Balance of Payments (BoP)
Balance of Payments (BoP)
Balance of Payments (BoP)
IF & Trade
Batch 2010
syllabus
• Balance of Payments
• International Monetary System
• An overview of International Financial
Markets
• Exchange Rate Determination and
Forecasting
BOP
BOP
– http://rbidocs.rbi.org.in/rdocs/Content/docs/FS
BPS3031_Full.xls
National Income Accounting
• GDP: National Spending = National Income
– Y=C+I+G+X–M
– Y = GDP; C = Consumption; I = Physical Investment; G =
Government Spending; X = Exports; M = Imports
– C + I + G = Domestic Absorption (spending on domestic output)
– (X – M) = Trade Balance = Net Exports
• Trade Balance = Nat’l Income less Domestic Absorption
– X – M = Y – (C + I + G)
• Trade Balance = Net Domestic Saving
– Y = C + Saving + Taxes = C + I + G + X – M
– X – M = (S – I) + (T – G)
– Trade Imbalances must be met with International Borrowing or
Lending, i.e., trade deficit borrow from rest of world.
• Note No Causation Implied!
BOP
• The balance of payments of a country is a
systematic accounting record of all
economic transactions during a given
period of time between residents of the
country and residents of foreign countries
– Flow
Balance of Payments
The BOP is a statistical record of the flow of
all of the payments between the residents of
a country and the rest of the world in a given
year.
Transactions are recorded on the basis of
double entry bookkeeping – by definition it
has to balance.
Every “source” must have a “use”.
CREDIT
Capital Outflow
Uses of FX
DEBIT
Accounting Principles
1. Any transaction resulting in a payment to foreigners is
entered in the BOP accounts as a debit and is given a
negative sign.
2. Any transaction resulting in a receipt from foreigners is
entered as a credit and given a positive sign.
3. Current Account records transactions involving exports
and imports of goods and services
4. Capital Account records transactions involving the
purchase and sale of assets.
5. Double-Entry book keeping: Every international
transaction automatically enters twice, once as a credit
and once as a debit.
Examples of Transactions
Credit Transactions (+ve):
Provision of goods and services to non-residents
Income receivable from non-residents
A decrease in foreign financial assets
An increase in foreign financial liabilities
Debit Transactions (-ve):
Purchase of goods & services from non-residents
Income payable to non-residents
An increase in foreign financial assets
A decrease in foreign financial liabilities
Balance of Payments
• Record of Payments to & Receipts from
Foreign Entities
– Double-entry bookkeeping system.
• Every transaction has two entries – a credit (+)
and a debit (-)!
– Payment = Debit (-)
– Receipt = Credit (+)
– Multiple Accounts
• Current Account (CA) and Capital Account (KA)
– Is a summary (net) record of flows, not stocks
1. Travel
BOP 2. Transportation
3. Insurance
a. Services 4. Govt not
Current account eslewhere
specified
Merchandise 5. miscellaneous
c. income
1. Investment
income
2. Compensation to
Employees
Capital account
BOP
r t f olio +
Current Account irec t; P o
a: D
nIndi
1. I
Capital Account 1. Foreign b r oad
2. A B anks I
Investments cial ties, NR
er
2. Loans (a+b-c) C omm , liabili
a. External a. s s ets
(a s its)
o
Assistance ( by 3. Banking capital dep
India, to India)
4. Rupee Debt o t hers
b.
b. Commercial Service
Borrowing (MT+LT)
5. Other Capital
c. Short term
Balance of Payments
Current Account (CA)
This is record of a country’s trade in goods and
services in the current period.
CA = Exports (X) – Imports (M)
CA + KA + RFX = 0
CA + KA = – RFX
For floating rate regime countries, such as the U.S., official
reserves are relatively unimportant.
Statistical Discrepancy (E&O)
The identity CA + KA = – RFX assumes that all
transactions are measured accurately.
Cap. a/c
Up in Foreign Bank holdings 200
BOP country A
Cu.A/c Cr Dt
Unrequited transfers 50
Cap. a/c
Increase in Foreign 50
Liabilities
Example Transactions
• Record transactions in the following accounts
– CA: A = merchandise; B = services; C = invest. income; D =
Unilateral Transfers
– KA: E = Change in U.S. claims on foreign assets; F = Change in
foreign claims on U.S. assets
• U.S. firm sells $1m wheat to Romania, paid for out of
Romanian-owned deposit account in U.S.
– A (+), F(-):
• merchandise export is credit
• decrease in foreign-owned dollar deposits = K-out = decreased foreign
claims on U.S.
• U.S. tourist spends DM10,000 deposit in German bank while
traveling in Germany
– B(-), E(+)
• tourist spending abroad is service import ~ a debit
• decrease in U.S. claims on foreigners ~ K-in
Example Transactions, cont.
• U.S. citizen receives DM10k interest payment from German bonds,
deposits in German bank
– C (+), E(-)
• U.S. citizen converts DM to US$ at German Bank
– E (+), F(-)
• debit = K-out = decrease foreign claims on U.S. (they gave up $)
• credit = K-in = decrease in U.S. claims on foreigners (we gave up DM)
• U.S. Bank loans US$ to German Bank
– F(+), E(-)
• debit = K-out = increase in U.S. claims on foreigner (future debt payments)
• credit = K-in = increase in foreign claims on U.S. (acquire $)
• German resident sells U.S Government Bond to French resident
– does not show on U.S. Balance of Payments!
• U.S. charity donates medicine to Nicaragua
– A (+), D(-): merchan. export, paid for by “gift” (unilateral transfer)
Valuation and Timing
• Market Prices – willingness of parties
• F.O.B. Vs. C.I.F – former is preferred
• India’s exports are valued @ fob; imports
are cif
• Translation
• Timing : exports are recorded when
cleared by customs, imports when
payment is made - conventions
Balance in BOP
• “imbalance” refers to disequilibrium
• Autonomous transactions arising from
normal business
• Accommodating transactions undertaken
with the motive of settling the imbalances
– funding deficits arising out of autonomous
transactions
Balance in BOP
• Trade balance
• Balance in Goods & services
• Current account Balance
• Balance on CA and LT capital
BOP in Total
exchange rate
Commodity derivatives
Balance in BOP
• Corporate Finance Managers monitor the
data on a regular basis to understand how
pressures in international market will
impact their firm in short term or long term
Interpretation of Deficit and
Surplus
• This is a difficult issue. Ever wonder why economics
is called a “dismal science”? An account deficit
theoretically means that foreign goods are more
competitive and that perhaps national industries
aren’t making competitive products, which could
then signal recession, depression, or closure of
economies or business firms .
• A surplus, could theoretically mean there is excess
demand, that could trigger inflation and eventual
economic slowdown.
Interpretation: Does it matter?
• Another group of people believe the
interpretations of deficit and surplus are
only good for politicians. They believe that
with globalization, the older interpretations
of deficit and surplus are becoming
meaningless.
BOP & Macroeconomic Variables
Where:
X = exports of goods and services
Current Account
M = imports of goods and servicesBalance
CI = capital inflows Capital Account
CO = capital outflows Balance
FI = financial inflows Financial Account
FO = financial outflows Balance
FXB = official monetary reserves
BOP & Exchange Rates