1. The Balance of Payments

2. BSP eyes $4.9-billion BOP surplus this year December 2009 Robust remittances from Filipino workers abroad, higher government borrowings and strong foreign portfolio investment inflows will more than offset foreign currencies paid out by the Philippines this year. BSP said that the country’s BOP would likely yield a surplus of $4.9 billion at the end of the year. The country posted a $93-million payment deficit in November following debt payments by the central bank and National Government. The November balance of payments (BOP) deficit was a reversal of the $19-million surplus posted a year earlier. For January to September, however, the Philippines recorded a $4.08-billion surplus due to higher government borrowings ($3.25 billion in the international capital markets), hot money inflows, and strong remittances from Filipinos abroad ($17.1 billion). BSP said the country’s foreign portfolio investments would hit a little over $2.5 billion instead of the projected $3 billion x x x and that the current account had posted a surplus of $6.2 billion in January to September, which was equivalent to the full-year target of $6.2 billion. “This developed as the more favorable performance of the current transfers and trade-in-goods accounts more than offset the relatively weaker balances in the service and income accounts," BSP said.

3. 3 Definition of Terms Trade – buying and selling of goods/services Exports – a credit entry Imports – a debit entry Trade balance – the sum of exports and imports Factor income – repayments and dividends from loans and investments Factor earnings – a credit entry Factor payments – a debit entry Factor income balance – the sum of earnings and payments

4. 4 The Balance of Payments The Balance of Payments (BOP) is the measurement of all international economic transactions between the residents of a country and foreign residents, over a period of time, prepared in a single currency, and presented in the form of double-entry bookkeeping. Sources of funds for a nation, such as exports or receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. N.B. When we say “a country’s Balance of Payments” we are referring to the transactions of its citizens and government.

5. The BOP Identity BOP Current Account Capital Account ++/- Current Account = BOT + Factor Income (foreign investments, payments to foreign investors) + Cash Transfers Capital Account = Reserve Accounts + Loans/Investments (but not future regular repayments or dividends that the loans/investments yield, since those earnings fall under current account) Balancing Item = accounts for any statistical errors and make sure the current and capital accounts sum to zero. = Balancing Item

6. The BOP Equation Current Account Balance Capital Account Balance Financial Account Balance Reserve Balance BOP(X- M)(CI-CO)(FI-FO)FxB + ++ X is exports; M is imports CI is capital inflows; CO is capital outflows FI is financial inflows; FO financial outflows FxB is official monetary reserves = Where:

7. 7 Entry Example: Suppose that Alabama Bicycles in Alabama, USA imports (buys) $100,000 worth of bicycle frames from Birmingham Bicycles in Birmingham, England (w/c exports in return). There will exist a $100,000 credit recorded by Birmingham Bicycles that offsets a $100,000 debit at Alabama Bicycle's bank account. This will lead to a rise in the supply of dollars and the demand for British pounds.

8. 8 The Balance of Payments Alabama, USA Birmingham, UK + - + - Bicycles$100,000$100,000Bicycles Debit in a bank in US (Maple’s Bank) Demand of £ s Supply of $s Credit in a bank in UK (Mercian’s Bank)

9. 9 BOP Accounting: Double-Entry Bookkeeping Debit and Credit A debit is created whenever: –An asset is increased –A liability is decreased –An expense is increased A credit is created whenever: –An asset is decreased –A liability is increased –An expense is decreased

10. 10 Typical BOP Transactions Each of the following represents an international economic transaction that is counted in and captured in the US BOP: –A US subsidiary of a foreign MNE acts as a distributor for the MNEs products in the US market –A US based firm, manages the construction of a major water treatment facility in a foreign country –The US subsidiary of a foreign firm pays profits (dividends) back to a parent in its home (foreign) country –The US government finances the purchase of military equipment for a foreign military ally

11. 11 The Balance of Payments BOP data is important for government policymakers and MNEs as it is a gauge of a nations competitiveness or health (domestic and/or foreign). For a MNE both home and host country BOP data is important as: –An indication of pressure on a country’s foreign exchange rate –A signal of the imposition or removal of controls in various sorts of payments (dividends, interest, license fees, royalties and other cash disbursements) –A forecast of a country’s market potential (especially in the short run)

12. 12 Fundamentals of BOP Accounting The BOP must balance. It cannot be in disequilibrium unless something has not been counted or has been counted improperly. Therefore it is incorrect to state that the BOP is in disequilibrium.

13. 13 Fundamentals of BOP Accounting Three (3) main elements of the actual process of measuring international economic activity: –Identifying what is and is not an international economic transaction –Understanding how the flow of goods, services, assets, and money create debits and credits to the overall BOP –Understanding the bookkeeping procedures for BOP accounting It is a daunting task to measure all international transactions that take place in and out of a country over a year. Identifying many international transaction is ordinarily not difficult. However, some international transactions are not obvious.

14. 14 The BOP as a Flow Statement The BOP is often misunderstood as a balance sheet, whereas in fact it is a cash flow statement. By recording all international transactions over a period of time such as a year, it tracks the continuing flows of purchases and payments between a country and all other countries. It does not add up the value of all assets and liabilities of a country on a specific date (as an individual firm’s balance sheet would do).

15. 15 The BOP as a Flow Statement Two types of business transactions dominate the balance of payments: –Real Assets –Financial Assets Although assets can be identified as belonging to distinct groups, it is easier to think of all assets simply as goods that can be bought or sold.

16. 16 BOP Accounting: Double-Entry Bookkeeping Double Entry Bookkeeping BOP employs an accounting technique called double-entry bookkeeping Every transaction produces a debit and a credit of the same amount

17. 17 Example No. 1 A credit entry is recorded when the transaction gives rise to a receipt by a domestic resident from a foreign resident: Ex. X Company exports bauxite worth $2M to Co. M which deposits $2M to X Company's bank account. Country of X Company: BOP CreditDebit Exports$2M (Trans. That gives rise to a receipt) Financial account$2M (Increase on claims on foreigners)

18. 18 Example No. 2 A debit entry is recorded when the transaction gives rise to payments to the rest of the world. Ex. X Company imports oil worth $1.5M from Co. M. X Company deposits $1.5M to Co. M's bank account. Country of X Company: BOP CreditDebit Imports$1.5M (Trans. that gives rise to a payment) Financial account$1.5M (The payment for the oil import)

19. Generic BOP Accounts A. Current Account (all items in this category when summed- up is called Current Account Balance) B. Capital Account (capital transfers related to the purchase and sale of fixed assets such as real estate) C. Financial Account A + B + C = Basic Balance D. Net Errors and Omissions (missing data such as illegal transfers) A + B + C+D = Overall Balance E. Reserves and Related Items (changes in official monetary reserves including gold, foreign exchange, and IMF position)

20. Current Account includes the following 1.Net exports/imports of goods (trade balance) 2.Net exports/imports of services 3. Net (or Factor) income (investment income from direct investment and portfolio investment plus employee compensation) 4. Net (or Cash) transfers (sums sent home by migrants and permanent workers abroad, gifts, grants, and pensions) 1 to 4 = Current Account Balance The current accounts shows the net earnings of a country if it is in surplus or spending if it is in deficit. Generic BOP Accounts

21. Financial Account includes the following: 1. Net foreign direct investment 2. Net portfolio investment 3. Other financial items Generic BOP Accounts

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25. 25 The Accounts of the BOP The BOP is composed of two primary sub accounts, the Current Account, and the Capital and Financial Account. In addition, the Official Reserves account tracks government currency transactions. A fourth account, the Net Errors and Omissions account is produced to preserve the balance of the BOP.

26. 26 The Current Account The Current Account includes all international economic transactions with income or payment flows occurring within one year, the current period. It consists of the following four subcategories: –Exports and import/trade of goods –Services trade –Income –Current transfers The Current Account is typically dominated by the first component which is known as the Balance of Trade (BOT) even though it excludes service trade.

27. 27 The Current Account Besides imports and exports of goods and services, it also includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is running a trade deficit. If the credits exceed the debits, then a country is running a trade surplus.

28. 28 U.S. Trade Balance 1992-2008 (Millions of US$) Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2009.

29. 29 The Capital and Financial Account The Capital Account of the balance of payments measures all international economic transactions of financial assets. It measures the difference between sales of assets to foreigners and purchases of foreign assets. It is divided into two major components: –The Capital Account –The Financial Account The Capital Account is minor (in magnitude), while the Financial Account is significant.

30. 30 The Capital Account The Capital Account is made up of transfers of: –Financial Assets –Acquisition of non-produced/non-financial assets

31. 31 The Financial Account Financial assets can be classified in a number of different ways including the length of the life of the asset (maturity) and the nature of the ownership (public or private). The Financial Account, however, uses a third method. This focuses on the degree of investor control over the assets or operations.

32. 32 The Financial Account The Financial Account consists of three components; –Direct Investment – in which the investor exerts some explicit degree of control over the assets –Portfolio Investment – in which the investor has no control over the assets –Other Investment – consists of various short- term and long-term trade credits, cross-border loans, currency deposits, bank deposits and other A/R and A/P related to cross-border trade

33. 33 Direct Investment This is the net balance of capital dispersed from and into the US for the purpose of exerting control over assets. Foreign direct investment arises from 10% ownership of voting shares in a domestic firm by foreign investors. The source of concern over foreign investment in any country focuses on two topics: – Control – Profit

34. 34 Direct Investment Some countries possess restrictions on foreigners may own in their country. The general rule or premise is that domestic land, assets and industry should be owned by residents of the country. Concerns over profit stem from the same argument.

35. 35 Portfolio Investment This is the net balance of capital that flows in and out of the US but does not reach the 10% threshold of direct investment. The purchase of debt securities across borders is classified as portfolio investment because debt securities by definition do not provide the buyer with ownership or control. Portfolio investment is motivated by a search for returns rather than to control or manage the investment.

36. 36 Other Investment Asset/Liabilities This category consists of: –Short-term trade credits –Long-term trade credits –Cross-border loans from all types of financial institutions –Currency deposits –Bank deposits –Other accounts receivable –Accounts payable

37. 37 Samples Example 1: Recording “Export of CD of Singer Sophie Ellis-Bextor amounting to £ 10,000 ” from the UK BOP perspective. This is classified as merchandise trade; it is export of goods of the UK, a credit is recorded on the UK BOP’s Current Account. ========================================================= Credit -------------------------------------------------------------------------------------------------------------- Exports of goods (General merchandise) £ 10,000 --------------------------------------------------------------------------------------------------------------

38. 38 Samples Example 2: Recording “tuition fees of € 50 million received by French universities from foreign students” from the French BOP perspective. This is classified as services export of France; a credit is recorded on the French BOP’s Current Account. ========================================================= Credit --------------------------------------------------------------------------------------------------------------- Exports of services (Cultural services) € 50 million --------------------------------------------------------------------------------------------------------------

39. 39 Samples Example 3: Applying double-entry bookkeeping to “French Citroen’s exports of € 10 million-worth of cars to China who receives payment in the form of a check drawn on a French bank”; recording these transactions on the French BOP accounts. A credit is recorded on the French BOP Current Account for the increase in French exports and a debit is recorded on the BOP Capital and Financial Account to reflect a decrease in liabilities to a foreigner associated with the check drawn on a French bank, which is a private capital outflow. =============================================================== Credit Debit -------------------------------------------------------------------------------------------------------------------------- Exports of goods (General merchandise) € 10 million Other investments (Decrease in liabilities) € 10 million --------------------------------------------------------------------------------------------------------------------------

40. 40 Samples Example 4: Applying double-entry bookkeeping to “Japan Sony’s investment of ¥ 3 billion in a video factory in Mexico that is financed by issuing bonds in London”; recording these transactions on Japan’s BOP accounts. A debit is recorded on Japan’s BOP Capital and Financial Account to reflect the increase in Japan’s direct investment abroad (the acquisition of foreign assets) and a credit is recorded on the BOP Capital and Financial Account for the inflow of foreign capital used to finance that investment, which is an increase in liabilities to foreigners. =============================================================== Credit Debit -------------------------------------------------------------------------------------------------------------------------- Direct investment abroad (Claims on affiliated enterprises) ¥3 billion Portfolio investment: bonds (Increase in liabilities) ¥3 billion -------------------------------------------------------------------------------------------------------------------------

41. 41 Current and Financial/Capital Account Balances for the United States, 1992-2000 (billions of US$) Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2001.

42. 42 Statistical Discrepancy/ Net Errors and Omissions There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance. The Net Errors and Omissions account ensures that the BOP actually balances.

43. 43 Official Reserves Accounts The Official Reserves Account is the total reserves held by official monetary authorities within the country. This is the total currency and metallic reserves held by official monetary authorities within the country Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF. The currencies (hard currencies) are major currencies used in international trade and financial transactions. The significance of official reserves depends generally on whether the country is operating under a fixed exchange rate regime or a floating exchange rate system.

44. 44 The BOP in a Floating Exchange Rate Regime BCA + BKA + BRA = 0 Where: BCA = Balance on Current Account BKA = Balance on Capital Account BRA = Balance on the Reserves Account Under a pure flexible exchange rate regime, BCA + BKA = 0

45. 45 U.S. Balance of Payments Data CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

46. 46 U.S. Balance of Payments Data In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion. CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

47. 47 U.S. Balance of Payments Data During the same year, the U.S. attracted net investment of $444.26B — clearly the rest of the world found the U.S. to be a good place to invest. CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

48. 48 U.S. Balance of Payments Data Under a pure flexible exchange rate regime, these numbers would balance each other out. CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

49. 49 U.S. Balance of Payments Data In the real world, there is a statistical discrepancy. CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

50. 50 U.S. Balance of Payments Data Including that, the balance of payments identity should hold: BCA + BKA = – BRA ($444.69) + $444.26 + $0.73 = –($0.30) CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73

51. 51 The BOP & Exchange Rate Q P Exchange rate $ CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.84($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 S D

52. 52 Q P As U.S. citizens import, they supply dollars to the Fx market. CreditsDebits Current Account 1Exports$1,418.6 4 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 Exchange rate $ S D The BOP & Exchange Rate

53. 53 Q P As U.S. citizens export, others demand dollars at the Fx market. CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 Exchange rate $ S D The BOP & Exchange Rate

54. 54 Q PS D As the U.S. government sells dollars, the supply of dollars increases. S1S1 CreditsDebits Current Account 1Exports$1,418.64 2Imports ($1,809.18) 3Unilateral Transfers$10.24($64.39) Balance on Current Account ($444.69) Cap’l & Fin’l Account 4Direct Investment$287.68($152.44) 5Portfolio Investment$474.39($124.94) 6Other Investments$262.64($303.27) Balance on Capital Account $444.26 7Statistical Discrepancies Overall Balance $0.30 Official Reserve Account ($0.30) 0.73 Exchange rate $ The BOP & Exchange Rate

55. 55 Balances on the Current (BCA) and Capital (BKA) Accounts of the United States Source: IMF International Financial Statistics Yearbook, 2000

56. 56 Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom Source: IMF International Financial Statistics Yearbook, 2000

57. 57 Balances on the Current (BCA) and Capital (BKA) Accounts of Japan Source: IMF International Financial Statistics Yearbook, 2000

58. 58 Balances on the Current (BCA) and Capital (BKA) Accounts of Germany Source: IMF International Financial Statistics Yearbook, 2000

59. 59 Balances on the Current (BCA) and Capital (BKA) Accounts of China Source: IMF International Financial Statistics Yearbook, 2000

60. 60 The BOP in Total — Surplus A surplus in the BOP implies that the demand for the country’s currency exceeded the supply and that the government should allow the currency value to increase – in value – or intervene and accumulate additional foreign currency reserves in the Official Reserves Account.

61. 61 The BOP in Total — Deficit A deficit in the BOP implies an excess supply of the country’s currency on world markets, and the government should then either devalue the currency or expend its official reserves to support its value.

62. 62 The BOP — Total The International Monetary Fund (IMF) is the multinational organization that collects the BOP statistics for over 160 different countries around the globe. The current, capital, and financial accounts combine to form the basic balance and is one of the most frequently used summary measures of the BOP. The current, capital, financial, and net errors and omissions accounts combine to form the summary measure known as the overall balance or official settlements balance.

63. 63 The BOP & Economic Crisis The sum of cross-border international economic activity can be used by international managers to forecast economic conditions and in some cases, the likelihood of economic crises. The mechanics of international economic crises often follow a similar path of development.

64. 64 Capital Mobility The degree to which capital moves freely across borders is critically important to a country’s balance of payments. While capital has not always been free to move in and out of a country, it clearly has increased over the past 40 years.

65. A Stylized View of Capital Mobility in Modern History Source: “Globalization and Capital Markets,” Maurice Obstfeld and Alan M. Taylor, NBER Conference Paper, May 4-5, 2001, p. 6. Low High Capital Mobility 1880 1860190019201940196019802000 1880 1900 1914 1929 1860 1925 1918 1945 1960 1971 1980 2000 Bretton Woods 1945-1971 Interwar, 1914-1945 Float 1971-2000 Gold Standard 1880-1914

66. 66 4 Periods in Capital Mobility Authors argue that the post-1860 era can be subdivided into four distinct periods with regard to capital mobility. –1860-1914 – continuously increasing capital mobility as the gold standard was adopted and international trade relations were expanded –1914-1945 – global economic destruction, isolationist economic policies, negative effect on capital movement between countries –1945-1971 – Bretton Woods era say a great expansion of international trade –1971-2002 – floating exchange rates, economic volatility, rapidly expanding cross-border capital flows

67. 67 Capital Flight Although no single definition of capital flight exists, it has been characterized as occurring when capital transfers by residents conflict with political objectives. Many heavily indebted countries have suffered capital flight, compounding their debt service problems. Capital can be moved via international transfers, with physical currency, collectables or precious metals, money laundering or false invoicing of international trade transactions.

68. Balance of Payments Trends Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account. During the same period, Japan has experienced the opposite. Germany traditionally had current account surpluses. Since 1991 Germany has been experiencing current account deficits. This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany. What matters is the nature and causes of the disequilibrium.