Economics of International Finance Econ. 315

Economics of International Finance Economics of International Finance Prof. M. El-Saqqa Prof. M. El-Saqqa CBA. Kuwait University CBA. Kuwait University

Economics of International FinanceEconomics of International FinanceEcon. 315Econ. 315

Chapter 1:Chapter 1:Balance of PaymentsBalance of Payments


Balance of Payments (BOP) Definition:Balance of Payments (BOP) Definition: A A SummarySummary statement in which all statement in which all TRANSACTIONSTRANSACTIONS of the of the RESIDENTSRESIDENTS

in a nation with the residents of all other nations (in a nation with the residents of all other nations (NON-RESIDENTSNON-RESIDENTS) ) which are recorded during a particular which are recorded during a particular PERIODPERIOD of time (usually one of time (usually one calendar year).calendar year).

Purpose: Purpose: inform the government of the international position of the nationinform the government of the international position of the nation Help in formulating monetary, fiscal and trade policies. Help in formulating monetary, fiscal and trade policies.

What is meant by:What is meant by:1.1. International transactions:International transactions:- The exchange of a The exchange of a goodgood, , serviceservice or an or an asset,asset, between the residents of between the residents of

one nation and the residents of other nations (one nation and the residents of other nations (payments are required payments are required for these transactionsfor these transactions). ).

- Gifts and other transfer payments are also included (Gifts and other transfer payments are also included (No Payments are No Payments are required hererequired here).).


2.2. The residents and Non-residents:The residents and Non-residents:Residents are Residents are Persons and other bodies that are Persons and other bodies that are normally residents in the country, Note:normally residents in the country, Note:

• Temporary immigrantsTemporary immigrants, e.g., diplomats, tourists and , e.g., diplomats, tourists and temporary workers are temporary workers are not residentsnot residents (they are residents of (they are residents of the country in which they hold citizenship). the country in which they hold citizenship).

• CorporationsCorporations are residents of the country in which they are are residents of the country in which they are incorporated, but incorporated, but branchesbranches and subsidiariesand subsidiaries are not. are not.

• International institutionsInternational institutions (UN, WB, IMF, WTO ..etc) are non (UN, WB, IMF, WTO ..etc) are non residents at the country in which they are located. residents at the country in which they are located.


3.3. The period The period Usually a Usually a calendar year, calendar year, however most of the countries however most of the countries

keep a record on a quarterly basis (keep a record on a quarterly basis (e.g., Kuwaite.g., Kuwait).).

BOP Accounting principlesBOP Accounting principles

Credits and debitsCredits and debits

1.1. Credit Transactions:Credit Transactions: involve involve receipts of paymentsreceipts of payments from from foreigners (foreigners (entered with a +ve sign because they involve entered with a +ve sign because they involve receipts of paymentsreceipts of payments), e.g., ), e.g., Export of goods and servicesExport of goods and services Gifts and aid received from foreignersGifts and aid received from foreigners Capital inflowsCapital inflows


2.2. Debit Transactions:Debit Transactions: involve the involve the making of paymentsmaking of payments to to foreigners (foreigners (entered with a -ve sign because they involve entered with a -ve sign because they involve making of paymentsmaking of payments), e.g., ), e.g., Imports of goods and servicesImports of goods and services Gifts and aid given to foreignersGifts and aid given to foreigners Capital outflowsCapital outflows

Capital inflows (credit):Capital inflows (credit): take two forms: take two forms:- An- An increase in foreign assets in the nation (increase in foreign assets in the nation (an American an American

investor purchases an asset in Kuwaitinvestor purchases an asset in Kuwait))- A reduction of the nation’s assets abroad (- A reduction of the nation’s assets abroad (A Kuwaiti investor A Kuwaiti investor

sells an asset in the UKsells an asset in the UK))

They both involve aThey both involve a receipt of payments receipt of payments from foreigners (i.e., capital from foreigners (i.e., capital inflows and are thus inflows and are thus credit transactionscredit transactions))


Capital outflows (debit):Capital outflows (debit): take two forms:take two forms:- an increase in the nations assets abroad (- an increase in the nations assets abroad (a Kuwaiti investor a Kuwaiti investor

purchases an asset in the UKpurchases an asset in the UK))- reduction of foreign assets in the nation (- reduction of foreign assets in the nation (an American an American

investor sells an asset in Kuwaitinvestor sells an asset in Kuwait))

They both InvolveThey both Involve payments to foreigners payments to foreigners (i.e., capital outflows (i.e., capital outflows and are thus and are thus debit transactionsdebit transactions). ).

Double entry bookkeepingDouble entry bookkeeping Each international transaction is recorded Each international transaction is recorded twice,twice, once in the once in the

credit and once in the debit of an equal amount. The reason credit and once in the debit of an equal amount. The reason for this is that every transaction has two sides (credit and for this is that every transaction has two sides (credit and debit). debit).


Example 1.Example 1. Kuwait exports $ 500 mn. of oil to be paid for in three Kuwait exports $ 500 mn. of oil to be paid for in three months.months.

Note the following: Note the following:

Exports of oil are entered as credits (Exports of oil are entered as credits (lead to receipts of payments from lead to receipts of payments from foreignersforeigners))

The payment itself is entered as a capital outflow (debit), The payment itself is entered as a capital outflow (debit), why?why?When Kuwait agrees to wait for three months for payments, it extends When Kuwait agrees to wait for three months for payments, it extends a a creditcredit to foreign importers (capital outflows). to foreign importers (capital outflows). This is an increase in This is an increase in domestic assets abroad (i.e. a debit)domestic assets abroad (i.e. a debit)

Credit (+)Credit (+) Debit (-)Debit (-)

Oil exportsOil exportsCapital outflow Capital outflow (an increase in Kuwaiti assts (an increase in Kuwaiti assts abroad)abroad)

500500500500


Example 2.Example 2. Kuwaiti tourists visit London and spend $ 200 mn. on Kuwaiti tourists visit London and spend $ 200 mn. on hotels, meals.. etc. hotels, meals.. etc. Note the following:Note the following:

Kuwaiti tourists purchased services from foreigners (require Kuwaiti tourists purchased services from foreigners (require payments to foreigners). This is similar to imports (payments to foreigners). This is similar to imports (debitdebit). ).

The payment is entered as a credit, as it represents an increase The payment is entered as a credit, as it represents an increase in in foreign claims on Kuwaitforeign claims on Kuwait, i.e. , i.e. an an increase in foreign assetsincrease in foreign assets in in Kuwait or a Kuwait or a capital inflowcapital inflow to Kuwait. to Kuwait.


Travel services purchased from foreignersTravel services purchased from foreignersCapital inflow (a rise in foreign assets in Capital inflow (a rise in foreign assets in Kuwait)Kuwait) 200200

200200


Example 3.Example 3. Kuwait gives a $ 100 mn. Kuwait gives a $ 100 mn. bank balancebank balance to the to the government of a less developed country (government of a less developed country (aidaid). ). Note the Note the following:following:

This unilateral transfer is a debit (This unilateral transfer is a debit (requires payments to requires payments to foreignersforeigners).).

The payment (an increase in a bank account) itself represents The payment (an increase in a bank account) itself represents an increase in foreign claims (of assets) in Kuwait.an increase in foreign claims (of assets) in Kuwait.


Unilateral transfers (aid)Unilateral transfers (aid)Capital inflowCapital inflow 100100

100100


Example 4.Example 4. A Kuwaiti resident purchases foreign stocks of $ 400 A Kuwaiti resident purchases foreign stocks of $ 400 mn. and pays for it by increasing foreign bank balances in mn. and pays for it by increasing foreign bank balances in KuwaitKuwait. . Note the following: Note the following:

The purchase of foreign stocks increases Kuwaiti assets abroad. This The purchase of foreign stocks increases Kuwaiti assets abroad. This is a capital outflow (is a capital outflow (debitdebit). ).

The payment is an increase in foreign assets in Kuwait. This is a The payment is an increase in foreign assets in Kuwait. This is a capital inflow (capital inflow (creditcredit). ). (Note: If the Kuwaiti resident paid for the foreign stock by reducing (Note: If the Kuwaiti resident paid for the foreign stock by reducing bank balances abroad; the payment will be a reduction in Kuwaiti bank balances abroad; the payment will be a reduction in Kuwaiti assets abroad, this is also a capital inflow and thus is a credit). assets abroad, this is also a capital inflow and thus is a credit).

Credit Credit (+)(+)

Debit (-)Debit (-)

Capital outflow (purchase of foreign stocks)Capital outflow (purchase of foreign stocks)Capital inflow (the increase in foreign bank Capital inflow (the increase in foreign bank balances)balances) 400400

400400


Example 5.Example 5. A foreign investor purchases $ 300 mn. of Kuwaiti A foreign investor purchases $ 300 mn. of Kuwaiti treasury bills and pays by drawing down his bank balances in treasury bills and pays by drawing down his bank balances in KuwaitKuwait. . Note the following:Note the following:

the purchase of the treasury bills is an increase in foreign the purchase of the treasury bills is an increase in foreign assets in Kuwait (assets in Kuwait (creditcredit))

The drawing down of Kuwaiti bank balances by foreigners is a The drawing down of Kuwaiti bank balances by foreigners is a reduction in foreign assets in Kuwait. this is a capital outflow reduction in foreign assets in Kuwait. this is a capital outflow ((debitdebit).).


Capital inflow (purchase of Kuwaiti Capital inflow (purchase of Kuwaiti treasury bill by foreigner)treasury bill by foreigner)Capital outflow (the reduction in foreign Capital outflow (the reduction in foreign bank balances in Kuwait)bank balances in Kuwait)

300300

300300


The results of the previous transactions on Kuwait’s balance of The results of the previous transactions on Kuwait’s balance of payments would be:payments would be:

Capital flows = (-500 +200 +100 +400 -400 +300 -300) = -200Capital flows = (-500 +200 +100 +400 -400 +300 -300) = -200

Note: the net capital debit balance -200 is obtained by adding Note: the net capital debit balance -200 is obtained by adding together the seven capital entriestogether the seven capital entries

Balance of payments Balance of payments Credit (+)Credit (+) Debit (-)Debit (-)

Goods (oil)Goods (oil)ServicesServicesUnilateral transfersUnilateral transfersCapital netCapital net

Total debits and creditsTotal debits and credits

500500

----------------500500

200200100100200200

--------------500500


Accounting balances and disequilibrium in international Accounting balances and disequilibrium in international transactionstransactions

1.1. The Current Account: The Current Account: lumps together all sales and purchases of lumps together all sales and purchases of goodsgoods and and servicesservices, ,

investment incomesinvestment incomes, and , and unilateral transfersunilateral transfers. . It provides the link between the nations international transactions It provides the link between the nations international transactions

and its and its national incomenational income. . The current account surplus The current account surplus stimulates stimulates domestic production and domestic production and

income, while a current deficit income, while a current deficit dampensdampens domestic production and domestic production and income. income.

2.2. The capital Account: The capital Account: Measures the change in the stock of all Measures the change in the stock of all non-reservenon-reserve financial assets. financial assets. Reserve changes are Reserve changes are excludedexcluded from the capital account because from the capital account because

they represent the government policy (they represent the government policy (below the line transactionsbelow the line transactions) ) rather than market forcesrather than market forces..

The capital account shows the net increase in the The capital account shows the net increase in the privately ownedprivately owned net assets abroad. net assets abroad.


Autonomous transactions.Autonomous transactions. All transactions in the current account and capital account are All transactions in the current account and capital account are

called “called “autonomousautonomous”, because they take place for ”, because they take place for businessbusiness oror profitprofit motivesmotives (except for unilateral transfers), and are (except for unilateral transfers), and are independentindependent of BOP considerations. of BOP considerations.

They are sometimes called “They are sometimes called “the items above the linethe items above the line””

Transactions in official reserves. Transactions in official reserves. They are called They are called accommodating transactionsaccommodating transactions ( (items below the items below the

lineline), because they are needed to balance international ), because they are needed to balance international transactions. transactions.

Below the line items form the “Below the line items form the “official reserve accountofficial reserve account”, and its ”, and its balance is called “balance is called “the official settlements balancethe official settlements balance”.”.

Do you know now what do we mean by the line?Do you know now what do we mean by the line?


Balance of payments: DeficitBalance of payments: Deficit If total debits exceed credits in current and capital accounts, If total debits exceed credits in current and capital accounts,

the net “the net “debitdebit” balance measures the “” balance measures the “deficitdeficit” in the country’s ” in the country’s BOP. BOP.

The deficit is The deficit is settled with an settled with an equalequal net “net “creditcredit” (to offset the ” (to offset the deficit), in the official reserve account. Deficit, can thus be deficit), in the official reserve account. Deficit, can thus be measured by the excess of measured by the excess of creditscredits over over debitsdebits in the official in the official reserve account.reserve account.

Balance of payments: SurplusBalance of payments: Surplus

If total credits exceed debits, in current and capital account, If total credits exceed debits, in current and capital account, there will be a there will be a surplussurplus in the BOP. in the BOP.

The surplus is settled by an The surplus is settled by an equalequal net “ net “debitdebit” in the official ” in the official reserve account. The surplus, can thus be measured by the reserve account. The surplus, can thus be measured by the excess of excess of debitsdebits over over creditscredits in the official reserve account. in the official reserve account.


Revision. Enter the following transactions in the BOP of KuwaitRevision. Enter the following transactions in the BOP of Kuwait

1.1. A Kuwaiti resident purchases a $ 1000 mn foreign stock and pays for it by A Kuwaiti resident purchases a $ 1000 mn foreign stock and pays for it by drawing down her bank balances abroad. drawing down her bank balances abroad.

2.2. A Kuwaiti resident receives a dividend of $ 100 mn on her foreign stock and A Kuwaiti resident receives a dividend of $ 100 mn on her foreign stock and deposits it into her bank account abroad. deposits it into her bank account abroad.

3.3. General Motors Co. purchases $ 100 mn PCs from China. General Motors Co. purchases $ 100 mn PCs from China. 4.4. A Kuwaiti computer manufacturer buys $ 20 mn hard disks from a Chinese A Kuwaiti computer manufacturer buys $ 20 mn hard disks from a Chinese

company and deposits the proceeds in NBK, China uses the proceeds to company and deposits the proceeds in NBK, China uses the proceeds to purchase oil. purchase oil.

5.5. The Kuwaiti government gives a $ 100 mn cash balance in a Kuwaiti bank to The Kuwaiti government gives a $ 100 mn cash balance in a Kuwaiti bank to a developing nation as part of the foreign aid program. a developing nation as part of the foreign aid program.

6.6. The developing nation uses the $ 100 mn bank balance to import $100 worth The developing nation uses the $ 100 mn bank balance to import $100 worth of oil from Kuwait. of oil from Kuwait.

7.7. An American tourist spends $ 20000 on hotels in Malaysia. An American tourist spends $ 20000 on hotels in Malaysia. 8.8. An American investor purchases $ 150 mn Kuwaiti stocks and pays by An American investor purchases $ 150 mn Kuwaiti stocks and pays by

increasing the seller's bank account in USA. increasing the seller's bank account in USA. 9.9. The American investor receives $ 15 mn on his Kuwaiti Stock and deposits The American investor receives $ 15 mn on his Kuwaiti Stock and deposits

the value in his bank account in Kuwait. the value in his bank account in Kuwait.


Current AccountDescription(Million Dinars) 2012 2013 2014

Debit Credit Debit Credit Debit Credit First : Current Account(A+B+C): - 22034 - 19789 - 14373 A - Goods and Services Account - 23274 - 21052 - 16941 1 - Balance on Goods: - 26706 - 25520 - 21613 - Goods : Exports (f.o.b.), of which: - 33492 - 32854 - 29405 - Oil Exports - 31608 - 30790 - 27515 - Goods : Imports (f.o.b.) 6786 - 7334 - 7790 - 2 - Services 3432 - 4468 - 4672 - - Transportation 1871 1142 1500 346 1567 466 - Travel 2589 119 3277 84 3219 105 - Communications 67 965 120 952 105 875 - Construction 579 - 370 - 606 - - Other Services 497 83 543 114 606 164 - Government Goods & Services 303 164 321 166 486 305 B - Primary Income - 3554 - 3450 - 3525 1 - Compensation of Employees 39 1 37 1 49 - 2 - Investment Income - 3592 - 3486 - 3572 - Direct Investment 206 1353 322 1056 451 1005 - Portfolio Investment 7 1907 15 2318 10 2429 - Other Investment 113 572 84 450 71 585 - Reserve Assets - 86 - 83 - 85 C - Secondary Income 4794 - 4713 - 6093 - 1- General Government 344 1 381 1 720 - 2- Other Sectors, of which: 4451 - 4333 - 5374 - -Workers Remittances 4289 - 4170 - 5325 -


Description(Million Dinars) 2012 2013 2014 Debit Credit Debit Credit Debit Credit

Second : Capital Account(A+B): - 1188 - 1268 - 1152 A - Capital Transfers - 1188 - 1276 - 1152 Third : Balance of Current & Capital Account

- 23221 - 21057 - 15524 Fourth : Financial Account (1+2+3+4+5) :

23524 - 20505 - 17053 - 1 - Direct Investment: 1083 - 1934 - 3848 - 2 - Portfolio Investment (Net) 6695 - 8300 - 13595 - 3 - Financial derivatives (Net): - 18 11 - 3 26 4 - Other Investments (Net): 14835 - 9302 - 3051 3776 5 - Reserve Assets (CBK) : 928 - 957 - 945 595 - Monetary Gold - - - - - - - Special Drawing Rights - 14 - 1 10 - - Reserve Position in the Fund 14 - 28 - 5 6 - Other reserve assets, of which: 927 - 930 - 933 592 Currency and Deposits 927 - 930 - 933 592 Fifth : Net Errors & Omissions - 303 552 - 1039 2567 Overall Balance - 928 - 957 - 350


Key TermsKey Terms

• Balance of payments Capital account

• Credit transactions Autonomous transactions

• Debit transactions Accommodating transactions

• Capital inflow Official reserve account

• Capital outflow Official settlements balance

• Double-entry bookkeeping Deficit in the balance of payments

• Unilateral transfers Surplus in the balance of payments

• International investment position Current account

Economics of International Finance Econ. 315

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Transcript of Economics of International Finance Econ. 315