Management 3460
Institutions and Practices in
International Finance
Fall 2003
Greg Flanagan
Chapter 3
The Balance of Payments
Chapter Objectives:
The student will be able to:
Explain the balance of payments accounts;
 interpret the accounts;
explain the BP effect on floating exchange
rates;
Explain the effect of government intervention
on the FE market;
Be aware of the trends in international BP.
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September 30, 2003
Outline
 Balance of Payments Accounts
 The Current Account
 The Capital Account
 Statistical Discrepancy
 Official Reserves Account
 The Balance of Payments Identity
 Canadian Balance of Payments Data
 The effect of BP on exchange rates
 Balance of Payments Trends in Major Countries
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Balance of Payments Accounting
The Balance of Payments is the statistical
record of a specific country’s international
transactions over a certain period of time
(annual) using double-entry bookkeeping.
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September 30, 2003
Balance of Payments Accounts
records all transactions between the
residents of a country and residents of all
foreign nations.
composed of the following:
The Current Account
The Capital Account
The Official Reserves Account
Statistical Discrepancy
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September 30, 2003
The Current Account
iMports and eXports of goods
“balance of merchandise trade”
mercantalism
and imports and exports of services
including:
investment income;
unilateral transfers (foreign aid).
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September 30, 2003
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September 30, 2003
The Current Account
Current account balance
If balance < 0 (debits exceed
credits), then a country is running a
trade deficit.
If balance > 0 (credits exceed
debits), then a country is running a
trade surplus.
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September 30, 2003
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The Capital Account
The capital account measures the
difference between sales of assets to
foreigners and purchases of foreign
assets.
The capital account is composed of
direct investment (FDI);
portfolio investments and;
other investments.
Reported as Canadian Assets Abroad
and Canadian Liabilities to non-residents
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September 30, 2003
Difference between Capital
and Current account balance
The balance of payments (BP) must
balance!
Official reserves can rise and fall
assets include gold, foreign currencies,
SDRs, reserve positions in the IMF.
Statistical discrepancy
some omissions and errors therefore a
estimate makes the accounts balance.
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September 30, 2003
The Balance of Payments Identity
BCA + BKA + BRA = 0
Where:
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves
account
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September 30, 2003
Cdn Balance of Payments 2002
Current Account $'000,000
Investment income
Goods & services
Exports
472,628
Imports
Balance
423,112
1 49,516
Goods
Receipts
31,638
Payments
59,149
of which: interest
29,643
Balance
2 -27,511
Receipts
414,305
Current transfers
Payments
Balance
356,459
57,846
Balance
Payments
Balance
of which: travel
16
1,361
Total
Services
Receipts
3
58,323
Receipts
511,268
66,653
-8,330
-1,853
Payments
487,902
Balance
1+2+3=4
4 23,366
September 30, 2003
Total
-13,145
Financial account
-17,961
Direct investment abroad
-45,217
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3
Portfolio assets
Capital and
Financial Account
$'000,000
Stocks
-18,707
Bonds
-6,243
Other investment assets
-10,657
Total Canadian assets
abroad
-80,825
Direct investment in
Canada
1
1+2 = 3
32,342
Portfolio liabilities
Stocks
-1,436
Bonds
18,712
Money market
3,782
Other investments
9,464
Total Canadian liabilities
to non-residents
17
3+4 = 5
Capital account
62,864
2
4,816
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September 30, 2003
Effect of Balance of Payments on
the Foreign Exchange Market
Reciprocal markets
Demand for foreign goods (imports) =
demand for FE
Demand for Cdn goods (exports) = supply
of Cdn$
Debits = demand for foreign exchange/
supply of Cdn$.
Credits = supply of foreign exchange/
demand
for Cdn$.
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Floating Foreign Exchange
Market
If the current account + capital account > 0
i.e. Trade surplus a Qs > Qd a Cdn$ i
If the current account + capital account < 0
i.e. Trade deficit a Qd > Qs a Cdn$ h
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September 30, 2003
Foreign Exchange Market
BP < 0 (Trade deficit)
Cdn$
BP > 0 (Trade surplus)
Cdn$
S
S
i
D
D
QUS$
Cdn$ depreciates
QUS$
Cdn$ appreciates
A floating exchange rate adjusts automatically
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September 30, 2003
Intervention in the Foreign
Exchange Market
the current account + capital account < 0
a Qs < Qd a Cdn$ h
Bank of Canada sells foreign exchange
= increase in supply of FE a Cdn$ h
If the current account + capital account > 0 If
a Qd < Qs a Cdn$ i
Bank of Canada buys foreign exchange
= increase in demand of FE a Cdn$ i
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Foreign Exchange Market
B of C buys FE
B of C sells FE
Cdn$
Cdn$
S
S
S*
h
D
D*
D
QUS$
Cdn$ appreciates
QUS$
Cdn$ depreciates
The Bank of Canada can intervene in the FE market
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September 30, 2003
Balance of Payments Trends
Canada has usually experienced surpluses
on the current account and deficits on the
capital account.
Since 1982 the U.S. has experienced
continuous deficits on the current account
and continuous surpluses on the capital
account.
During the same period, Japan has
experienced the opposite of the U.S.,
similar to Canada.
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
the United States
500
400
300
200
100
0
-1001982 1984 1986 1988 1990 1992 1994 1996 1998 2000
U.S. BCA
U.S. BKA
-200
-300
-400
-500
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Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
United Kingdom
40
30
20
10
0
-101982
UK BCA
1984
1986
1988
1990
1992
1994
1996
1998
2000
UK BKA
-20
-30
-40
-50
25
Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
Japan
150
100
50
0
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
-50
Japan BCA
Japan BKA
-100
-150
26
Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
Germany
80
60
40
20
0
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
-20
Germany BCA
Germany BKA
-40
-60
-80
27
Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
China
35
30
25
20
15
10
5
China BCA
China BKA
0
-51982 1984 1986 1988 1990 1992 1994 1996 1998 2000
-10
-15
28
Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003
Balance of Payments Trends
Germany traditionally had current account
surpluses, since 1991 Germany has been
experiencing current account deficits.
This is largely due to German reunification
and the resultant need to absorb more
output domestically to rebuild the former
East Germany.
What matters is the nature and causes of
the disequilibrium.
September 30, 2003
Balances on the Current (BCA)
and Capital (BKA) Accounts of
Five Major Countries
500
China BCA
400
China BKA
300
Japan BCA
200
Japan BKA
100
0
-1001982
Germany BCA
1984
1986
1988
1990
1992
1994
-200
-300
1996
1998
2000
Germany BKA
UK BCA
UK BKA
-400
U.S. BCA
-500
U.S. BKA
30
Source: IMF International
Financial Statistics Yearbook, 2000
September 30, 2003