 10 The J curve

Group discussion
Explain the J-curve effect
when domestic currency is
appreciated