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*C H A P T E R 2International Flow of Funds

*Chapter OverviewA. Balance of PaymentsB. International Trade FlowsC. International Trade IssuesD. Factors Affecting International Trade FlowsE.Correcting a Balance of Trade DeficitF. International Capital FlowsG. Agencies That Facilitate InternationalFlows

*Chapter 2 ObjectivesThis chapter will:A. Explain the key components of the balance of paymentB. Explain how international trade flows are influenced by economic factors and other factorsC. Explain how international capital flows are influenced by country characteristics

Copyright 2004 Pearson Addison-Wesley. All rights reserved.3-*A. Balance of PaymentsInternational business transactions occur in many different forms over the course of a year.The measurement of all international economic transactions between the residents of a country and foreign residents is called the balance of payments (BOP).

Copyright 2004 Pearson Addison-Wesley. All rights reserved.

Copyright 2004 Pearson Addison-Wesley. All rights reserved.3-*A. Balance of PaymentsBOP data is important for government policymakers and MNEs as it is a gauge of a nations competitiveness or health (domestic and/or foreign).For a MNE both home and host country BOP data is important as:An indication of pressure on a countrys foreign exchange rateA signal of the imposition or removal of controls in various sorts of payments (dividends, interest, license fees, royalties and other cash disbursements)A forecast of a countrys market potential (especially in the short run)


A. Balance of PaymentsBalance of PaymentsCurrent AccountThe summary of the flow of funds between one specified country and other countries due to the purchase of goods or services, or the provision of income on financial asset.Main components: Payments for; a) Goods and services b) Factor income c) TransfersCapital & Financial AccountThe summary of the flow of funds from the sale of assets between one specified country and other countries over a specified period of time

*A. Balance of PaymentsDouble-entry book keeping:

Currency inflows = credit(earn foreign exchange)

Currency outflows = debit(expend foreign exchange)

*A. Balance of Payments1. Current Account:a. Payments for merchandise and services (trade)-Imports and exports such asclothings, cars, tourism etc.-the difference between totalexports and imports is referredto as the balance of trade

*A. Balance of Payments1. Current Account:b. Factor Income Payments-Income received by investorson foreign investments infinancial assets (i.e. interestand dividend payments).c. Transfer Payments-Aids, grants, and gifts fromone country to another.

*Balance of Trade: MalaysiaSource: Dept of Statistics Malaysia

YearJanFebMarAprMayJunJulAugSepOctNovDecTotal20099.112.2137.4109.17.89.69.311.58.9107.820089.79.1812.315.512.914.412.614.79.611.511.5141.920077.66.96.55.988.888.811.58.610.49.4100.3200697.79.97.28.38.59.410.310.69.79.311.1111.1

Copyright 2004 Pearson Addison-Wesley. All rights reserved.3-*A. Balance of Payments2.The Capital Account of the balance of payments measures all international economic transactions of financial assets. It is divided into two major components:The Capital AccountThe Financial AccountThe Capital Account is minor (in magnitude), while the Financial Account is significant.


*A. Balance of Payments2. Capital and Financial Accounts- The capital account includes the value of financial assets transferred across country borders by people who move to different country.- It also includes the value of nonproduced nonfinancial assets that are transferred across country borders, such as patents and trademarks.

*A. Balance of Payments2. Capital and Financial Accounts- The financial account includes payments for:a)Direct foreign investment- Investment in fixed assets in foreign countries that can be used to conduct business operations.b)Portfolio Investment- Transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control.c)Other capital investment- Transactions involving short-term financial assets (such as money market securities) between countries.

*A. Balance of Payments2. Capital and Financial Accountd. Errors and Omissions and Reserves- A negative balance on the current account should be offset by a positive balance on the capital and financial account- Reserves are the foreign currency and securities held by the government, usually by its central bank, and is used to balance the payments from year to year.

*A. Balance of Payments Ex.In 2003, the United States exported $714 billion of merchandise and imported $1,263 billion, for a merchandise trade deficit of $549 billion. However, service exports were $305 billion and service imports were $246 billion, for a surplus of approximately $59 billion. The trade deficit on goods and services, therefore, was $490 billion. U.S. interest payments to other countries and U.S. interest income from abroad were $250 and $272, respectively, and there was a net outflow of $68 billion in unilateral transfers. Therefore, the current account showed an overall deficit of $536 billion.Capital account transactions yielded a net outflow of $3.1 billion. For the financial account, U.S. investors acquired $277 billion of assets abroad and foreign investors acquired $857 billion of assets in the United States, yielding a net financial and capital account surplus of $580 billion. That surplus, minus a statistical discrepancy of $40.9 billion, balanced the $536-billion current account deficit.

*B. International Trade FlowsDistribution of Malaysian Exports and Imports

Major ExportJan-DecJanuary - November(RM Million)2008p2008p2009Natural Rubber8,1117,8103,892Palm Oil & Palm Oil-Based Products64,98760,40946,209Crude Petroleum43,19841,50622,148Petroleum Products28,98627,43117,390Liqufied Natural Gas40,73235,55027,888Timber & Timber Based Products 22,55220,69717,571Electrical & Electronic Products 255,360238,348205,099Articles of Apparel & Clothing Accessories 12,09611,05510,002Other Manufactured Goods and Articles 86,07880,13569,085


The values of major import products :-Machinery and transport equipment (RM118.5 billion or 51.0% of total imports);Manufactured goods and articles (RM28.9 billion or 12.4% of total imports);Chemicals (RM21.3 billion or 9.2% of total imports);Mineral fuels, lubricants, etc., (RM17.5 billion or 7.5% of total imports); andFood (RM15.4 billion or 6.6% of total imports).


Malaysias top ten exports destinations were the Republic of Singapore, the United States of America, the Peoples Republic of China, Japan, Thailand, Hong Kong, the Republic of Korea, Australia, India and the Republic of Indonesia. These countries accounted for RM212.8 billion or 71.1% of Malaysias total exports in the period of January - July 2009.


The top ten import sources of Malaysia were the Peoples Republic of China, Japan, the United States of America, the Republic of Singapore, Thailand, the Republic of Indonesia, the Republic of Korea, the Federal Republic of Germany, Taiwan and Hong Kong. The total imports from these countries amounted to RM174.6 billion or 75.2% of Malaysias total imports in the first seven month of 2009.


Malaysias top ten trading partners were the Republic of Singapore, the Peoples Republic of China, the United States of America, Japan, Thailand, the Republic of Korea, the Republic of Indonesia, Hong Kong, the Federal Republic of Germany and Taiwan. These countries collectively contributed 71.8% (RM381.6 billion) of Malaysias total trade in the period of January July 2009.

*B. International Trade Flows2. Malaysian Balance of Trade (BOT) Trend

1. In July 2009, Malaysias exports grew 8.4% that registered total value of RM48.9 billion, while the imports were RM41. 1 billion, an increase of 14.2% as compared with June 2009. However, Malaysias exports decreased by 22.8% from RM63.3 billion and imports also declined by 16.0% from RM48.9 billion, year on year basis.

2. In July 2009, total trade recorded a positive growth of 11.0% or 8.9 billion, month on month basis. Total trade was valued at RM89.9 billion, a decrease of 19.9% from a year ago.

3. A trade surplus of RM7.8 billion was recorded in July 2009, a decrease of 45.8% as compared with RM14.4 billion registered in the same month of 2008. This was the 141th consecutive month of trade surplus since November 1997.


4. Electrical & electronic products retained its position as the main exports revenue earner, accounting for RM20.6 billion or 42.2% of total exports, recorded an increase of RM2.0 billion or 10.8% as compared with the previous month. However, for year on year basis, electrical & electronic products registered a decrease of RM3.8 billion (-15.6%).

5. Palm oil & palm oil-based products (9.6% of total exports), followed as the second largest exports revenue earner with a total combined value of RM4.7 billion in July 2009. It posted an increase of 2.6%, month on month.In contrast, it registered a decrease of 31.7%, year on year.


6.The third largest exports commodity, Liquefied natural gas (LNG) amounted to RM2.0 billion or 4.1% of total exports. Total exports of LNG went up by 11.5%, month on month, but dipped by 31.6% as against with July 2008.

7. Imports of intermediate goods, constituted 68.7% of total imports, posted an increase of 11.3% to RM28.2 billion, month on month. Conversely, it registered a decrease of 20.6% from RM35.6 billion as compared with the same month of 2008.

*B. International Trade Flows3. Should we be concerned about a huge BOT Deficit?If everyone from Malaysia purchase all their products from Malaysian firms, this would be advantageous for the Malaysian firms.International trade caused a shift of production to countries that can produce more efficiently. This forces products prices low.What about advanced countries where factors of production is high?

*C. International Trade Issues

1. Events that Increased International Tradea. Removal of the Berlin Wall -1989b. Single European Act -1980sc. NAFTA -1993d. Inception of the Euro -1999e. European Union Expansion - 2004

*C. International Trade Issues

*C. International Trade Issues2. Trade Friction: - Even though trade treaties have reduced tariffs and quotas over time, most countries still impose some type of trade restrictions on particular products in order to protect their local firms.

- Proton?

*C. International Trade Issues2. Trade Friction: - Certain countries are not strict on environmental issues, child labour, corruption, and subsidies.- Tax breaks for certain industries.

*C. International Trade Issues2. Trade Friction: Causesa. Using the exchange rate as policy (i.e. strong Euro andYuan)b. Outsourcing (i.e. job losses)c. Using trade and foreign ownership policies for security (i.e. military)d. Using trade policies for political reasons (i.e. sanctions/punishment)

*D. Factors Affecting International Trade Flows

a.Inflation (Interest Rates)- If a countrys inflation rate increases relative to the countries which it trades, its current account will be expected to decrease, cet. par.- Consumers and corporations in that country will most likely purchase more goods overseas (due to high local inflation)- The countrys export is expected to decline.


b.National Income- If a countrys income level (national income) increases by a higher % than those of other countries, its current account is expected to decrease, cet. par.- Consumption of goods will increase according to real income level.- Increase demand for foreign goods.


c.Government Policies (Tax Rates on Interest or Dividends)- Subsidies for Exporters.- Restrictions on Imports (i.e. tariffs and quota).- Lack of Restrictions on Piracy (piracy imports ).


d. Exchange Rates- If a countrys currency begins to rise in value against other currencies, cet. par., its current account balance should decrease.- Currency balance-of-trade deficit - Currency balance-of-trade deficit

*E. Correcting a Balance of Trade (BOT) Deficit- A country can benefit from BOT deficit via cheaper imported products

- This leads to reliance on foreign production (Job goes overseas).

- Government might have to interfere to correct BOT deficit.

*E. Correcting a Balance of Trade (BOT) Deficit- Any policy that will increase foreign demand for the countrys goods & services will improve its BOT position.

- Floating exchange rate?

- Because the country is selling its currency (to buy foreign goods) in greater volume than the foreign demand for its currency, the value of its currency should decrease.

- BUT NOT ALWAYS NECESSARILY!

*E. Correcting a Balance of Trade (BOT) Deficit1. Why a Weak Home Currency is Not a Perfect Solution

a. Counterpricing by Competitors

b. Impact of Other Weak Currencies (currencies dont always move together)


c. Prearranged International Transactions: J-curve Effect- International business transactions a prearranged transactions that cannot be immediately adjusted.

*Insert exhibit 2.6 page 38J-Curve Effect


d. Intercompany Trade- Importers and exporters that are under the same ownership have unique relationship.

- The impact of exchange rate movements on intracompany trade patterns is limited.

*F. International Capital Flows1. Distribution of DFI by U.S. Firms- Europe 50%- Latin America 30% - Asia & Pacific Region 16%

2. Distribution of DFI in the United States- UK, Japan, The Netherlands, Germany and Canada.

*F. International Capital Flows3. Factors Affecting DFIa. Changes in Restrictionsb. Privatizationc. Potential Economic Growthd. Tax Ratese. Exchange Rates- Invest when the host countrys currency is weak and reap the benefits when the currency is stronger.

*F. International Capital FlowsFactors Affecting International Portfolio Investmenta. Tax Rates on Interest or Dividendsb. Interest Rates- Money tends to flow to countries with high interest rates as long as the local currency are not expected to weaken.c. Exchange Rates

*Insert exhibit 2.7 page 39International Capital Flows (quarterly numbers, annualized; in billions of $)

*F. International Capital Flows4. Impact of International Capital Flows

Impact of the international Flow of Funds on U.S. Interest Rates and Business Investment in the United States

*G. Agencies that Facilitate International Flows1. International Monetary Funds- The International Monetary Fund (IMF) is an organization of 186 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.2. World Bank- Provide loans to countries to enhance economic development (fight poverty).- Cofinancing (Development agencies, export credit agencies, and commercial banks)

*G. Agencies that Facilitate International Flows3. World Trade Organization- Forum for multilateral trade negotiations and to settle trade disputes related to GATT accord.

*G. Agencies that Facilitate International Flows4. International Financial Corporation- Promote private enterprise within countries.- It not only provide loans but also purchases stocks.

5. International Development Association- Similar to the World Bank

6. Bank for International Settlements- Facilitate cooperation among countries with regard to international transactions.- Also provides assistance to countries experiencing financial crisis.

*G. Agencies that Facilitate International Flows7. Organization for Economic Cooperation and Development (OECD)- Facilitates governance in governments and corporations of countries with market economics.- Promotes international country relationship that lead to globalization.

8. Regional Development Agencies- Asian development Bank, African Development Bank, European Bank of Reconstruction and Development.

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