1

INTERNATIONAL BUSINESS

MANAGEMENT (BUSI 1346)

The Balance of Payments System

Lect 4/Wk 5, w/c 18th October Dr Michael Wynn-Williams wm97@gre.ac.uk

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

13

BOP FOR FOREIGN INVESTMENT DECISION

14

BOP FOR FOREIGN INVESTMENT DECISION

What is the BOP condition?

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

21

SEMINAR QUESTION FOR WEEK 6, 30TH OCT Read the article on Australia’s CAD/GDP

ratio

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