Download Balance of Payments Accounting

Lecture 1
International Finance
ECON 243 – Summer I, 2005
Prof. Steve Cunningham
The New World Economy

The world economy has become
increasingly interconnected:
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Globalization: markets exceed national
boundaries; increased mobility of workers,
products, and information.
Integration: people of different countries
choose to function jointly in governance,
economic interests, currency, etc.
Developments
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The possibility of such a global economy has been
brought about by:
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Collapse of communism
Lower transportation costs
Advances in telecommunications (internet, etc.) related
technological innovations
Economic need
These have led to reductions in trade barriers
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General barriers
Integration and free trade zones—Europe, North America, etc.
The relaxation of bank and capital market regulations
Top 20 Globalized Nations
Rank
Nation
Rank
Nation
1
Ireland
11
United States
2
Switzerland
12
France
3
Sweden
13
Norway
4
Singapore
14
Portugal
5
Netherlands
15
Czech Republic
6
Denmark
16
New Zealand
7
Canada
17
Germany
8
Austria
18
Malaysia
9
United Kingdom
19
Israel
10
Finland
20
Spain
Source: Foreign Policy
Sectors

Economists typically separate the production
and sale of goods and services from the
exchanges of financial assets.
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Real Sector: production and sale of goods and
services.
Financial Sector: transactions in global, foreign, or
domestic financial assets.
Measurement is difficult because trade may
include services (invisibles) and electronic
commerce.
Balance of Payments

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
A record of international transactions
between residents of one country and the
rest of the world
International transactions include
exchanges of goods, services or assets
“Residents” means businesses, individuals
and government agencies, including citizens
temporarily living abroad but excluding
local subsidiaries of foreign corporations
Double-entry Accounting in the BOP


All transactions are either debit or credit
transactions
Credit transactions result in receipt of
payment from foreigners
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Merchandise exports (valued f.o.b.)
Transportation and travel receipts
Income received from investments abroad
Gifts received from foreign residents
Aid received from foreign governments
Double-entry Accounting (Cont’d)

Debit transactions involve to payments to foreigners
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Merchandise imports
Transportation and travel expenditures
Income paid on investments of foreigners
Gifts to foreign residents
Aid given by home government
Overseas investments by home country residents
Each credit transaction has a balancing debit
transaction, and vice versa, so the overall balance of
payments is always in balance.
Accounts Overview (Level 1)

Current Account (all real transfers)

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Merchandise trade
Service trade
Transfers
Capital and Financial Account (transfers of
ownership and financial assets and liabilities)

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Changes in private assets
Changes in holdings of official international reserves
Statistical Discrepancy
Current Account

The current account is that balance of
payments account in which all short-term
flows of payments are listed:

Goods and services balance (exports – imports)
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Merchandise trade balance (exports – imports)
Services balance (exports – imports)
Net Investment income
Unilateral transfers
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Private transfer payments
Governmental transfers
What are Services?
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Travel and tourism
Trade transportation
Insurance
Education
Financial, technical, and marketing services
Telecommunication
Use of property rights (royalties)
Other professional and consulting services
What is Investment Income?

Payment to holders of foreign financial
assets, including:
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
Interest on bonds and loans
Dividends and other claims on profits by
owners of foreign businesses
Payments made to temporary (nonresident)
workers
Unilateral Transfers

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Official government grants in aid to foreign
governments
Charitable giving (e.g., famine relief)
Migrant workers transfers to families in their
home countries
Capital Account

The capital and financial account is that balance
of payments account in which all cross-border
transactions involving financial assets are listed.
This includes transactions between foreign and
domestic residents, and foreign and domestic
governments.

All purchases or sales of assets, including:
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Direct investment
Securities (debt)
Bank claims and liabilities
Official reserves transactions
When U.S. citizens buy foreign securities or when foreigners buy
U.S. securities, they are listed here as outflows and inflows,
respectively.
Foreign Direct Investment (FDI)

Any flow of lending to, or purchases of ownership in, a
foreign enterprise that is largely owned by residents of the
investing country.
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Securities (stocks and bonds)
Loans
Bank deposits
Minority ownership positions
FDI is the purchase of assets to establish financial control of a
foreign entity. Generally ownership of 10% or more of a
company’s outstanding stock is considered FDI.
Portfolio investment involves little management control or
interest, and is solely for financial gain.
Official Reserve Assets
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Early on in this century, this was primarily gold
Now primarily financial assets denominated in
a foreign currency that is widely accepted in
international transactions:
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Euro assets (heavily used by U.S.)
Yen assets (heavily used by U.S.)
U.S. dollar assets (key currency worldwide)
Reserve positions in IMF
SDRs (created by IMF)
Official Reserves Transactions
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Governments can influence exchange rates by
buying and selling official reserves.
The buying and selling of official reserves is recorded
in the “official transactions” account.
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Also referred to as “changes in holdings of official
international reserves” or “official settlements balance”.
It is the part of the balance of payments accounts
that records the amount of its own currency or
foreign currencies that a nation buys or sells.
Statistical Discrepancy?
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It is the net result of errors and omissions on
both the credit and debit sides.
Where do these errors come from?
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Under-reporting merchandise 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.
Account Overview (Level 2)
Current Account
Capital Account
Merchandise trade
exports
imports
Trade Balance
Services
military trans. (net)
other services, net
Service Balance
Balance on goods & services
Investment income, net
Changes in US assets abroad, net
other US govt assets
US private assets
All changes, net
Changes in foreign assets in the US,
net foreign private assets
All changes, net
Unilateral transfers
US government grants
US govt pensions, and
other transfers
Private remittances and
other transfers
All transfers, net
Balance on current account
Changes in holdings of official
international reserves, net
Statistical discrepancy
Balance on capital account
Current Account

The difference between the import and
export of goods is sometimes called the
balance of merchandise trade.
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Although the popular press often uses this
measure, the merchandise trade balance is not
a good summary because services are an
important component of trade.
The balance on goods and services includes
trade in services. This includes visible and
invisible trade .
Current Account, 1970-2002
200
100
0
-100
-200
-300
Current Account
-400
-500
-600
1970
Goods
Services
1975
1980
1985
1990
1995
2000
Current Account Surplus and Deficit


A current account surplus means exports
of goods and services, investment income
and transfers exceed imports and
outflows.
A current account deficit means imports
of goods and services, and outflows are
greater than exports and inflows; must be
financed by borrowing (capital account
inflows).
Linkage to NIPA and
the Domestic Economy

Current Account (CA) surplus equals net
foreign investment (If ). CA = If .
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If If > 0, the country has net foreign investment,
so the country must be investing part of its
saving abroad, and S = Id + If .
That means If = S – Id .
Recall that Y = C + Id + G + (X – M).
Also, CA = X – M.
Domestic Expenditures E = C + Id + G, and
Y – E = X – M = CA
C + Id + G is sometimes referred to as absorption.
Meaning of Overall Balance
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The current account and the capital account
measure the private and non-U.S. government
supply of and demand for dollars.
Official Settlements Balance:
B = CA + KA
Because the balance of payments must sum to
zero, any imbalance in the official settlements
balance must be financed (paid for) by official
reserves flows:
B + OR = 0
BOP Surplus and Deficit
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The Official Settlements Balance (B ) is sometimes
referred to as the net sum of the items above the
line or autonomous transactions, and
The Official Reserves Transactions (OR ) are
referred to as the sum of the items below the line,
also called nonautonomous or accommodating
transactions.
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When B = 0, there is said to be a BOP equilibrium, and
if B  0, a BOP disequilibrium.
When B > 0, there is said to be a BOP surplus.
When B < 0, there is said to be a BOP deficit.
BOP Surplus and Deficit (Continued)
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In terms of the supply and demand of
a nation’s currency, there is:
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A balance of payments surplus if quantity
demanded for a currency exceeds quantity
supplied, putting upward pressure on the value
of the nation’s currency.
A balance of payments deficit if quantity
supplied of a currency exceeds quantity
demanded, putting downward pressure on the
value of the nation’s currency.
Official Transactions Account
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Most of the Official Reserves flows are official
interventions by the country’s monetary authorities
in the foreign exchange markets.
When a government buys its own currency to hold
up the currency’s price, we say that the
government has supported its currency.
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It is holding the exchange rate higher than that rate otherwise
would have been.
When it sells its currency, it is attempting to depress
the value of its currency.
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It is forcing the exchange rate to be lower than that rate would
otherwise have been.
Official Transactions Account
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Because they are an accounting identity,
the current, capital, and official transactions
accounts must sum to zero—in total, the
balance of payments balances.
The supply of currency, including
government’s, must equal the demand for
currency, including government’s.
1999 Balance of Payments Accounts
1. Current Account
2.
Merchandise
3.
Exports
4.
Imports
5.
Balance of trade
6.
Services
7.
Exports
8.
Imports
9.
Balance of services
10. Balance of goods and services
+683
-1,030
-347
+277
-197
+80
-256
1999 Balance of Payments Accounts
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
Net invesment income
Net transfers
Invest. trans. balance
Balance on current account
Capital account
Capital inflows
Capital outflows
Balance on capital account
Current and capital balance
Statistical discrepancy
Official transaction account
Totals
-25
-47
-72
-339
+751
-373
+378
-39
-36
+3
0
BEA International Transactions Data
May 19, 2003, U.S. International Transactions (Millions)
Line (Credits +; debits -)/1/
2000
2001
2002/p/
Current account
1 Exports of goods and services and income receipts
1,417,236 1,281,793 1,216,504
2 Exports of goods and services
1,064,239
998,022
971,864
3 Goods, balance of payments basis/2/
771,994
718,762
682,586
4 Services/3/
292,245
279,260
289,278
12 Income receipts
352,997
283,771
244,640
13 Income receipts on U.S.-owned assets abroad
350,656
281,389
242,177
14
Direct investment receipts
149,677
125,996
128,068
15
Other private receipts
197,133
151,832
110,766
16
U.S. Government receipts
3,846
3,561
3,343
17 Compensation of employees
2,341
2,382
2,463
18 Imports of goods and services and income payments
(1,774,135) (1,625,701) (1,663,908)
19 Imports of goods and services
(1,442,920) (1,356,312) (1,407,406)
20 Goods, balance of payments basis/2/
(1,224,417) (1,145,927) (1,166,939)
21 Services/3/
(218,503)
(210,385)
(240,467)
29 Income payments
(331,215)
(269,389)
(256,502)
30 Income payments on foreign-owned assets in the United States
(323,005)
(260,850)
(247,601)
31
Direct investment payments
(60,815)
(23,401)
(50,121)
32
Other private payments
(179,217)
(156,784)
(124,542)
33
U.S. Government payments
(82,973)
(80,665)
(72,938)
34 Compensation of employees
(8,210)
(8,539)
(8,901)
35 Unilateral current transfers, net
(53,442)
(49,463)
(56,023)
36 U.S. Government grants/4/
(16,821)
(11,628)
(16,914)
37 U.S. Government pensions and other transfers
(4,705)
(5,798)
(5,131)
38 Private remittances and other transfers/6/
(31,916)
(32,037)
(33,978)
39
40
41
46
47
48
49
50
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
70a
Capital and financial account
Capital account
Capital account transactions, net
837
826
708
Financial account
U.S.-owned assets abroad, net (increase/financial outflow (-))
(606,489) (370,962) (156,169)
U.S. official reserve assets, net
(290)
(4,911)
(3,681)
U.S. Government assets, other than official reserve assets, net
(941)
(486)
379
U.S. credits and other long-term assets
(5,182)
(4,431)
(5,213)
Repayments on U.S. credits and other long-term assets/8/
4,265
3,873
5,696
U.S. foreign currency holdings and U.S. short-term assets, net
(24)
72
(104)
U.S. private assets, net
(605,258) (365,565) (152,867)
Foreign-owned assets in the United States, net (increase/financial
1,015,986
inflow (+))752,806 630,364
Foreign official assets in the United States, net
37,640
5,224
96,630
U.S. Government securities
30,676
31,665
74,013
U.S. Treasury securities/9/
(10,233)
10,745
43,656
Other/10/
40,909
20,920
30,357
Other U.S. Government liabilities/11/
(1,909)
(1,882)
158
U.S. liabilities reported by U.S. banks, not included elsewhere
5,746
(30,278)
18,831
Other foreign official assets/12/
3,127
5,719
3,628
Other foreign assets in the United States, net
978,346
747,582 533,734
Direct investment
307,747
130,796
30,114
U.S. Treasury securities
(76,965)
(7,670)
53,155
U.S. securities other than U.S. Treasury securities
455,213
407,653 284,611
U.S. currency
1,129
23,783
21,513
U.S. liabilities to unaffiliated foreigners reported by U.S. nonbanking
174,251
concerns
82,353
49,736
U.S. liabilities reported by U.S. banks, not included elsewhere 116,971
110,667
94,605
Statistical discrepancy (sum of above items with sign reversed)
7
10,701
28,524
Of which: Seasonal adjustment discrepancy
.....
.....
.....
Memoranda
Line
71
72
73
74
75
76
(Credits +; debits -)/1/
2000
2001 2002/p/
Balance on goods (lines 3 and 20)
(452,423) (427,165) (484,353)
Balance on services (lines 4 and 21)
73,742
68,875
48,811
Balance on goods and services (lines 2 and 19)
(378,681) (358,290) (435,542)
Balance on income (lines 12 and 29)
21,782
14,382 (11,862)
Unilateral current transfers, net (line 35)
(53,442) (49,463) (56,023)
Balance on current account (lines 1, 18, and 35 or lines 73, 74, and
(410,341)
75)/13/ (393,371) (503,427)
Int’l Investment Position

In order to buy U.S. assets foreigners need
dollars, so net capital inflows represent a
demand for dollars.


The demand for dollars comes from the
demand to buy goods and services and the
demand to buy (capital) assets.
In the 1980s, the inflow of capital into the
U.S. greatly exceeded the outflow of capital
from the U.S., and this trend has continued
into the late 1990s. (KA > 0, CA < 0)
Int’l Investment Position (continued)


International Investment Position (IIP) is
another related balance sheet. It is a
statement of the stocks of a nation’s
international assets and foreign liabilities at a
point in time, usually the end of a year.
Any capital flows (related to a current
account imbalance) creates a change in the
IIP.
Int’l Investment Position (continued)
We say that a nation is a lender or a
borrower depending on whether its current
account is in surplus or deficit during a time
period.
 We say that a nation is a creditor or debtor
depending on whether its net stock of
foreign assets is positive or negative.
The first refers to flows over time, the second
to stocks at a point in time.

Int’l Investment Position (continued)
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Prior to WWI, the U.S. was a net debtor.
From WWI through 1983, the U.S. was a net
creditor (the world’s leading creditor).
Since 1983, the U.S. has run large current
account deficits, requiring int’l borrowing.
By 1989, the U.S. was a net debtor, and
continues to be so until the present.