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1
INTERNATIONAL BUSINESS
MANAGEMENT (BUSI 1346)
The Balance of Payments System
Lect 4/Wk 5, w/c 18th October Dr Michael Wynn-Williams [email protected]
2
UNDERSTANDING INTERNATIONAL TRANSACTIONS Internal transactions can be of two types
Trade related Trade exposure ratio = (X+M)/gdp
Investment related FDI Portfolio investment Invisible earnings Unrequited transfers
Balance of payments is the “statement of international transactions” – shows balance of countries trade and transactions with the rest of the world
3
BALANCE OF PAYMENTS Comprises two main accounts
Current account – trade in merchandise Sum of the balance of trade (exports –
imports) Value of visibile trade – merchandise,
commodities etc. Service sector – payments and receipts Private and official transfers
Capital account (IMF financial account) – sale and purchase of assets Long-term capital flows – investment in
firms Short-term capital flows – speculation
4
BALANCING THE BOOKS Balancing the books -
A trade surplus The current account must swell on incoming
funds Capital account deficit as overseas liabilities
increase Rising currency value Accumulation of foreign exchange to suppress
own currency valueA trade deficit
The current account is shrinking Depletion of foreign exchange Falling currency value The funds return as loans in the capital account –
“owned by foreigners” Increase in capital due to incoming FDI
5
MERCHANDISE TRADE Exports
Measured fob Imports
Measured cif Exports minus imports gives TRADE BALANCE Trade data is available from Customs Department of
Ministry of Finance/ Commerce, Most countries follow the 10 digit HS system An improvement over the BTN, SITC-1, and SITC-2,
and SITC-3 Represents harmonization between customs and
excise duties 10 digit disaggregate classification
1= agriculture 13 = agri products 138 = agri products processed 1382 = agri…processed, made from milk
6
TRADE IN SERVICES Services are the “invisibles”
Current classification describes seven types of invisibles
Travel, debit & credit
Transportation “ Insurance “ GNIE “ Investment income “ Miscellaneous “ Transfers “
This data is reported by the Central Bank of the country
7
THE CAPITAL ACCOUNT
The capital account has following aggregatesOfficial transactions, IMF, Aid, etc (PL480)Portfolio investmentCommercial BorrowingGapfil Borrowing/ exceptional financing
Changes in reserves Negative sign implies accretion to reserves
8
A NUMERICAL EXAMPLE, ALT 1
Exports = 28,000 Imports = 40,000
Trade balance = -12,000 Invisibles, net = 6,000
Balance on current a/c = -6,000 To be financed by
Official transactions = 3,000Portfolio investments = 1,000Commercial borrowing = 2,000Exceptional financing = 0
Changes in reserves = 0
9
A NUMERICAL EXAMPLE, ALT 2
Exports = 28,000 Imports = 40,000
Trade balance = -12,000 Invisibles, net = 6,000
Balance on current a/c = -6,000 To be financed by
Official transactions = 3,000Portfolio investments = 2,000Commercial borrowing = 2,000Exceptional financing = 0
Changes in reserves = -1,000
10
A NUMERICAL EXAMPLE, ALT 3
Exports = 28,000 Imports = 40,000
Trade balance = -12,000 Invisibles, net = 6,000
Balance on current a/c = -6,000 To be financed by
Official transactions = 1,000Portfolio investments = 1,000Commercial borrowing = 2,000Exceptional financing =
2,000+interest upfront
Changes in reserves = 0
11
BOP AND INTERNATIONAL BUSINESS
Current account deficit:Export opportunities are poor Import opportunities are goodRising consumerism
Current account surplusExport opportunities are good Import opportunities are poorRising production levels
12
CLASS TASK
You are a business adviser to your national government
The country is currently running a large current account surplus
With the global recession dragging on, your government needs to know what kind of industries to encourage
Your advice will show:Plan for short-term recoveryPlan for long-term sustainability
15
BOP FOR FOREIGN INVESTMENT DECISION
What is the BOP condition?
What is the ability to pay for imports?
16
BOP FOR FOREIGN INVESTMENT DECISION
What is the BOP condition?
What is the ability to pay for imports?
What quantity of imports is needed?
17
BOP FOR FOREIGN INVESTMENT DECISION
What is the BOP condition?
What is the ability to pay for imports?
What quantity of imports is needed?
18
ERA, IMF MEMO ITEMS
Measuring the 3 memo items [a] cad/gdp ratio
Should be in similar prices, either constant or current
should be less than 2% [b] debt service ratio
(I +A)/ (Xr + Ir)should be less than 20%
[c] import reserve ratio(Reserves/imports)* 12should be more than 3 months of imports
19
KUZNETS AND ECONOMIC STRUCTURE Economies can be divided into three
sectorsPrimary (agri + mining)Secondary (manufacturing+food
processing)Services (banking, insurance etc)
Transition takes place fromPrimary -> Secondary -> Services
20
SOME POINTS TO REMEMBER A (-) sign in the changes in reserves figures implies
an accretion to reserves
In exceptional financing, interest is paid upfront, with interest being added to the investment income component of invisibles
This will result in two current account deficits, ex-ante and ex-post
The US/ World Bank does not consider private (unrequited) transfers as part of invisibles. Thus the CAD tend to get inflated
22
SOURCES IMF Balance of Payments Manual (5th ed.)
<http://www.imf.org/external/np/sta/bop/BOPman.pdf>
Online tutorial Tutor2U http://tutor2u.net/economics/revision-notes/a2-macro-balance-of-payments-deficits.html
Abhijit Sen and C. P. Chandrasekhar Balance of Payments Adjustment: Some Issues and Estimates in Economic and Political Weekly, Vol. 26, No. 11/12, Annual Number (Mar., 1991), pp. 655-658