Balance of Payments
Dr Renata Orłowska
IB 2015/2016
Lecture Objective:
to introduce students to the balance of
payments.
How it is constructed and how balance of
payments data may be interpreted.
• Balance of Payments Accounting
• Balance of Payments Accounts
▫
▫
▫
▫
The Current Account
The Capital Account
Statistical Discrepancy
Official Reserves Account
• The Balance of Payments Identity
• Balance of Payments Trends in Major
Countries
Statistics
• As economist you need an overall view of your
money transaction with the rest of the word
• The government system for analysing this is the
Balance of Payments (BOP)
• It is made up of three seperate accounts.
Together it measures all of the economic
transactions that one country has with the rest of
the world in one year
Current Account
Capital Account
Financial Account
Definition: The balance of payments is a record of
transactions between residents of a country and
residents of the rest of the world.
The balance of payments is use to:
• project exchange rates
• assess the health of the economy
• assess the credit worthiness of an
economy
N.B. when we say “a country’s balance of payments” we are referring to the
transactions of its citizens and government.
BOP records all the transactions that create
demand for and supply of a currency.
This indicates demand-supply equation of the
currency. This can drive changes in exchange
rate of the currency with other currencies.
BOP may confirm trend in economy’s
international trade and exchange rate of the
currency. This may also indicate change or
reversal in the trend.
This may indicate policy shift of the monetary
authority of the country.
BOP
• The BOP summarises international
transactions for a specific period, usually a
year, and is prepared in a single currency,
typically the domestic currency for the
country concerned.
• The BOP is maintained on a double-entry
bookkeeping system
The Balance of Payments Accounts
• A country’s balance of payments accounts keep
track of both its payments to and its receipts
from foreigners.
• Every international transaction automatically
enters the balance of payments twice: once as a
credit (+) and once as a debit (-).
Definition. Assets are economic resources which are
expected to benefit future activities.
Definition. Liabilities are outsiders claims against
assets.
Definition. Credit : this means “right”.
Definition. Debit : this means “left”.
Balance of Payments
The difference between receipts and payments
BOP Receipts
• costs of goods exported.
• money spent by foreign
tourists.
• transportation.
• payments of dividends
and interest from FDI
abroad.
• new foreign investments
BOP Payments
• costs of goods imported.
• spending by tourists
abroad
• new overseas
investments.
• cost of foreign aid.
Balance of Payments
The Balance of Payments includes three accounts:
(1) current account
(2) capital account
(3) fianacial account
Current Account (CA)
• The Current Account is a record of transactions
affecting the left-hand side of the budget
constraint.
• It is a measure of the change in a country’s net
worth.
• It is a record of trade in goods in services
(including the services of capital and labour) and
gifts.
Current Account
•
•
•
•
Merchandise Trade
Services
Income
Current Transfers
Merchandise Trade
This is trade in physical goods such as computers
and automobiles.
It is often broken down into:
merchandise exports
merchandise imports
Services
• This is trade in invisible or intangible goods.
• Examples are: shipping, travel, communications,
financial services, insurance, tourism
• The sum of merchandise trade and services is
called the trade balance (TB)
Current Transfers
These are one-sided transactions such as
government grants, pension payments, and
private gifts.
• The CA balance is the sum of the balance of
trade in goods and services, current transfers
and investment income.
• More simply, the CA measures what a country
saves minus what it spends or invests.
The Current Account
• Includes all imports and exports of goods and
services.
• Includes unilateral transfers of foreign aid.
• If the debits exceed the credits, then a country is
running a trade deficit.
• If the credits exceed the debits, then a country is
running a trade surplus.
The Balance of Payments Accounts
• Examples of Paired Transactions
▫ A Polish citizen buys for PLZ 4000 a PC from an
American company, and the American company
deposits the PLZ 4000 in its account at MultiBank
in Poland.
 That is, the Polish trades assets for goods.
 This transaction creates the following two offsetting
entries in the Polish balance of payments:
 It enters the Poish CA with a negative sign (-PLZ 4000).
 It shows up as a PLZ 4000 credit in the Polish financial
account.
The Balance of Payments Accounts
▫ A Polish citizen pays 600 PLZ for dinner at a
French restaurant in France by charging his Visa
credit card.
 That is, the Polish trades assets for services.
 This transaction creates the following two offsetting
entries in the Polish balance of payments:
 It enters the Polish CA with a negative sign (-PLZ 600).
 It shows up as a PLZ 600 credit in the Polish financial
account.
Balance of Trade
(1) current account
(2) capital account
• If exports exceed imports, The Balance
of Trade is positive
• If imports exceed exports, the Balance
of Trade is negative
(3) financial account
POSITIVE Current Account
• Means that another part of the account must be in deficit to
create balance of money.
• Impacts include:
1) A CA account surplus usally means the country has high
demand for its exports;
2) Can be financed this high levels of lending from overseas
countries. This requires a good credit rating with other
countries and a short term impact of paying interest
3) This create high demand for local currency, export must be
purchased with this local currency, which leads to an
appreciation compared to other contries
• An appreciation of currency makes imports cheaper.
NEGATIVE Current Account Balance
• Means that another part of the account must be in surplus to
create a balance of money
• Options include:
1) Can use its Foreign Currency Reserves to outset the deficit,
this requires large reserves of funds (short term solution)
2)Sometimes foreign ownership of local assets can increase
which balances the CA. This relies on confidence in the local
market (Asian Financial Crises 1997)
3) Can be financed this high levels of lending from overseas
countries. This requires a good credit rating with other
countries and a short term impact of paying interest
How do you fix a country with a large CA
deficit?
• Encouriging people to buy local product
• Attempt to devaluate currency to make imported
products more expensive and exports more
attractive to overseas buyer
• Broader expenditure reduction policies –
reducing aggregate demand
Balance of Payments
The Balance of Payments includes three accounts:
(1) current account
(2) capital account
(3) financial account
Capital Account
• Sale and purchase of capital assets and nonproduced or non-financial assets
The Balance of Payments Accounts
▫ A Polish bank PKO BP forgives PLZ 15 000 in debt
owed to it by the government of Ibland.
 This transaction creates the following two offsetting
entries in the Polish balance of payments:
 It enters the Polish capital account with a negative sign
(-PLZ 15000).
 It shows up as a PLZ 15000 credit in the Polish
financial account.
Balance of Payments
The Balance of Payments includes three accounts:
(1) current account
(2) capital account
(3) financial account
The Financial Account
• This is the right-hand side of the government’s
budget constraint.
• The financial account is a record of capital
flows between residents of a country and the rest
of the world.
One way to break down capital flows is by the type of
transaction.
There are two main types of capital flows
1. Direct investment: When residents of a country acquire
shares in a foreign business with the intent of exercising
management control. This is typically defined as
purchasing 10 percent of a firm’s stock.
2. Portfolio investment: Investment without the intention
of exercising management control.
The Balance of Payments Accounts
▫ A Polish citizen buys a PLz 400 newly issued share of
stock in the United Kingdom oil giant British
Petroleum (BP) by using a check drawn on his
stockbroker money market account. BP deposits the
PLZ 400 in its own Polish bank account at the Citi
Handlowy in Warsaw
 That is, the Polish trades assets for assets.
 This transaction creates the following two offsetting
entries in the Polish balance of payments:
 It enters the Polish financial account with a negative sign (PLZ 400).
 It shows up as a PLZ 400 credit in the Polish financial
account.
Statistical Discrepancy
• There’s going to be some omissions and
misrecorded transactions—so we use a “plug”
figure to get things to balance.
Errors and Omissions
• Each transaction is entered once as a debit and
once as a credit; that is, once as a positive
number and once as the same negative number.
• So, all of the transactions should sum to zero.
• In practice, it does not work out that way.
Errors and Omissions
• Data on merchandise trade comes from customs
declarations.
• Trade in services is typically estimated by
various sampling techniques; errors can be
substantial.
• Reporting of capital flows and investment
income is highly imperfect; people try to hide
these to evade taxes.
• The Statistical Discrepancy or Errors and
Omissions is the amount we need to add or
subtract to make things add up to zero.
The Official Reserve Account
• The reserve account is a record of changes in the
home country’s official (government) assets.
• When fixed exchange rates were more prevalent
this used to be separate from the financial
account.
The Official Reserves Account
• Official reserves assets include gold, foreign
currencies, SDRs, reserve positions in the IMF.
Reserve Account Balance
• Negative balance (debit, increase in an asset):
Reserves rose.
• Positive balance (credit, decrease in an asset):
Reserves fell.
• Another definition of the balance of payments is
minus one times the reserve account balance.
• A positive (negative) balance of payments:
reserves rose (fell)
Balance of Payments
Current Account
Merchandise Trade
Exports
Imports
Services
Income
Current Transfers
Capital Account
Financial Account
Direct Investment
Portfolio Investment
Home claims on Foreigners
Foreign Claims on the Home Country
Errors and Omissions
Reserves
The Balance of Payments Identity
BCA + BKA + BRA = O
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,
BCA + BKA = O
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
($0.30)
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
($0.30)
In 2000, the
U.S. imported
more than it
exported, thus
running a
current account
deficit of
$444.69 billion.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
($0.30)
During the
same year, the
U.S. attracted
net investment
of $444.26
billion—clearly
the rest of the
world found the
U.S. to be a
good place to
invest.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
($0.30)
Under a pure
flexible
exchange rate
regime, these
numbers would
balance each
other out.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
($0.30)
In the real
world, there
is a statistical
discrepancy.
U.S. Balance of Payments Data
Credits
Debits
Current Account
1
Exports
2
Imports
$1,418.64
($1,809.18)
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
Including that, the
balance of payments
identity should hold:
BCA + BKA = –
BRA
($0.30)
($444.69) + $444.26 + $0.73 = $0.30= –($0.30)
Balance of Payments and the
Exchange Rate
Credits
Exchange rate $
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
P
$1,418.64
S
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
D
Q
($0.30)
Balance of Payments and the
Exchange Rate
Credits
Exchange rate $
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
P
$1,418.64
S
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
D
Q
($0.30)
As U.S. citizens import, they are supply dollars to the FOREX
market.
Balance of Payments and the
Exchange Rate
Credits
Exchange rate $
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
P
$1,418.64
S
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
D
Q
($0.30)
As U.S. citizens export, others demand dollars at the FOREX
market.
Balance of Payments and the
Exchange Rate
Credits
Exchange rate $
Debits
Current Account
1
Exports
2
Imports
3
Unilateral Transfers
Balance on Current Account
Capital Account
4
5
6
7
Direct Investment
Portfolio Investment
Other Investments
Balance on Capital Account
Statistical Discrepancies
Overall Balance
Official Reserve Account
P
$1,418.64
($1,809.18)
$10.24
($64.39)
($444.69)
$287.68
$474.39
$262.64
$444.26
0.73
$0.30
($152.44)
($124.94)
($303.27)
S
S1
D
Q
($0.30)
As the U.S. government sells dollars, the supply of dollars
increases.
Balance of Payments Example
• Suppose that Maplewood Bicycle in
Maplewood, Missouri, USA imports
$100,000 worth of bicycle frames from
Mercian Bicycles in Darby England.
• There will exist a $100,000 credit recorded
by Mercian that offsets a $100,000 debit at
Maplewood’s bank account.
• This will lead to a rise in the supply of dollars
and the demand for British pounds.
Balance of Payments Trends
• 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.
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
-200
-300
-400
-500
Source: IMF International Financial Statistics Yearbook, 2000
U.S. BCA
U.S. BKA
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
-20
-30
-40
-50
Source: IMF International Financial Statistics Yearbook, 2000
1996
1998
2000
UK BKA
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
-100
-150
Source: IMF International Financial Statistics Yearbook, 2000
Japan BCA
Japan BKA
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
-40
-60
-80
Source: IMF International Financial Statistics Yearbook, 2000
Germany BCA
Germany BKA
Balances on the Current (BCA) and
Capital (BKA) Accounts of China
35
30
25
20
15
10
5
0
-51982 1984 1986 1988 1990 1992 1994 1996 1998 2000
-10
-15
Source: IMF International Financial Statistics Yearbook, 2000
China BCA
China BKA
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.
Summary
• All transactions between a country and the rest
of the world are recorded in its balance of
payments accounts.
• The current account equals the country’s net
lending to foreigners.
▫ National saving equals domestic investment plus
the current account.
▫ Transactions involving goods and services appear
in the current account of the balance of payments,
while international sales or purchases of assets
appear in the financial account.
Summary
• Any current account deficit must be matched by
an equal surplus in the other two accounts of the
balance of payments, and any current account
surplus by a deficit somewhere else.
• International asset transactions carried out by
central banks are included in the financial
account.