INTERNATIONAL FINANCE LESSON 2

Balance of PaymentsAntu Panini Murshid... Today’s Agenda Balance of payments  Review sustainability of current accounts... Balance of Payments Accounts  The balance of payments is a c

Balance of Payments

Antu Panini Murshid

Today’s Agenda

 Balance of payments

 Review sustainability of current

accounts

Balance of Payments

Accounts

 The balance of payments is a

comprehensive statement of a

country’s economic transactions with the rest of the world for a given period

of time—normally a quarter or a year

 It is composed of the current account

and the capital account

Current Account

 The current account measures

transactions associated with trade in goods and services, income from

abroad and also transfers and gifts

than simply the balance of trade, which is

a narrower concept

Capital Account

 The capital account measures financial

transactions, such as purchases of

bonds and equities or direct

investment activities

The Balance of Payments

Must Balance

 The current account and capital account

should balance each other out

 Each international transaction gives rise to

two offsetting entries one appearing in the current account and the other appearing in the capital account

 Thus a current account surplus is matched

by a capital account deficit and a current account deficit is matched by a current

account surplus

The Change in Foreign

Reserves

 The change in foreign reserves refers

to the sale and purchase of official

reserve assets by central banks

 Official reserves are foreign assets held

by the central bank (usually as cushion against economic troubles)

The Change in Foreign

Reserves

 The change in foreign reserves appears in

the capital account, although sometimes

people will separate this item from the

capital account and refer to a “balance of

payments deficit” (or surplus)

 Change foreign reserves = CA + KA

Here “KA” refers

to the non-reserve

capital account

Balance of payments

Trade balance = -$90

billion Net private inflows = $80 billion Net factor income from

abroad = -$10 billion

Change in foreign reserves = -$20 billion

Current account balance

= -$100 billion Capital account balance = +$100 billion

US Balance of Payments

Accounts, 1999

Merchandise Trade Balance -344.82 Capital Inflows (e.g foreign

borrowing, receive + sign) 751.32

Trade Balance on Services 77.27 Capital Outflows (e.g US

lending, receive a – sign) -421.13

Overall Trade Balance -267.55 Statistical discrepancy 17.45

Net Foreign Income From

Abroad -24.78 Change in Official Reserves -8.72 Balance on Goods and

Services and Income -292.33 Capital Account Balance 338.92 Net Unilateral Transfers (e.g

foreign aid donations) -46.59

Current Account Balance -338.92

Sustainability of the Current

Account

 What factors affect the sustainability of

a current account deficit?

 Growth rate

 Composition of the current account

 Openness

 CA/GDP and debt burden

 Composition of capital flows

 Foreign exchange reserves

 Financial system

 Political stability