Presentation on theme: "International Finance"— Presentation transcript:
1 International Finance Chapter 3Balance of Payments
2 The Balance of Payments Balance of Payments (BOP):A measurement of all international economic and financial transactions between the residents of a country and foreign residents.The International Monetary Fund (IMF) is the primary source of similar statistics worldwide.Think of a country’s BOP as a country cash flow account (statement); not as a balance sheet.Represents transactions over some period of time
3 Use of BOP Data by Businesses Multinational businesses use various BOP measures to gauge the growth and health of specific types of trade or financial transactions by country.BOP helps to forecast a country’s market potential; where business may opportunities exist.BOP is important indicator of pressure on a country’s exchange rate.Thus indicates potential losses or gains from foreign currency exposed positions of business firms.Changes in a country’s BOP may signal imposition (or removal) of controls over payments, dividends, interest.Government policies to deal with BOP disequilibria.
4 Two Types of BOP Transactions Exchange of Real Assets (for money):Goods:Cars, computers, agricultural products, clothing…Services:Banking, consulting, travel, student exchanges.Exchange of Financial Assets (for money or other financial claims):Stocks, bonds, loans, purchases (or sale) of businesses.
5 Balance in the BOPWhile individual components in a country’s BOP may be out of balance, the overall BOP must be in balance!!!Transactions recorded using a double-entry bookkeeping (in theory).In theory, each BOP transaction should be recorded as both a debit and a credit entry.In reality the two transactions are recorded independently (which, as you will see leads to the errors and omissions BOP account).
6 DEBIT OR CREDIT? Basic Rule to determine BOP transaction: Follow the flow of money!If money is flowing out of a country, it is a deficit item (recorded as a debit)If money is flowing into a country, it is a surplus item (recorded as a credit)
7 Example of BOP FlowsJapan Airlines purchase aircraft from Boeing (United States)From U.S. standpoint: Exchange of real assets for money:Aircraft exports from the U.S.: Surplus transactionMoney inflow to U.S. manufacturer: Credit transaction.From Japan’s standpoint: Exchange of money for real asset:Aircraft imports from the U.S.: Deficit transactionMoney outflow from Japan: Debit transaction.
8 Example of BOP Flows British company acquires a U.S. company. From U.S. standpoint: Exchange of real asset for money:Foreign direct investment in U.S.: Surplus transactionMoney flow to U.S. company (shareholders): Credit transaction.From U.K.’s standpoint: Exchange of money for real asset.Foreign direct investment overseas: Deficit transactionMoney outflow from U.K. company (shareholders): Debit transaction.
9 Example of BOP FlowsCanadian worker in U.S. sends money home to family.From U.S. standpoint: remittances abroad.Net transfer abroad. Deficit transaction.Money outflow from U.S.: Debit transaction.From Canada’s standpoint: remittances from abroad.Net transfer (from) abroad: Surplus transaction.Money inflow from U.S.: Credit transaction.
10 Balance of Payments Accounts The BOP is divided into two major accounts: the Current Account and the Capital/Financial Account:Current Account tracks:Balance of Trade: (net) merchandise exports and imports.Services Balance: (net) financial services and travel (other) servicesFinancial: Provided by banks to non-residents.Travel/other: Provided by domestic entities to foreign country residents, such as meals, hotels, air travel, student exchanges, construction.Income Balance: (net) investment income from abroad and to foreign entities (arises from previous investments).Net Transfers: (net) private remittances to residents abroad (money/gifts) or by governments (aid).
11 Balance of Payments Accounts Capital/Financial Account captures cross border investments during the recorded period. These include:Purchases (or sales) of real estate.(net) Direct investment (FDI).FDI in the U.S. minus U.S. FDI abroad (positive number if net direct investment into the U.S.; and thus capital inflow)(net) Portfolio investmentNon-controlling equity investments (<10%)Debt investments.Either personal or institutional (mutual funds)Portfolio investment in the U.S. minus U.S. portfolio investment abroad (positive number if net portfolio investment in the U.S.; and thus capital inflow).(net) Other financial transactionsBank loans, trade credit
12 Other BOP Accounts Two additional BOP accounts are: Official Reserve Account: tracks the transactions by the official monetary authorities (central bank and treasury department) of a country:Increase in international reserves (major currencies of the world: dollar, yen, euro, gold).Net Errors and Omissions: Balancing account; included because transactions are collected individually (double entry bookkeeping in theory).
13 Current and Capital Account The two major sub-accounts of the BOP, the Current and Financial Account, summarize the current trade and international capital flows of the country respectivelyThe Current and Financial Account are typically inverse on balance, one in surplus while the other experiences deficitIn fact, a deficit in a country’s current account needs to be financed through a surplus in its financial account!If not, pressures will be placed on the exchange rate!Issuing facing the United States today!Reason for the U.S. dollar performance of late!
14 Current and Financial/Capital Account Balances for the United States, Annual Data (billions of US$)Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.
16 Sources of U.S. BOP DataBureau of Economic Research (an agency of the U.S. Department of Commerce)What does it show?Per DayCurrent Account -$481B -$542B $1.5BFin/Cap Account +$527B +$576BDifference $ 46B +$ 34B
17 Thailand’s BOP in the 1990sSource: International Financial Statistics, International Monetary Fund, Washington DC, monthly.