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Balance of Payment

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Balance of Payments

Balance of Payments

A system of accounts that measures transaction of

goods, services, income, and financial assets

between domestic residents, businesses, and

governments and the rest of the world during aspecific time period.

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Introduction

Balance of payments

Record of the economic transactions between the

residents of one country and the rest of the world

International transaction

Exchange of goods, services, or assets between

residents of one country and those of another

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Double-Entry Accounting

Arrangement of international transactions intoa balance-of-payments account

Credit: Receipt of a payment from foreigners

Debit: Payment to foreigners

Balance-of-payments accounts utilize a

double-entry accounting system

Total balance-of-payments account must balance

Subaccounts may not balance Surplus occurs when the balance is positive

Deficit occurs when the balance is negative

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BOP Statements and Accounting

Double-Entry accounting is used.

Balance of payments may not balance - individual

transactions are recorded independently and double-entry accounting is used in theory only.

Will be balanced by the net errors and omissions

account.

Cash flow statement dominated by two types of

business transactions -

Real assets

Financial assets

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Balance-of-Payments Structure:

Current Account

Monetary value of international flowsassociated with transactions Merchandise trade

Merchandise trade balance: Combining the exports and

imports of goods Exports and imports of services

Goods and services balance

Add services to the merchandise trade account

Income receipts and payments

Unilateral transfers Private transfer payments

Governmental transfers

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Capital and Financial Account

All international purchases or sales of assets Includes both private-sector and official transactions

Capital transactions

Capital transfers

Acquisition and disposal of certain nonfinancial assets

Private-sector financial transactions

Direct Investment

Securities

Bank Claims and Liabilities

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Capital and Financial Account Financial inflows and outflows

A capital (financial) inflow can be likened to theexport of goods and services

A capital (financial) outflow is similar in effect to the

import of goods and services. Official settlements transactions

Movement of financial assets among official holders Official reserve assets

Liabilities to foreign official agencies

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Balance-of-Payments Accounts

Current Account Measures the flow of goods, services, income, and

transfers or gifts between domestic residents,

businesses, and governments and the rest of the

world. Goods: imports and exports of tangible goods.

Services: imports and exports of services, tourism and

travel, and military transactions.

Income: interest and dividend payments to foreign holders

of domestic financial assets.

Unilateral transfers: international transfers, or gifts,

between individuals and governments.

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Balance-of-Payments Accounts

(contd)

Capital AccountA tabulation of the flows of financial assets between

domestic private residents and businesses and

foreign private residents and businesses.

Includes three categories of financial assets: Financial assets of the domestic government

Private domestic financial assets

Foreign financial assets.

Tabulates two types of asset flows Investment flows and changes in banks and brokers cash

deposits that arise from foreign transactions.

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611

Deficits and Surpluses in the Balance

of Payments (contd)

Balance-of-Payments Deficit

The sum of the credits and debits in the current

account and the private capital account is negative.

Balance-of-Payments SurplusA situation where the sum of the debits and credits in

the current and private capital account is positive.

Balance-of-Payments Equilibrium

A situation where the sum of the debits and credits inthe current account and the private capital account is

zero.

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What does a Current Account Deficit

(Surplus) Mean?

Total debits will always equal total credits If the current account registers a deficit, the capital

and financial account must register a surplus, or net

capital/financial inflow

If the current account registers a surplus, the capitaland financial account must register a deficit, or net

capital/financial outflow

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Net Foreign Investment and the

Current Account Balance

Current account balance

Synonymous with net foreign investment in national

income accounting

Current account surplus - net supplier of funds

Current account deficit - net demander of funds

Net borrowing of the nation:

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Impact of Financial Flows on the

Current Account

Capital and financial flows may initiate changes inthe current account

Countrys current account deficit can be caused by

a net financial inflow to the Country

Appreciating dollar makes imports cheaper and exportscostly

Declining exports and increasing imports results in a rise in

the current account deficit, or a decline in the current

account surplus

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Is a Current Account Deficit a

Problem?

Benefit of a current account deficitAbility to push current spending beyond current

production

Cost of debt service

Debt: Good or bad for a nation? Is the deficit used to finance more consumption or more

investment?5

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Business Cycles, Economic Growth,

and the Current Account

Current account and economic performance Rapid growth of production and employment:

Large or growing trade and current account deficits

Slow output and employment growth

Large or growing surpluses

Holds for both short-term and long-term

Economic growth, employment growth, and trade

balances

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International Economic Crisis Path

Country has Current

Account deficit and

a Financial Account

surplus

Capital acts as

financing for

growingmerchandise/service

s deficits

Event questions

countrys economic

stability- investorswithdraw capital

rapidly

Capital flight

causes loss of

financial account

surplus - deficit in

overall balance of

payments results

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Recession or depression.

Reduction in world demand for

products.

World markets suffer severe pricereductions as demand falls.

Declining earnings and growth

prospects for other emerging

economies.

Global Effects of Economic Crisis

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