Dr.

Sangeeta Yadav

 How

nations measure intl economic activity?

Define Current Account, Capital/Financial Account?
How can one use the BOP sub-accounts to make financial
decisions?
What leads to capital flight? Some History.

The balance of payments is a record of all

economic transactions conducted between a
country and the rest of the world for a given
time period, usually one year.

An economic transaction is an exchange of

value. It involves a receipt and a payment of
money in exchange for economic goods and
services.

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Balance of Payments (BOP):

measures all international economic transactions
b/n residents & foreign residents.
Monetary

and fiscal policy must take the BOP into

account at the national level
BOP data may be important

Indicates pressure on exchange rate

May signal imposition/ removal of controls over payments,
dividends, interest.
Helps forecast countrys market potential

The BOP must balance

How to measure international economic activity?
Is

it an international economic transaction?

How do flow of goods/services/assets/money translate
in debits & credits?
Bookkeeping procedures for BOP?

Mistakes are common

BOP is a flow statement, not a stock statement.
Main

transactions in BOP:

Exchange of real assets.

Exchange of financial assets.

BOP transactions (US side)

GM

China pays dividends to parent in US.

An American tourist purchases a necklace in India.
A Mexican lawyer purchases US bond via investment
broker in Cleveland.

Rule of thumb: follow the cash flow

In standard accounting double entry bookkeeping, each transaction will result in a

debit and a credit entry of equal size or
amount.

Thus in that sense, a countrys balance of

payments accounts for any given year always
balances.

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In terms of actual receipts and payments, a

country may be faced in any given year with
one of two situations.
(a) A surplus or favourable balance on the
BOP accounts.
(b) A deficit or unfavourable balance on the
BOP accounts.

11/18/16

Any item which gives rise to a sale of foreign

exchange (an inflow) is recorded as a credit item
(+) in the accounts e.g. export of goods and
services

Any item which gives rise to the purchase of

foreign exchange (an outflow) is recorded as a
debit item (-) in the accounts e.g imports of
goods and services.

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A deficit or an unfavourable balance exists when the

value of autonomous debit items exceeds the value
of autonomous credit items.

A surplus or a favourable balance exists when the

value of autonomous credit items exceeds the value
of autonomous debit items.

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10

The Balance of Payments Account consists of

two parts:
(i) A current account
(ii) A capital (and financial) account

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11

The Current Account generally comprises two sections:

(a) Visible balance (balance of visible trade): primarily
the
Import and export of merchandise or goods)
(b) Invisible balance (Balance of invisible trade):
primarily
the import and export of services.

N.B. The sum of the two balances is referred to as the

balance on the current account.
account

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12

The Current Account generally comprises four main

items:
(a) Merchandise Trade Balance

(b) Services Balance

(c) Net Property Income Balance

(d) Current Transfers Balance

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13

Goods Trade or Balance of Trade (BOT)

export/import of goods.
Services Trade export/import of services
(financial, construction, and tourism).
Income predominately current income
associated with investments made in previous
periods, + wages & salaries paid to non-resident
workers.
Current Transfers financial settlements due to
change in ownership of real resources or
financial items. Any transfer b/n countries
which is one-way, a gift or a grant.
CA typically dominated by export/import of
goods, for this reason Balance of Trade (BOT) is
widely quoted.

Trade balance
Debit: Sun Microsystems buys LCDs from Hong Kong.
Credit: Singapore Airlines buys Boeing jet.
Trade in services
Debit: American rents an apartment in Singapore.
Credit: TUI - Germany places an ad in the NYT.
Income payments
Debit: Honda US pays dividend to Honda Japan.
Credit: Bank Austria pays salary to rep in NY office.
Unilateral Current Transactions
Debit: Peace Corps pays US volunteer teachers in Bosnia.
Credit: TotalFina pays tuition of employee for Stern MBA.

US Current Account, 1997-1999 (US$ bn)

Goods exports
Goods imports
Goods trade balance (BOT)

1997
682
(876)
(194)

1998
672
(917)
(245)

1999
687
(1030)
(343)

Services exports
Services imports
Services trade balance

255
(167)
88

261
(183)
78

270
(191)
79

Income receipts
Income payments
Income balance

257
(251)
6

258
(265)
(7)

276
(295)
(19)

Current transfers, credits

Current transfers, debits
Net transfers

8
(49)
(41)

9
(53)
(44)

9
(57)
(48)

The capital account records all movement of

capital from both private sources as well as
official government sources between a
country and the rest of the world.

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17

The Capital Account deals primarily with short term

and long term flows/movements of capital, that is, it
is concerned with international loans and
investments.
It may consist of transfer of ownership of a fixed
asset; direct investments, portfolio investments,
other investments and reserve assets.

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18

It must be noted that when the balances

of both sections are added there can be a
surplus or a deficit.

The account must therefore show the

treatments of any of these two situations
as well as the item to balance off the
account. This is strictly for accounting
purposes. All surplus or deficits must be
dealt with.
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19

Capital account: transfers of fixed assets, real

estate, acquisitions/disposal of non-produced/nonfinancial assets
Financial account: three components; classified by
degree of control,
Direct

Investment Net balance of capital which is

dispersed from and into US for the purpose of exerting
control over assets.

E.g. US company acquires foreign company stake (-)

Foreign company acquires US company stake (+)
foreign direct investment (FDI): 10%+ of voting shares
acquired.

 Portfolio

Investment Net balance of capital which flows

in/out of US but does not reach 10% ownership.

No voting or control rights over the asset.

Purchase/sale of equity securities.
Purchase/sale of debt securities.
E.g. T-bill purchases by foreigners (net portfolio investment)
E.g. US$ debt issues by foreign companies/ governments.
Risk/Return motivated.
Far more volatile than FDI.

Other

Investment Assets/Liabilities Short & long-term

trade credits, cross-border loans, currency & bank
deposits, & other accounts receivable and payable in
cross-border trade.

US Capital/Financial Account, 1997-1999 (billions of US$)

Direct investment abroad

Direct investment in the US
Net direct investment

(105)
106
1

(146)
186
40

(151)
276
125

Portfolio Investment
Assets purchased by US residents, net
Assets purchased by foreign residents, net
Net portfolio investment

(119)
386
267

(136)
269
133

(129)
342
213

Other Investment
Other investment assets
Other investment liabilities
Net other investment

(264)
265
1

(47)
27
(20)

(159)
136
(23)

Financial Account Balance

269

153

315

Direct Investment
Debit: Ford builds factory in Australia.
Credit: Ford sells its factory in UK.
Portfolio Investment
Debit: US investor buys BASF stock @ Frankfurt Stock
Exchange
Credit: Korean govt buys US T-bills to hold as forex
reserves.
Other investment
Debit: HP deposits $10m in a bank account in London.
Credit: HP generates accounts receivable in Canada.

Net Errors and Omissions Account is used to

account for statistical errors and/or untraceable
monies within a country
Official Reserves (ORA) total reserves held by
official monetary authorities within a country.
Comprised

of major currencies used in international

trade and financial transactions, & reserve accounts
(SDR) held @ IMF.

Important indicator for countries w/ fixed exchange rate

regimes
Need to maintain parity rate w/ official reserves.

A.

B.

Current Account
A.

Net exports/imports goods&services (Balance of Trade)

B.

Net Income (investment income from direct portfolio investment plus employee
compensation

C.

Net transfers (sums sent home by migrant abroad)

Capital Account
Capital transfers related to purchase and sale of fixed assets such as real estate

C.

D.

Financial Account
A.

Net foreign direct investment

B.

Net portfolio investment

C.

Other financial items

Net Errors and Omissions

Basic Balance = A+B+C

Overall Balance = A+B+C+D

Missing data such as illegal transfers

E.

Reserves and Related Items

Changes in official monetary reserves including gold and foreign exchange reserves

(A:E) = Overall Balance

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27

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28

Very important for BoP these days

Some history on it
1860-1914

increasing capital openness,

countries adopted gold standard
1914-1945 couple of wars & depression
1945-1971 Bretton Woods
1971-2003 floating exchange rates, financial
volatility, rapidly expanding capital flows

Capital Mobility
Capital Mobility
High

2000

1914

Gold Standard
1880-1914

1900

Float
1971-2000

1929

Low

1880

1860

1918

1880

1900

1920

1980

1960

1925

Interwar, 1914-1945

1860

Bretton Woods
1945-1971

1971

1945

1940

1960

1980

2000

Source: Globalization and Capital Markets, Maurice Obstfeld and Alan M. Taylor, NBER Conference Paper, May 4-5, 2001, p. 6.

How to move capital across borders:

International

payments, regular bank transfers.

Transfer by bearer (smuggling).
Transfer of collectibles/ precious metals.
Money laundering

Off-shore zones & tax heavens.

Invoicing

international trade transactions.

Transfer pricing

BOP records all the transactions that

create demand for and supply of a
currency. This indicates demand-supply
equation of the currency. This can drive
changes in exchange rate of the
currency with other currencies.
BOP may confirm trend in economys
international trade and exchange rate
of the currency. This may also indicate
change or reversal in the trend.
This may indicate policy shift of the
monetary authority (RBI) of the country.

BOP may confirm trend in economys

international trade and exchange rate of
the currency. This may also indicate
change or reversal in the trend.
This may indicate policy shift of the
monetary authority (RBI) of the country.

2. CA Deficit means
the nation is not saving
enough to finance (I) and the
deficit.
3. CA Surplus means
the nation is saving more
than needed to finance its (I)
and deficit.

I.

POSSIBLE SOLUTIONS
UNLIKELY TO
WORK:
A.

Currency Depreciation

B.

Protectionism

II.

CURRENCY DEPRECIATION
A.
U.S. Experience:
Does not improve the trade
deficit.

B.

Depreciations are ineffective

because
1.
It takes time to affect trade.
2.

J-Curve Effect
states that a decline in
currency
value will initially
worsen the deficit before
improvement.

Trade balance

Net change
in trade

Currency

balance

depreciation

improves

TIME

Trade balance
initially deteriorates

III.

PROTECTIONISM
A.
Trade Barriers used:
1.
Tariffs
2.
Quotas
B.
Results:
Most likely will reduce both
X and M.

C. FOREIGN OWNERSHIP
one protectionist solution would
place limits on or eliminate
foreign ownership
leading to
capital inflows.

D.

STIMULATE NATIONAL SAVING

change the tax regulations and
rates.

III.

SUMMARY: CURRENT-ACCOUNT
DEFICITS
- neither bad nor good inherently
1.
Since one countrys exports
are anothers imports, it is
possible for all to run a

not
surplus

2.

Deficits may be a solution to

the problem of different
national propensities to save
and
invest.

A country, like India, which is on the path of

development generally, experiences a deficit
balance of payments situation.
This is because such a country requires
imported machines, technology and capital
equipments in order to successfully launch
and carry out the programme of
industrialization

During the first plan period, the balance of

payments was affected by the Korean War
boom, American recession of 1953 and
favorable monsoon at home which helped to
boost agricultural and industrial production.
balance of payment during the first plan was
only Rs. 42 crores.

An important feature of the second plan

period was the heavy deficit in the balance
of trade which aggregated to Rs. 2339
crores.
The foreign exchange reserves sharply
declined and the country was left with no
choice but to think of ways and means to
restrict imports and expand exports.

The balance of current account was

unfavorable during the third plan .
The serious adverse balance of payments
which started with the second plan
continued relentlessly during the third and
annual plans.
Heavy amount had to be paid by India in the
form of interest payments on loans

One of the objectives of the fourth plan was

self-reliance i.e., import substitution of
certain critical commodities on the one side
and export promotion so as to match the
rising import bill, on the other
Accordingly the government managed to
restrict imports and succeeded in expanding
exports.

During the whole of the Fifth Plan India

experienced a surplus balance of
payments due to a sharp increase in the
exports surplus on account of invisibles.
From 1979-80 onwards, India started
experiencing very adverse balance of
payments.
India had to meet this colossal deficit in
the current account through withdrawals
and borrowings from IMF .

The Sixth plan characterize the balance of

payments position acute.
The annual average current account deficit
was of the order of rs.2600 crores during the
Sixth Plan.
During the Sixth Plan, the trade deficit was
3.3 per cent of GDP and current account
deficit was 1.4 per cent of GDP.

Exports performance substantially

improved in the Seventh Plan with
average volume growth exceeding 7 per
cent.
The share of net invisible earnings in
financing trade deficit declines from 63
per cent during the Sixth Plan to 29.5 per
cent during the Seventh Plan.
The average current account deficit as a
per cenr of GDP increased to 2.4 per cent
in the Seventh Plan.

In the year 1993-94, India saw a remarkable

turnaround from a foreign-exchange
constrained control regime to a more open,
market driven by liberalized economy.
During the last three years export earnings,
on average, accounted for nearly 90 per cent
of the value of imports

Exports recorded a growth of 20 per cent in

dollar terms. The surplus on the invisible
account doubled.
Foreign currency reserves which were just
$1205 million in 990 reached the level of
$19386 million in 1994.
The economy thus moved to a more stable
and sustainable balance of payments
position.

(April, 2005-Oct. 2006)

Exports
2004-05

42200.62

2005-06

51516.87

Y-O-Y Growth

22.08

Imports
2004-05

56381.09

2005-06

75032.08

Y-O-Y Growth

33.08

Trade Balance
2004-05

-14180.47

2005-06

-23515.21

Source: Federal Ministry of Commerce,

Govt. of India

Items

2004-05
(P)

2003-04

2002-03

2001-02

2000-01

1990-91

Trade
Balance

-38,130

-15,454

-10,690

-11574

-12460

-9437

Invisibles,
net

31,699

26,015

17,035

17,035

9,794

-243

Current
Account
Balance

-6,431

10,561

6,345

6,345

2,666

-9,680

Capital
Account

32,175

20,542

10,840

10,840

8,840

7,056

Overall
Balance

26159

31,421

16,985

16,985

5,868

-2,492

-26,159

-31,421

-16,985

-16,985

-5,842

1,278

Foreign
Exchange
Reserve
Increase
(+)/Decrea
se (-)

April, 2004-March, 2005

EXPORTS
2003-2004*

63978.78

2004-2005

79593.59

% Growth

24.41

IMPORTS
2003-2004*

78250.86

2004-2005

106121.18

% Growth

35.62

TRADE BALANCE
2003-04*

-14272.08

2004-05

-26527.59

Source:
Federal
Ministry
* Final figures as given by DGCI&S

of

Commerce,

Government

of

India