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UNDERSTANDING -ANALYSIS -INTERPRETATION BALANCE OF PAYMENT
15

Balance of payment, Current Account, Capital Account, Unilateral transfers

Aug 17, 2014

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Economy & Finance

Sachin Pourush

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Page 1: Balance of payment, Current Account, Capital Account, Unilateral transfers

U N D E R S T A N D I N G - A N A L Y S I S - I N T E R P R E T A T I O N

BALANCE OF PAYMENT

Page 2: Balance of payment, Current Account, Capital Account, Unilateral transfers

INTRODUCTION

• The statistical record of a country’s internationaltransactions over a certain period of time presented inthe form of double-entry book-keeping.

• In BoP, any transaction resulting in a receipt fromforeigners is recorded as a credit, with a positive signforeigners is recorded as a credit, with a positive sign

• any transaction resulting in a payment to foreigners isrecorded as a debit, with a minus sign

Page 3: Balance of payment, Current Account, Capital Account, Unilateral transfers

CASE #1

• The Boeing Corporation exported a Boeing 747 aircraftto Japan Airlines for $50 Mn, and that Japan Airlinespays from its dollar bank account kept with ChaseManhattan Bank in New York City. Then, the receipt of$50 Mn by Boeing will be recorded as a credit (+), which$50 Mn by Boeing will be recorded as a credit (+), whichwill be matched by a debit (-) of the same amountrepresenting a reduction of the U.S. bank’s liabilities.

Page 4: Balance of payment, Current Account, Capital Account, Unilateral transfers

CASE #2

• Boeing imports jet engines produced by Rolls-Royce for$30Mn and that Boeing makes payment by transferringthe funds to a New York bank account kept by Rolls-Royce. In this case, payment by Boeing will be recordedas a debit (-), whereas the deposit of the funds by Rolls-as a debit (-), whereas the deposit of the funds by Rolls-Royce will be recorded as a credit (+).

Page 5: Balance of payment, Current Account, Capital Account, Unilateral transfers

CASE #3

• Ford acquires Jaguar, a British car manufacturer, for$750 Mn and Jaguar deposits the money in BarclaysBank in London, which, in turn, uses the sum to purchaseU.S> treasury notes. In this case, the payment of $750 Mnby Ford will be recorded as a debit (-) whereas Barclaysby Ford will be recorded as a debit (-) whereas Barclayspurchase of the US Treasury notes will be recorded as acredit (+)

Page 6: Balance of payment, Current Account, Capital Account, Unilateral transfers

ACCOUNT

Transactions Credit Debit

Boeing’s export + $50 million

Withdrawal from US Bank - $50 million

Bowing’s import - $30 million

Deposit at US bank + $30 millionDeposit at US bank + $30 million

Ford’s acquisition of Jaguar - $750 million

Barclays’ purchase of US securities +$750 million

Balance of Payment $ 830 million $ 830 million

Page 7: Balance of payment, Current Account, Capital Account, Unilateral transfers

COMPOSITION

• A country’s international transactions can be grouped into three main categories:

• The current account

• The capital account

• The official reserve account• The official reserve account

Page 8: Balance of payment, Current Account, Capital Account, Unilateral transfers

THE CURRENT ACCOUNT

• It includes

• Exports and imports of goods

• Exports and imports of services

• Divided into four subcategories:

• Merchandise trade• Merchandise trade

Represents exports and imports of tangible goods,

• Services

Receipts and payments for legal, engineering, consulting and other performed services and tourist expenditures

• Factor income

Payments and receipts of interest, dividends and other income on previously made foreign investments

• Unilateral transfers

Unrequited payments such as gifts, foreign aid, and reparations

Page 9: Balance of payment, Current Account, Capital Account, Unilateral transfers

THE CAPITAL ACCOUNT

• It includes:

• All purchases and sales of assets such as stocks, bonds, bank accounts, real estate and businesses

• Divided into three sub-categories:

• Direct investment• Direct investment

Acquisitions of controlling interests in foreign businesses

• Portfolio investment

Investments in foreign stocks and bonds that do not involve acquisitions of control

• Other investment

Includes Bank deposits, Currency investment, Trade credit etc

Page 10: Balance of payment, Current Account, Capital Account, Unilateral transfers

THE OFFICIAL RESERVE ACCOUNT

• It includes:

• All purchases and sales of international reserve assets, suchas dollars, foreign exchanges, gold and SDRs.

• Computing the cumulative balance of paymentsincluding the current account, capital account, and theincluding the current account, capital account, and thestatistical discrepancies, we get overall balance orofficial settlement balance

• It is indicative of a country’s BoP gap that must beaccommodated by official reserve transactions.

• If a country must make a net payment to foreignersbecause of a BoP deficit, the country should run down itsofficial reserve assets such as gold, foreign exchangesand SDRs or borrow a new from foreigners.

Page 11: Balance of payment, Current Account, Capital Account, Unilateral transfers

ANALYSIS WITH AN EXAMPLE

• US exports were $2116 Bn in 2009 while US imports were$2405.6 billion. The current account balance, which isdefined as exports minus imports plus unilateral transfers,that is, (1) +(2) + (3) was negative -$419.8 Bn. The US thushad a balance-of-payments deficit on the currenthad a balance-of-payments deficit on the currentaccount in 1009. the current account deficit implies thatthe United States used up more output than it produced.

Page 12: Balance of payment, Current Account, Capital Account, Unilateral transfers

CONTD.

Credit Debit

Current Account

1. Exports 2116.0

1.1 Merchandise 1050.0

1.2 Services 504.81.2 Services 504.8

1.3 Factor Income 561.2

2. Imports -2405.6

2.1 Merchandise -1562.7

2.2 Services -370.7

2.3 Factor Income -472.2

3. Unilateral transfer 19.2 -149.4

Balance on Current Account (1 + 2 + 3) -419.8

Page 13: Balance of payment, Current Account, Capital Account, Unilateral transfers

CONTD.

Credit Debit

Capital Account

4. Direct investment 152.1 -221.0

5. Portfolio investment 376.6 -549.4

5.1 Equity securities 141.9 -68.65.1 Equity securities 141.9 -68.6

5.2 Debt securities 234.7 -480.8

6. Other investment 616.3 -93.5

Balance on capital account (4 + 5 + 6) 281.1

7. Statistical Discrepancies 192.8

Overall balance 52.2

Official Reserve Account -52.2

Page 14: Balance of payment, Current Account, Capital Account, Unilateral transfers

INTERPRETATION

• A country can run BoP surplus or deficit by increasing or decreasing its official reserves.

• Under the fixed exchange rate regime , the combinedbalance on current and capital accounts will be equalin size, but opposite in sign, to the change in the officialin size, but opposite in sign, to the change in the officialreserves. Under the pure flexible exchange rate regimewhere the central bank does not maintain any officialreserves, a current account surplus or deficit must bematched by a capital account deficit or surplus.

Page 15: Balance of payment, Current Account, Capital Account, Unilateral transfers

PRACTICE QUE.

1. Define Balance of Payments.

2. Why would it be useful to examine a country’s balance-of-payments data?

3. Comment on the statement: “Since the United States importsmore than it exports, it is necessary for United States to importmore than it exports, it is necessary for United States to importcapital from foreign countries to finance its current accountdeficits.”

4. Explain how a country can run an overall balance-of-payments deficit or surplus.

5. Explain official reserve assets and its major components.