Balance of Payments Account Census and Statistics Department

Outline of Presentation Balance of Payments (BoP) - What is, and what is not Structure of a BoP account and typical BoP transactions Double-entry accounting system and examples of BoP transaction entries BoP and National Income Relationship between BoP imbalances, the foreign exchange market, exchange rate movements and reserve assets

International compilation standards and recommendations Compilation of BoP account in HK follows international standards and recommendations established by the International Monetary Fund (IMF)

Balance of Payments (BoP): What is and what is not?

From Economics Textbooks BoP is ... ... ...

The report must involves: a report on a country’s international performance in trading with other nations The report must involves: measurement of all the reasons why the country currency is supplied and demanded i.e. an itemization of the factors behind the demand and supply of the currency Maurice D.L. (1990) ‘International Finance’

From Compilation Standards BoP is a statistical statement ... ... ...

mainly between residents and nonresidents that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world transactions mainly between residents and nonresidents involve goods, services, and income involve financial claims on, and liabilities to, the rest of the world transfers which involve offsetting entries to balance one-sided transactions International Monetary Fund. (1996) ‘Balance of Payments Textbook’

 Residents of an Economy  In compiling the BoP account, it is necessary to distinguish residents of an economy from non-residents.

How Residents of an Economy are Defined?  For individuals:  normally stay in the economic territory of the economy  irrespective of their nationality  For organizations:  ordinarily operate in the economic Residents of the mainland of China are non-residents of HKSAR

Standard BoP sub-accounts : ‘Current account’ ‘Capital and Financial account’

Current Account Goods General merchandise Good for processing, repairs on goods and goods procured in ports by carriers Non-monetary gold Services Transportation Travel Other services Income Compensation of employees Investment income Direct investment income Portfolio investment income Other investment income Current Transfers General government Other sectors

Capital and Financial Account Capital Account Capital Transfers General government Other sectors Acquisition/Disposal of non-produced, non-financial assets Financial Account Direct Investment Aboard In reporting economy Portfolio Investment Assets Liabilities Financial derivative? Other investment Reserve Assets

Current account Covers all external transactions other than financial offsets to one-sided provision / acquisition of economic values Major components : Goods and Services Income Current Transfers

Under BoP conventions Current account Credit Debit Goods and Services exports imports Income receivable payable Current Transfers acquisition provision

Capital and Financial account Major components Capital account Financial account

Capital account External transactions in Capital transfers one-sided provision (donate/forgive) of capital asset financial asset linked to the acquisition or disposal of a capital asset Non-produced, non-financial assets (e.g. : patents, copyrights, licenses)

A transfer is a capital transfer when : transfer in kind transfer of ownership of a fixed asset forgiveness of a liability by a creditor transfer in cash related to acquisition/disposal of a fixed asset (e.g. : investment grant) But all transfers that are not transfers of capital are current transfers

conform with business and national accounting Capital and Financial account credit : net↓ in claims or other assets net↑in liabilities debit : net↑in claims or other assets net↓in liabilities conform with business and national accounting

Financial account covers all transactions in the external financial assets and liabilities of an economy External financial items ? creditor debtor } But currency denomination of the item is irrelevant residents of 2 different economies

external financial assets of an economy claims on non-residents holdings of monetary gold special drawing rights (SDR) external liabilities indebtedness to non-residents

Four broad categories of external investment Direct investment (DI) Portfolio investment (PI) Other investment (OI) Reserve assets

Financial account changes in the holdings of ‘Reserve Assets’ BoP imbalances official foreign exchange market intervention other actions / influence

under the BoP framework Double-entry accounting system under the BoP framework

Credit Debit ↓ in assets ↓ in liabilities ↑ in liabilities ↑ in assets

Double-entry accounting conventions used for compiling a BoP account

Under BoP convention (10.3.1.3) each transaction is represented by two entries with equal values but in opposite sign a credit (+) a debit (-)

In principle sum of all credit entries = sum of all debit entries net balance of all entries in BoP account = 0

Example * A HK resident imports private cars worth HK$ 10Mn from Japan HK$ Million Credit Debit Goods 10 Appropriate financial 10 account item

What is “Overall BoP Balance”?

BoP account must balance current account deficit (surplus) capital and financial account surplus (deficit)

Goods Services Income Current Transfers Capital Transfers Direct Investment Portfolio Investment Financial Derivatives Other Investment Reserve Assets

In practice the accounts frequently do not balance different BoP components are derived independently from different sources

In practice BoP account ≠ 0 i.e. sum of all credit entries ≠ sum of all debit entries BoP account made to balance by adding “net errors and omissions”

standard practice use a separate entry to balance the account net errors and omissions = residual amount (reversed sign)

+ + CURRENT ACCOUNT BALANCE CAPITAL AND FINANCIAL ACCOUNT (NON-RESERVES) BALANCE + NET ERRORS AND OMISSIONS = OVERALL/MARKET BoP BALANCE = RESERVE ASSETS NET CHANGE

Points to note : 1. BoP double-entry accounting system capital and financial account balance current account = In theory Same magnitude opposite sign 2. Any one transaction may have impact on more than one BoP sub-account

Example of BoP transaction entries (for the economy of Hong Kong) Current Account transactions with their possible offsetting entries Goods

A HK trader exports jeans to USA and extends a trade credit to the corresponding importer Current Account Credit Debit Goods xxxxx Financial Account Credit Debit OI-assets Trade credits xxxxx

HK imports a number of private cars from Japan and payment is settled immediately by cash Current Account Credit Debit Goods xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

Services

A foreign traveler flying from HK by Cathay Pacific to USA Current Account Credit Debit Services Transportation xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

A HK resident buys a life insurance policy from an insurance company in Canada Current Account Credit Debit Services Insurance services xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

Income

Current Account Credit Debit Income DI income xxxxx A HK company receives profit remitted by its branch company operating in mainland China Current Account Credit Debit Income DI income xxxxx Financial Account Credit Debit Reserve assets xxxxx (or other appropriate financial account item)

Current Account Credit Debit Income PI income xxxxx A foreign investor receives interests from HKMA for their investment in Exchange Fund Bills Current Account Credit Debit Income PI income xxxxx Financial Account Credit Debit Reserve assets xxxxx (or other appropriate financial account item)

A bank in HK earns interests from lending a loan to a company in Indonesia Current Account Credit Debit Income OI income xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

Current Account Credit Debit Income CE xxxxx A computer company in HK employs a US computer expert to work in HK for 6 months receiving salary from the company Current Account Credit Debit Income CE xxxxx Financial Account Credit Debit Reserve assets xxxxx (or other appropriate financial account item)

Current transfers

Current Account Credit Debit Current transfers HK government donates money to a charitable organization in mainland China Current Account Credit Debit Current transfers General government xxxxx Financial Account Credit Debit Reserve assets xxxxx (or other appropriate financial account item)

An imported worker in HK from mainland China was employed to work in HK for 2 years as a HK resident. During his stay in HK, he remits money to his relatives in mainland China Current Account Credit Debit Current transfers Workers’ remittances xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

A HK student receives scholarship from a foreign educational foundation Current Account Credit Debit Current transfers Other transfers xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

A HK resident received, from friends abroad, gifts of goods valued at a certain amount of money Current Account Credit Debit Goods Current transfers Other transfers

A HK resident received, from friends abroad, gifts of goods valued at a certain amount of money Current Account Credit Debit Goods xxxxx Current transfers Other transfers xxxxx

Capital Account : Capital Transfers Capital and Financial Account transactions with their possible offsetting entries Capital Account : Capital Transfers

A company in USA donates a medical equipment to a charitable organization in HK Current Account Credit Debit Goods xxxxx Capital Account Credit Debit Capital transfers Other sectors xxxxx

HK government forgives a loan extended to Thailand government a year earlier Capital Account Credit Debit Capital transfers General government Debt forgiveness xxxxx Financial Account Credit Debit OI-assets Loans General government xxxxx

A HK resident migrated to Canada and at the time of migration, he had a bank deposit in HK Capital Account Credit Debit Capital transfers Migrant transfers Financial Account Credit Debit OI-liabilities Currency and deposits

A HK resident migrated to Canada and at the time of migration, he had a bank deposit in HK Capital Account Credit Debit Capital transfers Migrant transfers xxxxx Financial Account Credit Debit OI-liabilities Currency and deposits xxxxx

Capital Account : Non-produced and Non-financial Assets

A company in HK sells a patent of toy design to a company in Japan Capital Account Credit Debit Acquisition/disposal of NP, NF assets xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

A company in HK purchases the copyright of a film produced by a film producer in USA Capital Account Credit Debit Acquisition/disposal of NP, NF assets xxxxx Financial Account Credit Debit OI-assets Currency and deposits xxxxx

Financial Account : Direct Investment

A firm in HK sets up a branch in Canada A HK resident purchases a house in mainland China Financial Account Credit Debit DI abroad Equity capital xxxxx Financed by cash withdrawal : OI-assets Currency and deposits xxxxx Financed by external borrowings : OI-liabilities Loans xxxxx

Financial Account : Portfolio Investment

A US investor buys shares of a publicly listed company of HK Financial Account Credit Debit PI-liabilities Equity securities xxxxx Offsetting entry : OI-assets Currency and deposits xxxxx

A Japanese investor buys Exchange Fund Bills issued by HKMA Financial Account Credit Debit PI-liabilities Debt securities xxxxx Offsetting entry : Reserve assets xxxxx

Financial Account : Other Investment

A HK company borrows a sum of money from a bank in Singapore Financial Account Credit Debit OI-liabilities Loans xxxxx Offsetting entry : OI-assets Currency and deposits xxxxx

A HK importer makes a prepayment on import of a shipment of computers to an exporter in USA Financial Account Credit Debit OI-assets Trade credits xxxxx Offsetting entry : Currency and deposits xxxxx

Financial Account : Reserve Assets

HKMA acquires HK$ by selling ￡ Financial Account Credit Debit Reserve assets Foreign exchange Currency and deposits xxxxx Offsetting entry : OI-assets Currency and deposits xxxxx (Banks)

HKMA acquires US Treasury Bills by selling HK$ Financial Account Credit Debit Reserve assets Foreign exchange Securities xxxxx Offsetting entry : Portfolio investment-assets Debt securities xxxxx Notes P.12 Section 10.3.1.4

Meaning of BoP Imbalance?

The account must balance BoP account is based on double-entry bookkeeping The account must balance From Maurice D.L. (1990) ‘International Finance’

current account deficit (surplus) 10.3.2.1(b) With flexible exchange rates : market balance current account deficit (surplus) capital and financial account surplus (deficit) = Assumption : all deficit / surplus are correctly measured From Maurice D.L. (1990) ‘International Finance’

[ ] 10.3.2.1(c) With fixed exchange rates : increase (decrease) in official reserves surplus (deficit) of [ ‘capital and financial (non-reserves)’ accounts + current accounts ] From Maurice D.L. (1990) ‘International Finance’

10.3.2.2 From compilation standard BoP problem persistent financial outflows loss of reserve assets persistent current account deficit

Read Wong (2000: 122) Point 3 10.3.2.2 Viable BoP deficit position some recourse to reserve assets deficit on private goods and and private services official capital transfers inflows Read Wong (2000: 122) Point 3 International Monetary Fund (1993) ‘Balance of Payments Manual’

10.3.3 BoP surplus Vs deficits: possible causes and implications

10. 3. 3(1) BoP identity constitutes the budget 10.3.3(1) BoP identity constitutes the budget constraint for the entire economy net provision of resources to or from change in net claims on Rest of world

(2) Current account surplus (Outflow > inflow) 10.3.3 (2) Current account surplus (Outflow > inflow) increase in net claims on rest of world Implies in the form of official / private claims

{ 10.3.3 (3) Current account deficit net acquisition of resources from rest of world implies Paid for by liquidating foreign assets or increasing liabilities to non-residents (inflow > outflow) {

Changes in domestic saving relative 10.3.3(4) Changes in current account position Changes in domestic saving relative to investment Any policy measures for altering current account balance must affect domestic saving and investment behaviour & Y

spending > receipts 10.3.3(5) Government budgetary position: HK spending > receipts persistent sustained current account deficit

Is it necessarily bad for an economy to have a current account deficit?

No, what is important is the composition of the current account deficit eg: if external borrowings generate return > future interest or dividend payments current account deficit is healthy and sustainable

The effect of increase or decrease in net Y-line E’ = C+I+G+(X-M)’ (a) E = C+I+G+(X-M) 10.3.4a The effect of increase or decrease in net exports on national income 45o Y0 Y1 Y E Y-line E = C+I+G+(X-M) (b) E’ = C+I+G+(X-M)’ 45o Y2 Y0 Y

E E Y-line Y-line E’ = C+I+G+(X-M)’ E = C+I+G+(X-M) E = C+I+G+(X-M) M E’ = C+I+G+(X-M)’ Trade deficit M X X Trade surplus 45o 45o Y0 Y1 Y Y2 Y0 Y (a) (b) 10.3.4b The effect of increase or decrease in national income on the current account 89