International Financial
Management: INBU 4200
Fall Semester 2004
Lecture 5: Part 2
Balance of Payments
(Chapter 3)
The Balance of Payments
• Balance of Payments (BOP):
– A measurement of all international economic
and financial transactions between the
residents of a country and foreign residents.
– The International Monetary Fund (IMF) is the
primary source of similar statistics worldwide.
– Think of a country’s BOP as a country cash
flow account (statement); NOT as a balance
sheet.
• Represents transactions over some period of time
Use of BOP Data by Businesses
• Multinational businesses use BOP measures to assess
the growth and health of specific types of trade or
financial transactions by country.
– BOP helps to forecast a country’s market potential; where
business may opportunities exist.
– What are country’s buying (imports), selling (imports), etc.
• BOP is important indicator of potential pressure on a
country’s exchange rate.
– Surplus countries generally have strong currencies.
– Deficit countries generally have weak currencies.
– Thus, BOP indicates suggests the potential exposure from
international activities.
• Or, the potential losses or gains from foreign currency exposed
positions of business firms.
Two Types of BOP Transactions
• Cross Border purchase
(or Sale) of Real Assets:
– Goods:
• Cars, computers, clothing,
agricultural products,
industrial products…
– Services:
• Banking, consulting, air
travel, student exchange
programs, foreign
workers.
– Enterprises:
• Cross border acquisitions
of companies in other
countries.
• Cross Border purchase
(or Sale) of Financial
Assets:
– Equity
• Stocks
– Debt
• Bonds, bank loans.
Balance in the BOP
• While individual components in a country’s BOP
are likely to out of balance, the overall BOP must
be in balance.
• Why?
– Transactions recorded using a double-entry
accounting bookkeeping methodology (in theory).
• Thus, in theory, each BOP transaction should be recorded as
both a debit and a credit entry.
• In reality the two transactions are recorded independently
• Thus, the debits and credits are not likely to be equal.
– BOP is balances through an errors and omissions account.
Debit or Credit Transactions
• Basic Rule to determine debit or credit BOP
transaction.
• Follow the flow of money!
– If money is flowing out of a country, it is recorded
as a debit transactions, and hence a BOP deficit.
– If money is flowing into a country, it is recorded
as a credit transaction, and hence a BOP
surplus.
Example of BOP Flows
• Japan Airlines purchase aircraft from Boeing
(United States)
– From U.S. BOP standpoint: Sale of real asset.
• Money inflow to U.S. manufacturer: Credit transaction.
• Aircraft exports from the U.S.: Surplus transaction
– From Japan’s BOP standpoint: Purchase of real
asset.
• Money outflow from Japan: Debit transaction.
• Aircraft imports from the U.S.: Deficit transaction
Example of BOP Flows
• British company acquires a U.S. company.
– From U.S. BOP standpoint: Sale of real asset.
• Money flow to U.S. company (shareholders): Credit
transaction.
• Foreign direct investment in U.S.: Surplus transaction.
– From U.K.’s BOP standpoint: Purchase of real
asset.
• Money outflow from U.K. company (shareholders):
Debit transaction.
• Foreign direct investment overseas: Deficit transaction
Example of BOP Flows
• Canadian worker in U.S. sends money home
to family in Vancouver, B.C..
– From U.S. BOP standpoint: remittances abroad.
• Money outflow from U.S.: Debit transaction.
• Net transfer abroad. Deficit transaction.
– From Canada’s BOP standpoint: remittances
from abroad.
• Money inflow from U.S.: Credit transaction.
• Net transfer (from) abroad: Surplus transaction.
Balance of Payments Accounts
• The BOP is divided into two major accounts:
– the Current Account and the Capital/Financial
Account.
– Current Account tracks:
• Balance of Trade: (net) merchandise exports and imports.
• Services Balance: (net) financial services and travel (other)
services
– Financial: Provided by banks to non-residents.
– Travel/other: Provided by domestic entities to foreign country
residents, such as meals, hotels, air travel, student exchanges,
construction.
• Income Balance: (net) investment income from abroad and to
foreign entities (arises from previous investments).
• Net Transfers: (net) private remittances to residents abroad
(money/gifts) or by governments (aid).
Balance of Payments Accounts
• Capital/Financial Account captures cross border
investments during the recorded period. These
include:
– Purchases (or sales) of real estate.
– (net) Direct investment (FDI).
• FDI in the U.S. minus U.S. FDI abroad (positive number if net
direct investment into the U.S.; and thus capital inflow)
– (net) Portfolio investment
• Non-controlling equity investments (<10%)
• Debt investments.
– Either personal or institutional (mutual funds)
– Portfolio investment in the U.S. minus U.S. portfolio investment
abroad (positive number if net portfolio investment in the U.S.;
and thus capital inflow).
– (net) Other financial transactions
• Bank loans, trade credit
Other BOP Accounts
• Two additional BOP accounts are:
– Official Reserve Account: tracks the
transactions by the official monetary
authorities (central bank and treasury
department) of a country:
• Increase in international reserves (major
currencies of the world: dollar, yen, euro, gold).
– Net Errors and Omissions: Balancing account;
included because transactions are collected
individually (double entry bookkeeping in
theory).
Current and Capital Account
• The two major sub-accounts of the BOP, the
Current and Financial Account, summarize the
current trade and international capital flows of
the country respectively
• The Current and Financial Account are typically
inverse, i.e., one in surplus while the other is in
deficit
– In fact, a deficit in a country’s current account needs
to be financed through a surplus in its financial
account!
– If not, pressures will be placed on the exchange rate!
– Issuing facing the United States today!
• Reason for the U.S. dollar performance of late!
Current and Financial/Capital Account Balances for the
United States, Annual Data 1992-99 (billions of US$)
$400
$300
$200
$100
$0
-$100
-$200
-$300
-$400
1992
1993
1994
1995
1996
1997
1998
Source: International Monetary Fund, Balance of Payments Statistics Yearbook, 2000.
Current account
Financial/capital account
1999
Response of Exchange Rate to 1997 and 1998
U.S. Current and Capital Account Imbalance.
• Note: Relate back to previous slide.
Thailand’s BOP in the 1990s
25
20
Billions of US dollars
15
10
5
0
1991
1992
1993
1994
1995
1996
1997
1998
-5
-10
-15
-20
Current Account
Capital/Financial Account
Source: International Financial Statistics, International Monetary Fund, Washington DC, monthly.
Thai Baht in 1997
SOURCE OF BOP DATA
• The Economist
– Trade Balance, Current Account Balance and
Forecasts
• Economic and Financial Indicator Section
• OECD Country data (Current Account)
– http://www.oecd.org/LongAbstract/0%2C2546
%2Cen_2649_33715_2487499_119656_1_1_
1%2C00.html