UNDERSTANDING -ANALYSIS -INTERPRETATION BALANCE OF PAYMENT
Aug 17, 2014
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
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
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.
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 (+).
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 (+)
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
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
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
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
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.
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.
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
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
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.
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.