Balance of Payment PhD. Trang Nguyen Trangnt.tcnh@ftu.edu.vn Balance of Payment • Fundamentals of BOP accounting • The Accounts of the Balance of Payments • BOP Impacts on Key Macroeconomic Rates • Trade Balances and Exchange rates What is the Balance of Payments • The measurement of all international economic transactions that take place between the residents of a country and foreign residents is called the balance of payments (BOP) • What are the residents of a country? => They are those economic units that together comprise the domestic economy. In Vietnam, individuals will be determined to be residents when they simultaneously satisfy the following two conditions: - Individuals must be present and live in the territory of Vietnam for at least 12 consecutive months from the first day of presence in Vietnam. - Individuals must have income in Vietnam 1. Fundamentals of BOP Accounting Defining International Economic Transactions The BOP as a Flow Statement BOP accounting What are International Economic Transactions An international economic transaction occurs when an economic value is provided by one economic unit to another. Economic values are goods, services, and financial items. Sometimes economic values are exchanged against one another. They are provided or acquired without a quid pro quo. What are International Economic Transactions • Five basic types of economic transactions: - Purchases and sales of goods and services against financial items (the interchange of goods and services against claims and monetary gold…) - Barter (the interchange of goods and services against other goods/services…) - The interchange of financial items against financial items (sales of securities against money…) - The provision or acquisition of goods and services without a quid pro quo (under grants in kind) - The provision or acquisition of financial items without a quid pro quo (in payment of taxes or as a gift) The BOP as a Flow Statement BOP is a cash flow statement. BOP tracks the continuing flows of purchases and payments between a country and all other countries. Double-entry book-keeping is employed in theory, but not in practice. BOP accounting All account entries are recorded independently of one another. There will be discrepancies between debits and credits Rules of BOP accounting • For the first three types of transaction: - Credit entries are made for the provision of goods/ services/ financial items - Debit entries are made for the acquisition of goods/ services/ financial items • The two remaining types:: - Credit entry for goods/services/financial items - Debit entry for a transfer payment (donation) - And vice versa 2. The Accounts of the Balance of Payments The current account (CA) The capital account (KA) The Financial account (FA) The official reserves account The net errors and omissions account The Current Account The current account includes all international economic transactions with income or payment flows occurring within the year, the current period: - Goods trade - Services trade - Income: current income associated with investments made in previous periods (dividends, wages, and salaries paid to nonresident workers) - Current transfers: financial settlements associated with a change in ownership of real resources or financial items (one-way gift or grant…) The Capital and Financial Accounts • The capital accounts are made up of transfers of financial assets and the acquisition and disposal of non-produced/nonfinancial assets • The Financial Accounts measure all international economic transactions of financial assets • The financial account consists of four components: direct investment, portfolio investment, net financial derivatives, and other asset investment Financial Account DIRECT INVESTMENT: the net balance of capital dispersed from and into a country that reaches a minimum ownership interest of 10%. PORTFOLIO INVESTMENT: the net balance of capital that flows into and out of a country but that does not reach the 10% ownership threshold of direct investment OTHER ASSET INVESTMENT: consists of various short-term and long-term trade credits, cross-border loans from all types of financial institutions, currency deposits and bank deposits, and other receivables and payables related to cross-border trade. Official Reserves Account • The total reserves held by official monetary authorities within a country. • They are composed of the major currencies used in international trade and financial transactions (USD, EURO, JPY, Gold, SDR) Net Errors and Omissions Accounts • Current and financial account entries are collected and recorded separately, errors or statistical discrepancies will occur. • The net errors and omissions account ensures that the BOP actually balances. 3. BOP impacts on Key Macroeconomic Rates • BOP = (X – M) + (CI – CO) + (FI – FO) + FXB Where: BOP: Balance of Payments X – M: Current Account Balance CI – CO: Capital Account Balance FI – FO: Financial Account Balance FXB: the change in Reserve Balance Exchange rate regimes • Fixed Exchange Rate countries: - The government bears the responsibility to ensure that the BOP is near zero - the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves +) CA + KA > 0 => sell domestic currency for foreign currencies or gold +) CA + KA < 0 => buy domestic currency with its reserves of foreign currencies/ golds. +) If the country runs out of foreign exchange reserves => devalue its currency Exchange rate regimes • Floating Exchange Rate countries: - the government of a country has no responsibility to peg its foreign exchange rate. +) CA + KA > 0 => a net BOP surplus => demand of domestic goods increase => DC will rise in value => CA + FA decrease => BOP = 0 sell domestic currency for foreign currencies or gold +) CA + KA < 0 => a net BOP deficit => market lower the price => DC will fall in value => CA + KA increase => BOP = 0 The BOP and Interest rates - the overall level of a country’s interest rates has an impact on the financial account. - Low i => an outflow of capital => KA deficit - High i => an inflow of capital => KA surplus The BOP and Inflation Rates - the overall level of a country’s inflation rates has an impact on the current account. - Low inflation rate => domestic => KA deficit - High i => an inflow of capital => KA surplus Trade Balances and Exchange Rates • Trade and Devaluation • The J-Curve Adjustment Path Trade and Devaluation • Countries occasionally devalue their currencies as a result of trade deficits. • What is the logic and likely result of intentionally devaluing the domestic currency to improve the trade balance? The J-Curve Adjustment path • International economic analysis characterizes the trade balance adjustment process as occurring in three stages: - The currency contract period - The pass-through period - The quantity adjustment period The J-Curve Adjustment path Q increase >> E increase EX QUANTITY OF THE CONTRACT The J-Curve Adjustment path • The currency contract period: the result of a sudden depreciation would be an increase in the size of the trade deficit • The Exchange rate Pass-through period: importers and exporters eventually must pass these exchange rate changes through to their own product prices • The Quantity Adjustment Period: achieves the balance of trade adjustment that is expected from a domestic currency devaluation or depreciation
