1. International Finance
Chapter 3
Balance of Payments

2. The Balance of Payments
Balance of Payments (BOP):
A measurement of all international economic and financial transactions between the residents of a country and foreign residents.
The International Monetary Fund (IMF) is the primary source of similar statistics worldwide.
Think of a country’s BOP as a country cash flow account (statement); not as a balance sheet.
Represents transactions over some period of time

3. Use of BOP Data by Businesses
Multinational businesses use various BOP measures to gauge the growth and health of specific types of trade or financial transactions by country.
BOP helps to forecast a country’s market potential; where business may opportunities exist.
BOP is important indicator of pressure on a country’s exchange rate.
Thus indicates potential losses or gains from foreign currency exposed positions of business firms.
Changes in a country’s BOP may signal imposition (or removal) of controls over payments, dividends, interest.
Government policies to deal with BOP disequilibria.

4. Two Types of BOP Transactions
Exchange of Real Assets (for money):
Goods:
Cars, computers, agricultural products, clothing…
Services:
Banking, consulting, travel, student exchanges.
Exchange of Financial Assets (for money or other financial claims):
Stocks, bonds, loans, purchases (or sale) of businesses.

5. Balance in the BOP
While individual components in a country’s BOP may be out of balance, the overall BOP must be in balance!!!
Transactions recorded using a double-entry bookkeeping (in theory).
In theory, each BOP transaction should be recorded as both a debit and a credit entry.
In reality the two transactions are recorded independently (which, as you will see leads to the errors and omissions BOP account).

6. DEBIT OR CREDIT? Basic Rule to determine BOP transaction:
Follow the flow of money!
If money is flowing out of a country, it is a deficit item (recorded as a debit)
If money is flowing into a country, it is a surplus item (recorded as a credit)

7. Example of BOP Flows
Japan Airlines purchase aircraft from Boeing (United States)
From U.S. standpoint: Exchange of real assets for money:
Aircraft exports from the U.S.: Surplus transaction
Money inflow to U.S. manufacturer: Credit transaction.
From Japan’s standpoint: Exchange of money for real asset:
Aircraft imports from the U.S.: Deficit transaction
Money outflow from Japan: Debit transaction.

8. Example of BOP Flows British company acquires a U.S. company.
From U.S. standpoint: Exchange of real asset for money:
Foreign direct investment in U.S.: Surplus transaction
Money flow to U.S. company (shareholders): Credit transaction.
From U.K.’s standpoint: Exchange of money for real asset.
Foreign direct investment overseas: Deficit transaction
Money outflow from U.K. company (shareholders): Debit transaction.

9. Example of BOP Flows
Canadian worker in U.S. sends money home to family.
From U.S. standpoint: remittances abroad.
Net transfer abroad. Deficit transaction.
Money outflow from U.S.: Debit transaction.
From Canada’s standpoint: remittances from abroad.
Net transfer (from) abroad: Surplus transaction.
Money inflow from U.S.: Credit transaction.

10. Balance of Payments Accounts
The BOP is divided into two major accounts: the Current Account and the Capital/Financial Account:
Current Account tracks:
Balance of Trade: (net) merchandise exports and imports.
Services Balance: (net) financial services and travel (other) services
Financial: Provided by banks to non-residents.
Travel/other: Provided by domestic entities to foreign country residents, such as meals, hotels, air travel, student exchanges, construction.
Income Balance: (net) investment income from abroad and to foreign entities (arises from previous investments).
Net Transfers: (net) private remittances to residents abroad (money/gifts) or by governments (aid).

11. Balance of Payments Accounts
Capital/Financial Account captures cross border investments during the recorded period. These include:
Purchases (or sales) of real estate.
(net) Direct investment (FDI).
FDI in the U.S. minus U.S. FDI abroad (positive number if net direct investment into the U.S.; and thus capital inflow)
(net) Portfolio investment
Non-controlling equity investments (<10%)
Debt investments.
Either personal or institutional (mutual funds)
Portfolio investment in the U.S. minus U.S. portfolio investment abroad (positive number if net portfolio investment in the U.S.; and thus capital inflow).
(net) Other financial transactions
Bank loans, trade credit

12. Other BOP Accounts Two additional BOP accounts are:
Official Reserve Account: tracks the transactions by the official monetary authorities (central bank and treasury department) of a country:
Increase in international reserves (major currencies of the world: dollar, yen, euro, gold).
Net Errors and Omissions: Balancing account; included because transactions are collected individually (double entry bookkeeping in theory).

13. Current and Capital Account
The two major sub-accounts of the BOP, the Current and Financial Account, summarize the current trade and international capital flows of the country respectively
The Current and Financial Account are typically inverse on balance, one in surplus while the other experiences deficit
In fact, a deficit in a country’s current account needs to be financed through a surplus in its financial account!
If not, pressures will be placed on the exchange rate!
Issuing facing the United States today!
Reason for the U.S. dollar performance of late!

14. Current and Financial/Capital Account Balances for the United States, Annual Data (billions of US$)
Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

15. 1997 and 1998

16. Sources of U.S. BOP Data
Bureau of Economic Research (an agency of the U.S. Department of Commerce)
What does it show?
Per Day
Current Account -$481B -$542B $1.5B
Fin/Cap Account +$527B +$576B
Difference $ 46B +$ 34B

17. Thailand’s BOP in the 1990s
Source: International Financial Statistics, International Monetary Fund, Washington DC, monthly.

18. Thai Baht

19. SOURCE OF BOP DATA FOR OTHER COUNTRIES
The Economist
Trade Balance, Current Account Balance and Forecasts
Economic and Financial Indicator Section
OECD Country data (Current Account)