INTERNATIONAL MONETARY ECONOMICS LECTURE

BALANCE OF PAYMENT ACCOUNTS

Introduction

The BOP transactions include all the foreign receipts of and payments by a country
during a given year.

RECEIPTS – includes  all the earnings and borrowings of foreign exchange,

PAYMENTS - includes all the spending and lending of foreign exchange, and they
are recorded as debit item (-).

∴ All the foreign receipts are financial inflows and all the foreign
payments are financial outflows in an year.

- In the purely accounting or book-keeping sense, the BOP must always balance,
because the BOP is a schedule of debit and credit transactions which must
necessarily be equal.

However,

The term BOP gives a false impression. Balance – does not imply a situation of
equilibrium, it only means that it is a balance sheet of receipts and payments having an
accounting balance.

The BOP statement basically include 6 major accounts

2) Goods Account
3) Service Account
4) Unilateral Transfers Account
5) Long-term Capital Account
6) Short-term Capital Account
7) International Liquidity Account

Goods Account

- It includes the value of merchandise X and the value of merchandise imports. These
items of forex earning and spending are called as ‘visible’ items in the BOP.

Service Account

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- Records all the service exported and imported by a country in a year. The service
transactions take various forms.

a) Transportation, banking and insurance receipts and payments from and to the
foreign countries.
b) Tourism, travel services and tourist purchases of goods and services.
c) Expenses of students studying abroad and receipt from foreign students
studying in the country.
d) Expenses of diplomatic and military personal stationed overseas as well as the
receipts from similar personnel from overseas who are stationed in the home
country.
e) Interest rate, profit, dividends and royalties received from foreign countries
and paid out to another country.

Unilateral Transfers Account

- This account includes all gifts, grant and repatriation receipts and payments to
foreign countries.

- Consists of two types of transfers

• Foreign economic aid or assistance and foreign military and or assistance

e.g. A Malaysian settled in the US sends $100 a month to his aged parents in Malaysia is
a unilateral private transfers.

- Unilateral transfer receipts and payments are also called ‘unrequited transfers’
because as the have itself suggests, the flow is only in one direction with no
automatic reverse flow in the other direction. There is no repayment obligation
attached to these transfers because they are not borrowings and lending but gifts
and grants exchanged between government and people in one with the government
and peoples in the rest of the world.

Long-term Capital Account

It includes the amount of capital that moved into or out of the country in a year-or
more. It includes:-

2) Private Direct Investment – these investments are done by home country citizens
and firms in foreign countries (debit) and by foreigners in the home country (credit).
e.g. Foreign Direct Investment by MNCS – capital inflow – favorable effects on
the BOP. But when the foreign investment in our country starts repatriating profits

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to their home country, there will be capital outflow from our country to foreign
countries. This goes into our service account (debit).

3) Private Portfolio Investment – these investments are done by home country citizens
and firms in foreign securities or stocks or bonds or share (debit) and vice versa.
This type of movement in and out of a country is induced by differences in interest
rate, dividends or rate of return of assets.

4) Government loans to foreign government – when the home country lends out long
term capital to foreign countries – capital outflow ∴ debit long term capital account.
But when we begin to receive reverse flow in the form of return to investment, the
amount will be credited in our BOP as investment income receipt in the service
account.

Short-Term Capital Account

- Bank deposits and other short term payments and or arrangements – mature in less
than a year are included in this account. The vast majority of short-term K
transactions basically represent bank transfers that finance trade and commerce.

e.g. When Malaysian exporter exports rubber worth $5mn. to an importer in the
USA, it generates a credit of $5mn. to the Malaysian merchandise account; but if the
US importer pays this sum of $5mn into the bank account of the Malaysian exporter
held in New York bank, the sum of $5mn would be held as debit in Malaysia’s short term
capital account. The latter constitutes a short term capital outflow of $5mn from
Malaysia to the US.

1. It is often hard to keep track of all the short term capital movements in
and out of the country. --- it usually constitutes rough estimates. Indeed in some
countries the separate category of short term capital account does not exist.  it is
included in an account under the general term ‘errors and omissions’.

- This is what is done in the Malaysian system of BOP account. What happens is that
any differences in the BOP debit and credit accounts will be recorded in errors and
omission.

Basic Balance

Basic Balance = Current Account + Capital Account (Long-Term)

Short Term capital account is not included: Why?

1) Unlike long term capital flows, short term capital account is relatively volatile and
unpredictable. They move in and out of the country in a less than a year period.

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∴ It would be improper to treat short term capital movements on the same footing as
current account transactions which are extremely durable in nature.

2) In many countries do not have a separate short term capital account.

Overall Balance of Payments

Overall balance consists of two account’s balances – i.e. Current Account and Capital
Account.

Can we say that a surplus in the overall balance of payments is a good sign? Or a deficit
is a bad sign?

We cannot give sensible answers to these questions simply by reading the entries in the
debit and credit columns of the overall BOP. We must not only know the extent of BOP
overall surplus or deficit but also the locations of these surpluses or deficits.

1) If the overall surplus in the BOP was caused by current account and not capital
account surplus – could be a good sign.

2) If the overall deficit in the BOP was caused by current account deficits rather than
capital account deficits, then the deficit may be considered as a bad sign.

Important Concepts and Distinction that We Came Across In BOP Discussions

1. Balance Of Trade

- Some writers – define balance of trade as the difference between the value of
merchandise exports and the value of merchandise imports.

- In countries like Malaysia, goods balance is always favourable but services balance is
always infavourable.

2. Balance of Payments on Current Account

- Includes the sum of three balances – merchandise balance, service balance and
unilateral transfers balance.

∴ It comprises of trade balance and transfer balance.

3. Capital Account

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- All transactions involving inward or outward movement of capital and investment are
included in capital account  shot term, direct or portfolio, tied or untied, interest
bearing or non-interest bearing.

Is capital account surplus good?  not necessarily. LDCs  recipients of foreign

QUESTIONS

1. In accounting sense, the BOP is always balance. So, if there is no imbalance, then
what is the meaning of disequilibrium? Why do countries talk and debate about
BOP adjustment? And BOP settlement?

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