FINA 4324 Chapter 3: Balance-of-Payments

country's balance-of-payments (bop)

is an accounting statement that summarizes all the economic transactions of that country's citizens, businesses, and governments with citizens, businesses, and governments of all other countries.

Examples of balance-of-payments

Export and import of goods and services; cross-border investments in businesses, real estate, and financial assets; financial aid provided to or received from other countries, etc.

The financial inflows to a country (receipts from foreigners)

are treated as credits (with a positive sign)

The financial outflows from a country (payments to foreigners)

are treated as debits (with a negative sign)

An export from the U.S. creates

financial inflow to the U.S.

An import to the U.S. creates

financial outflow from the U.S.

A Japanese firm setting up a plant in the U.S. creates

financial inflow to the U.S.

An American firm setting up a plant in Europe creates

financial outflow from the U.S.

Asian investors purchasing T-bills in the U.S. create

financial inflow to the U.S.

The Balance-of-Payments Statement is based on double-entry bookkeeping

For every credit in the account, there is a matching debit, and vice-versa.

While double entry bookkeeping is to be employed in a BoP statement as per theory,

it isn't always practical.

A country's international transactions can be grouped into three main types:

Current account. Capital account. Official reserve account

statistical discrepancies

reflects omitted and misrecorded transactions, and the fact that double entry bookkeeping is employed in theory but not in practice.

The current account reflects

the net flow of goods, services, income, and unilateral transfers.

current Account: Merchandise trade

Exports and imports of tangible goods

current Account: Services

Payments and receipts for legal, engineering, consulting, and other services and tourist expenditures.

current Account: Income

Payments and receipts of interest, dividends, and other income on foreign investment.

current Account: Unilateral transfers

Gifts, foreign aid, pension payments and receipts, and other cross-border transfers for which no specific services are rendered.

Capital Account

The capital account reflects investment and lending activities.

Capital Account: Direct investment

A cross-border investment in which the investor acquires a measure of control of the foreign business. In the US Balance-of-Payments, acquisition of 10% or more of voting shares is considered a direct investment.

Capital Account: Portfolio Investment

Sales and purchases of foreign financial assets such as stocks and bonds, that do not represent a controlling interest and have a maturity greater than one year.

Capital Account: Other investment

Other investments, such as sales and purchases of foreign financial assets with maturity less than one year.

Official Reserve Account

is the total reserves held by official monetary authorities within the country.

These reserves include the major foreign currencies used in international trade such as

the USD, EUR, JPY, GBP, etc.

Let "B" be a country's balance-of-payments after cumulating the current account, the capital account, and any statistical discrepancies.

This is known as the overall balanceorofficial settlement balance.

The change in Official Reserve Account offsets

the above surplus or deficit (B).

If there is a deficit, i.e. B < 0

then the balance on official reserves would be positive. There would be a decrease in the country's official reserves (gold and foreign currencies). [A decrease in gold and foreign currencies implies a "source" of dollars.] For example, if the US has a de

The opposite would be true if there is a surplus, i.e. B > 0

and there would be an increase in the country's official reserves.

Sale of super computers to France

Current account, merchandise trade, credit

Purchase of wine from France

Current account, merchandise trade, debit

Licensing fees earned by Microsoft from software buyers in Switzerland

Current account, services, credit

Spending by American tourists in Africa

Current account, services, debit

Interest earned by American banks on loans made to other countries

Current account, income, credit

Payment of $25 million in social security benefits to Americans living in Europe

Current account, unilateral transfer, debit

Japanese automakers setting up auto plants in the U.S.

Capital account, direct investment, credit

Americans purchasing stocks of Chinese firms

Capital account, portfolio investment, debit

Japanese investors purchasing U.S. Treasury-bills:

Capital account, other investment, credit

Sale of gold by the U.S. treasury:

Official Reserve Account, credit (since sale of gold is a "source" of dollars)

Increase in holdings of Euros by the Federal Reserve

Official Reserve Account, debit (since increase in FX holdings is a "use" of dollars)

Trade Balance =

Exports of goods -Imports of goods

Services Balance =

Exports of services -Imports of services

Income Balance =

Income receipts -Income Payments

Current Account Balance=

-Capital Account Balance

One way to sustain a current account deficit is by using the official reserves. However,

that will lead to a depletion of reserves.

a current account deficit can be sustained on a long-term basis only with

a capital account surplus