Chapter 5 Balance of Payments

Chapter 5

Balance of Payments

Nguyen Thi Vu Ha MA

FIBE - UEB - VNU

 In Parts One and Two, we dealt with international trade theory and policy

 We now begin our examination of the monetary aspects of international economics, or

international finance and begin our discussion

by examining the balance of payments

Introduction

Learning Goals

measures

international flow of goods, services and capital

current account and other macroeconomic indicators of the economy

Contents

accounts of BoP

indicators

current account

• What is an international transaction?

• Who is a resident of a nation?

• Why the BoP is not a full statement but summary

statement?

• What are the main purpose of the BoP?

What is an international transaction?

 Refers to the exchange of a commodity, service, or asset (for which payment is usually required)

between the residents of one nation and residents of other nations

 Types of the international transactions

◦ Exchange goods/services for goods/services

◦ Exchange goods/services for assets

◦ Exchange assets for assets

What is an international transaction?

 Gift for relatives oversea can be included in a

nation’s BoP True or False?

 Gift and certain other transfers (for which no payment

is required) are also included in a nation’s BoP

 the last type of the international transaction is the unilateral transfers

Who are residents of Vietnam?

 Vietnamese diplomats and military personnel?

Who are residents of Vietnam?

 Foreign branches/subsidiaries of a corporation?

 International institutions: IMF, WB, WTO?

Residents of the nation in which they hold citizenship NOT depend on their

domicile

Who are residents of Vietnam?

 Foreign branches/subsidiaries of a corporation?

 International institutions: IMF, WB, WTO?

Depend on the time duration in the foreign country

A worker is considered a resident of a country when he has stayed or intends to

stay in that country for one year or more

Who are residents of Vietnam?

 Foreign branches/subsidiaries of a corporation?

 International institutions: IMF, WB, WTO?

A resident of the nation in which

it is incorporated

Who are residents of Vietnam?

 Foreign branches/subsidiaries of a corporation?

 International institutions: IMF, WB, WTO?

NOT Residents

of the nation in which they are

located

Why the BoP is summary statement?

 Because there are many international economic

transactions of the resident of a nation with the rest

of the world

They cannot appear individually in the BoP

BoP has some main categories

The main purpose of the BoP

 Inform the government of the international

position of the nation to help it in its formulation

of monetary, fiscal, and trade policies

 Provide the data of important trade partners for governments to make policy decisions

 Provide the data for banks, firms, and

individuals directly or indirectly involved in

international trade and finance

BoP Accounting Principles

International transactions are

classified as credits or debits

Credit transactions

involve the

receipt of

payments

from foreigners

are entered with a positive sign (+) in the nation's BoP

Debit transactions

involve the

making of payments to

foreigners

are entered with a negative sign (-) in the nation's BoP

Credits and Debits

Flows of Goods, services or assets

Flows of capital

BoP Accounting Principles

twice, once as a credit and once as a

debit of an equal amount WHY?

 every transaction has two sides

 We sell something and we receive payment for it We buy something and we have to pay for it

◦ A debit entry  a payment to foreigners

◦ A credit entry  a receipt from foreigners

The Accounts of the BOP

BoP structure

the Current Account (CA)

the Capital and Financial

Current Account (CA)

Main categories (IMF - BPM6)

Goods and

Unilateral transfers

The record of commodity and service

transactions and unilateral current transfers

Current Account (CA)

Main categories (IMF - BPM6)

Goods and

Unilateral transfers

commodity

transactions

The record of commodity and service transactions and unilateral current transfers

Current Account (CA)

Main categories (IMF - BPM6)

Goods and

Unilateral transfers

Current Account (CA)

Main categories (IMF - BPM6)

Goods and

Unilateral transfers

Compensation of employees

Investment income

Current Account (CA)

Main categories (IMF - BPM6)

Goods and

Unilateral transfers

Government transfers/ government grants (in cash or in kind);

Pensions, private remittances;

Other current transfer

Accounting of Current Account

Credits

Exports of goods and services

Income receipts

Income receipts on the nation-owned assets abroad

Direct

investment

receipts

Other private receipts

The nation government receipts

Compensation

of employees

Unilateral current transfers into the

nation

foreign aid, gifts, retirement pensions, workers’ remittances into the nation

Accounting of Current Account

Debits

Imports of goods and services

Income payments

Income payments

on foreign-owned assets in the nation

Direct investment payments

Other private payments

The nation government payments

Compensation

of employees

Unilateral current transfers out of the nation

Invisible Trade Balance

< 0  Deficit in Trade Balance

Trade Balance

> 0  Surplus in Trade Balance

Current Account - Notes

 The current account is commonly used to

assess the balance of trade , which is simply the difference between merchandise exports and merchandise imports

 CA balance is often reported as the "trade

balance using a broad measure of international trade."

◦ Because unilateral transfers are relatively small and because investment income can be interpreted as payments for a service, it is common to say that a

CA deficit means that imports of goods and

services exceeds exports of goods and services

Capital/Financial Account (KA)

The record of financial asset transactions and public and private investment and lending

What do assets represent?

• All forms of ownership claims in things that have

value

• Examples: bonds, treasury bills, stocks, mutual

funds, bank deposits, real estate, currency and other types of financial instruments

What are types of assets?

• IOUs

• Ownership shares in a business or property

Capital/Financial Account (KA)

IOUs

• Bonds, savings accounts,

treasury bills, etc.,

• the purchaser of the asset

agrees to give money to

the seller of the asset in

return for an interest

payment plus the return of

the principal at some time

in the future

• These asset purchases

represent borrowing and

lending

Ownership shares in a business or property

• common stock, real estate

• give the purchaser an

ownership share in a corporation and entitles the owner to a stream of dividend payments in the future if the company is profitable

• Real estate purchases

entitle the owner to the future stream of rental payments by the tenants

in the building

Capital/Financial l Account (KA)

Homework: distinguish IOUs and assets

consisting of ownership shares in a business or property

Capital/Financial Account (KA)

Capital transfer

Acquisition/disposal of produced, non-financial assets

non-Financial Account

The Capital Account

Capital transfer (shifts in assets,

not current income)

Debt

forgiveness

The transfer of goods and financial assets

by migrants leaving or entering a country

Transfer of ownership on fixed assets

The transfer of funds received

to the sale or acquisition of fixed assets

The Capital Account

Acquisition/disposal of produced, non-financial assets

Other Investment Assets/Liabilities

Currency deposits Bank deposits

Other accounts

receivable

Accounts payable

3 Decreases in foreign assets in a nation

4 Lending

5 Increases in the nation’s claims

6 Decreases in the nation’s liabilities

KA surplus KA deficits

• KA surplus

• the country is a net debtor

The Net Errors and Omissions

account (EO)

 Theoretically, current account and capital account

should add up to zero

 But in reality, there is a discrepancy in BoP Why?

◦ Because recordkeeping for the BoP is incomplete, especially on the financial side of international

transactions

◦ Because data associated with a given transaction may come from different sources that differ in

coverage, accuracy, and timing

◦ Because of errors, time lags, and so on

 The EO is the sum of CA+KA with the sign reversed

Some examples of the double-entry

bookkeeping principles – The U.S BoP

1. Mr A pays $65,000 in cash to Mr B of U.K for a new XJ8

convertible Mr B deposits the dollars into its U.S bank

account

2. Dell buys $15,000,000 worth of hard-disk drives from a

South Korean company and sells $25,000,000 worth of

computers to another Korean company Dell now has $10 million that it lends to Daewoo, which is struggling to build cars

3. Mr A buy $10,000 worth of shares of Mushy Peas-R-Us by

borrowing money from a British broker

4. Shell, a mining company in the U.S exports US$2.0m worth

of bauxite to Jimpex a company in the Jamaica and Jimpex pays for the bauxite by depositing US$2.0mn to Shell’s bank account

Some examples of the double-entry

bookkeeping principles – The U.S BoP

5. A U.S citizen buys a $1000 typewriter from an Italian

company, and the Italian company deposits the $1000 in its account at Citibank in New York

6. A U.S citizen pays $200 for dinner at a French restaurant in

France by charging his Visa credit card

7. A U.S citizen buys a $95 newly issued share of stock in the

United Kingdom oil giant British Petroleum (BP) by using a check drawn on his stockbroker money market account BP deposits the $95 in its own U.S bank account at Second Bank of Chicago

8. A U.S bank forgives $5000 in debt owed to it by the

government of Pakistan

Some examples of the double-entry

bookkeeping principles – The U.S BoP

 Example 1: Mr A pays $65,000 in cash to Mr B of U.K for a new XJ8 convertible Mr B deposits the dollars into its U.S bank account

◦ CA: -$65,000 [Imports of goods]

◦ KA: + $65,000 [Mr B has increased holdings of U.S currency - Increases in foreign assets in a nation]

Some examples of the double-entry

bookkeeping principles – The U.S BoP

 Example 2: Dell buys $15,000,000 worth of disk drives from a South Korean company and

hard-sells $25,000,000 worth of computers to another Korean company Dell now has $10 million that it lends to Daewoo, which is struggling to build cars

◦ CA: + $25,000,000 [Exports of goods]

◦ CA: - $15,000,000 [Imports of goods]

◦ KA: - $10,000,000 [Increased loans to foreigners -

Increases in the U.S assets abroad]

Some examples of the double-entry

bookkeeping principles – The U.S BoP

 Example 3: Mr A buy $10,000 worth of shares of Mushy Peas-R-Us by borrowing money from a

British broker

◦ KA: - $10,000 [U.S Purchase of Foreign Asset -

Increases in U.S assets abroad ]

◦ KA: + $10,000 [Foreign loan to U.S resident - Capital Inflow]

Some examples of the double-entry

bookkeeping principles – American BoP

 Example 4: Shell, a mining company in the U.S exports US$2.0m worth of bauxite to Jimpex a company in the Jamaica and Jimpex pays for the bauxite by depositing US$2.0mn to Shell’s bank account

◦ CA: + $2.0m [Exports of goods]

◦ KA: - $2.0m [increase in the U.S claims on foreigners]

U.S BoP in 2009 (Millions of dollars)

(credits +, debits - ) http ://www.bea.gov/

Current account

1 Exports of goods and services and income receipts 2159000

2 Exports of goods and services 1570797

3 Goods, balance of payments basic 1068499

12 Income receipts 588203

13 Income receipts on U.S.-owned assets abroad 585256

17 Compensation of employees 2947

18 Imports of goods and services and income payments -2412489

19 Imports of goods and services -1945705

20 Goods, balance of payments basis -1575443

U.S BoP in 2009 (Millions of dollars)

(credits +, debits - ) http://www.bea.gov/

41 U.S official reserve assets -52256

46 U.S government assets, other than official reserve assets 541342

50 U.S private assets -629552

55

Foreign-owned assets in the United States, excluding

financial derivatives (increase/financial inflow (+)) 305736

56 Foreign official assets in the United States 450030

63 Other foreign assets in the United States -144294

70 Financial derivatives, net 50804

71

Statistical discrepancy (sum of above items with sign

U.S BoP in 2009 (Millions of dollars)

(credits +, debits - ) http://www.bea.gov/

Line (Credits +; debits -) 2009

Memoranda:

72 Balance on goods (lines 3 and 20) - 506944

73 Balance on services (lines 4 and 21) 132036

74 Balance on goods and services (lines 2 and 19) - 374908

75 Balance on income (lines 12 and 29) 121419

76 Unilateral current transfers, net (line 35) - 124943

77

Balance on current account (lines 1, 18, and 35 or

lines 74, 75, and 76) - 378432 Balance on financial account 216075 Balance on financial account and Capital account 215935

What were the U.S comparative advantages and disadvantages?

Unilateral current transfers, net - 124943

Balance on current account - 378432

Balance on financial account 216075

Balance on financial account

and Capital account 215935

the US imported more physical goods than it exported

the US exports more services than it

imports from the rest

of the world

Unilateral current transfers, net - 124943

Balance on current account - 378432

Balance on financial account 216075

Balance on financial account

and Capital account 215935

US residents earned more

on their investments abroad than foreigners earned on their

investments in the US

more of the government and private transfers were made to foreigners than were received by U.S residents

the US recorded a current account deficit

of $ 378432 million

Unilateral current transfers, net - 124943

Balance on current account - 378432

Balance on financial account 216075

Balance on financial account

and Capital account 215935

• foreigners are

buying more US assets than US residents are buying

of foreign assets

• the US is borrowing

money from the rest

of the world

Unilateral current transfers, net - 124943

Balance on current account - 378432

Balance on financial account 216075

Statistical discrepancy (sum of

above items with sign

• recorded credit

entries on the BoP exceeded recorded debit entries

• an additional $16

billion debit entry is needed to make the

accounts balance

Chapter 5

Balance of Payments (cont.)

Nguyen Thi Vu Ha MA

FIBE - UEB - VNU

Official Reserves Account

 Official Reserve Account (ORA) measures the

change in a country’s official reverse assets and the change in foreign official assets in that country

◦ The Official Reserve Settlement Balance

 Official reserves assets include

◦ Gold at international Standard

◦ Foreign currencies

◦ Special Drawing Rights - SDRs

◦ Reserve positions in the IMF