1. Balance of payments What is the price of a country’s currency?
If we know the factors affecting demand & supply, then we shall know the factors influencing exchange rates

2. Hence, the considerable interest in
maintaining a record of the factors
behind the supply & demand of a
country’s currency
Can be visualised as an itemisation of the factors behind the demand & supply of a currency

3. Why is the BOP account published?
To report the country’s international performance in trading with other nations

4. Factors affecting exports & hence the demand for home currency
Home prices v/s comparable goods abroad
Foreign income
Foreign import duties & quotas

5. Principles of BOP accounting
Double entry bookkeeping
It is a cash flow statement
Designed to always balance; rules for debits and credits
The way it is balanced tells us how a country is doing in its transactions with other countries

6. Components of BOP Current account Capital/financial account
Net errors and omissions
Official reserves account

7. Current account
Goods
Services
Investment income
Transfers

8. Current account balance
Fair indicator of a country’s international competitiveness
A current account surplus will strengthen the currency

9. Current account balance
Affected by:
Inflation
A comparatively high economic growth- increase in imports while demand for exports lag behind

10. Capital / Financial Account
Capital account
Transfers of financial assets and
the acquisition and disposal of
non-produced/ non-financial
assets

11. Financial Account Direct investment Portfolio investment
Other investment assets/ liabilities

12. Current & Capital Account Relationship
Inverse relation between the current and capital account
Countries experiencing large current account deficits “ finance” these purchases through equally large surpluses in the capital account

13. Official Reserves Account
Total reserves held by official monetary authorities within the country.
Normally composed of the major currencies used in international trade and financial transactions

14. Net Errors & Omissions
Reasons?
Capital Mobility
Capital Flight

15. Link Between Current & Capital Account
National Income = Consumption + Savings
National spending= Consumption+Investment
National Income- National spending =
Savings – Investments
Savings – Investments = surplus capital
( that must be invested overseas)

16. i.e Savings = Domestic Inv Net Foreign Inv Net Foreign Inv= Nation’s net public & private capital flows = capital account deficit

17. Alternatively, A national savings deficit = capital account surplus( net borrowing from abroad) This borrowing finances the excess of national spending over income.

18. If we subtract expenses on domestic goods & services from National Product, the remaining goods & services must be exports

19. Similarly, subtracting spending domestic goods & services from total expenditure, the remaining goods & services must be imports

20. We have now another national income identity: National Income – National spending = Exports – Imports = Net Foreign Investment

21. Thus, in a freely floating exchange rate system, The current account balance & the capital account balance must exactly offset each other

22. Question
A deficit or surplus in the current account is it inherently “good” or “bad”?