Balance of Payments: Pankaj Kumar International Business Environment

Balance of Payments
Pankaj Kumar
International Business Environment
Part I
Balance of Payments
Accounting
Balance of Payments Accounting
Records of transactions
among nations have not
always been kept. Are
they very recent?
General use of BP
accounting is more
recent, but in 1381
Richard Aylesbury, an
Englishman, had not
only collected such
statistics, but was
developing analysis as to
why the accounts
behaved as the did.
It is not clear that

they are really
necessary!
For example, who keeps

track of California’s
balance of payments
transactions with other US
states?
What kind of records should

be kept?
What do you want to find
out?
The nature of the record
changes by what we are
trying to find out.
What kind of things do
governments wish to know?
What is the international
demand for our currency
doing to its value?
Do we have enough currency
reserves, or capacity to pay
for our trade?
Does our trade promote full
employment? And so on.
 What kinds of transactions represent the basic
focus of balance of payments accounting?
 All transactions between the citizens of a

nation and those of other nations are recorded
in the balance of payments for a given period
of time.
Recording International Payments
 How is information recorded in balance of
payments accounting?
 The basic technique is standard, double-entry

accounting,
 a flow of funds statement that shows changes in

assets, liabilities and net worth over time.
Recording International Payments
 The balance of payments statement is to

inform government authorities of the
international position of the country to assist
them with monetary-fiscal questions as well as
trade and payments policies.
Debits, Credits, and International Payments
 What is the meaning of a debit in a balance of

payments account? What is a credit?
 A debit records a transaction increasing assets
or reducing liabilities.
 A debit results from some kind of transaction

requiring an immediate out-payment.
 A debit arises from the purchase of goods,
claims, or reserve assets and represents an
inflow of value.
 A credit records a transaction reducing assets

or increasing liabilities.
 It results from some kind of transaction
requiring an immediate in-payment.
 A credit arises from the sale of goods, claims,
or reserve assets and represents an outflow of
value.
Sources and Uses of Funds
 How does a country derive foreign currencies
it needs to conduct its international business?
 The sources of funds, the supply of foreign

exchange, are
 exports,
 investment income,
 The sources of funds, the supply of foreign
exchange, are
 transfer payments received,

 and long-term and short-term borrowing.
 Credit entries reflect the sources, debit entries

indicate the uses of foreign exchange.
Part II
The Balance of Payments
Accounts
BALANCE OF PAYMENTS
ACCOUNTS
These accounts are to summarize payments a
country receives from other nations and payments
it must make to other nations.
They consist of the following five categories:
1. MERCHANDISE OR TRADE BALANCE:

(Exports minus imports )
BALANCE OF PAYMENTS
ACCOUNTS
2. GOODS AND SERVICES BALANCE:
(Just add services)
3. NET UNILATERAL TRANSFERS

(Gifts)
 Government transfers to foreigners
 (E.g., Foreign aid or wheat from stockpiles)
 Private remittances of wages earned abroad, and
 Lots of other transfers.
BALANCE OF PAYMENTS
ACCOUNTS
To here, we are looking at the

CURRENT ACCOUNT BALANCE
(Net flows of goods, services and gifts).
Again:
2. GOODS AND SERVICES* BALANCE:
Balance of Payments
There is also a set of asset flows referred to as the
CAPITAL ACCOUNT BALANCE
4. NET CHANGES IN FOREIGN HOLDINGS OF

ASSETS
Flows of financial assets and similar claims, or
Foreign direct and other investments or
“Private capital flows.”
(Note that we are talking direct and portfolio investments

here).
Balance of Payments
5. NET OFFICIAL INTERNATIONAL
RESERVE TRANSACTION
Foreign official holdings of assets,
holdings of official reserve (gold and foreign
exchange) assets
or, “Official asset flows.”
All Together Now
2. GOODS AND SERVICES* BALANCE:
4. NET CHANGES IN FOREIGN HOLDINGS
OF U.S. ASSETS
5. NET OFFICIAL INTERNATIONAL
RESERVE TRANSACTION
Balance of Payments
 THE BALANCE OF
PAYMENTS IS,
THEREFORE, THE
SUM OF THE
CURRENT AND
CAPITAL ACCOUNT
BALANCES.
Services in the Balance of Payments
Note:
*Services include travel and
tourism, trade transportation,
insurance, education, financial,
technical, telecommunications
and other business and
professional services.
In addition there are royalties,

payments for capital services
besides interest, such as
dividends, payments for foreign
labor, etc.
Overall Surpluses and Deficits
 What is an overall balance of payments
surplus? What is an overall deficit?
 A surplus is when the sum of the current

account plus the private capital account is
counterbalanced by an accumulation of official
net assets, so official reserve assets increase.
Overall Surpluses and Deficits
 What is an overall balance of payments
surplus? What is an overall deficit?
 If it is in deficit , the sum is counterbalanced

by an accumulation of official net liabilities, so
the country sees its official reserve assets
decline.
 What Drives Large U.S. Current Account Deficits?
 See Coughlin & Pollard and the readings

suggested in King, if interested. They are very
short and reassuring.
The U.S. currently has a huge current account
deficit.
Why do we have it?
Is it sustainable?
 The current account balance is the difference
between domestic saving and domestic
investment. If domestic saving falls, the US
must borrow from abroad to finance domestic
investment…
 US foreign indebtedness is not necessarily bad
if foreign funds are used towards investment.
 Repayment of the debt is potentially a problem
if foreign funds are used to purchase
consumption goods since future generations
will bear the burden of debt.
Poole presents evidence that the rising current
account deficit is associated with rising
domestic investment, and a significant share of
foreign investment in the US is equity
investment which does not have to be repaid.
He concludes that the US does not have a
current account disorder.”
Poole reminds us that a “capital and financial
account surplus is identical to a “current
account deficit” because their dollar values are
identical by the rules of accounting.
 If a foreign firm builds a production facility in
the US, the capital and financial account
surplus increases, which, in turn, means that
the U.S. current account deficit would
increase.
 The rising current account deficit in recent
years has been accompanied by a rising rate of
U.S. domestic investment.
MATHEMATICAL
INTERPRETAION
 Balance of Payments Accounting
 Balance of Payments Accounts
 The Current Account
 The Capital Account
 Statistical Discrepancy
 Official Reserves Account
 The Balance of Payments Identity
 Balance of Payments Trends in Major
Countries
BOP Accounting
 The Balance of Payments is the statistical
record of a country’s international transactions
over a certain period of time presented in the
form of double-entry bookkeeping.
N.B. when we say “a country’s balance of

payments” we are referring to the transactions
of its citizens and government.
Balance of Payments Example
 Suppose that Maplewood Bicycle in
Maplewood, Missouri, USA imports $100,000
worth of bicycle frames from Mercian
Bicycles in Darby England.
 There will exist a $100,000 credit recorded by
Mercian that offsets a $100,000 debit at
Maplewood’s bank account.
 This will lead to a rise in the supply of dollars
and the demand for British pounds.
Balance of Payments Accounts
 The balance of payments accounts are those
that record all transactions between the
residents of a country and residents of all
foreign nations.
 They are composed of the following:
 The Current Account
 The Capital Account
 The Official Reserves Account
 Statistical Discrepancy
The Current Account
 Includes all imports and exports of goods and
services.
 Includes unilateral transfers of foreign aid.
 If the debits exceed the credits, then a country
is running a trade deficit.
 If the credits exceed the debits, then a country
is running a trade surplus.
The Capital Account
 The capital account measures the difference between
U.S. sales of assets to foreigners and U.S. purchases
of foreign assets.
 The U.S. enjoys about a $444,000,000,000 capital
account surplus—absent of U.S. borrowing from
foreigners, this “finances” our trade deficit.
 The capital account is composed of Foreign Direct
Investment (FDI), portfolio investments and other
investments.
Statistical Discrepancy
 There’s going to be some omissions and
misrecorded transactions—so we use a “plug”
figure to get things to balance.
 Exhibit 3.1 shows a discrepancy of $0.73
billion in 2000.
The Official Reserves Account
 Official reserves assets include gold, foreign
currencies, SDRs, reserve positions in the
IMF.
The Balance of Payments Identity
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,

BCA + BKA = 0
U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies 0.73
Overall Balance $0.30
Official Reserve Account ($0.30)
Credits Debits
Current Account In 2000, the
1 Exports $1,418.64
U.S. imported
2 Imports ($1,809.18)
more than it
Balance on Current Account ($444.69) exported, thus
Capital Account running a
5 Portfolio Investment $474.39 ($124.94) current account
6 Other Investments
Balance on Capital Account
$262.64 ($303.27) deficit of
$444.26
7 Statistical Discrepancies 0.73 $444.69 billion.
Credits Debits During the same
Current Account
1 Exports

$1,418.64

year, the U.S.
2 Imports ($1,809.18)
attracted net
3 Unilateral Transfers $10.24 ($64.39) investment of
Balance on Current Account ($444.69) $444.26 billion
Capital Account
—clearly the
5 Portfolio Investment $474.39 ($124.94) rest of the world
found the U.S.
7 Statistical Discrepancies 0.73 to be a good
place to invest.
Credits Debits
Current Account
1 Exports

$1,418.64

Under a pure
2 Imports ($1,809.18)
flexible
3 Unilateral Transfers $10.24 ($64.39) exchange rate
Balance on Current Account ($444.69) regime, these
Capital Account
4 Direct Investment $287.68 ($152.44) numbers would
5 Portfolio Investment $474.39 ($124.94) balance each
other out.
Credits Debits
Current Account
1 Exports

$1,418.64

In the real
2 Imports ($1,809.18)
world, there
3 Unilateral Transfers $10.24 ($64.39) is a statistical
Balance on Current Account ($444.69) discrepancy.
Capital Account
Credits Debits
Current Account
1 Exports

$1,418.64

Including that,
2 Imports ($1,809.18)
the balance of
3 Unilateral Transfers $10.24 ($64.39) payments identity
Balance on Current Account ($444.69) should hold:
Capital Account
4 Direct Investment $287.68 ($152.44) BCA + BKA = – BRA
($444.69) + $444.26 + $0.73 = $0.30= –($0.30)
Balance of Payments and the
Exchange Rate
Credits Debits Exchange rate $
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
6 Other Investments $262.64 ($303.27) D
Overall Balance $0.30 Q
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
As U.S. citizens import, they are supply dollars to the FOREX market.
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18)
Capital Account
Exchange Rate
Current Account
1 Exports $1,418.64 P S
2 Imports ($1,809.18) S1
Capital Account
As the U.S. government sells dollars, the supply of dollars increases.
Thank you

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Balance of Payments

It is not clear that

For example, who keeps

What kind of records should

 All transactions between the citizens of a

 The basic technique is standard, double-entry

 a flow of funds statement that shows changes in

 The balance of payments statement is to

 What is the meaning of a debit in a balance of

 A debit results from some kind of transaction

 A credit records a transaction reducing assets

 The sources of funds, the supply of foreign

 transfer payments received,

 Credit entries reflect the sources, debit entries

They consist of the following five categories:

1. MERCHANDISE OR TRADE BALANCE:

3. NET UNILATERAL TRANSFERS

To here, we are looking at the

4. NET CHANGES IN FOREIGN HOLDINGS OF

(Note that we are talking direct and portfolio investments

In addition there are royalties,

 A surplus is when the sum of the current

 If it is in deficit , the sum is counterbalanced

 See Coughlin & Pollard and the readings

N.B. when we say “a country’s balance of

Under a pure flexible exchange rate regime,

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