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INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition

Chapter Objective:

This chapter serves to introduce you to the balance of payments. How it is constructed and how balance of payments data may be interpreted.

3Chapter Three

The Balance of Payments

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Outline

Balance of Payments Accounting Balance of Payments Accounts

The Current Account The Capital Account Official Reserves Account Statistical Discrepancy

The Balance of Payments Identity

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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 The Official Reserves Account Statistical Discrepancy

Balance of Payments Accounts

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Balance of Payments (BOP)

BOP = cash flow of the country

Sources of the cash flow:1) earned income from trade in goods and services

2) donated money

3) foreign loans and investment

1) + 2) Current Account (cannot be taken back)

3) Capital Account (can be taken back)

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The Current Account (CA)

Mainly consist of 4 types of transactions:1. Exports and imports of goods

2. Exports and imports of services

3. Interest payments received and paid out on international investments

4. Unilateral transfers

If the debits exceed the credits, then a country is running a current account deficit.

If the credits exceed the debits, then a country is running a current account surplus.

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The Capital Account (KA)

KA primarily tracks transactions involving buying and selling of financial and non-financial assets.

Can be divided into 3 categories:

1. Direct investment

2. Portfolio investment

3. Other investments (mostly loans, currencies)

Purchase of residents assets by non-residents (i.e. inflows) are credits. Purchases of non-residents assets by residents (i.e. outflows) are

debits

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Example: Thai Net Capital FlowMillions of USD 200

72007 2008

H1 H2 Q1 Q2 Apr May JunE

Monetary authorities -619 -766 147 641 -375 -50 -83 -242

Government -2,159

-1,90

7-252 446 146 -276 829 -407

Bank 368-

6,052

6,420 7,097 204 659 -160 -294

Other sectors -570 6,755

-7,325 4,842

-1,30

21,00

4 607-

2,913

Non – bank 1,082

6,722

-5,64

04,68

3 -954 1,029 555

-2,53

9

FDI 7,451

4,180

3,270

1,825

1,346 431 489 425

- Equity invest . 7,468 3,64

8 3,820 1,699 1,344 424 455 465

- Direct loans -18 532 -550 126 1 7 34 -40

Portfolio-

5,180

2,783

-7,96

33,13

7-

3,730

-61 -596

-3,07

4

- Foreign 4,507

3,671 836 515

-1,08

0427 -92

-1,41

5 Equity sec. 4,241 3,56

6 675 705 -990 435 -68-

1,357

Debt sec. 267 105 162 445 -90 -9 -24 -57

-Thai-

9,687

-888-

8,799

2,621

-2,65

0-

488-

504-

1,659

Loans (foreign)

1,356 422 933

-1,41

4362 311 171 -120

Others-

2,544

-663-

1,881

1,136

1,068 348 491 230

State enterprises

-1,65

233

-1,68

5159 -348 -25 52 -375

Total capital flow -2,980

-1,97

0-

1,01013,02

6-

1,3271,33

71,19

3-

3,856

BOP Analysis Team Tel. 0-2283-5636

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The Official Reserves Account (RA)

Reports the net change in FX reserves.

Increases in FX reserves held by a central bank count as debits to the RA

FX reserves = BOP + Valuation

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Statistical Discrepancy

There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance.

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The Balance of Payments Identity

Most important feature of the BOP is a double-entry system of accounts: a positive entry in BOP has a corresponding negative entry elsewhere in the BOP, and vice versa.

In general,

Under a pure flexible exchange rate regime,

CA + KA = 0

CA + KA + RA = 0

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Example: U.S. Balance of Payments Data

  Credits DebitsCurrent Account    

1 Exports $1,516.2  

2 Imports   ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

  Balance on Current Account ($665.9)Capital Account    

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

  Balance on Capital Account $611.2  

7 Statistical Discrepancies  

  Overall Balance $2.8  Official Reserve Account $2.8

51.9

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U.S. Balance of Payments Data

Including the statistical discrepancies, the balance of payments identity should hold:

CA + KA = – RA

($665.9) + $611.2 + $51.9 = ($2.8)

  Credits DebitsCurrent Account    

1 Exports $1,516.2  

2 Imports   ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

  Balance on Current Account ($665.9)Capital Account    

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

  Balance on Capital Account $611.2  

7 Statistical Discrepancies  

  Overall Balance $2.8  Official Reserve Account $2.8

51.9

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BOP and Exchange Rate

Q

P

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

Exchange rate $

S

D

  Credits DebitsCurrent Account    

1 Exports $1,516.2  

2 Imports   ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

  Balance on Current Account ($665.9)Capital Account    

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

  Balance on Capital Account $611.2  

7 Statistical Discrepancies  

  Overall Balance $2.8  Official Reserve Account $2.8

51.9

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BOP and Exchange Rate

Q

P

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

Exchange rate $

S

D

  Credits DebitsCurrent Account    

1 Exports $1,516.2  

2 Imports   ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

  Balance on Current Account ($665.9)Capital Account    

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

  Balance on Capital Account $611.2  

7 Statistical Discrepancies  

  Overall Balance $2.8  Official Reserve Account $2.8

51.9

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BOP and Exchange Rate

Q

P S

D

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

S1

Exchange rate $  Credits DebitsCurrent Account    

1 Exports $1,516.2  

2 Imports   ($2,109.1)

3 Unilateral Transfers $16.4 ($89.4)

  Balance on Current Account ($665.9)Capital Account    

4 Direct Investment $115.5 ($248.5)

5 Portfolio Investment $794.4 ($90.8)

6 Other Investments $524.3 ($483.7)

  Balance on Capital Account $611.2  

7 Statistical Discrepancies  

  Overall Balance $2.8  Official Reserve Account $2.8

51.9

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BOP adjustments

Suppose CA deficit > KA surplus (at some point in time)

Under flexible regime: Currency depreciates

CA improves (more exports, less imports)

KA improves (more inflows, less outflows)

Under fixed regime: FX reserves decrease

If not enough reserves, then BOP crisis

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CA and KA of the United States

Source: IMF International Financial Statistics Yearbook, various issues

U.S. Balance of Payments Trend: 1982-2004

-1000

-800

-600

-400

-200

0

200

400

600

800

1000

1982 1987 1992 1997 2002 2007

Year

(bil

lio

n U

SD

)

U.S. CA

U.S. KA

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CA and KA of China

Source: IMF International Financial Statistics Yearbook, various issues

-50

0

50

100

150

200

250

300

350

400

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

(billio

n U

SD

)

China CAChina KA

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CA and KA of Thailand

Thailand Balance of Payments Trend: 1991-2007

-20

-15

-10

-5

0

5

10

15

20

25

1990 1992 1994 1996 1998 2000 2002 2004 2006

Year

(bil

lio

n U

SD

)

Thai CA

Thai KA

Source: BOT

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100.5110.0 109.8 108.9 105.7

4.6 3.8

6.9

9.5

12.9

19.1

21.9

23.3

21.1 20.4 18.818.4

92.8

49.8 52.1

67.073.0

87.580.7

40

60

80

100

120

140

2004 2005 2006 H1-07 Q3-07 Q4-07 Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Reserves Net Forward Position

Billion USD

Thailand’s International Reserves

54.4 55.9

Source: BOT