Bop

The Balance of Payments

(or chapter 3)

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Talk Agenda

• How nations measure int’l 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.

• Some Q & A (I ask the Q, you give the A)

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The Balance of Payments 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 country’s market potential

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For example…

BOP transactions (US side)• Daimler-Chrysler purchases manufacturer in Chicago.

• 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”

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B of PA. 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)

B. Capital Account

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

C. Financial Account

A. Net foreign direct investment

B. Net portfolio investment

C. Other financial items

D. Net Errors and Omissions

Missing data such as illegal transfers

E. Reserves and Related Items

Changes in official monetary reserves including gold and foreign exchange reserves

Σ (A:E) = Overall Balance

Basic Balance = A+B+C

Overall Balance = A+B+C+D

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BOP Accounting 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.

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The Current Account 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.

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For example…•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.

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The Current Account1997 1998 1999

Goods exports 682 672 687Goods imports (876) (917) (1030)

Goods trade balance (BOT) (194) (245) (343)

Services exports 255 261 270Services imports (167) (183) (191)

Services trade balance 88 78 79

Income receipts 257 258 276Income payments (251) (265) (295)

Income balance 6 (7) (19)

Current transfers, credits 8 9 9Current transfers, debits (49) (53) (57)

Net transfers (41) (44) (48)

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

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U.S. Trade Balance vs. Balance on Services & Income, 1985-99 (US$ bn)

-$350

-$300

-$250

-$200

-$150

-$100

-$50

$0

$50

$100

$150

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Balance on goods Services & income

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

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The Capital/Financial Account Capital account: transfers of fixed assets, real estate,

acquisitions/disposal of non-produced/non-financial 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.

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The Capital/Financial Account• 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.

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Direct Investment Concerns• How much shall the country control the direct

investments?– What can foreigners buy?

– Land, real estate sale to foreigners limited (Eastern Europe)

– Certain stock can not be purchased (China, Russia)

– How shall profit be distributed?– Profit drain?

– Many foreign firms in US reinvest most of their profits.

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The Capital/Financial Account

Direct investment abroad (105) (146) (151)Direct investment in the US 106 186 276

Net direct investment 1 40 125

Portfolio InvestmentAssets purchased by US residents, net (119) (136) (129)Assets purchased by foreign residents, net 386 269 342

Net portfolio investment 267 133 213

Other InvestmentOther investment assets (264) (47) (159)Other investment liabilities 265 27 136

Net other investment 1 (20) (23)

Financial Account Balance 269 153 315

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

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For example…•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 gov’t 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.

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US Financial Account, 1985-99 (US$ bn)

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

-$100

-$50

$0

$50

$100

$150

$200

$250

$300

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Net direct investment Net portfolio investment Net other investment

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Current & Financial/Capital Account Balances, US, 1992 - 1999 (US$ bn)

Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.

-$400

-$300

-$200

-$100

$0

$100

$200

$300

$400

1992 1993 1994 1995 1996 1997 1998 1999

Current account Financial/capital account

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The Other Accounts 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.

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The Balance of Payments in Total1997 1998 1999

A. Current Account (140.55) (217.13) (331.48)

Goods exports FOB 681.65 672.29 686.66Goods imports FOB (876.37) (917.19) (1029.92)

Goods trade balance (BOT) (194.72) (244.90) (343.26)Services exports 255.29 260.69 269.58Services imports (166.51) (182.68) (191.30)

Services trade balance 88.78 78.01 78.28Income credit 257.35 258.45 276.17Income debit (251.16) (264.66) (294.65)

Balance on Goods, Services & Income 6.19 (6.21) (18.48)Current transfers, credits 8.47 9.33 9.41Current transfers, debits (49.27) (53.36) (57.43)

B. Capital Account 0.35 0.64 (3.50)

Capital account credit 0.35 0.64 0.49Capital account debit 0.00 0.00 (3.99)

Total, Groups A plus B (140.20) (216.49) (334.98)

C. Financial Account 269.04 153.59 314.64Direct invesment 1.02 40.27 124.64

Direct investment abroad (105.02) (146.05) (150.90)Direct investment in the US 106.04 186.32 275.54

Portfolio investment assets (118.98) (136.00) (128.59)Equity securities (57.58) (101.24) (114.40)Debt securities (61.40) (34.76) (14.19)

Portfolio investment liabilities 385.60 269.33 342.19Equity securities 67.85 41.95 98.07Debt securities 317.75 227.38 244.12

Other investment assets (263.94) (46.60) (159.45)Monetary authorities 0.00 0.00 0.00General government 0.07 (0.42) 2.75Banks (141.12) (35.57) (69.86)Other sectors (122.89) (10.61) (92.34)

Other investment liabilites 265.34 26.59 135.85Monetary authorities (18.85) 6.88 24.71General government (2.86) (3.48) (1.37)Banks 171.31 30.27 80.10Other sectors 115.74 (7.08) 32.41

Total, Groups A through C 128.84 (62.90) (20.34)

D. Net Errors and Ommisions (127.83) 69.65 11.63

Total, Groups A through D 1.01 6.75 (8.71)

E. Reserves and Related Items (1.01) (6.73) 8.73

US Balance of Payments, Analytic

Presentation, 1997-1999

Q:

Why did FDI increase so much?

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What if…? BOP shows surplus:

• D > S for that currency.

• Allow currency value to increase,

• Or accumulate foreign reserves.

BOP shows deficit:• S > D for that currency.

• Devalue currency,

• Or use official reserves to support currency.

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Capital Mobility

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 –”Annees des miracles” of international trade

• 1971-2003 – floating exchange rates, financial volatility, rapidly expanding capital flows

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

Low

High

Capital Mobility

18801860 1900 1920 1940 1960 1980 2000

•

••

•1880

1900

1914

1860

Gold Standard1880-1914

Capital Mobility

••1960

1971

Bretton Woods1945-1971

•

• 1980

2000

Float1971-2000

•1918

•

Interwar, 1914-1945

1929

1925

•1945

•

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Capital Flight 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

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Where can I find this in … BOP?

– Calpers (the Cal mutual fund) buys shares of stock on the Tokyo & London stock exchanges?

– American tourist pays hotel in Paris w/ AMEX credit card (US issued)?