Balance of payments

LE CTURE 14/ 02/ 2017 OR 15/ 02/ 2017

What is the Balance of Payments?
 It’s an accounting document that records all the economic transactions
of (the residents of) a country with (the residents of) the rest of the
world during a specific period (usually one year but it can also be one
month or one quarter).
 International transactions include exchanges of goods, services or
assets.
 “Residents” means businesses, individuals and government agencies.
 Central Banks are responsible for recording all the economic
transactions.
Why do we need it?
 The main purpose of the balance of payments is to inform the
government of the international position of the country.
 To help it in its formulation of monetary, fiscal, and trade
policies.
 It is also indispensable to banks, firms, and individuals directly
or indirectly involved in international trade and finance.
How does it work exactly?
• It is the place where countries record their transactions so it works
much like the accounting of a firm.
• Spain receives money (receives payment) from foreign firms,
institutions or citizens → CREDIT
• Spain gives money (makes payment) to foreign firms, institutions
or citizens → DEBIT
Some examples of
transactions
SPAIN IS HOME COUNTRY
 Spanish resident buys Italian coffee
maker for €50 in Barcelona

DEBIT
Why? Spanish resident GIVES to Italian firm in exchange for good.
IMPORT OF A GOOD
Italian coffee making firm deposits €50 in
Spanish bank account in Barcelona

CREDIT
Why? Spanish bank RECEIVES money from Italian firm in exchange
for financial service.
EXPORT OF A SERVICE
Spanish resident buys €200 dinner in
Paris

DEBIT
Why? Spanish resident GIVES money to a French restaurant.
IMPORT OF A SERVICE
 Spanish resident buys €100 in German
car company stock.

DEBIT
Why? Spanish resident GIVES money to German firm in exchange for
a financial asset.
IMPORT FINANCIAL ASSET
German car company deposits €100 in
Spanish bank.

CREDIT
Why? Spanish bank RECEIVES money from a German firm in
exchange for a financial service.
EXPORT FINANCIAL SERVICE
 UK resident purchases Spanish stock
• CREDIT
• UK gives money to Spain in exchange for a financial asset.
• Increase in foreign assets in Spain.
• This is a capital inflow because Spain receives payment.
Spanish resident sells a UK bond to a UK
resident
• CREDIT
• UK gives money to Spain in exchange for a financial asset.
• Reduction in Spanish assets abroad.
• This is a capital inflow because Spain receives payment.
 Spanish resident purchases UK stock
• DEBIT
• Spain gives money to UK in exchange for a financial asset.
• Decrease in foreign assets in Spain.
• This is a capital outflow because Spain gives payment.
UK resident sells a Spanish bond to a
Spanish resident
• DEBIT
• Spain gives money to UK in exchange for a financial asset.
• Increase in Spanish assets abroad.
• This is a capital outflow because Spain gives payment.
Components of the Balance of Payments
A complete balance of payments is composed of three sections:
 Current Account (CA)
 Capital Account (KA)
 Financial Account (FA)
The Current Account (CA)
 Import and export of:
o Goods: movable and physical in nature e.g. general
merchandise, goods used in production of other goods.
o Services: transactions resulting from an intangible action: e.g.
transportation, business service (accounting, legal advice),
tourism.
 Income: payment of interest rate (or dividends) on some
investments, including royalties.
 Unilateral Transfers: e.g. Remittances. NOT FOREIGN AID.
Current Account example
(part 1 of BOP example)
1. Spanish pork products sold to USA worth 1000 €.
2. Spanish resident spends 2000 € on vacation in Napoli.
3. Spanish residents receives 140 € worth of interest on stock in
Germany.
4. Italian worker sends 140 € back to family in Italy.
Surplus or Deficit?
 If the balance of the CA is positive (Credit>Debit), we say that the
country presents a current account surplus.

 In contrast, if the balance is negative: current account deficit

Note difference between trade balance
and current account balance
 Trade balance
TB=X - M
 Current Account balance
CAB=X-M + Net Income + Net U. Transfers
 Germany Spain United States China United Kingdom
600000

400000
330602.2
283907.7
200000

16206.9
0

-200000
-152950.1

-400000

-462961
-600000

-800000

-1000000

Spanish CA in relation to other countries 2000-2015

source: http://databank.worldbank.org/data/reports.aspx?source=2&country=
 Germany Spain United States China United Kingdom
15

10

8.4

3
1.3
0

-2.5

-5
-5.3

-10

-15
Spanish CA as % of GDP in relation to other countries 2000-2015
source: http://databank.worldbank.org/data/reports.aspx?source=2&country=
Current Account Map
http://data.worldbank.org/indicator/BN.CAB.XOKA.CD?view=map
The Capital Account (K)
Records activities resulting in transfers of wealth between countries. These
international asset movements result from nonmarket activities or represent
non-produced, nonfinancial, and possibly intangible assets (Krugman et al, 2012,
p. 307).
 Institutional donations for development.
 All bank deposits held by foreign residents in the country and by citizens
abroad.
 Investments in land and intangible assets (patents, trademarks, copyrights,…)
Capital Account example
(part 2 of BOP example)
5. Spanish government forgives 50€ million in debt owed to it by the
government of Pakistan.
6. The World Bank makes a donation to Spain to help reconstruct a
hospital after a forest fire in the amount of 50€million.
The Financial Account (FA)
Measures the difference between acquisitions of assets from foreigners and the buildup of
liabilities to them. It records:
 foreign direct investment (FDI) inflows and outflows
 credits granted by (or to) foreign institutions
 all credit or debit leftovers for transactions that took place at a specific moment during the
period we are considering, but without being completed with the entire monetary
compensation
 investment in foreign treasury bonds (or other assets that guarantee a return) are recorded as
well
These investments have an implied return. All returns on investments are recorded in the
CURRENT ACCOUNT.
Financial Account example
(part 3 of BOP example)
7. Spanish resident buys stock in USA for 100 €
8. Canadian buys Spanish bonds for 100 €
9. Spanish food company imports Italian wine for 1000 €, 50% of this
payment is delayed for one year.
a.Returns on Spanish resident stock investment in USA 10 €
b.Returns on Canadian investment in Spain 10 €
Variation of Official Reserve Assets (R)
 Corresponds to the entry or exit of official reserve assets.
 It records the amount of its own currency or foreign currencies
that a nation buys or sells.
The Statistical discrepancies (SD)
Is minor section including measurement errors in the definition of the value of
each transaction due, for example, to the different values of the exchanges rates.
Where do these errors come from?
 Under-reporting imports
 Under-reporting investment incomes
 Under-reporting capital exports
 Basically, people succeed in hiding their imports, foreign investment incomes,
capital flight from their governments for tax and other purposes
Interpret balance
 The aggregate balance indicates the capacity or necessity of funding of a given country in
relation to the rest of the world.
 If the balance is positive (surplus), the revenues from the rest of the world higher than the
payments, and therefore we are financing the rest of the worlds debt to us. Our country is
lending.
 In contrast if the balance is negative (deficit), the revenues are not sufficient to cover the
payments to the rest of the world, and therefore we need that the rest of the world finance
the difference between revenues and payments. Our country is borrowing.
 We say that a nation is a lender or a borrower depending on whether it is in surplus or deficit
during a time period.
How to clear the Balance of Payments
 The Balance of Payments clears as follows:
CA+K+FA+R+SD=0
 The fulfilment of this condition implies that the results of each section can be
positive or negative, but the total value has to sum up to zero.
 Because the balance of payments must sum to zero, any imbalance in the
official settlements balance (e.g., more imports than exports) must be
financed (paid for) by official reserves flows:
CA+K+FA+OR=0
 The Spanish balance of Payments
BALANCE OF PAYMENTS SPAIN 2008 (billions of euros)
Balance
Current Account -104.6
Capital Account 5.5
CA+KA -99.1
NCL-NCA
Financial Account 89.9
Non-Bank of Spain 59.8
Bank of Spain 30.1
Errors and omisions 9.2
NCL: Net changes in liabilities
NCA: Net changes in assets
Source: Banco de España
 BALANCE OF PAYMENTS SPAIN 2014 (billions of euros)
Balance
Current account 1.2
Capital account 4.4
CA+KA 5.6
NCL-NCA
Financial account -25.1
Non-bank of Spain -0.8
Bank of Spain (1) -24.3
Errors y omissions 19.5
NCL: Net changes in liabilities
NCA: Net changes in assets

Source: Banco de España

Seminar
16-02-2017
17-02-2017
What does Spain export and import?
http://atlas.media.mit.edu/en/profile/country/esp/
http://atlas.media.mit.edu/en/profile/country/usa/
 Balance of payments Example 1
1. A Spanish bank granted a credit of 300€ to a non-resident firm 8. The Spanish government granted a donation of 1700€ to
and it has to be paid back in 10 years. Zimbabwe to finance the construction of a hospital and a school.
2. In the Spanish airport, local providers served fuel to foreign 9. A Spanish bank buys computers from a Japanese enterprise for
airlines for a value of 260€ paid in cash. 1200€. The freight costs are paid by the Japanese firm; a Spanish
3. Immigrants from Ecuador Living in Spain send remittances to their firm has been selected to provide this service for 23€ paid cash
(and this cost is not included in the computer price).
home-family for 830€.
10. Foreign investors buy Spanish treasury bonds for 180€.
4. A Portuguese firm paid 15€ of interest on a credit granted by a
Spanish savings banks. 11. After a natural earthquake, the Spanish government sends foods
5. Spanish Erasmus students spent 535€ on tourism at their host and medicines to Thailand in the amount of 500€.
universities. 12. A Spanish textile firm pays 25€ to a Belgian firm for technical
assistance. The payment has been delayed in 1 year and a half.
6. A Norwegian firm opens a Spanish branch. The full amount is
1030€. The firm pays 50% cash and 50% with a credit granted by a 13. A German investor gets 9€ per year as return to some Spanish
Spanish bank. bonds he bought in the past.
7. A Spanish consulting firm sells services to Greek firms for 430€.
Balance of payments of Ithaca
1. Ithaca gets a donation from an organization for development to finance the construction of a
hospital in the amount of 7500€.
2. Immigrants from Crete living in Ithaca send remittances home for a value of 2000€.
3. A firm producing toys imports intermediate mechanical inputs for about 4500€. These imports
have been paid as follows: (a) 1/3 in cash and (b) 2/3 in 3 years with a credit granted by non-
resident providers.
4. A car-component industry exports goods for a value of 4000€ however, , out of these 4000€, 800€
are used to pay freight costs for services provided by some Ithacan transporters and paid by the
non-resident importer.
5. An Australian investor buys a property which has a value of 400€ and he pays cash for it.
6. In the Ithacan airports, international airlines: Air France, Air Berlin and British Airways bought fuel
for 10000€.
7. A Japanese firm buys 4% of the commercial Ithacan firm UlyssSofa which has a value of 5000€ aid it
is paid cash.
Source: Banco de España. http://www.bde.es/webbde/es/estadis/infoest/a1701.pdf
 BALANCE OF PAYMENTS SPAIN 2014 (billions of euros)
Balance
Current account 1.2
Capital account 4.4
CA+KA 5.6
NCL-NCA
Financial account -25.1
Non-bank of Spain -0.8
Bank of Spain (1) -24.3
Errors y omissions 19.5
NCL: Net changes in liabilities
NCA: Net changes in assets

Source: Banco de España

Bibliography
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Krugman, Paul R., Obstfeld, Maurice, Melitz, Mark J. International Economics: Theory and Policy,,
9th Edition. Pearson: 2012.
Abel, Andrew B. and Bernanke, Ben S. Macroeconomics. 4th Ed. Addison Wesley Longman: 2001.