International Finance
Chapter 3
Balance of Payments
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 various BOP measures to
gauge 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.
• BOP is important indicator of pressure on a country’s
exchange rate.
– Thus indicates potential losses or gains from foreign currency
exposed positions of business firms.
• Changes in a country’s BOP may signal imposition (or
removal) of controls over payments, dividends, interest.
– Government policies to deal with BOP disequilibria.
Two Types of BOP Transactions
• Exchange of Real
Assets (for money):
– Goods:
• Cars, computers,
agricultural products,
clothing…
– Services:
• Banking, consulting,
travel, student
exchanges.
• Exchange of Financial
Assets (for money or
other financial
claims):
• Stocks, bonds, loans,
purchases (or sale) of
businesses.
Balance in the BOP
• While individual components in a country’s
BOP may be out of balance, the overall
BOP must be in balance!!!
– Transactions recorded using a double-entry
bookkeeping (in theory).
– In theory, each BOP transaction should be
recorded as both a debit and a credit entry.
– In reality the two transactions are recorded
independently (which, as you will see leads to
the errors and omissions BOP account).
DEBIT OR CREDIT?
• Basic Rule to determine BOP transaction:
• Follow the flow of money!
– If money is flowing out of a country, it is a deficit
item (recorded as a debit)
– If money is flowing into a country, it is a surplus
item (recorded as a credit)
Example of BOP Flows
• Japan Airlines purchase aircraft from Boeing
(United States)
– From U.S. standpoint: Exchange of real assets
for money:
• Aircraft exports from the U.S.: Surplus transaction
• Money inflow to U.S. manufacturer: Credit transaction.
– From Japan’s standpoint: Exchange of money for
real asset:
• Aircraft imports from the U.S.: Deficit transaction
• Money outflow from Japan: Debit transaction.
Example of BOP Flows
• British company acquires a U.S. company.
– From U.S. standpoint: Exchange of real asset for
money:
• Foreign direct investment in U.S.: Surplus transaction
• Money flow to U.S. company (shareholders): Credit
transaction.
– From U.K.’s standpoint: Exchange of money for
real asset.
• Foreign direct investment overseas: Deficit transaction
• Money outflow from U.K. company (shareholders):
Debit transaction.
Example of BOP Flows
• Canadian worker in U.S. sends money home
to family.
– From U.S. standpoint: remittances abroad.
• Net transfer abroad. Deficit transaction.
• Money outflow from U.S.: Debit transaction.
– From Canada’s standpoint: remittances from
abroad.
• Net transfer (from) abroad: Surplus transaction.
• Money inflow from U.S.: Credit 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 on balance, one in surplus while the
other experiences 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
1997 and 1998
Sources of U.S. BOP Data
• Bureau of Economic Research (an agency
of the U.S. Department of Commerce)
• http://www.bea.gov/bea/newsrel/transnewsrelea
se.htm
• What does it show?
2002
– Current Account -$481B
– Fin/Cap Account +$527B
• Difference
+$ 46B
2003
Per Day
-$542B $1.5B
+$576B
+$ 34B
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
SOURCE OF BOP DATA FOR
OTHER COUNTRIES
• 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