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Contents

Measure Nation’s levels of international economic activity, and how it is measured by the balance of payments; Examine the economic relationships underlying the two basic sub-components of the balance of payments – the Current and Capital Accounts; Identify the financial dimensions of international economic activity, and how they differ between merchandise & services trade; Identify balance of payment activities by nations in pursuit of domestic and global economic and political policies; Evaluate the history of capital mobility, and conditions that lead to capital flight in times of crisis

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What is Balance of Payments?---->

• The Balance of payments is the summary statement of all international transactions between one country and all other countries ---- Eiteman

• A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world.

• The measurement of all international economic transactions between the residents of a country and foreign residents is called the Balance of Payments (BOP)

• An accounting record of all transaction made by a country over a certain time period, comparing the amount of foreign currency taken in to the amount of domestic currency paid out.

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

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Elements of Balance of Payments Transactions

These transactions include payments for the country's Exports of goods & services imports of goods & services financial capital financial transfer.

¤ The BOP summarizes international transactions for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned.

¤ Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items.

¤ Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

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Importance of The Balance of Payments

1. Monetary and fiscal policy must take the BOP into account at the national level

2. Businesses need BOP data to anticipate changes in host country’s economic policies driven by BOP events

3. Above of these, BOP data may be important for the following reasons

BOP is important indicator of pressure on a country’s exchange rate, thus potential to either gain or lose if firm is trading with that country or currency Changes in a country’s BOP may signal imposition (or removal) of controls over payments, dividends, interest, etc BOP helps to forecast a country’s market potential, especially in the short run

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Examples of BOP Transactions

¤ An American tourist purchases a T-Shirt in Bangladesh.

¤ A Bangladeshi Tourist purchase a canned coke from Heathrow Airport, London, UK

¤ Nitol Motors, Dhaka, Bangladesh is the distributor of cars manufactured in Japan by its parent, Honda of Japan

¤ BATBC’s subsidiary in Bangladesh pays profits (dividends) back to parent firm in London

¤ A Mexican lawyer purchases a US corporate bond through an investment broker in Cleveland

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• 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¤ Financial Account¤ The Official Reserves Account¤ Statistical Discrepancy/ Net Errors and

Omissions

Balance of Payments Accounts

Next slide

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Structure of The Balance of Payments

A. Current Accounti. Net exports/imports of goods and services (Balance of Trade)ii. Net Income (investment income from direct portfolio investment

plus employee compensationiii. Net transfers (sums sent home by migrant and permanent workers

abroad)B . Capital Account

Capital transfers related to purchase and sale of fixed assets such as real estate

C. Financial Accounti. Net foreign direct investmentii. Net portfolio investment iii. Other financial items

D. Net Errors and OmissionsMissing data such as illegal transfers

E. Reserves and Related ItemsChanges in official monetary reserves including gold and foreign exchange reserves

Σ (

A:E

) =

Ove

rall

Bal

ance

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The Current Account• Goods Trade – export/import of goods. • Services Trade – export/import of services; common services are

financial services provided by banks to foreign investors, construction services and tourism services

• Income – predominately current income associated with investments which were made in previous periods. Additionally the wages & salaries paid to non-resident workers

• Current Transfers – financial settlements associated with change in ownership of real resources or financial items. Any transfer between countries which is one-way, a gift or a grant, is termed a current transfer

• Foreign Aid: Includes unilateral transfers of foreign aid.

Trade Deficit: If the debits exceed the credits, then a country is running a trade deficit.Trade Surplus: If the credits exceed the debits, then a country is running a trade surplus.

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Main Component Accounts Of The Current Accounts: One Debit & One Credit Example For Bangladesh.

Trade in goods:Debit: Bangladeshi firm purchases German machine tools.Credit: Texmark UK purchase garments products from Dhaka. Trade in services:Debit: A Bangladeshi takes a physician advice by paying US$500 in New YorkCredit: The Brazilian tourist agency places an ad in The New Age, Dhaka.Income payments and receipts:Debit: The Bangladeshi subsidiary of a Abu Dhabi TV manufacturer pays dividends to its parent.Credit: A British company pays the salary of its executive stationed in Dhaka

Unilateral current transactions.Debit: The BRAC, Bangladesh pays for a Bangladeshi working on the Afghan border.Credit: A Srilankan company pays tuition for an employee to study MBA in the University of Dhaka, Bangladesh.

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The Capital/Financial Account

• Capital account is made up of transfers of fixed assets such as real estate and acquisitions/disposal of non-produced/non-financial assets

• Financial account consists of three components and is classified either by maturity of asset or nature of ownership. The three components are1. Direct Investment:

Net balance of capital which is dispersed from and into a country for the purpose of exerting control over assets. This category includes foreign direct investment

2. Portfolio InvestmentNet balance of capital which flows in and out of the country but does not reach the 10% ownership threshold of direct investment. The purchase and sale of debt or equity securities is included in this category. This capital is purely return motivated

3. Other Investment Assets/LiabilitiesConsists of various short and long-term trade credits, cross-border loans, currency and bank deposits and other accounts receivable and payable related to cross-border trade

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The Other Accounts

• Net Errors and Omissions – Account is used to account for statistical errors and/or untraceable monies within a country

• Official Reserves – total reserves held by official monetary authorities within a country. ¤ These reserves are typically comprised of major

currencies that are used in international trade and financial transactions and reserve accounts (SDRs) held at the IMF

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Examples 01: BOP’s Current Account

797888 02. Balance on services

(48)(44)(41) 05. Balance on current transfers

575349Current transfers: debit

998Current transfers: credit

(19)(7)6 04. Balance on income

295265251Income: debit (Payments)

276258257Income: credit (Receipts)

(264)(167)(106)03. Balance on Goods & Services

191183167Services: debit (imports)

270261255Services: credit (exports)

(343)(245)(194) 01. Balance on goods

1030917876Goods: imports

687672682Goods: exports

200920102011Assumptions (millions of US

dollars)

Using the data from the table, answer the following questions:

1. What is the balance on goods?

2.What is the balance on services?

3.What is the balance on goods and services?

4.What is the current account Balance?

-331-218-141 Balance on current Account = (1+2+4+5)

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Practice 02: BOP Current account

Assumptions (millions of US dollars) 2005 2006 2007 2008 2009 2010

Goods: exports 55,884 56,096 64,052 63,676 65,099 70,577

Goods: imports 61,215 65,857 68,865 61,890 70,530 85,946

Balance on goods ? ? ? ? ? ?

Services: credit 16,181 17,399 18,677 16,689 17,906 21,205

Services: debit 17,272 18,330 18,388 16,948 18,107 21,638

Balance on services ? ? ? ? ? ?

Income: credit 6,532 7,394 8,984 8,063 8,194 9,457

Income: debit 17,842 18,968 19,516 18,332 19,884 24,245

Balance on income ? ? ? ? ? ?

Current transfers: credit 2,651 3,003 2,622 2,242 2,310 2,767

Current transfers: debit 2,933 3,032 2,669 2,221 2,373 2,851

Balance on current transfers ? ? ? ? ? ?

Using the data from the table, answer the following questions:1. What is the balance on goods?2.What is the balance on services?3.What is the balance on goods and services?4.What is the current account services?

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Practice 03: Balance of Payments

Find out (a) the balance of trade and (b) balance of current account, if: inflow on account of services: $1000; outflow on account of services: $800; Outflow of dividend, royalty, etc, $1100; inflow of dividend, etc. $560; export of goods: $10000; import of goods: $12000, Remittances: $1200

Items Amounts

Goods: exports 10000

Goods: imports -12000

Balance on goods -2000

Services: credit 1000

Services: debit -800

Balance on services 200

Inflow of Dividend 560

Outflow of Dividend -1100

Investment income -540

Remittances 1200

Balance on current transfers -1140

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Main Component Accounts of The Capital & Financial Accounts: One Debit & One Credit Example For Bangladesh

Direct investment.

Debit: Nitol Motor Company builds a factory in Nepal.

Credit: Nitol Motor Company sells its factory in Srilanka to Srilankan investors.

Portfolio investment.

Debit: A Bangladeshi buys shares of stock of a European food chain on the Frankfurt Stock Exchange.

Credit: The government of Korea buys Bangladesh Bank Treasury bills to hold as part of its foreign exchange reserves.

Other investment.

Debit: A Bangladeshi firm deposits $1 million in a bank balance in London.

Credit: A Bangladesh firm generates an account receivable for exports to Canada.

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Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved:

• A U.S. food chain imports wine from Chile.¤ Current Account¤ Debit to U.S. goods¤ Credit to Chilean goods

• A U.S. resident purchases a euro-denominated bond from a German company. ¤ Portfolio part of financial account;¤ Debit to U.S.¤ Credit to German

• Singaporean parents pay for their daughter to study at a U.S. university.¤ Current transfers in current account ¤ Credit to U.S.¤ Debit to Singapore

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The Capital/Financial Account

Direct investment abroad (105) (146) (151)Direct investment in the US 106 186 276

Net direct investment 1 40 125

Portfolio InvestmentAssets purchased by US residents, net (119) (136) (129)Assets purchased by foreign residents, net 386 269 342

Net portfolio investment 267 133 213

Other InvestmentOther investment assets (264) (47) (159)Other investment liabilities 265 27 136

Net other investment 1 (20) (23)

Capital Account Balance 269 153 315

US Capital/Financial Account, 2009-2011-1999 (billions of US$ 2009 2010 2011

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2009 2010 2011 A. Current Account (140.55) (217.13) (331.48)

Goods exports FOB 681.65 672.29 686.66 Goods imports FOB (876.37) (917.19) (1029.92)Goods (BOT) . . . (194.72) (244.90) (343.26)

Services exports 255.29 260.69 269.58 Services imports (166.51) (182.68)(191.30)Services trade balance 88.78 78.01 78.28 Income credit 257.35 258.45 276.17 Income debit (251.16) (264.66) (294.65)Balance on Income . . . 6.19 (6.21) (18.48)

Current transfers, credits 8.47 9.33 9.41 Current transfers, debits (49.27) (53.36) (57.43)_____________________________________________________________

The Balance of Payments in Total

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2009 2010 2011 C. Financial Account 269.04 153.59 314.64

Direct investment . . . 1.02 40.27 124.64 Direct investment abroad (105.02) (146.05) (150.90) Direct investment in the US 106.04 186.32 275.54 Portfolio investment assets . . . (118.98) (136.00)(128.59) Equity securities (57.58) (101.24)(114.40) Debt securities (61.40) (34.76) (14.19)

Portfolio investment liabilities . . . 385.60 269.33 342.19 Equity securities 67.85 41.95 98.07 Debt securities 317.75 227.38 244.12 ___________________________________________________________

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Capital Mobility/Flight

• Capital Mobility: The degree to which capital moves freely cross-border is critically important to a country’s balance of payments

• Capital Flight: “International flows of direct and portfolio investments under ordinary circumstances are rarely associated with the capital flight phenomenon. Rather, it is when capital transfers by residents conflict with political objectives that the term “flight” comes into general usage.”

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Capital Flight…….

•Five primary mechanisms exist by which capital may be moved from one country to another:

1. Transfers via the usual international payments mechanisms, regular bank transfers are easiest, cheapest and legal

2. Transfer of physical currency by bearer (smuggling) is more costly, and for many countries illegal

3. Transfer of cash into collectibles or precious metals, which are then transferred across borders

4. Money laundering, the cross-border purchase of assets which are then managed in a way that hide the movement of money and its owners

5. False invoicing on international trade transactions

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In million US$  

Items 1999-002000-2001

2001-2002

2002-2003

2003-2004

2004-2005(June-July)

1 2 3 4 5 6 7

Trade balance -1865 -2011 -1768 -2215 -2319 -3297

Export f.o.b. (including EPZ) 5701 6419 5929 6492 7521 8573

Of which : Readymade garments (RMG) 

4352 4860 4584 4912 5686 6418

Import f.o.b. (including EPZ) -7566 -8430 -7697 -8707 -9840 -11870

Services -645 -914 -499 -691 -874 -870

Receipts 849 759 865 887 924 1177

Payments -1494 -1673 -1364 -1578 -1798 -2047

Income -302 -344 -402 -358 -374 -680

Receipts 97 97 50 64 63 116

Payments -399 -441 -452 -452 -437 -796

Of which : Official interest payments

-160 -168 -161 -167 -175 -203

Current transfers 2394 2171 2826 3440 3743 4290

Official 165 72 69 82 61 37

Private 2229 2099 2757 3358 3682 4253

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In million US$  

Items

1999-00

2000-2001

2001-2002

2002-20032003-2004

2004-2005(June-July)

- - - - - -

1 2 3 4 5 6 7

Of which : Workers' remittances

1949 1882 2501 3062 3372 3848

Current Account Balance -418 -1098 157 176 176 -557

Capital Account 561 432 410 428 196 163

Capital transfers 561 432 410 428 196 163

Financial Account -116 682 391 413 78 760

Foreign direct investment (net) 383 550 391 376 385 776

Portfolio investment 0 0 -6 2 6 0

Other investment -499 132 6 35 -313 -16

MLT loans (excluding suppliers credit)

806 790 733 918 544 940

MLT amortization payments -396 -416 -435 -452 -397 -449

Other long term loans (net) 127 -13 -42 -20 -41 -46

Other short term loans (net) 71 31 63 142 13 241

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In million US$  

Items1999-

002000-2001

2001-2002

2002-2003

2003-2004

2004-2005

(June-July)

Other short term loans (net)

71 31 63 142 13 241

Other capital -190 -114 -87 -125 -125 -182

Trade Credit (net) -641 -260 -253 -499 -321 -320

Commercial Bank -276 114 27 71 14 -200

          Assets -161 147 -90 217 86 -91

          Liabilities -115 -33 117 -146 -72 -109

Errors and Omissions 152 -297 -550 -202 -279 -299

OVERALL BALANCE 179 -281 408 815 171 67

Reserve Assets -179 281 -408 -815 -171 -67

Bangladesh Bank -179 281 -408 -815 -171 -67

Assets -79 302 -276 -887 -235 -225

Liabilities -100 -21 -132 72 64 158