BBA(Hons.), MBA(Finance), London Topic # 04 The Balance Of Payments The International Financial Environment Zulfiqar Hasan BBA(Hons.), MBA(Finance), London Associate Professor hasanzulfiqar@yahoo.co.uk

Contents Measure Nation’s levels of international economic activity, and how it is measured by the balance of payments; Examine the economic relationships underlying the two basic sub-components of the balance of payments – the Current and Capital Accounts; Identify the financial dimensions of international economic activity, and how they differ between merchandise & services trade; Identify balance of payment activities by nations in pursuit of domestic and global economic and political policies; Evaluate the history of capital mobility, and conditions that lead to capital flight in times of crisis ZULFIQAR HASAN

What is Balance of Payments?----> The Balance of payments is the summary statement of all international transactions between one country and all other countries ---- Eiteman A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. The measurement of all international economic transactions between the residents of a country and foreign residents is called the Balance of Payments (BOP) An accounting record of all transaction made by a country over a certain time period, comparing the amount of foreign currency taken in to the amount of domestic currency paid out. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government. ZULFIQAR HASAN

Elements of Balance of Payments Transactions These transactions include payments for the country's Exports of goods & services imports of goods & services financial capital financial transfer. The BOP summarizes international transactions for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. ZULFIQAR HASAN

Importance of The Balance of Payments Monetary and fiscal policy must take the BOP into account at the national level Businesses need BOP data to anticipate changes in host country’s economic policies driven by BOP events Above of these, BOP data may be important for the following reasons BOP is important indicator of pressure on a country’s exchange rate, thus potential to either gain or lose if firm is trading with that country or currency Changes in a country’s BOP may signal imposition (or removal) of controls over payments, dividends, interest, etc BOP helps to forecast a country’s market potential, especially in the short run ZULFIQAR HASAN

Examples of BOP Transactions An American tourist purchases a T-Shirt in Bangladesh. A Bangladeshi Tourist purchase a canned coke from Heathrow Airport, London, UK Nitol Motors, Dhaka, Bangladesh is the distributor of cars manufactured in Japan by its parent, Honda of Japan BATBC’s subsidiary in Bangladesh pays profits (dividends) back to parent firm in London A Mexican lawyer purchases a US corporate bond through an investment broker in Cleveland ZULFIQAR HASAN

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. They are composed of the following: The Current Account The Capital Account Financial Account The Official Reserves Account Statistical Discrepancy/ Net Errors and Omissions Next slide ZULFIQAR HASAN

Structure of The Balance of Payments A. Current Account Net exports/imports of goods and services (Balance of Trade) Net Income (investment income from direct portfolio investment plus employee compensation Net transfers (sums sent home by migrant and permanent workers abroad) B . Capital Account Capital transfers related to purchase and sale of fixed assets such as real estate Σ (A:E) = Overall Balance C. Financial Account Net foreign direct investment Net portfolio investment Other financial items D. Net Errors and Omissions Missing data such as illegal transfers E. Reserves and Related Items Changes in official monetary reserves including gold and foreign exchange reserves ZULFIQAR HASAN

The Current Account Goods Trade – export/import of goods. Services Trade – export/import of services; common services are financial services provided by banks to foreign investors, construction services and tourism services Income – predominately current income associated with investments which were made in previous periods. Additionally the wages & salaries paid to non-resident workers Current Transfers – financial settlements associated with change in ownership of real resources or financial items. Any transfer between countries which is one-way, a gift or a grant, is termed a current transfer Foreign Aid: Includes unilateral transfers of foreign aid. Trade Deficit: If the debits exceed the credits, then a country is running a trade deficit. Trade Surplus: If the credits exceed the debits, then a country is running a trade surplus. ZULFIQAR HASAN

Debit: Bangladeshi firm purchases German machine tools. Main Component Accounts Of The Current Accounts: One Debit & One Credit Example For Bangladesh. Trade in goods: Debit: Bangladeshi firm purchases German machine tools. Credit: Texmark UK purchase garments products from Dhaka. Trade in services: Debit: A Bangladeshi takes a physician advice by paying US$500 in New York Credit: The Brazilian tourist agency places an ad in The New Age, Dhaka. Income payments and receipts: Debit: The Bangladeshi subsidiary of a Abu Dhabi TV manufacturer pays dividends to its parent. Credit: A British company pays the salary of its executive stationed in Dhaka Unilateral current transactions. Debit: The BRAC, Bangladesh pays for a Bangladeshi working on the Afghan border. Credit: A Srilankan company pays tuition for an employee to study MBA in the University of Dhaka, Bangladesh. ZULFIQAR HASAN

The Capital/Financial Account Capital account is made up of transfers of fixed assets such as real estate and acquisitions/disposal of non-produced/non-financial assets Financial account consists of three components and is classified either by maturity of asset or nature of ownership. The three components are Direct Investment: Net balance of capital which is dispersed from and into a country for the purpose of exerting control over assets. This category includes foreign direct investment Portfolio Investment Net balance of capital which flows in and out of the country but does not reach the 10% ownership threshold of direct investment. The purchase and sale of debt or equity securities is included in this category. This capital is purely return motivated Other Investment Assets/Liabilities Consists of various short and long-term trade credits, cross-border loans, currency and bank deposits and other accounts receivable and payable related to cross-border trade ZULFIQAR HASAN

The Other Accounts Net Errors and Omissions – Account is used to account for statistical errors and/or untraceable monies within a country Official Reserves – total reserves held by official monetary authorities within a country. These reserves are typically comprised of major currencies that are used in international trade and financial transactions and reserve accounts (SDRs) held at the IMF ZULFIQAR HASAN

Examples 01: BOP’s Current Account Assumptions (millions of US dollars) 2011 2010 2009 Using the data from the table, answer the following questions: What is the balance on goods? What is the balance on services? What is the balance on goods and services? What is the current account Balance? Goods: exports 682 672 687 Goods: imports 876 917 1030 01. Balance on goods (194) (245) (343) Services: credit (exports) 255 261 270 Services: debit (imports) 167 183 191 02. Balance on services 88 78 79 03. Balance on Goods & Services (106) (167) (264) Income: credit (Receipts) 257 258 276 Income: debit (Payments) 251 265 295 04. Balance on income 6 (7) (19) Current transfers: credit 8 9 9 Current transfers: debit 49 53 57 05. Balance on current transfers (41) (44) (48) Balance on current Account = (1+2+4+5) -141 -218 -331 ZULFIQAR HASAN

Practice 02: BOP Current account Using the data from the table, answer the following questions: What is the balance on goods? What is the balance on services? What is the balance on goods and services? What is the current account services? Assumptions (millions of US dollars) 2005 2006 2007 2008 2009 2010 Goods: exports 55,884 56,096 64,052 63,676 65,099 70,577 Goods: imports 61,215 65,857 68,865 61,890 70,530 85,946 Balance on goods ? Services: credit 16,181 17,399 18,677 16,689 17,906 21,205 Services: debit 17,272 18,330 18,388 16,948 18,107 21,638 Balance on services Income: credit 6,532 7,394 8,984 8,063 8,194 9,457 Income: debit 17,842 18,968 19,516 18,332 19,884 24,245 Balance on income Current transfers: credit 2,651 3,003 2,622 2,242 2,310 2,767 Current transfers: debit 2,933 3,032 2,669 2,221 2,373 2,851 Balance on current transfers ZULFIQAR HASAN

Practice 03: Balance of Payments Find out (a) the balance of trade and (b) balance of current account, if: inflow on account of services: $1000; outflow on account of services: $800; Outflow of dividend, royalty, etc, $1100; inflow of dividend, etc. $560; export of goods: $10000; import of goods: $12000, Remittances: $1200 Items Amounts Goods: exports 10000 Goods: imports -12000 Balance on goods -2000 Services: credit 1000 Services: debit -800 Balance on services 200 Inflow of Dividend 560 Outflow of Dividend -1100 Investment income -540 Remittances 1200 Balance on current transfers -1140 ZULFIQAR HASAN

Debit: Nitol Motor Company builds a factory in Nepal. Main Component Accounts of The Capital & Financial Accounts: One Debit & One Credit Example For Bangladesh Direct investment. Debit: Nitol Motor Company builds a factory in Nepal. Credit: Nitol Motor Company sells its factory in Srilanka to Srilankan investors. Portfolio investment. Debit: A Bangladeshi buys shares of stock of a European food chain on the Frankfurt Stock Exchange. Credit: The government of Korea buys Bangladesh Bank Treasury bills to hold as part of its foreign exchange reserves. Other investment. Debit: A Bangladeshi firm deposits $1 million in a bank balance in London. Credit: A Bangladesh firm generates an account receivable for exports to Canada. ZULFIQAR HASAN

Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved: A U.S. food chain imports wine from Chile. Current Account Debit to U.S. goods Credit to Chilean goods A U.S. resident purchases a euro-denominated bond from a German company. Portfolio part of financial account; Debit to U.S. Credit to German Singaporean parents pay for their daughter to study at a U.S. university. Current transfers in current account Credit to U.S. Debit to Singapore ZULFIQAR HASAN

The Capital/Financial Account US Capital/Financial Account, 2009-2011-1999 (billions of US$ 2009 2010 2011 ZULFIQAR HASAN

The Balance of Payments in Total 2009 2010 2011 A. Current Account (140.55) (217.13) (331.48) Goods exports FOB 681.65 672.29 686.66 Goods imports FOB (876.37) (917.19) (1029.92) Goods (BOT) . . . (194.72) (244.90) (343.26) Services exports 255.29 260.69 269.58 Services imports (166.51) (182.68) (191.30) Services trade balance 88.78 78.01 78.28 Income credit 257.35 258.45 276.17 Income debit (251.16) (264.66) (294.65) Balance on Income . . . 6.19 (6.21) (18.48) Current transfers, credits 8.47 9.33 9.41 Current transfers, debits (49.27) (53.36) (57.43) _____________________________________________________________ ZULFIQAR HASAN

Direct investment abroad (105.02) (146.05) (150.90) 2009 2010 2011 C. Financial Account 269.04 153.59 314.64 Direct investment . . . 1.02 40.27 124.64 Direct investment abroad (105.02) (146.05) (150.90) Direct investment in the US 106.04 186.32 275.54 Portfolio investment assets . . . (118.98) (136.00) (128.59) Equity securities (57.58) (101.24) (114.40) Debt securities (61.40) (34.76) (14.19) Portfolio investment liabilities . . . 385.60 269.33 342.19 Equity securities 67.85 41.95 98.07 Debt securities 317.75 227.38 244.12 ___________________________________________________________ ZULFIQAR HASAN

Capital Mobility/Flight Capital Mobility: The degree to which capital moves freely cross-border is critically important to a country’s balance of payments Capital Flight: “International flows of direct and portfolio investments under ordinary circumstances are rarely associated with the capital flight phenomenon. Rather, it is when capital transfers by residents conflict with political objectives that the term “flight” comes into general usage.” ZULFIQAR HASAN

False invoicing on international trade transactions Capital Flight……. Five primary mechanisms exist by which capital may be moved from one country to another: Transfers via the usual international payments mechanisms, regular bank transfers are easiest, cheapest and legal Transfer of physical currency by bearer (smuggling) is more costly, and for many countries illegal Transfer of cash into collectibles or precious metals, which are then transferred across borders Money laundering, the cross-border purchase of assets which are then managed in a way that hide the movement of money and its owners False invoicing on international trade transactions ZULFIQAR HASAN

Balance of Payment of Bangladesh During 1999-2005 In million US$   Items 1999-00 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 (June-July) 1 2 3 4 5 6 7 Trade balance -1865 -2011 -1768 -2215 -2319 -3297 Export f.o.b. (including EPZ) 5701 6419 5929 6492 7521 8573 Of which : Readymade garments (RMG)  4352 4860 4584 4912 5686 6418 Import f.o.b. (including EPZ) -7566 -8430 -7697 -8707 -9840 -11870 Services -645 -914 -499 -691 -874 -870 Receipts 849 759 865 887 924 1177 Payments -1494 -1673 -1364 -1578 -1798 -2047 Income -302 -344 -402 -358 -374 -680 97 50 64 63 116 -399 -441 -452 -437 -796 Of which : Official interest payments -160 -168 -161 -167 -175 -203 Current transfers 2394 2171 2826 3440 3743 4290 Official 165 72 69 82 61 37 Private 2229 2099 2757 3358 3682 4253 Balance of Payment of Bangladesh During 1999-2005 ZULFIQAR HASAN

Current Account Balance In million US$   Items 1999-00 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 (June-July) - 1 2 3 4 5 6 7 Of which : Workers' remittances 1949 1882 2501 3062 3372 3848 Current Account Balance -418 -1098 157 176 -557 Capital Account 561 432 410 428 196 163 Capital transfers Financial Account -116 682 391 413 78 760 Foreign direct investment (net) 383 550 376 385 776 Portfolio investment -6 Other investment -499 132 35 -313 -16 MLT loans (excluding suppliers credit) 806 790 733 918 544 940 MLT amortization payments -396 -416 -435 -452 -397 -449 Other long term loans (net) 127 -13 -42 -20 -41 -46 Other short term loans (net) 71 31 63 142 13 241 ZULFIQAR HASAN

Other short term loans (net) 71 31 63 142 13 241 Other capital -190 In million US$   Items 1999-00 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 (June-July) Other short term loans (net) 71 31 63 142 13 241 Other capital -190 -114 -87 -125 -182 Trade Credit (net) -641 -260 -253 -499 -321 -320 Commercial Bank -276 114 27 14 -200           Assets -161 147 -90 217 86 -91           Liabilities -115 -33 117 -146 -72 -109 Errors and Omissions 152 -297 -550 -202 -279 -299 OVERALL BALANCE 179 -281 408 815 171 67 Reserve Assets -179 281 -408 -815 -171 -67 Bangladesh Bank Assets -79 302 -887 -235 -225 Liabilities -100 -21 -132 72 64 158 ZULFIQAR HASAN