A countrys balance of payments accounts keep track of both---- its payments to and its receipts from foreigners. Payment to foreigners is entered in the

A country’s balance of payments accounts keep track of both----

its payments to and its receipts from foreigners. Payment to foreigners is entered in the balance of

payments accounts as a debit and is given a negative (—) sign.

Receipt from foreigners is entered as a credit and is given a positive (+) sign.

Balance of Payments Accounting

The Balance of Payments is the statistical record of a country’s international transactions

Over a certain period of time Double-entry bookkeeping.

N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.

Balance of payment: Definition BOP: The BOP is an accounting record of all economic

transactions between the residents of a country &

residents of foreign countries

Rules of BOP Account

A transaction that leads to payments from residents of a country to rest of the world (ROW)

-----recorded as a debit(in that country’s BOP)

A transactions that leads to payment from ROW to residents -------is a credit entry

A transaction that increase the availability or reduces demand for foreign exchange is a credit entry

A transaction that uses up foreign exchange is a debit entry

Eg: Export from India to Germany,

---Leads to payment from Germany to Indian exporter

A. It should be recorded as credit The German importer pays the Indian exporter

with a euro draft drawn in a German bank The exporter sell this draft to his Indian bank ---

SBI.

SBI sends this draft to its correspondent bank in Frankfurt, ------deutsche bank.

Deutsche bank collects on it and credit the amount to SBIs account with itself

This leads to an increase in SBI s foreign assets and

debit entry which effects the credit entry Credit entry in the current account and debit entry

in the capital account

Components of BOP

A. Current account : Imports and exports of goods and services Unilateral transfers of cash , goods and services B. Capital account: Grouped transactions leading to changes in

foreign financial assets and liabilities of the country

C. Reserve account:

Same as capital accounts But in assets category only reserve assets are

included Assets which the monetary authority of the

country uses to settle the deficits and-----

------surplus that arise on the other two categories taken together

E.g. monetary gold, assets denominated foreign currencies,

special drawing rights, and reserves positions in the IMF

In short - it is the difference between

both visible and invisible items

included in export and import

If total debits and credit are equal

Then balance exceeds credit

There is un favourable BOP

If credit > debit then BOP is favourable-

demand for home currency in foreign market is greater than its supply

Three types of International Transactions are recorded in Balance of Payments: Transactions that involve the export or import of goods

or services. They enter directly into the current account.

The financial account records all international purchases or sales of financial assets.

Certain other activities resulting in transfers of wealth between countries are recorded in the capital account.

Balance Of Payments:Current Account

The balance of payments accounts divide exports and imports into three categories: Merchandise trade

Exports or imports of goods.

Services Payments for legal assistance, tourists’ expenditures, and shipping

fees.

Income International interest and dividend payments and the earnings of

domestically owned firms operating abroad.

It also includes unilateral current transfers (like gifts and foreign aids)

Balance Of Payments:Financial Account

It measures the difference between sales of assets to foreigners and purchases of assets located abroad. Financial inflow (capital inflow)

A loan from the foreigners with a promise that they will be repaid.

Financial outflow (capital outflow) A transaction involving the purchase of an asset from foreigners.

Example: When an American company buys a French factory, the

transaction enters the U.S. balance of payments as a debit in the financial account

Balance Of Payments:Capital Account

Result of nonmarket activities, or represent the acquisition or disposal of non-produced, nonfinancial, and possibly intangible assets (such as copyrights and trademarks).

Examples: If U.S. government forgives $1 billion in debt owed to

it by Pakistan, U.S. wealth declines by $1 billion, or the $1 billion is recorded as debt in U.S. capital account.

If wealthy British citizen immigrates to U.S. and brings along $5billion in British asset, result would be a $5 billion credit in U.S. capital account

Simple rule of double-entry book keeping: “Every international transaction automatically enters

the balance of payments twice, once as a credit and once as a debit.”

It holds true as every transaction has two sides: If you buy something from foreigner, you must pay

him/her in someway

Examples

A U.S. citizen buys a $1000 typewriter from an Italian company, and the Italian company deposits the $1000 in its account at Citibank in New York.

That is, the U.S. trades assets for goods. This transaction creates the following two offsetting

entries in the U.S. balance of payments:It enters the U.S. CA with a negative sign (-$1000).It shows up as a $1000 credit in the U.S. financial account.

A U.S. citizen pays $200 for dinner at a French restaurant in France by charging his Visa credit card.

That is, the U.S. trades assets for services. This transaction creates the following two offsetting

entries in the U.S. balance of payments:It enters the U.S. CA with a negative sign (-$200).It shows up as a $200 credit in the U.S. financial account.

A U.S. bank forgives $5000 in debt owed to it by the government of Pakistan.

This transaction creates the following two offsetting entries in the U.S. balance of payments: It enters the U.S. capital account with a negative sign (-$5000). It shows up as a $5000 credit in the U.S. financial account.

Any international transaction automatically gives rise to two offsetting entries in the balance of payments resulting in a fundamental identity:

Current account + financial account + capital account = 0

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.

The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations.

They are composed of the following: The Current Account The Capital Account The Official Reserves Account

Balance of Payments Accounts

The Official Reserves Account

Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.

The Balance of Payments Identity

BCA + BKA + Balance reserve account= 0where

BCA = balance on current account

BKA = balance on capital account

Under a pure flexible exchange rate regime,

BCA + BKA = 0

U.S. Balance of Payments Data

Credits DebitsCurrent Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)

Balance on Current Account ($166.80)Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)

Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)

Overall Balance $1.02 Official Reserve Account ($1.02)


In 1997, the U.S. imported more than it exported, thus running a current account deficit of $166.8 billion.


1 Exports $1,167.61

2 Imports ($1,295.53)










During the same year, the U.S. attracted net investment of $264.58 billion—clearly the rest of the world found the U.S. to be a good place to invest.


1 Exports $1,167.61

2 Imports ($1,295.53)










Under a pure flexible exchange rate regime, these numbers would balance each other out.


1 Exports $1,167.61

2 Imports ($1,295.53)










In the real world, there is a statistical discrepancy.


1 Exports $1,167.61

2 Imports ($1,295.53)










1 Exports $1,167.61

2 Imports ($1,295.53)










Including that, the balance of payments identity should hold:BCA + BKA = - Balance reserve account

($166.80) + $264.58 + ($96.76) = $1.02= –($1.02)

Balance of Payments and the Exchange Rate

Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)










Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)









As U.S. citizens import, they are supply dollars to the FOREX market.


Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)









As U.S. citizens export, others demand dollars at the FOREX market.


Q

P S

D

Exchange rate $


1 Exports $1,167.61

2 Imports ($1,295.53)









As the U.S. government sells dollars, the supply of dollars increases.

S1

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.


U.S. Balance of Payments Trends

-200

-150

-100

-50

0

50

100

150

200

Year

Ba

lan

ce o

f P

aym

en

ts (

$b)

Current Account

Capital Account


Japan's Balance of Payments Trend

-150

-100

-50

0

50

100

150

Year

Ba

lan

ce o

f P

aym

en

ts (

$b)

Current Account

Capital Account


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.


Germany's Balance of Payments Trend

-80

-60

-40

-20

0

20

40

60

80

Year

Ba

lan

ce o

f P

aym

en

ts (

$b)

Current Account

Capital Account

Documents

A countrys balance of payments accounts keep track of both---- its payments to and its receipts from foreigners. Payment to foreigners is entered in the