Trading Block

NAME - rohan

ROLL NO - 113153

SUB - INTERNATIONAL FINANCIAL

MANAGEMENT

TRADING BLOCK

A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members. Trading blocs are a form of economic integration and increasingly shape the pattern of world trade. There are several types of trading bloc:

1) Free Trade AreaFree Trade Areas (FTAs) are created when two or more countries in a region agree to reduce or eliminate barriers to trade on all goods coming from other members.

2) Customs UnionA customs union involves the removal of tariff barriers between members, plus the acceptance of a common (unified) external tariff against non-members. This means that members may negotiate as a single bloc with 3rd parties, such as with other trading blocs, or with the WTO. 

3) Common MarketA ‘common market’ is the first significant step towards full economic integration, and occurs when member countries trade freely in all economic resources – not just tangible goods. This means that all barriers to trade in goods, services, capital, and labor are removed. In addition, as well as removing tariffs, non-tariff barriers are also reduced and eliminated. For a common market to be successful there must also be a significant level of harmonization of micro-economic policies, and common rules regarding monopoly power and other anti-competitive practices. There may also be common policies affecting key industries, such as the common Agricultural policy (CAP) and Common Fisheries Policy (CFP) of the European Single Market (ESM).

4) Preferential Trade AreaPreferential Trade Areas (PTAs) exist when countries within a geographical region agree to reduce or eliminate tariff barriers on selected goods imported from other members of the area. This is often the first small step towards the creation of a trading bloc.

EUROPEAN UNION – Highly integrated trading bloc of European countries.

The Eu is the world’s largest trading bloc, and second largest economy, after USA.The Eu was originally called the Economic community (Common Market, or The Six)after its formation following the treaty of Rome in 1957.The original six members were Germany, France, Italy, Belgium, Netherland, Luxembourg. The initial aim to create a single market for goods, services, capital, and labour by eliminating barriers to trade and promoting free trade between members. In terms of dealing with non-members, common tariff barriers were erected against cheap imports, such as those from Japan, whose goods prices were artificially low because of the undervalued yen.

The EU has found it difficult to shed its protectionist past based on the idea of self-sufficiency in agriculture which limits agricultural exports from the other countries, although it has implemented a major reform of its Common Agricultural Policy to shift subsides to support the environment.

By 2009 .following continuous element, the Eu had 27 members:

Members:

Austria: Belgium: Cyprus; Czech Republic; Denmark; Estonia; Finland; France; Germany; Greece; Hungary; Ireland; Italy; Latvia; Lithuania; Luxembourg; Malta; Netherlands; Poland; Portugal; Slovakia; Slovenia; Spain; Sweden; United Kingdom.

The main advantages for members of trading blocs

Free trade within the bloc

Knowing that they have free access to each other’s markets, members are encouraged to specialise. This mean that, at the regional level, there is wider application of the principle of comparative advantage.

Market access and trade creation

Easier access to each other’s markets means that trade between members is likely to increase. Trade creation exists when free trade enables high cost domestic producers to be replaced by lower cost,and more efficient imports. Because low cost imports lead to lower priced imports,there is ‘consumption effect’,with increased demand resulting from lower prices.

Trade creation and trade diversion

Economies of scale

Producers can benefit from the application of scale economies, which will lead lower cost and lower prices for consumers.

Jobs

Jobs may be created as a consequence of increased trade between member economies.

Firms inside the bloc are protected from cheaper imports from outside, such as the protection of the EU shoe industry from cheap imports from china and Vietnam.

The main disadvantage of trading Blocs

Loss of benefits

The benefits of free trade between countries in different blocs is lost.

Distortion of trade

Trading blocs are likely to distort world trade, and reduce the beneficial effects of specialisation and the exploitation of comparative advantage.

Inefficiencies and trade diversion

Inefficient producers within the bloc can be protected from more efficient ones outside the bloc. For example; inefficient European farmers may be protected from low-cost imports from developing countries. Trade diversion arises when trade is diverted away from efficient producers who are based outside the trading area.

NAFTA – LEDC and MEDC trading bloc

Members:Canada; Mexico; United States

The United States has linked with Canada and Mexico to form a free trade zone, the North American Free Trade Agreement (NAFTA).

The NAFTA agreement covers environmental and labour issues as well as trade and investment, but US unions and environmental groups argue that the safeguards are too weak.

Plans to include the rest of Latin America creating a Free Trade Area of the Americas (FTAA) have been put on hold following opposition from key countries like Brazil.

But the US is separately signing free trade agreements with some Andean Pact nations and on 1 January 2006 the Central American Free Trade Area (CAFTA) will come into effect, including Guatemala, Honduras, Nicaragua, El Salvador, Costa Rica, and Dominican Republic.

Meanwhile, the regional free trade pact called Mercosur, between Brazil, Argentina, Uruguay, and Paraguay, will be expanded to include Venezuela..

ASEAN – Regional Bloc of Pacific rim countries

Members:Australia; Brunei; Canada; Chile; China; Hong Kong; Indonesia; Japan; South Korea; Malaysia; Mexico; New Zealand; Papua New Guinea; Peru; Philippines; Russia; Singapore; Taiwan; Thailand; United States; Vietnam

The Asia-Pacific Economic Cooperation forum is a loose grouping of the countries bordering the Pacific Ocean who have pledged to facilitate free trade.

Its 21 members range account for 45% of world trade.

They have pledged to liberalises trade among themselves by 2010 for developed countries and 2015 for developing countries.

Recently China has begun signing bilateral free trade deals with a number of Apec members

Cairns Group – Agricultural producers

Members:Argentina; Australia; Bolivia; Brazil; Canada; Chile; Colombia; Costa Rica; Guatemala; Indonesia; Malaysia; New Zealand; Paraguay; Philippines; South Africa; Thailand; Uruguay

The Cairns group of agricultural exporting nations was formed in 1986 to lobby at the last round of world trade talks in order to free up trade in agricultural products.

It is named after the town in Australia where the first meeting took place.

Highly efficient agricultural producers, including those in both developed and developing countries, want to ensure that their products are not excluded from markets in Europe and Asia.

The developing country members of this group have now formed their own grouping, the G20.

G20 – Bloc of LEDCs to rival EU and USA

Members:Argentina, Bolivia, Brazil, Chile, China, Cuba, Egypt, Guatemala, India, Indonesia, Mexico, Nigeria, Pakistan, Paraguay, Philippines, South Africa, Thailand, Tanzania, Uruguay, Venezuela, Zimbabwe

At the Cancun meeting of the world trade talks in September 2003, a powerful new grouping of developing countries emerged.

Led by rapidly growing countries and major exporters like Brazil, China, India, and South Africa, this group has been powerful enough to challenge the EU and the US in trade negotiations.

At Cancun, the G20 made it clear that it could not accept the EU plans to include investment and competition as elements in the trade talks.

Now, the G20 are standing firm in insisting that rich countries make concessions on agriculture before there will be any final agreement on services or reductions in tariffs on manufactured goods.

OPEC:-TRADING BLOC OF OIL EXPORTERS

The organization of the petroleum exporting countries(OPEC) is an international organization made up of Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. Since 1965 its international headquarters have been in Vienna, Austria. It is considered to be a cartel by many observers.

Impact of FDI in India after LPG in 1992

The economy of India had undergone significant policy shifts in the beginning of the 1990s. This new model of economic reforms is commonly known as the LPG or Liberalization, Privatization and Globalization model. The primary objective of this model was to make the economy of the seventh largest country in the world the fastest developing economy in the globe with capabilities that help it match up with the biggest economies of the world.

The chain of reforms that took place with regards to business, manufacturing, and financial industries targeted at lifting the economy of the country to a more proficient level. These economic reforms had influenced the overall economic growth of the country in a significant manner. LIBERALIZATION

Liberalization refers to the slackening of government regulations. The economic liberalization in India denotes the continuing financial reforms which began since July 24, 1991.

PRIVATIZATION AND GLOBALIZATION

Privatization refers to the participation of private entities in businesses and services and transfer of ownership from the public sector (or government) to the private sector as well. Globalization stands for the consolidation of the various economies of the world.

LPG AND THE ECONOMIC REFORM POLICY OF INDIA

In the 1980s, Rajiv Gandhi, the Prime Minister of India, started a number of economic restructuring measures. In 1991, the country experienced a balance of payments dilemma following the Gulf War and the downfall of the erstwhile Soviet Union. The country had to make a deposit of 47 tons of gold to the Bank of England and 20 tons to the Union Bank of Switzerland. This was necessary under a recovery pact with the IMF or International Monetary Fund. Furthermore, the International Monetary Fund necessitated India to assume a sequence of systematic economic reorganizations. Consequently, the then Prime Minister of the country, P. V. NarasimhaRao initiated groundbreaking economic reforms. However, the Committee formed by P.V. NarasimhaRao did not put into operation a number of reforms which the International Monetary Fund looked for.Dr. Manmohan Singh, the present Prime Minister of India, was then the Finance Minister of the Government of India. He assisted P.V. NarasimhaRao and played a key role in implementing these reform policies. 

Until 191, Indian government followed protectionist policies and that were influenced by socialist economics. Widespread state intervention and regulations caused the Indian economy to be largely closed to the outside world since 1991; India liberalized its economy and continued to move towards a free market system, emphasizing both foreign trade and investment. Consequently,India’s economic model is now being described overall as capitalist.Trade of FDI inflow in India

Year 1970 1975 1980 1985 1990 1995 2000 2005 2009

FDI 45.46 85.09 79.16 106 234 2151 3588 7622 34613

It can be seen from table 1 that India has travelled from a foreign investment level of $ 45.46 million in 1970 to $ 234 million in year 1990 registering a growth rate of fourfold increase in inflows. On the country, the share and increase of inflow since 1990s have been astounding.of the FDI inflows in to the Asian economies India’s share stood at 46.5% in year 2009 with an investment of $34613 million as against its share of FDI inflow in 1990 was just 1.61% .The impressive surge in FDI flows in to India during the post reform period has given a unique position in the map of MNC’s strategic investment locations. Moreover, India has also been ranked second in global foreign direct investments in 2010 and likely continues to remain among the top five attractive destinations for international investors during 2010-12(UNCTED. NARSIMHA RAO COMMITTEE’S RECOMMENDATIONS

The recommendations of the NarasimhaRao Committee are as follows:

Bringing into the Security Regulations (Modified) and the SEBI Act of 1992 which rendered the legitimate power to the Securities Exchange Board of India to record and control all the mediators in the capital market.

Doing away with the Controller of Capital matters in 1992 that determined the rates and number of stocks that companies were supposed to issue in the market.

Launching of the National Stock Exchange in 1994 in the form of a computerized share buying and selling system which acted as a tool to influence the restructuring of the other stock exchanges in the country. By the year 1996, the National Stock Exchange surfaced as the biggest stock exchange in India.

In 1992, the equity markets of the country were made available for investment through overseas corporate investors. Allowing the companies of the country in fund raising on overseas markets through issuance of GDRs or Global Depository Receipts.

Promoting FDI (Foreign Direct Investment) by means of raising the highest cap on the contribution of international capital in business ventures or partnerships to 51% from 40%. In high priority industries, 100% international equity was allowed.

Cutting down duties from a mean level of 85% to 25%, and withdrawing quantitative regulations. The rupee or the official Indian currency was turned into an exchangeable currency on trading account.

Reorganization of the methods for sanction of Foreign Direct Investment. In 35 sectors as a minimum, routinely sanctioning plans within the boundaries for international investment and involvement.

The outcome of these reorganizations might be estimated by the statistic that the overall amount of overseas investment (comprising portfolio investment, FDI, and investment collected from overseas equity capital markets) in the country) rose to $5.3 billion in 1995-1996 from a microscopic US $132 million in 1991-1992. P.V. NarasimhaRao started industrial guideline changes with the production zones. He did away with License Raj, leaving just 18 sectors which required licensing. Control on industries was moderated. 

HIGHLIGHTS OF THE LPG POLICY

given below are the salient highlights of the Liberalization, Privatization and Globalization Policy in India:

Foreign Technology Agreements Foreign Investment MRTP Act, 1969 (Amended) Industrial Licensing Deregulation Beginning of privatization Opportunities for overseas trade Steps to regulate inflation Tax reforms Abolition of License Raj or Permit Raj

What Is The Balance Of Payments?

The balance of payment (BOP) is the method countries use to monitor all international monetary

transactions at a specific period of time. Usually, the BOP is calculated every quarter and every

calendar year. All trades conducted by both the private and public sectors are accounted for in the BOP

in order to determine how much money is going in and out of a country. If a country has received

money, this is known as a credit, and, if a country has paid or given money, the transaction is counted

as a debit. Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits)

should balance. But in practice this is rarely the case and, thus, the BOP can tell the observer if a

country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.

The balance of payments dividend

The BOP is divided into three main categories: the current account, the capital account and the

financial account. Within these three categories are sub-divisions, each of which accounts for a

different type of international monetary transaction. 

The current Account

The current account is used to mark the inflow and outflow of goods and services into a country.

Earnings on investments, both public and private, are also put into the current account. Within the

current account are credits and debits on the trade of merchandise, which includes goods such as raw

materials and manufactured goods that are bought, sold or given away (possibly in the form of aid).

Services refer to receipts from tourism, transportation (like the levy that must be paid in Egypt when a

ship passes through the Suez Canal), engineering, business service fees (from lawyers or management

consulting, for example), and royalties from patents and copyrights. When combined, goods and

services together make up a country's balance of trade (BOT). The BOT is typically the biggest bulk of

a country's balance of payments as it makes up total imports and exports. If a country has a balance of

trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more

than it imports. 

Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in

the current account. The last component of the current account is unilateral transfers. These are credits

that are mostly worker's remittances, which are salaries sent back into the home country of a national

working abroad, as well as foreign aid that is directly received. 

The capital Account

The capital account is where all international capital transfers are recorded. This refers to the

acquisition or disposal of non-financial assets (for example, a physical asset such as land) and non-

produced assets, which are needed for production but have not been produced, like a mine used for the

extraction of diamonds. The capital account is broken down into the monetary flows branching from

debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country,

the transfer of ownership on fixed assets (assets such as equipment used in the production process to

generate income), the transfer of funds received to the sale or acquisition of fixed assets, gift and

inheritance taxes, death levies, and, finally, uninsured damage to fixed assets.

The Financial Account

In the financial account, international monetary flows related to investment in business, real estate,

bonds and stocks are documented. Also included are government-owned assets such as foreign

reserves, gold,  special drawing rights (SDRs) held with the International Monetary Fund, private

assets held abroad, and direct foreign investment. Assets owned by foreigners, private and official, are

also recorded in the financial account. 

The Balancing Act

The current account should be balanced against the combined-capital and financial accounts. However,

as mentioned above, this rarely happens. We should also note that, with fluctuating exchange rates, the

change in the value of money can add to BOP discrepancies. When there is a deficit in the current

account, which is a balance of trade deficit, the difference can be borrowed or funded by the capital

account. If a country has a fixed asset abroad, this borrowed amount is marked as a capital account

outflow. However, the sale of that fixed asset would be considered a current account inflow (earnings

from investments). The current account deficit would thus be funded.

When a country has a current account deficit that is financed by the capital account, the country is

actually foregoing capital assets for more goods and services. If a country is borrowing money to fund

its current account deficit, this would appear as an inflow of foreign capital in the BOP.

Liberalizing the Accounts

The rise of global financial transactions and trade in the late-20th century spurred BOP and

macroeconomic liberalization in many developing nations. With the advent of the emerging market

economic boom - in which capital flows into these markets tripled from USD 50 million to USD 150

million from the late 1980s until the Asian crisis - developing countries were urged to lift restrictions

on capital and financial-account transactions in order to take advantage of these capital inflows. Many

of these countries had restrictive macroeconomic policies, by which regulations prevented foreign

ownership of financial and non-financial assets. The regulations also limited the transfer of funds

abroad. But with capital and financial account liberalization, capital markets began to grow, not only

allowing a more transparent and sophisticated market for investors, but also giving rise to foreign

direct investment. For example, investments in the form of a new power station would bring a country

greater exposure to new technologies and efficiency, eventually increasing the nation's overall gross

domestic product  by allowing for greater volumes of production. Liberalization can also facilitate less

risk by allowing greater diversification in various markets.

Balance of Payment problem arises when an economy has to take loans in order to balance the balance

of payment.

First, we must know the situation of Balance of Trade. A deficit Balance of Trade means that the

country imports good and services which together in a year exceeds the value of exports the country

could achieve.

This deficit can be met by net receipts on invisibles etc that are not part of the exports or imports or the

balance of trade.

So, if such current receipts of income, interest, fees or other invisible earnings are more than the

current payments of similar type, it helps meet the deficit in the balance of trade. But, these current net

receipts may not be positive, in which case the current account has a deficit. Also, if these net receipts

are positive but lower in absolute terms as compared to the deficit in the balance of trade, the current

account balance will still be negative. With negative current account balance, one cannot now pay for

the repayment of past borrowed capital. So, you have entered into a balance of payment problem. The

only way to solve this problem is to take further loans from the foreigners. For some time foreigners

will give you fresh loans so that they can get their past loans repaid. But if the ba;ance of trade is

negative year after year for long periods and so do the receipts on current account , the economy will

be running current account deficit year after year and the current account deficit will continue to grow

and to make the balance of payment balance, more and more foreign loans will have be raised. So, the

first way to solve a balance of payment problem is to go on borrowing more. But the foreigners will

lose faith on you if the balance of payments is in growing problem year after year for long. The

economy will not be given loans by the foreigner’s ad infinite. First, they will start charging higher

interest on loaned they give your country and then start giving only short-term loans and then finally

your economy gets in default situation and trapped in high debt.

So, your economy as a defaulter in repayment of loans or even for imports already made, the only

second way to solve the problem is to beg for rescheduling the foreign loans. They foreigners might

give some more time to repay past loans but will not give you any fresh loans. So, you are now

deemed. No other country will trade with you. So you go to the IMF or the World Bank to get loans

that would help the country to repay the past loans taken from private parties, banks etc and even the

IMF and the World Bank. Now, they will certain help your country with fresh loans but only under

certain conditions. What are these conditions? These conditions are nothing but that you implement

economic measures that will over a few years make your balance of trade positive and current account

balance positive so that after a few years you have the capability to repay all past and new loans taken

from foreigners, foreign banks/ financial institutions, international fiancé bodies. Since you have

willing avoided taking correct economic policies for long, you landed yourself in this position of final

bankruptcy in which situation you are just about going to be declared outcast and ineligible for any

financial transactions or trade with any other country. Only international smugglers can help you only

for exploiting your country.

You then have no option left for continuing with wrong economic policies. So now you force yourself

into doing the correct things that the economy should have done long time back. (this is what is called

economic reforms, opening up, privatization, macro-economic stabilization, drastic reduction in budget

and fiscal deficit by stopping the country's profligate tendency to spend as much as possible to get

popular support for your political party to remain in govt. power, globalization, dismantling govt.

controls and oppression of your citizens, reducing all kinds of administrative actions to distort and kill

the competitive market mechanism).

What should you have done long time back, you start doing that now. So, the new policies you pursue

are:

1. Devalue your currency by a big percentage in one or two or three installments in quick succession so

that foreigners can find your goods cheaper to buy and your exports go up rapidly.

2. With devaluation imports become costlier for your countrymen. As a result they start reducing their

imports. 

3. You stop taking or renewing short maturity loans from abroad.

4. You allow foreign investment to take place and mostly in the form of equity of companies and not

much fresh debt inflows from abroad.

5. Your balance of payments problem starts getting less severe now. But the process has been

sustained. So now you take policies that will help exports to go up at much faster rate than the imports.

6. To encourage exports you change your customs procedure, you improve the efficiency of your ports,

announce lower taxes on income out of exports.

7. You star privatizing the inefficient white elephant public sector companies and allow fresh capacity

in investments by private sector without trying to impose conditions of price and distribution controls,

licensing for new plants and capacity. So the foreign direct investment and liberated private take their

own risks and set up state of the art state technology based, factories to produce at adequately large

scale to be produce goods that are cost efficient, of high quality so that not only domestic consumers

gain but even foreigners would like to buy your products

8. You start strict budgetary control to reduce your budget and fiscal deficits.

9. You allow stock exchanges and capital markets to become efficient so that investors feel

comfortable and allow foreign institutional investors to trade in the shares and debentures of your

country's companies.

10. You remove inerestciontrols and private the nationalized/ public sector banks.

11. You allow free markets to operate without Govt. directives and intervention.

As a result of all these your country's export starts rising fast, your factories and farms become more

efficient, your rationalize your tax subset\y system . You start creating infrastructure; allow private and

foreign enterprise to build modern factories and farms to enhance the efficiency of the economy. You

change your labor unions stance from one of being violent to one of being reasonable and disciplined.

All this enhance your capacity to increase your economy's ability to export.

You may also start giving sops to exporters.

Producing later and ensuring setting up of large capacity firms and farms operating at scales that would

enjoy scale economies larger output of industry, agriculture and services.

In the ultimate sense becoming globally cost efficient in the production of most items, is a pre-requisite

to become a competitive exporter and increase exports. With increasing the exports of goods and

services, you cannot solve the balance of payment problem on a sustained basis.

Read the Notes below for better understanding in technical terms:

1. The balance of payments, (or BOP) measures the payments that flow between any individual

country and all other countries. It is used to summarize all international economic transactions for that

country during a specific time period, usually a year. The BOP is determined by the country's exports

and imports of goods, services, and financial capital, as well as financial transfers. It reflects all

payments and liabilities to foreigners (debits) and all payments and obligations received from

foreigners (credits). Balance of payments is one of the major indicators of a country's status in

international trade, with net capital outflow.

The Balance of Payments is the sum of the Current Account and the Capital Account and the Financial

Account. The Balance of Payments Identity states that:

Current Account + Capital Account + Financial Account + Net Errors and Omissions = Change in

Official Reserve Account 

A country will have a negative balance of payments (a net decrease in official reserves, net errors and

omissions, or some combination) if the net of the current account, the capital account and the financial

account is a deficit. Similarly, there will be a positive balance of payments (a net increase in official

reserves, net errors and omissions, or some combination) if the net of the current, the financial and the

capital account results in a surplus. The basic principle behind the identity is that a country can only

consume more than it produces (a current account deficit) if it is supplied capital from abroad (a capital

account surplus). From Alfred Marshall's Money, Credit, and Commerce, "In short, when a country

lends abroad ₤1,000,000 in any form, she gives foreigners the power of taking from her ₤1,000,000 of

goods".

Components

The Balance of Payments for a country is the sum of the current account, the financial account and the

capital account, and the change in official reserves.

The current account is the sum of net sales from trade in goods and services, net factor income (such as

interest payments from abroad), and net unilateral transfers from abroad. Positive net sales to abroad

corresponds to a current account surplus; negative net sales to abroad corresponds to a current account

deficit. Because exports generate positive net sales, and because the trade balance is typically the

largest component of the current account, a current account surplus is usually associated with positive

net exports.

The Income Account or Net Factor Income, a sub-account of the Current Account, is usually presented

under the headings "Income Payments", as outflows, and "Income Receipts", as inflows. If the Income

Account is negative, the country is paying more than it is taking in interest, dividends, etc. For

example, the United States' net income has been declining exponentially since it allowed the Dollar's

price relative to other currencies to be determined by the market to a point where income payments and

receipts are roughly equal. The difference between Canada's Income Payments and Receipts have been

declining exponentially as well since its central bank in 1998 began its strict policy not to intervene in

the Canadian Dollar's foreign exchange.[2] The various subcategories in the Income Account are

linked to specific respective subcategories in the Financial account. From here, economists and central

banks determine implied rates of return on the different types of capital exchanged in the Financial

Account. The United States, for example, gleans a substantially larger rate of return from foreign

capital than foreigners from domestic capital.

When analyzing the current account theoretically, it is often written as a function X of the real

exchange rate, p, domestic GDP, Y, and foreign GDP, Y*. Thus the current account can be written as

X(p, Y, Y*). According to theory, the current account X should increase if (1) the domestic currency

depreciates (p increases), (2) domestic GDP decreases, or (3) foreign GDP increases. A domestic

currency depreciation makes domestic goods relatively cheaper, boosting exports relative to imports. A

decrease in domestic GDP reduces domestic demand for foreign goods, lowering imports without

affecting exports. An increase in foreign GDP increases foreign demand for domestic goods,

increasing exports without affecting imports.

Current account =

Trade Balance 

Net Exports (Exports - Imports) of Merchandise (tangible goods) 

Net Exports (Exports - Imports) Services (such as legal and consulting services) 

+ Net Factor Income From Abroad (such as interest and dividends) 

+ Net Unilateral Transfers From Abroad (such as foreign aid, grants, gifts, etc.) 

Capital Account

The capital account "records the international flows of transfer payments relating to capital items". It

therefore records a country's inflows and outflows of payments and transfer of ownership of fixed

assets (capital goods). Examples of such goods could be factories and so on. Summing up: the Capital

Account accounts for the transfer of capital goods. 

Financial Account

The financial account is the net change in foreign ownership of domestic financial assets. If foreign

ownership of domestic financial assets has increased more quickly than domestic ownership of foreign

assets in a given year, then the domestic country has a financial account surplus. On the other hand, if

domestic ownership of foreign financial assets has increased more quickly than foreign ownership of

domestic assets, then the domestic country has a financial account deficit

The accounting entries in the financial account record the purchase and sale of domestic and foreign

assets. These assets are divided into categories such as Foreign Direct Investment (FDI), Portfolio

Investment (which includes trade in stocks and bonds), and Other Investment (which includes

transactions in currency and bank deposits).

Financial account =

Increase in foreign ownership of domestic assets - Increase of domestic ownership of foreign assets 

Current Account

This section covers the flow of goods, services and income in and out of a given country and also

financial aid from governments abroad:

Trade in goods is also known as trade in visibles or tangibles, 

Trade in services is also known as trade in invisibles or intangibles. 

Income refers not only to the money given back from investments made abroad (attention!:

investments are recorded in the financial account but income from investments is recorded in the

current account) but also to the money sent by individuals working abroad that send money to their

families back home (this is usual only in diasporas and developing countries). (source: see book

reference list) 

Net Errors and Omissions

This is the last component of the BOP and only exists to correct any possible errors made in

accounting for the three other accounts. These errors are common to occur due to the complexity of the

calculations. It is often referred as "the balancing item". (source: see book reference list)

Official reserves

The official reserves account records the current stock of reserve assets (and often simply referred to as

foreign exchange reserves) available to and controlled by the country's authorities for financing of

international payment imbalances, foreign exchange intervention and other uses.[3] Reserves include

official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRs), all

denominated in foreign currency (although the amounts may be expressed in any relevant unit).

Changes in the official reserves account for the differences between the capital account and current

account, and effectively represent foreign exchange interventions; the magnitude of these changes will

depend on monetary policy.

According to the standards published by the IMF in the IMF Balance of Payments Manual, net

decreases of official reserves indicate that a country is buying its domestic assets, usually currency or

bonds, to support its value relative to whatever asset, usually a foreign currency, thatthey are selling in

exchange. Countries with large net increases in official reserves are effectively attempting to keep the

price of their currency low by selling domestic currency and purchasing foreign currency, increasing

official reserves. For countries with floating exchange rates, the official reserves will tend to change

less, and be used as another tool of monetary policy to influence intervention by directly controlling

the domestic money supply (by buying or selling foreign currency); however, this usage has been

challenged by economists such as Milton Friedman who in an interview on Icelandic television said

that a central bank can control an exchange rate or control inflation but cannot do both:

Interest in official reserve positions as a measure of balance of payments greatly diminished after 1973

as the major countries gave up their commitment to convert their currencies at fixed exchange rates.

This reduced the need for reserves and lessened concern about changes in the size of reserves.

Countries that attempt to control the price of their currency will tend to have large net changes in their

official reserves. Some of the most extreme examples include China and Japan. In 2003 and 2004,

Japan had an outflow of reserves, yen, by more than equivalently one third of one trillion US Dollars if

calculated using exchange rates prevailing at the time. Note that the reported deficit of official reserves

representing an outflow of yen on this publication is not in accordance with the IMF standards.

Balance of Payments Equilibrium

A Balance of Payments Equilibrium is defined as a condition where the sum of debits and credits from

the Current Account and the Financial Account equal to zero; in other words, equilibrium is where

Current Account + Financial Account = 0 

This is a condition where there are no changes in Official Reserves. When there is no change in

Official Reserves, the balance of payments may also be stated as follows:

Current Account = - Financial Account or 

Current Account Deficit (Surplus) = Financial Account Surplus (Deficit) 

Canada's Balance of Payments currently satisfies this criterion.

History

Historically these flows simply were not carefully measured, and the flow proceeded in many

commodities and currencies without restriction, clearing being a matter of judgement by individual

banks and the governments that licensed them to operate. Mercantilism was a theory that took special

notice of the balance in payments and sought simply to monopolize gold, in part to keep it out of the

hands of potential military opponents (a large "war chest" being a prerequisite to start a war,

whereupon much trade would be embargoed).

As mercantilism gave way to classical economics, these crude systems were later regulated in the 19th

century by the gold standard which linked central banks by a convention to redeem "hard currency" in

gold. After World War II this system was replaced by the Breton Woods institutions (the International

Monetary Fund and Bank for International Settlements) which pegged currency of participating nations

to the US dollar, which was redeemable nominally in gold. In the 1970s this redemption ceased,

leaving the system without a formal base. Some consider the system today to be based on oil, a

universally desirable commodity due to the dependence of so much infrastructural capital on oil

supply. Since OPEC prices oil in US dollars, the US dollar remains a reserve currency, but is

increasingly challenged by the euro, and to a small degree the Japanese yen.

The United States has been running a current account deficit since the early 1980s. The U.S. current

account deficit has grown considerably in recent years, reaching record high levels in 2006 both in

absolute terms ($758 billion) and as a fraction of GDP (6%). This interpretation of the data, however,

is disputed by Milton Friedman (Balance of Trade) claiming that cheaper, riskier, foreign capital is

exchanged for "riskless", expensive, US capital and that the difference is made up with extra goods and

services. Nevertheless, Friedman's interpretation is incomplete with respect to countries that interfere

with the market prices of their currencies through the changes in their reserves.

I am going to mention here five country BOP.

Japan’s balance of payment

Japan's current account surplus decreased to 9.6 trillion yen in 2011, down from 17.9 trillion yen in 2010, mainly because the balance on goods turned to a deficit. The capital and financial account shifted to net inflows of 6.3 trillion yen in 2011 from net outflows of 12.0 trillion yen in 2010, registering net inflows for the first time in seven years due to a decrease in net purchases of foreign securities by Japanese investors (outflows) and an increase in net purchases of Japanese securities by foreign investors (inflows) under portfolio investment. Reserve assets continued to increase, rising by 13.8 trillion yen in 2011, compared to an increase of 3.8 trillion yen in 2010, due to foreign exchange interventions and an increase in investment income on reserve assets.

Japan's Balance of Payments

UAE Balance of Payments  

The balance of payments is the country’s primary record of all trade and financial transactions conducted with the outside world. These transactions reflect the economic strength of the national economy and the degree of its adaptability to changes in the global economy since they gauge the size and structure of both exports and products, including factors that influence them such as the size of investments, employment levels and pricing. As an oil exporter, oil and natural gas exports have allowed the United Arab Emirates (UAE) to sustain a current account surplus for many years, but changes in the oil prices cause this surplus to fluctuate widely from one year to year.

The decline in oil prices during 2009, led to a noticeable deficit in UAE’s balance of payments due to the decline in the hydrocarbon revenues and exports, as the average price of UAE’s Murban crude oil, produced by Abu Dhabi National Company, reached USD 63.7. However, during 2010, Murban crude oil price increased to reach USD 79.85.

Abu Dhabi Murban Crude Oil Price [Avg, USD/Barrel]

Consequently, UAE’s current account surplus, the main component of the balance of payments, surged to AED 41.3 billion (2010), compared to AED 28.8 billion (2009). This surplus was attributed to the increased oil exports beside the high per-barrel prices in the global markets. Correspondingly, the current account balance reached 3.8% of GDP in 2010.

UAE’s Balance of Payments

This was also accompanied by a large improvement in the capital and financial account resulting from an increase in direct investment inflow to AED 7.1 billion (2010) from AED 4.7 billion (2009) along with a decline in the outflow to AED 7.4 billion compared to AED 10 billion (2009). Besides, funds outflow by banks in 2010 also plunged to AED 4.7 billion from AED 36.28 billion (2009).As a result of this, the capital and financial account achieved a surplus of nearly AED 7.4 billion in 2010 compared to the AED 35.5 billion deficit in 2009.Accordingly, UAE’s balance of payments has turned from the AED 22.5 billion fiscal deficit in 2009 to AED 26.9 billion surplus in 2010. Furthermore, it is forecasted that the country’s current account will post a robust surplus in 2011. This is expected to be driven by higher oil prices and a sustained recovery in tourism and exports as well as the country’s increasing reputation as a safe haven in a volatile region

Balance of payment of UK

The UK trade / current account of the balance of payments figures for 2011. Has there been a noticeable improvement in our trade performance given the 25% depreciation of sterling in recent years? Which parts of the trade accounts have improved? What are some of the key underlying trends? Follow the charts and the brief commentary on each.

The balance of payments (BOP) records financial transactions made between consumers, businesses and the government in one country with others. The BOP figures tell us about how much is being spent

by consumers and firms on imported goods and services, and how successful firms have been in exporting to other countries and markets.

At AS level (unit 2) you need to focus on the current account of the balance of payments

The current account

In 2011, there was a current account deficit of £29.0 billion, compared with a deficit of £48.6 billion in 2010. The 2011 deficit is equivalent to 1.9 per cent of GDP. The OECD is forecasting that the UK will move back into a current account surplus by 2013.

Trade in Goods

Trade in goods includes items such as:* Manufactured goods* Semi-finished goods and components* Energy products* Raw Materials* Consumer goods i) Durable goods and (ii) Non-durable goods e.g. foods* Capital goods (e.g. equipment)

The deficit on trade in goods was £99.7 billion in 2011, the highest on record, compared with £98.5 billion in the previous year.

The trade deficit on oil widened by £6.4 billion to £11.2 billion in 2011

The trade deficit on finished manufactured goods narrowed by £9.5 billion to £50.4 billion - rising exports of manufactured products suggest that the lower exchange rate has provided a competitive boost to our export sectors. Can this continue to help the re-balancing of the UK economy?

Trade in Services

Trade in services includes the exporting and importing of intangible products – for example, Banking and Finance, Insurance, Shipping, Air Travel, Tourism and Consultancy.

Britain has a strong trade base in services with over thirty per cent of total export earnings come from services. Indeed the success of our service sector industries has been one of the strong points in tour economic performance over the last twenty years

The surplus for trade in services was a record £71.9 billion in 2011, an increase of £10.1 billion compared with 2010. Exports increased by £13.0 billion - the increase in exports was mainly in financial services and other business services. The increase in imports was mainly in financial services and transportationservices.

Here are some areas where a growing trade surplus reveals the UK to have a strong competitive advantage in service businesses

The diverging path of trade deficit and trade surplus for goods and services is shown clearly in the chart below

Net investment income

Net investment income comes from interest payments, profits and dividends from external assets located outside the UK.

For example a UK firm may own a business overseas and send back some of the operating profits to the UK. This would count as a credit item for our current account as it is a stream of profits flowing back into the UK.

Similarly, an overseas investment in the UK might generate a good rate of return and the profits are remitted back to another country – this would be a debit item in the balance of payments accounts.

Transfers

Transfers into and out of a country include foreign aid payments. For the UK the net transfers figure is negative each year, mainly due to the UK being a net contributor to the budget of the European Union. As a rich nation, the UK makes sizeable foreign aid payments to many other countries

The annual deficit on current transfers was £22.2 billion in 2011, £1.8 billion higher than in 2010 and the highest on record. The current transfers deficit with EU institutions increased by £0.6 billion in 2011.

Balance of payment

CURRENT ACCOUNT

The current account balance recorded a lower surplus of RM9.5 billion for the period of July - September 2012, as compared to RM9.6 billion in the preceding quarter. This lower surplus was reflected in:

Goods account: lower surplus RM25.5 billion (Q2 2012: RM29.4 billion); and

Current transfers: the net payments widened to RM4.7 billion (Q2 2012: -RM4.6 billion).

Meanwhile, income and services account recorded lower net payments of RM7.9 billion (Q2 2012: -RM11.7 billion) and RM3.4 billion (Q2 2012: -RM3.6 billion), respectively.

Year-on-year, the surplus on current account balance declined by RM17.9 billion to register RM9.5 billion from RM27.4 billion in Q3 2011. This was due to a lower surplus on goods by RM12.2 billion, and higher net outflow on both income and services by RM4.0 billion and RM2.3 billion, respectively. Meanwhile, current transfers recorded lower net payments by RM0.5 billion from -RM5.3 billion in Q3 2011.

During January - September 2012, the current account balance recorded RM37.2 billion, reduced by RM37.6 billion from RM74.7 billion posted in the same period of 2011. This was attributed to:

Goods account : lower surplus of RM90.7 billion (2011: RM111.2 billion);

Services account : higher net payments of RM10.7 billion (2011: -RM4.3 billion); and

Income account : higher net payments of RM28.2 billion (2011: -RM16.6 billion).

Goods AccountIn the quarter under review, the goods account registered a lower surplus of RM25.5 billion as compared to RM29.4 billion in the previous quarter. This was due to decrease in exports f.o.b by 1.8 per cent relative to increase in imports f.o.b by 0.5 per cent.

Exports f.o.b decreased to RM174.4 billion compared to RM177.7 billion in Q2 2012. This was mainly contributed by lower exports for crude petroleum, palm oil & palm oil based products and rubber products. The top three exports destinations were Singapore, The People's Republic of China, and Japan.

Imports f.o.b increased slightly to RM148.9 billion (Q2 2012: RM148.2 billion). The share of imports by end-use for three major categories was intermediate goods (64.3 per cent), capital goods (16.5 per cent), and consumption goods (8.0 per cent). The top three imports sources were The People's Republic of China, Singapore, and Japan.

Year-on-year, the surplus on goods decreased by RM12.2 billion to RM25.5 billion from RM37.7 billion recorded in the same quarter last year. This was due to increase in imports f.o.b by RM10.0 billion to RM148.9 billion (Q3 2011: RM138.9 billion) and decrease in exports f.o.b by RM2.3 billion to RM174.4 billion (Q3 2011: RM176.7 billion).

Cumulatively for three quarters, exports f.o.b rose by RM10.6 billion or 2.1 per cent to RM526.1 billion while imports f.o.b rose by 7.7 per cent or RM31.1 billion to RM435.3 billion. This had resulted in a lower surplus on goods account of RM90.7 billion from RM111.2 billion in the same period of 2011.

Services AccountIn Q3 2012, exports of services remained the same as previous quarter to register RM28.9 billion. This constitute of:

transportation : RM3.4 billion (Q2 2012: RM3.3 billion);

travel : RM14.8 billion (Q2 2012: RM14.4 billion); and

other services : RM10.7 billion (Q2 2012: RM11.0 billion), mainly contributed by other business services RM6.2 billion, computer and information services RM1.5 billion, and construction services RM1.0 billion.

Meanwhile imports of services recorded RM32.3 billion, a decrease of RM0.1 billion from RM32.4 billion registered last quarter. The components that contributed to total payments of services account were:

transportation : RM10.2 billion (Q2 2012: RM10.4 billion);

travel : RM9.1 billion (Q2 2012: RM9.0 billion); and

other services : RM12.8 billion (Q2 2012: RM12.8 billion), mainly contributed by other business services of RM6.2 billion, construction services of RM1.6 billion, and both royalties & license fees and computer & information services of RM1.2 billion each. 

On net basis, the services account recorded lower net payments of RM3.4 billion from RM3.6 billion last quarter. This was mainly due to lower net payments on transportation by RM0.3 billion and higher net receipts on travel by RM0.2 billion.

Year-on-year, exports on services increased marginally by 0.3 per cent to RM28.9 billion from RM28.8 billion in Q3 2011, whilst imports on services recorded higher payments increased by 7.8 per cent to RM32.3 billion from RM29.9 billion a year ago. This led to higher net payments by RM2.3 billion to -RM3.4 billion from -RM1.1 billion in the same period last year. This was mainly due to lower net receipts of travel account by RM2.2 billion.

In the first nine months of 2012, exports of services widened to RM85.7 billion, an increase of 5.7 per cent from RM81.1 billion, while imports recorded RM96.4 billion (2011: RM85.3 billion), an increase of 13.0 per cent. On net basis, services account saw higher net payments of RM10.7 billion from RM4.3 billion. This was attributed to lower net receipts on travel by RM3.4 billion and higher net payments on both transportation and other services by RM1.9 billion and RM1.2 billion, respectively.

Income AccountDuring July - September 2012, the income receipts recorded RM11.4 billion increased by RM2.5 billion from RM9.0 billion in Q2 2012. Compensation of employees remained RM1.0 billion and investment income attained RM10.4 billion (Q2 2012: RM8.0 billion). The investment income comprises of:

direct investment abroad (DIA): higher receipts of RM3.8 billion (Q2 2012: RM3.5 billion), mainly generated from financial & insurance, oil & gas, and information & communication sectors;

portfolio investment: higher receipts of RM1.3 billion (Q2 2012: RM0.8 billion); and

other investment: higher receipts of RM5.4 billion (Q2 2012: RM3.6 billion).

However, income payments (debit) recorded RM19.4 billion, decreased by RM1.3 billion from RM20.7 billion in Q2 2012. Of the total payments, compensation of employees recorded RM1.8 billion (Q2 2012: RM1.6 billion) while investment income posted RM17.6 billion (Q2 2012: RM19.0 billion). The investment income was derived from:

foreign direct investment (FDI): lower payments of RM14.6 billion (Q2 2012: RM15.4 billion), mainly generated from manufacturing, financial & insurance, and oil & gas sectors;

portfolio investment: lower payments of RM2.5 billion (Q2 2012: RM2.8 billion); and

other investment: lower payments of RM0.4 billion (Q2 2012: RM0.8 billion).

On net basis, the income account deficit reduced to RM7.9 billion from RM11.7 billion previously. This was primarily due to a lower net payments in investment income amounting to RM7.2 billion (Q2 2012: -RM11.1 billion), while compensation of employees recorded higher net payments of RM0.7 billion (Q2 2012: -RM0.6 billion).

Year-on-year, income receipts (credit) decreased by RM2.5 billion to RM11.4 billion from RM14.0 billion in the same period last year. Meanwhile, income payments (debit) increased by RM1.4 billion to RM19.4 billion from RM17.9 billion previously. This led to higher net payments by RM4.0 billion to RM7.9 billion from RM3.9 billion.

On cumulative basis, for the period January - September 2012, income receipts (credit) declined by RM7.3 billion to RM30.1 billion (2011: RM37.4 billion) whereas income payments (debit) increased by RM4.3 billion to RM58.3 billion (2011: RM54.0 billion). This resulted to higher net payments by RM11.6 billion to RM28.2 billion (2011: -RM16.6 billion).

Current TransfersIn the third quarter 2012, both receipts and payments decreased to record RM1.4 billion (Q2 2012: RM2.3 billion) and RM6.1 billion (Q2 2012: RM6.9 billion), respectively. On net basis, this account recorded higher net payments RM4.7 billion (Q2 2012: -RM4.6 billion).

Year-on-year, net payments narrowed by RM0.5 billion from RM5.3 billion a year ago. Current transfers receipts recorded RM1.4 billion (Q3 2011:RM1.3 billion), while payments posted RM6.1 billion (Q3 2011:RM6.5 billion). The first nine months of the year saw the net payments on current transfers decreased by 6.3 per cent to RM14.6 billion from RM15.6 billion recorded in the same period of last year.

CAPITAL ACCOUNT

In Q3 2012, the net outflow decreased to RM42.0 million from RM67.0 million last quarter. This was due to lower outflow on both capital transfers and nonproduced nonfinancial assets which recorded RM24.0 million (Q2 2012: -RM34.0 million) and RM18.0 million (Q2 2012: -RM33.0 million), respectively.

Year-on-year, the capital account recorded lower net outflow by RM17.0 million to RM42.0 million from RM58.0 million last year. Meanwhile, during January - September 2012, capital account experienced higher net outflow of RM275.0 million from RM139.0 million posted in the same period of last year.

FINANCIAL ACCOUNT

In the current quarter, the financial account reverted to a net outflow of RM8.7 billion from net inflow of RM5.4 billion reported previously. This was due to a swing in both portfolio investment from net outflow of RM5.0 billion to net inflow of RM27.6 billion and other investment to net outflow of RM38.1 billion from net inflow of RM5.9 billion. On the contrary, direct investment recorded lower inflow RM1.9 billion from RM3.5 billion.

Year-on-year, the financial account registered a lower net outflow by RM13.8 billion to RM8.7 billion from RM22.5 billion posted in the corresponding period of last year. This was mainly due to a turnaround in portfolio investment to an inflow of RM27.6 billion from an outflow of RM28.0 billion.

Cumulatively for the three quarters, financial account switched to a net outflow of RM13.6 billion from a net inflow of RM22.5 billion. The main contributor to the reversal was due to higher net outflow of other investment amounting to RM58.3 billion (2011: -RM4.4 billion).

Direct InvestmentDirect investment posted a lower net inflow of RM1.9 billion from RM3.5 billion during previous quarter. Both DIA and FDI recorded higher investments, of which:

DIA: a higher net outflow of RM7.7 billion from RM2.5 billion previously. The investments were largely reflected by financial & insurance, wholesale & retail trade, real estate, and oil & gas sectors. The top three immediate investing countries were Singapore, United Kingdom, and Thailand.

FDI: a higher net inflow of RM9.6 billion from RM6.1 billion in Q2 2012. The investments were mainly channelled into manufacturing and oil & gas sectors. The top three sources of FDI were Singapore, United States, and Australia.

Year-on-year, direct investment showed a reversal to a net inflow RM1.9 billion from a net outflow RM3.9 billion. This was mainly attributed to lower net outflow in DIA amounting to RM7.7 billion from RM13.0 billion last year.

In the first nine months of 2012, direct investment experienced higher net outflow by RM2.2 billion to RM4.0 billion (2011: -RM1.8 billion). Both DIA and FDI recorded lower investments of RM27.1 billion (2011: -RM32.0 billion) and RM23.2 billion (2011: RM30.1 billion), respectively.

Portfolio InvestmentPortfolio investment recorded a net inflow of RM27.6 billion, turned around from net outflow of RM5.0 billion previously. Similarly, year-on-year, portfolio investment switched to net inflow from net outflow of RM28.0 billion in Q3 2011.

Meanwhile, for the period January - September 2012, portfolio investment recorded higher net inflow of RM47.9 billion from RM28.4 billion posted in the same period last year.

Other InvestmentIn Q3 2012, other investment reversed to an outflow of RM38.1 billion from net inflow of RM5.9 billion registered last quarter. This was mainly due to a reversal in private sector investments to a net outflow RM38.0 billion from a net inflow of RM6.1 billion.

Year-on-year, other investment turned around to net outflow of RM38.1 billion from net inflow RM9.7 billion attained in the same period of 2011. Such circumstances were solely reflected by a reversal of private sector investments to net outflow of RM38.0 billion from net inflow of RM10.2 billion in Q3 2011. Meanwhile, for the period of January to September 2012, other investment recorded a substantial outflow of RM58.3 billion against RM4.4 billion in 2011.

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