BALANCE OF PAYMENTS Chapter 3 -

Definition Is a statistical record of a country’s international transactions over a certain period of time represented in the form of double-entry bookkeeping – Eg. Import and export of goods – Cross-border investments in Bank accounts, bonds, stocks and real estate.

U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

Three types of international transactions – Payments for exports or imports of goods or services – If the debits exceed the credits, then a country is running a trade deficit. – If the credits exceed the debits, then a country is running a trade surplus.  Current Account ( credit – receipts, debit - payment ) – Purchases or sales of assets namely: stocks, bond, bank accounts, real estate, and businesses.  Capital Account ( credit – sales, debit - purchases) – Purchases and sales of reserve assets such as dollars, foreign exchanges, gold and special drawing rights (SDR)  Official Reserve Account The Balance of Payments Accounts

Current Account Balance what does it signal? Current account deficit implies that import > export or that the country consumed more than it produced in case of current account deficit - the country would finance its deficit either by borrowing or pulling down on its accumulated wealth Ex-rate changes affect the current account to a greater extent – If currency depreciates then exports may rise and imports fall … this can improve the trade balance. – But if the exports and imports are inelastic then the trade balance can still worsen

Capital Account Balance what does it signal? Direct Investment ie. FOREIGN DIRECT INVESTMENT (FDI) e.g. Coca-Cola built bottling facilities all over the world Toyota opening its manufacturing unit in U.S. & U.K. Portfolio Investment investing in another company through shares or bonds Sovereign wealth funds - Abu Dhabi Investment Authority invested $8 billion in Citigroup to help to manage subprime mortgage loses Other investment includes trade credit, bank deposit…….. Capital account surplus denotes more foreign investments in the country.

OFFICIAL RESERVE ACCOUNT Include transactions undertaken by the authorities to finance the overbalance and intervene in foreign exchange markets. Transactions are like say… for strengthen $.. The central bank of the country would sell gold or foreign currencies and buy $ and vice- versa. Thus the official reserve account of a country has a. gold b. Foreign exchanges c. Special Drawings rights (SDRs) d. Reserve positions in the international Monetary Fund.

OFFICIAL RESERVE Balance what does it signal? In case of surplus trade balance.. The country would use it to pay its debt or acquire additional reserve assets … hence it will appear in the debit side of the BOP statement In case of deficit trade balance.. The country would sell its reserve holdings or borrow anew, it will receive funds which will be recorded under credit.

Special Drawing Rights (SDRs) To partially pull the down the pressure on the dollar, the IMF created an artificial international reserve called the SDR. SDR is a basket of currency namely $,€,¥,£ Members of IMF can use SDR to trade among themselves for with the IMF. SDR is a portfolio of currencies, hence its value tends to be more stable than value of any individual currency in the SDR basket

The Balance of Payments Identity BCA + BKA + BRA = 0 where BCA = balance on current account BKA = balance on capital account BRA = balance on the reserves account Under a pure flexible exchange rate regime, the central banks will not intervene BCA = - BKA Under a fixed exchange rate regime, BCA + BKA is non-zero BCA + BKA = - BRA

U.S. Balance of Payments Data In 2000, the U.S. imported more than it exported, thus running a current account deficit of $ billion. CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

U.S. Balance of Payments Data During the same year, the U.S. attracted net investment of $ billion—clearly the rest of the world found the U.S. to be a good place to invest. CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

U.S. Balance of Payments Data Under a pure flexible exchange rate regime, these numbers would balance each other out. CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

U.S. Balance of Payments Data In the real world, there is a statistical discrepancy. CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

Balance of Payments Data ($444.69) + $ $0.73 = $0.30= –($0.30) CreditsDebits Current Account 1Exports$1, Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Capital Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $ Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

What does Balance of Payment (BOP) Signal ? The demand and supply of a country’s currency – If U.S. imports > exports  implies that SUPPLY OF U.S. $ > DEMAND OF U.S. $, hence $ value will depreciate and vice - versa Signals a country’s potential to be a business partner for the rest of the world – If a country is facing a Balance of Payment deficit ( negative value ie. Supply of currency > Demand of a currency)  it will not be able to expand imports and thereby restrict imports  prevent more capital outflows for the country – If a country is having a Balance of Payment surplus ( positive value ie. Demand of currency > Supply of a currency)  it will expand imports and encourage investments by foreign enterprises  bring more capital inflows in the country Evaluate the performance of the country in international economic competition – Signals that a company’s domestic industries lack international competitiveness

Management of overall balance of payments deficit or surplus A country can run an overall BOP deficit or surplus by engaging in the official reserve transactions. – For example, an overall BOP deficit can be supported by drawing down the central bank’s reserve holdings. Likewise, an overall BOP surplus can be absorbed by adding to the central bank’s reserve holdings.

Recent trend in BOP RankCountry CAB (billion US dollars) US dollars Year 1 People's Republic of ChinaPeople's Republic of China Japan Germany Russia Norway Saudi Arabia Switzerland Netherlands Singapore

Questions Define balance of payment What is meant by: current account, capital account & official reserves account? Why would it be useful to examine a country’s balance –of- payment data? What is meant by trade deficit and trade surplus? What are the reasons for trade deficit and trade surplus? What is an SDR? What is meant by Balance of Payment Account surplus or deficit? How do countries manage a surplus or a deficit balance of payment?