INTERNATIONAL

BUSINESS
TRANSACTIONS

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF

PAYMENT
Understand the balance of
payment and its components

Understand how balance of LEARNING

payment is calculated and its
importance OBJECTIVES
Understand the relationship
between balance of payment
and key macroeconomic
variables

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

 1 2
The international balance sheet The measurement of all
of a nation that records all international economic
international transactions in transactions between the
goods, services, and assets over residents of a country and
a year foreign residents

WHAT IS THE BALANCE OF PAYMENTS?

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT
WHY DO WE NEED BALANCE OF PAYMENT?

A gauge for a nation’s competitiveness and health

An indication of pressure on a country’s exchange rate

A signal of the imposition or removal of controls in various sorts of payments
(dividends, interest, license fees, royalties and other cash disbursements)
A forecast of a country’s market potential (especially in the short run)

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

 Understand
Identify what is the
and is not bookkeeping
international procedures for
economic BOP
F U N DAM E N TALS O F BO P transaction accounting
AC C O U N T IN G

The BOP must be balance

Understand
how the flow
of goods,
services, assets
and money
create debits
and credits to
the overall
BOP
 Record all international
transactions over a period of
time
HOW DOES
IT WORK?
Track the continuing flows of
purchases and payments
between a country and all
other countries

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

BUSINESS TRANSACTIONS IN
BOP
• Exchange of Real Assets
• Exchange of Financial Assets

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

 Financial
Account
THE BASIC
Current Capital
COMPONENTS Account Account
OF BALANCE
OF PAYMENTS
BOP
 Goods
Trade

Services
Trade
CURRENT
ACCOUNT Income

Current
Transfers

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

GOODS TRADE
TRADE IN GOODS GOODS BALANCE (GB)
• Refer only to physical goods • Net flow of goods
crossing over the border • Outflow = export (X)
• Inflow = import (M)
• GB = X – M
• If GB > 0, surplus
• If GB < 0, deficit

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

 • The export and import of services
SERVICES
• Financial services, travel services of airlines and
TRADE construction services
 • Current income associated with investments
that were made in previous periods
INCOME • Wages and salaries paid to non-resident
workers
 • The change in ownership of real resources or
CURRENT financial items
TRANSFERS • Transfers between countries that is one way - a
gift or grant
 • Made up of transfers of financial/capital
assets and acquisition and disposal of
non-produced or non-financial assets
• Capital transfers - inflows minus
CAPITAL ACCOUNT outflows for such things as debt
forgiveness (when debt is cancelled),
non-life insurance claims and
investment grants (money given as a gift
by governments to finance physical
capital
 Other
Direct Portfolio
Investment
Investment Net balance of capital Investment
Assets/Liabilities
dispersed from and Net balance of capital Consisting of various
into the home country does not reach 10% short-term and long-
for the purpose of ownership threshold term trade credits,
exerting control over of direct investment cross-border loans
assets

Not for the purpose of

Capital outflow as a
controlling or
negative cash flow in
managing the
BOP
investment

Capital inflow as a Purchase or sale of

positive cash flow in debt securities across
BOP border

FINANCIAL ACCOUNT
NET ERRORS
AND • To ensure that the BOP actually balance

OMIISIONS
 • The total reverses held by official monetary
authorities within the country
OFFICIAL • Normally composed of the major currencies
used in international trade and financial
REVERSES transactions (hard currencies)
• The significance of official reserves depends
ACCOUNT generally on whether the country is operating
under a fixed exchange rate regime or a floating
exchange rate system
 Capital
Account
THE Financial
Net Errors
and
Account
COMPONENTS Omissions
OF BALANCE
Official
OF PAYMENTS Current
BOP Reverses
Account
Account
 BOP Credits (+) BOP Debits (-)

• A credit or positive item is the flow for which the

THE BOP country is paid -- it sets up a claim on the foreign
resident, so that funds (or "money") flow into the
ACCOUNTING country.
• A debit or negative item is the flow that the country
must pay for-it sets up a foreign claim- on a resident of
the country, so that funds (or "money") flow out of the
country
 • BOP = Current Account + Financial Account +
Capital Account = Debit – Credit  0
THE BALANCE • If BOP > 0 → surplus
OF PAYMENT • If BOP < 0 → deficit
 THE BALANCE OF PAYMENT IN
TOTAL

• A surplus in the BOP implies that the demand for the

country’s currency exceeded the supply and that the
government should allow the currency value to increase or
intervene and accumulate additional foreign currency
reserves in the Official Reserves Account
• A deficit in the BOP implies an excess supply of the
country’s currency on world markets, and the government
should then either devalue the currency or expend its
official reserves to support its value.
 GDP

BALANCE
Inflation Interest
rate OF rate
PAYMENT

Exchange
rate

BOP INTERACTION WITH KEY

MACROECONOMIC VARIABLES
 • GDP = C + I + G +X – M
C = consumption spending
THE BOP and I = capital investment spending
G = government spending
GDP X = exports of goods and services
M = imports of goods and services
X – M = the current account balance
 (X – M) + (CI – CO) + (FI – FO) + FXB = BOP
Where:
X = exports of goods and services Current Account Balance

THE BOP and M = imports of goods and services

CI = capital inflows
EXCHANGE CO = capital outflows
Capital Account Balance

RATES FI = financial inflows

Financial Account Balance
FO = financial outflows
FXB = official monetary reserves
 • Fixed Exchange Rate Countries
• Under a fixed exchange rate system, the government
bears the responsibility to ensure that the BOP is
near zero
THE BOP and • Floating Exchange Rate Countries
• Under a floating exchange rate system, the
EXCHANGE government has no responsibility to peg its foreign
exchange rate
RATES • Managed Floats
• Countries operating with a managed float often find
it necessary to take action to maintain their desired
exchange rate values
THE BOP and EXCHANGE RATES

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT

 • Apart from the use of interest rates to intervene in
the foreign exchange market, the overall level of a
country’s interest rates compared to other countries
does have an impact on the financial account of the
BOP
• Relatively low real interest rates should normally
stimulate an outflow of capital seeking higher rates
THE BOP and elsewhere
• However, in the case of the U.S., the opposite has
INTEREST occurred due to perceived growth opportunities and
political stability – allowing it to finance its large
RATES fiscal deficit
• However, it is beginning to appear that the favorable
inflow on the financial account is diminishing while
the current account balance is worsening – making
the U.S. a bigger debtor nation vis-à-vis the rest of
the world
 • Imports have the potential to lower a country’s
inflation rate.
• Foreign competition substitutes for domestic
THE BOP AND competition to maintain a lower rate of inflation
than might have been the case without imports.
INFLATION • On the other hand, to the extent that lower-
RATES priced imports substitute for domestic
production and employment, gross domestic
product will be lower and the balance on the
current account will be more negative.
 SUMMARY

INTERNATIONAL FINANCE – CHAPTER 3 – BALANCE OF PAYMENT