Download Understanding Balance of Payments accounting

Chapter 2
Understanding International Transactions
1) International transactions in Assets
2) Understanding The Balance of Payments Accounts (BOP)
3) Examples to illustrate how transactions are recorded in BOP
4) Investment position of the U.S.
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International trade in assets (also refer to capital flows) is also an important component of international
trade. It is growing even faster than growth in international trade in services (Table 2).
Understanding Balance of Payments accounting
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A country’s international transactions for a given year are recorded in the balance of payments accounts
(BOP).
Credit (+) items reflects transactions that result payments inflow to the home country, e.g., exports of
goods and services.
Debit (-) items reflects transactions that result payments outflow to the home country, e.g., imports of
goods and services.
BOP accounts consist of two main accounts: current account and capital account.
Current account records transactions in goods, services and investment income.
Capital account records transactions in assets.
Because of double-entry bookkeeping, the sum of current account and capital account must be zero
(that’s why it is called the balance of payments accounts). In particular, a surplus (deficit) in the current
account must be exactly offset by a deficit (surplus) in the capital account.
There are four categories of transactions.
Category I transactions are all recorded in the current account. They are export and import of goods and
services, investment income paid and received, and unilateral transfers to and from abroad.
Categories II, III, and IV transactions are all recorded in the capital account.
Category II transactions are private direct foreign investment and other long-term capital flows.
Category III transactions are short-term private capital flows.
Category IV transactions are changes in reserve assets (official international reserves) of central banks.
Official reserves consist of gold, major currencies such as the U.S. dollars, the Japanese Yen, and the
German deutsche mark.
Generally speaking:
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An increase (decrease) in domestic holding of foreign assets is recorded as a debit (-) (credit, +) in the
capital account.
An increase (decrease) in holding of domestic assets by foreigners is recorded as a credit (+) (debit, -) in
the capital account.
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BOP accounts record the flow of transaction in a given time period.
Examples of BOP transactions:
Transaction 1: country A (home) exports goods to country B (foreign) and receives short-term bank deposit in
country B.
(+)
Cat. I:
exports of goods, +$6,000
(-)
Cat. III:
increase in short-term private assets abroad,
-$6,000
Transaction 2: country A imports goods from country B and pays by transferring bank accounts into country
B’s accounts in country A.
(-)
(+)
Cat. I:
Cat. III:
imports of goods, -$12,000
increase in foreign short-term private assets in country A, +12,000
Transaction 3: country A sends gift to country B.
(+)
(-)
Cat. I:
Cat. I:
exports of goods, +$1,000
unilateral transfers made, -$1,000
Transaction 4: country A provides country B with services. Country B pays by transferring funds from its
country A checking accounts into country A’s account.
(+)
(-)
Cat. I:
Cat. III:
exports of services, +$2,000
decrease in foreign short-term private assets in country A,
-$2,000
Transaction 5: Country A receives dividends from country B. This is paid out of country B checking account
in country A.
(+)
(-)
Cat. I:
Cat. III:
investment income receipts from abroad, +$2,500
decrease in foreign short-term private assets in country A,
-$2,500
Transaction 6: country A purchases long-term corporate bond from county B and pays by transferring funds
from county A bank account to country B’s bank account in country A.
(-)
(+)
Cat. II:
Cat. III:
increase in long-term assets abroad, -$5,000
increase in foreign short-term private assets in country A, +$5,000
Transaction 7: country B’s banks sell to their central bank some of their holding of county’s A currency held
in country A.
(-)
(+)
Cat. III:
Cat. IV:
decrease in foreign short-term private assets in country A, -$800
increase in foreign short-term official assets in country A, +$800
Cat. I, II, III transactions are referred to as autonomous items in the balance of payments.
Cat. III transactions are accommondating items in the balance of payments.
National income and the current account
Y = C + I + G + (X - M)
Y= national income
C = consumption spending
I =investment spending
C = government spending
X = exports of goods and services
M = imports of goods and serices
(X - M) = net exports which we will use as approxmiating current account
rearranging,
Y - (C + I + G) = (X -M)
which shows that a current account deficit (surplus) is the result of the excess of domestic spending (income)
over income (spending).
Now,
Y - C - T - (I + G) + T = (X -M),
T = total taxes
or
S + (T - G) - I = (X - M),
Y - C - T = S is total private saving,
(T - G) = total government saving,
S + (T - G) = total national saving,
which shows that in an open economy, borrowing from or lending to overseas is possible. The amount of
borrowing from or lending to overseas is equal to the current account deficit (surplus).
International investment position of the U.S.
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To understand what we mean by the U.S. being a net debtor country, we need to examine the stock of
foreign assets held by the U.S. (assets) and the stock of U.S. assets held by foreign countries (liabilities to
the U.S.) at a given point in time.
Net creditor (debtor) country when the stock of foreign assets held by the U.S. is greater (smaller) than the
stock of U.S. assets held by foreign counties.