Chapter 3.balance of Payments

Main contents
Nguyen Thi Dieu Chi. Assoc. Prof. – Course of International Finance
 Balance of Payments Accounting

 Balance of Payments Accounts
 The Current Account
 The Capital Account
Chapter 3
 Statistical Discrepancy
 Official Reserves Account
BALANCE OF PAYMENTS  The Balance of Payments Identity
 Balance of Payments Trends in Major Countries
School of Banking and Finance

Nguyen Thi Dieu Chi (Assoc. Prof.) 3-2
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Why study the BoP Balance of Payments Accounting

Nguyen Thi Dieu Chi. Assoc. Prof. – Course of International Finance Nguyen Thi Dieu Chi. Assoc. Prof. – Course of International Finance
 The balance of payments is the statistical record of a country’s

 Indicator of pressure on a country exchange rate international transactions over a certain period of time presented
in the form of double-entry bookkeeping.
 Signaling the imposition or removal of controls over capital Note:
and other related payments - When we say “a country’s balance of payments” we are
referring to the transactions of its citizens and government.
 Help assess a country potential as trading partner - Resident: dependent on local law, but in general: time of
staying:>12 months and generate regular income in that
country.
- Some special cases: international organizations, embassies,
military bases, multinational businesses.
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Balance of Payments Example Balance of Payments Accounts

 Suppose that Maplewood Bicycle in Maplewood, Missouri,  The balance of payments accounts are those that record all
USA imports $100,000 worth of bicycle frames from transactions between the residents of a country and residents
Mercian Bicycles in Darby, England. of all foreign nations.
 They are composed of the following:

 There will exist a $100,000 credit recorded by Mercian that
offsets a $100,000 debit at Maplewood’s bank account.  The Current Account
 The Capital Account

 This will lead to a rise in the supply of dollars and the
 The Official Reserves Account
demand for British pounds.
 Statistical Discrepancy
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The BoP composition Current Account
 Relates to the transfer of ownership of real assets
 Current Account (CA)  Trade Balance
 Trade Balance (TB)  Export of goods
 Services Balance  Import of goods
 Factor Income (IC)  Service Balance
 Unilateral Transfer (Tr)  Export of services
 Capital Account (KA)  Import of services
 Factor Income
 Direct Investment
 Labor
 Portfolio Investment
 Land
 Other Investment
 Capital: dividend, interest, coupon,…
 Errors and Omissions (OM)  Unilateral Transfer
 Official Reserve Balance  Private transfer
 Government transfer
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Capital Account ORB

• Relates to the transfer of usage of assets • Changes in Official Reserve Account (dR):
• FDI: > 30% equity • dR > 0  a negative entry
• FII: corporate bond, government bond, company stock … • dR < 0  a positive entry
• Net financial derivatives
• Loans with IMF and other central banks (L)
• Other investment: trade credit, cross-border loans, bank
deposits…. • Changes in Official Reserve denominated in the
• Unilateral capital transfer home country currency held by other countries’
central banks.
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Errors and Omissions Statistical Discrepancy

• There are going to be Credits Debits

 Current and financial account entries are collected and some omissions and Current Account
misrecorded 1 Exports $2,843.7
recorded separately  errors or statistical discrepancies will transactions—so we 2 Imports ($3,182.8)
use a “plug” figure to
occur get things to balance. 3 Unilateral Transfers $19.5 ($154.0)
Balance on Current Account ($473.6)
 This is the residual account, a plug-in figure to ensures that Capital Account
• Exhibit 3.1 shows a 4 Direct Investment $227.9 ($406.2)
discrepancy of $79.40
BoP will balance. billion in 2011.
5 Portfolio Investment $166.9 ($14.7)
6 Other Investments $395.8 $40.4
Balance on Capital $410.1
7 Account
Statistical Discrepancies $79.4
Overall Balance $15.9
Official Reserve Account ($15.9)
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The Official Reserves Account The Balance of Payments Identity
BCA + BKA + BRA = 0

Official reserves assets include gold, foreign where
currencies, SDRs, and reserve positions in the IMF. BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,

BCA + BKA = 0
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U.S. Balance of Payments Data 2011 U.S. Balance of Payments Data 2011
Credits Debits Credits Debits

Current Account Current Account
1 Exports $2,843.7 1 Exports $2,843.7
2 Imports ($3,182.8) 2 Imports ($3,182.8)
3 Unilateral Transfers $19.5 ($154.0) 3 Unilateral Transfers $19.5 ($154.0)
Balance on Current Account ($473.6) Balance on Current Account ($473.6)
Capital Account Capital Account
4 Direct Investment $227.9 ($406.2) 4 Direct Investment $227.9 ($406.2)
5 Portfolio Investment $166.9 ($14.7) 5 Portfolio Investment $166.9 ($14.7)
6 Other Investments $395.8 ($40.4) 6 Other Investments $395.8 ($40.4)
Balance on Capital Account $410.1 Balance on Capital $410.1
In 2011, the U.S.
7 Statistical Discrepancies $79.4 7 Account
Statistical Discrepancies $79.4 imported more than it
Overall Balance $15.9 Overall Balance $15.9 exported, thus running a
Official Reserve Account ($15.9) Official Reserve Account ($15.9) current account deficit
of $473.6 billion.
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Credits Debits
Current Account
1 Exports $2,843.7 Credits Debits
Current Account
2 Imports ($3,182.8)
During the same Under a pure
1 Exports $2,843.7
3 Unilateral Transfers $19.5 ($154.0)
year, the U.S. flexible exchange
2 Imports ($3,182.8)
Balance on Current Account ($473.6) attracted net rate regime, these
Capital Account 3 Unilateral Transfers $19.5 ($154.0)
investment of Balance on Current Account
numbers would
4 Direct Investment $227.9 ($406.2) ($473.6)
$410.1 billion— Capital Account balance each
5 Portfolio Investment $166.9 ($14.7)
6 Other Investments $395.8 ($40.4) clearly the rest of 4 Direct Investment $227.9 ($406.2) other out.
Balance on Capital Account the world found 5 Portfolio Investment $166.9 ($14.7)
$410.1
$79.4 6 Other Investments $395.8 ($40.4)
7 Statistical Discrepancies the U.S. to be a Balance on Capital $410.1
Overall Balance $15.9
Official Reserve Account ($15.9) good place to 7 Account
invest. Overall Balance $15.9
Official Reserve Account ($15.9)
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Credits Debits Credits Debits

Current Account Current Account
1 Exports $2,843.7 In the real 1 Exports $2,843.7
2 Imports ($3,182.8) world, there is 2 Imports ($3,182.8) Including that,
3 Unilateral Transfers $19.5 ($154.0) a statistical 3 Unilateral Transfers $19.5 ($154.0) the balance of
discrepancy. payments
identity should
5 Portfolio Investment $166.9 ($14.7) 5 Portfolio Investment $166.9 ($14.7) hold:
6 Other Investments $395.8 ($40.4) 6 Other Investments $395.8 ($40.4) ($473.6)
BCA + BKA
+ $410.1+
= – BRA$15.9=
Balance on Capital $410.1 Balance on Capital $410.1 ($15.9)
7 Account
Statistical Discrepancies $79.4 7 Account
Overall Balance $15.9 Overall Balance $15.9
Official Reserve Account ($15.9) Official Reserve Account ($15.9)
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Balance of Payments and the Exchange Rate Balance of Payments and the Exchange Rate
Credits Debits Exchange rate Credits Debits Exchange rate

Current Account $ Current Account $
1 Exports $2,843.7 P S 1 Exports $2,843.7 P S
2 Imports ($3,182.8) 2 Imports ($3,182.8)
3 Unilateral Transfers $19.5 ($154.0) 3 Unilateral Transfers $19.5 ($154.0)
6 Other Investments $395.8 ($40.4) D 6 Other Investments $395.8 ($40.4) D
Balance on Capital $410.1 Balance on Capital $410.1
7 Account
Overall Balance $15.9 Q Overall Balance $15.9 Q
Copyright © 2014 by the Mcraw-Hill Companies,

3-21 Inc. All rights reserved. 3-22
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Balance of Payments and the Exchange Rate Balance of Payments and the Exchange Rate
Credits Debits Exchange rate Credits Debits Exchange rate

Current Account $ Current Account $
1 Exports $2,843.7 P S 1 Exports $2,843.7 P S
2 Imports ($3,182.8) 2 Imports ($3,182.8)
S
3 Unilateral Transfers $19.5 ($154.0) 3 Unilateral Transfers $19.5 ($154.0) 1
6 Other Investments $395.8 ($40.4) D 6 Other Investments $395.8 ($40.4) D
Balance on Capital $410.1 Balance on Capital $410.1
7 Account
Overall Balance $15.9 Q Overall Balance $15.9 Q
As the U.S. government sells dollars, the supply of dollars increases.
Copyright © 2014 by the McGraw-Hill Companies,
Inc. All rights reserved. 3-23 3-24
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The J-Curve Effect Balance of Payments Trends
Following a currency  Since 1982 the U.S. has experienced continuous deficits
depreciation, the trade
balance may at first on the current account and continuous surpluses on the
deteriorate before it
Trade Balance
Change in the
improves. capital account.

The shape depends on
Time the elasticity of the  During the same period, Japan has experienced the
imports and exports.
opposite.
As an example, consider an imported good for which there is

no domestic producer. If demand is price inelastic, then
following a depreciation the trade balance gets worse (until
domestic production begins).
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Balance-of-Payments Trends: 1982-2011 Balance-of-Payments Trends: 1982-2011

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Balance-of-Payments Trends: 1982-2011 Balance of Payments Trends

 The U.S. and the U.K. tend to realize current account

deficits, whereas China, Japan, and Germany tend to realize
current account surpluses.
 This “global imbalance” implies that the U.S. and U.K.

generally use up more outputs than they produce, while the
opposite holds for China, Japan, and Germany.
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Top U.S. Trading Partners, 2012
Mercantilism and the Balance of Payments (in billions of dollars)
 Mercantilism holds that a country should avoid trade deficits at Rank Country Imports Exports Trade Total
Balance Trade
1 Canada 324.2 292.4 -31.8 616.7
all costs, even to imposing various restrictions on imports. 2 China 425.6 110.6 -315 536.2
3 Mexico 277.7 216.3 -61.4 494.0
 Mercantilist ideas were criticized in the 18th century by such 4

5
Japan
Germany
146.4
108.5
70.0
48.8
-76.4
-59.7
216.4
157.3
6 United Kingdom 54.9 54.8 -0.1 109.8
British thinkers as Adam Smith, David Ricardo, and David
7 Korea, South 58.9 42.3 -16.6 101.2
8 Brazil 32.1 43.7 11.6 75.8
Hume. 9 Saudi Arabia 55.7 18.1 -37.6 73.8
10 France 41.6 30.8 -10.8 72.4
11 Taiwan 38.9 24.4 -14.5 63.2
 They argued that the main source of wealth in a country is its 12 Netherlands 22.3 40.7 18.4 63.0
13 India 40.5 22.3 -18.2 62.9
14 Venezuela 38.7 17.6 -21.1 56.4
productive capacity not its trade surpluses. 15 Italy 36.9 16.0 -20.9 52.9
Source: Census Bureau
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Relationship between Balance of Payments

and National Income Accounting
National income (Y), or gross domestic product (GDP),

The following slides cover the is equal to the sum of the nominal consumption of goods
appendix to Chapter 3. and services (C), private investment (I), government
spending (G), and the difference between exports (X)
and imports (M):
Y ≡ GDP ≡ C + I + G + (X – M)
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Relationship between Balance of Payments Relationship between Balance of Payments

and National Income Accounting and National Income Accounting
Private savings is defined as the amount left from (S – I) + (T – G) ≡ X – M ≡ BCA

national income after consumption and taxes (T) are  This shows that there is an intimate relationship between a
paid: country’s BCA and how it finances its domestic investment
S ≡ Y – C – T or
and pays for government spending.
S ≡ C + I + G + (X – M) – C – T
 If (S – I) < 0, then a country’s domestic savings is insufficient
Note that BCA ≡ X – M; we can rearrange the last
to finance domestic investment.
equation as
(S – I) + (T – G) ≡ X – M ≡ BCA  Similarly, if (T – G) < 0, then tax revenue is insufficient to
cover government spending and a government budget deficit
exists.
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Relationship between Balance of Payments
and National Income Accounting
(S – I) + (T – G) ≡ X – M ≡ BCA
 When BCA < 0, government budget deficits and/or part of
domestic investment are being financed by foreign-
controlled capital.
 To reduce a BCA deficit, one of the following must occur:
 For a given level of S and I, the government budget deficit
(T – G) must be reduced.
 For a given level of I and (T – G), S must be increased.
 For a given level S and (T – G), I must fall.
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Main contents

Nguyen Thi Dieu Chi. Assoc. Prof. – Course of International Finance

 Balance of Payments Accounting

School of Banking and Finance

Why study the BoP Balance of Payments Accounting

 The balance of payments is the statistical record of a country’s

Balance of Payments Example Balance of Payments Accounts

Mercian Bicycles in Darby, England. of all foreign nations.

 They are composed of the following:

 The Capital Account

Capital Account ORB

Errors and Omissions Statistical Discrepancy

• There are going to be Credits Debits

BCA + BKA + BRA = 0

Under a pure flexible exchange rate regime,

Credits Debits Credits Debits

Credits Debits Credits Debits

Credits Debits Exchange rate Credits Debits Exchange rate

Copyright © 2014 by the Mcraw-Hill Companies,

Credits Debits Exchange rate Credits Debits Exchange rate

improves. capital account.

As an example, consider an imported good for which there is

Balance-of-Payments Trends: 1982-2011 Balance-of-Payments Trends: 1982-2011

Balance-of-Payments Trends: 1982-2011 Balance of Payments Trends

 The U.S. and the U.K. tend to realize current account

 This “global imbalance” implies that the U.S. and U.K.

 Mercantilist ideas were criticized in the 18th century by such 4

Relationship between Balance of Payments

National income (Y), or gross domestic product (GDP),

Relationship between Balance of Payments Relationship between Balance of Payments

Private savings is defined as the amount left from (S – I) + (T – G) ≡ X – M ≡ BCA

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