NATIONAL ECONOMICS UNIVERSITY

‫ﻯﻯﻯﻯﻯﻯﻯﻯ‬

GROUP WORK
Topic: BALANCE OF PAYMENTS

Group’s members : Nguyễn Đức Phúc An (11210228)

Nguyễn Kỳ Anh (11216846)
Phạm Quang Anh (11210700)
Phạm Tuấn Anh ( 11210720)
Tạ Quỳnh Anh (11216849)
Trần Thị Quỳnh Anh (11218583)
Trịnh Duy Anh (11210796)

Group : 1
Class : International Economics 63C (AEP)

TABLE OF CONTENTS
1. Definition: Balance of payments:.............................................................................2
2. The purpose of the balance of payments:................................................................2
3. Accounting principles:..............................................................................................2
4. Structures:.................................................................................................................4
a, Current account (CA)...............................................................................................4
b, Capital and financial account (CFA):.....................................................................5
c, Statistical discrepancy:.............................................................................................9
d, Official reserve transaction:....................................................................................9
5. Balance of trade v/s balance of payment................................................................12
6. Disequilibrium in the balance of payments..............................................................13
7. The importance of the BOP for the government.....................................................16

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1. Definition: Balance of payments:
- All the transactions (good, service or asset) of the residents of a nation
with the residents of all other nations are recorded during a particular
period of time, usually a calendar year.
- International transactions made between the residents of all other nations
are recorded during a particular period of time (usually a calendar year)

2. The purpose of the balance of payments:

- To inform the government of the international position of the nation
- To formulate the monetary, fiscal and trade policies (the process of policy
making helps in monitoring the flow of money and developing the economy

3. Accounting principles:
* Credits & debits.
- Credit transaction (+): The export of goods and services, as well as primary
income, secondary income, and capital transfers receivable from abroad.
- Debit transaction (-): The imports of goods and services, as well as primary
income, secondary income, and capital transfers payable to foreign residents.
- Net lending (+) from current- and capital-account transactions occurs when
the total credits exceed the total debits in the nation’s current and capital
accounts.
- Net borrowing (−) from current- and capital-account transactions occurs
when the total debits exceed the total credits in the nation’s current and capital
accounts.
* Financial inflow and outflow.
- Financial inflow: an increase in foreign assets in the nation or a reduction in
the nation's assets abroad.
- Financial outflow: an increase in the nation's assets abroad or a reduction in
foreign assets in the nation.

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 * Double-Entry Bookkeeping.
Each international transaction is recorded twice, once as a credit and once as
a debit of an equal amount.

* Total BOP account must always in balance

Debit amounts = Credit amounts

Example 1: Suppose that a VN firm exports $2,000 of goods to be paid for in 6 months.

Credit (+) Debit (-)

Good exports
+200
(Transaction that give rise to a receipt
0$
from abroad )

Financial inflow
(Receipts from exports or increase in -
claims on foreigners or an increase in 2000$
VN’s asset abroad )

Example 2: Suppose that a VN resident visits Bangkok and spends $500 on hotel,
meals, clothes, etc.

Credit (+) Debit (-)

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 +500
Financial outflow
$

Overseas transaction by VN resident -500$

4. Structures:
a, Current account (CA)
* Record all the transactions relating to:
 Export and import of goods and services
 Investment income:
Net earnings (dividents, interest) and compensation to employees
Ex: Net earnings on US investments abroad; minus payments on foreign
assets in the US
 Unilateral transfers
Transfer of goods and services or financial assets
Private transfer payments
Governmental transfers
Current account – types of balance
 Balance of trade= Export – Import
* Trade balance:
 Trade surplus: EX > IM (EX - export; IM - import)
 Trade deficit: EX < IM
* Income flows and payments:
 Net investment income: net income receipts from assets
 Net international compensation to employees: net compensation of
employees
* Unilateral transfers:

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  Gifts or grants received from foreign countries - gifts or grants to foreign
countries
Ex: The U.S. government sends $100,000 worth of food aid to a poor
nation.
* Current Account Balance= Trade balance + Income Balance + Net Unilateral
Transfer

If the current account > 0 => Current account surplus

If the current account < 0 => Current account deficit

b, Capital and financial account (CFA):

* Capital account:
 A country's capital account records all international capital transfers. The income
and expenditures are measured by the inflow and outflow of funds in the form of
investments and loans. A deficit shows more money is flowing out, while a surplus
indicates more money is flowing in.
 Along with non-financial and non-produced asset transactions, the capital account
includes
 Dealings such as debt forgiveness
 The transfer of goods and financial assets by migrants leaving or
entering a country
 The transfer of ownership of fixed assets and of funds received for
the sale or acquisition of fixed assets
 Gift and inheritance taxes
 Death levies, patents, copyrights, royalties
 Uninsured damage to fixed assets.

*Financial accounts:

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  The financial account measures increases or decreases in international ownership
of assets, whether they be individuals, businesses, governments, or central banks.
 Include:
 Direct investment and portfolio investment assets (both short and
long term)
 Financial derivatives and employee stocks options
 Other investments
 Reserve assets

EX1:

Fig. 4 - Calculating the Balance of Payments

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Net current account: £350,000 + (-£400,000) + £175,000 + (-£230,000) = -£105,000
Net capital account: £45,000
Net financial account: £75,000 + (-£55,000) + £25,000 = £45,000
Balancing item: £15,000
Balance of Payments = Net Current Account + Net Financial Account + Net
Capital Account + Balancing Item
Balance of payments: (-£105,000) + £45,000 + £45,000 + £15,000 = 0

EX 2: Let us take the case of country A to calculate the balance of payments based on
the given information and determine whether the economy is in surplus or deficit. The
following information is used for the calculation:

Balance of current account:

 Balance of current account = exports of goods + imports of goods + exports of
services + imports of services
 = $3,50,000 + (-$4,00,000) + $1,75,000 + (-$1,95,000)

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  = -$70,000 i.e. current account is in deficit

Balance of capital account:

 The balance of capital account =net capital account balance
 = $45,000 i.e. capital account is in surplus

Balance of financial account:

 Balance of financial account =net direct investment + net portfolio investment +
assets funding + errors and omissions
 = $75,000 + (-$55,000) + $25,000 + $15,000
 = $60,000 i.e. financial account is in surplus

Therefore, by using the above-calculated value, we will now calculate the BOP
 The balance of payments = $35,000, i.e., overall, the economy is in surplus.

Relevance and Use BOP Formula

The concept of balance of payments is very important because it reflects whether the
country has enough funds to pay for its imports. It also demonstrates whether the country
has enough production capacity that its economic output can pay for its growth. Usually,
it is reported on a quarterly or yearly basis.
If the balance of payments of a country is in deficit, then it means that the country
imports more services, goods, and capital items than exports goods/services. In such a
scenario, the country is forced to borrow funds from other countries to pay off its
imports. In the short term, such measures can fuel the country’s economic growth.
However, in the long term, the country becomes a net consumer of the world’s economic
output. Such a country will be forced to go into more debt to pay for its consumption
instead of investing in its future growth prospects. If the deficit lasts for too long, the
country might have to start selling off its assets to pay for its debt. Examples of such
assets are land, natural resources, and commodities.
If the balance of payments of a country is in surplus, it means that the country exports
more services, goods, and capital items than imports. Such a country and its residents are

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good savers. They have the potential to pay for all their domestic consumption. Such a
country can even extend loans to other countries. In the short term, a surplus BOP
can boost economic growth. This is because they have enough savings to extend loans to
those countries that buy their products.
Consequently, the increase in exports can boost the production requirement, which means
hiring more people. However, the country might become too dependent on exports in the
end. In such a country, a large domestic market can guard the country against exchange
rate fluctuations.
As such, the balance of payments enables analysts and economists to understand the
strength of the economy of a country in comparison to that of other countries. In addition,
theoretically, the capital and the financial accounts should be balanced against the current
account, i.e., BOPs should be zero, but that seldom happens.
c, Statistical discrepancy:
 Because of double-entry-bookkeeping, the balance on the current and capital

accounts must equal the balance of the financial account of the nation. But this
equality does not hold in the real world.
 Statistics discrepancy results from incorrectly recording or from not recording at
all only one side of some transactions:
 Errors may arise because of different reporting requirements, different collecting
agencies, wrong estimates of some transactions, and so on.
 Omissions are more likely in service than trade transactions, may arise because of
forgetfulness or to evade taxes.
 Information – some is collected, some is estimated
 The statistical discrepancy, which keeps the BOP account in balance

d, Official reserve transaction:

 Conducted in the form of international reserve assets by central banks, such as:

 Gold
 Convertible currencies
 IMF credits and SDR (Special Drawing Right)
 Changes in foreign central bank holding of domestic assets

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  Changes in domestic central bank holding of foreign assets
EX: When US and foreign governments wish a strong dollar, they sell foreign
currency, SRDs, or gold to buy dollars. These transactions, which give rise to the
demand for dollars, will be recorded as a positive entry, although the central
bank’s reserves are declining.
When US and foreign governments wish a weak dollar, they “sell” dollars and buy
foreign currency, SRDs, or gold. These transactions, which give rise to the supply
of dollars, will be recorded as a negative entry, although the central bank’s
reserves are increasing
*The significant of official reserve transactions:

1.The official transaction reserve assists in bringing the country’s balance of payments
into balance:
Countries keep track of official settlement accounts to determine their economic health.
Nations can monitor the inflows and outflows of other countries via official settlement
accounts. Investments, loans, services and products are among the inflows and outflows.
These accounts reflect the current account and capital account of central banks in the
international balance of payments accounting which is very important for an economy.
Reserve asset inflows or outflows put the ledger back into balance when there is either a
balance of payments deficit surplus. The total of the current account should, under ideal
conditions, balance with the total of the capital and finance accounts

2. The procurement of a country’s own currency is a credit item in the balance of

payments, but the safe of the currency is a negative item:
Different types of transactions can be used to determine the balance i.e. products, goods
and services. For foreign transactions, the current account, capital account, and financial
account balances are also computed. When an international transaction account has a
negative net amount or balance, it is called a trade deficit. The balance of payments
records all negative net amount or balance, it is called a trade deficit. The balance of

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payments records all economic transactions between residents and non-residents that
result in a change in ownership (international transaction accounts). A trade deficit or net
amount can be calculated in a variety of categories under an international transaction
account. Products, goods and services, as well as the current account and total current and
capital account balances, are all included. Net lending/borrowing is equal to the sum of
the current and capital account balances. This is also the financial account balance plus a
statistical mismatch. In contrast to the current and capital accounts, which track purchases
and payments, the financial account measures financial assets and liabilities

3. It assist in the management of the deficit and surplus in the balance of payments:
An account that maintains track of central bank transactions is known as official reserve
transactions. It may be seen in the financial account for balance of payments. The country
is in balance of payments surplus if this account shows a net increase in official reserves
over time. If the official reserve balance continues to decline over time. The country’s
balance payments will then be in deficit
In a fixed exchange rate system, suppose a country has a trade deficit. When the demand
for imports exceeds the demand for our exports to other nations, a trade imbalance
emerges. Domestic demand for foreign currency is higher than international demand for
domestic currency. To maintain the exchange rate steady, the central bank would have to
take action. If there are no more foreign demands for domestic currency on the financial
account, the central bank can intervene by selling foreign money in exchange for
domestic currency. As a result, foreign reserves would decline, resulting in a balance-of-
payments deficit. A trade deficit and a steady exchange rate imply a balance of payments
deficit in the absence of financial account activities. When there is an extra demand for
anything, it results in a balance of payments deficit of foreign currency in the private
Forex market at the government-regulated exchange rate. To accommodate the excess
demand, the central bank will automatically act in the Forex market and sell (purchase)
foreign reserves (supply). We can determine whether a country has a balance of payments

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deficit or surplus by tracking sales and purchases of foreign reserves in the official
reserve account

5. Balance of trade v/s balance of payment

 BOP
1. Is a broad term
2. Include all transactions related to visible invisible and capital transfer
3. Always balance itself
4. BOP = current account + capital account +/- balancing items (errors and
omissions) Financial Account?
5. Factors that affect BOP
 Conditions of foreign leaders
 Government economic policy
 All BOT factors
 BOT
1. It's a narrow term
2. Only visible items
3. Can be favorable or unfavorable
4. BOT = net earning on export - net payments for imports
Balance of financial account = Net direct investment + Net portfolio
investment + Assets funding + Errors and omissions
*Financial account components include direct investment, portfolio
investment, and reserve assets broken down by sector
(portfolio : stocks, government bonds, corporate bonds)
(assets funding : the use of a company's balance sheet assets, including
short-term investments…. To borrow money or get a loan)

5. Factors that affect BOT

 Cost of production

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  Availability of raw material
 Exchange rate
 Domestic price of manufactured goods

6. Disequilibrium in the balance of payments

 A disequilibrium in the balance of payment means its condition of Surplus Or

deficit.
 • A Surplus in the BOP occurs when Total Receipts exceeds Total Payments.
Thus, BOP= CREDIT>DEBIT.
 • A Deficit in the BOP occurs when Total Payments exceeds Total Receipts. Thus,
BOP= CREDIT<DEBIT.
 In a market setting, disequilibrium occurs when quantity supplied is not equal to
the quantity demanded.
*Causes of disequilibrium in the BOP
• Inadequate Promotion of Exports (A vast increase in the domestic production of
foodstuff, raw material, substitute goods)
example:In advanced countries has decreased their need for import from the
agrarian underdeveloped Nations.
Thus, export demand has considerably changed, resulting in structural
disequilibrium in these Nations.
 structural disequilibrium refers to a changes in the supply and
demand for exports/imports -> disequilibrium in a country's BOP
 Similarly, advanced nations also have suffered in their exports as a
result of the loss of their colonial markets, the tendency of poor
nations for self-reliance and their ways and means of curtailing their
imports
• Economic Development (Due to rapid economic development, the resulting
income and price effects will adversely affect the balance of payments position of
a developing country.
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  With an increase in income, the marginal propensity to import is high in
these countries, their demand for imported articles will consume is also in
these countries, people’s demand for domestic goods also rise, and hence
less may be spread for export
• Rapid increase in population
A huge population and its high rate of growth in poor countries also have
adversely affected their BOP position.It is easy to see that an increase in
population increases the need for these countries for imports and decrease the
capacity to export

• Natural Calamities (Natural calamities like floods, drought, and earthquakes also
cause disequilibrium in the country’s BOP. It destroys the agricultural and industrial
production of the nation thereby adversely affecting its exports and creating the need
for imports)

*Measures to correct disequilibrium in the BOP:

1.Monetary measures:
a. Monetary Policy: The monetary policy is concerned with money supply and credit in
the economy. TheCentral Bank may expand or contract the money supply in the
economy through appropriate measures which will affect the prices.
b. Fiscal Policy: Fiscal policy is the government's policy on income and expenditure.
Government incurs development and non -development expenditure,. It gets income
through taxation and non - tax sources. Depending upon the situation governments
expenditure may be increased or decreased.
c. Exchange Rate Depreciation: By reducing the value of the domestic currency,
government can correct the disequilibrium in the BOP in the economy. Exchange rate
depreciation reduces the value of home currency in relation to foreign currency. As a

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 result, import becomes costlier and export become cheaper. It also leads to
inflationary trends in the country
d. Devaluation: Devaluation is lowering the exchange value of the official currency.
When a country devalues its currency, exports becomes cheaper and imports become
expensive which causes a reduction in the BOP deficit.
e. Deflation: Deflation is the reduction in the quantity of money to reduce prices and
incomes. In the domestic market, when the currency is deflated, there is a decrease in the
income of the people. This puts curb on consumption and government can increase exports
and earn more foreign exchange.
f. Exchange Control: All exporters are directed by the monetary authority to
surrender their foreign exchange earnings, and the total available foreign exchange is
rationed among the licensed importers. The license-holders can import any good but
amount if fixed by monetary authority

2. Non- Monetary measures :

a. Export Promotion To control export promotions the country may adopt measures to
stimulate exports like: export duties may be reduced to boost exports cash assistance,
subsidies can be given to exporters to increase exports: goods meant for exports can be
exempted from all types of taxes.
b. Import Substitutes Steps may be taken to encourage the production of import
substitutes. This will save foreign exchange in the short run by replacing the use of
imports by these import substitutes.
c. Import Control Import may be kept in check through the adoption of a
wide variety of measures like quotas and tariffs. Under the quota system, the
government fixes the maximum quantity of goods and services that can be
imported during a particular time period.
1. Quotas – Under the quota system, the government may fix and permit the
maximum quantity or value of a commodity to be imported during a given period. By

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 restricting imports through the quota system, the deficit is reduced and the balance of
payments position is improved.
2. Tariffs – Tariffs are duties (taxes) imposed on imports. When tariffs are imposed,
the prices of imports would increase to the extent of tariff. The increased prices will
reduced the demand for imported goods and at the same time induce domestic
producers to produce more of import substitutes

7. The importance of the BOP for the government

 Helps government determine potential industry -> develop policies to encourage

production
 Provides government with a broad view of a import and export levies
->boost exports to achieve self-sufficiency
 Help government identify the economy status and plan expansion of the country
through monetary and fiscal policy based on BOP.

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