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  • 1. Balance of Payments Accounting By Dr. Neelam Tandon
  • 2. The Balance of Payments
    • Recall the open economy accounting identity: Income = Expenditures
          • Y = C + I + G + NX
    • Trade Deficits imply NX< 0
    • Therefore, Y- (C + I + G) = NX < 0
    • Trade deficit countries are spending more than they earn (borrowing from the rest of the world)
  • 3. Balance of Payments Accounting
    • Anything that we buy or sell to the rest of the world must be paid for.
    • The current account (CA) tracks the flow of goods and services between India and the rest of the world
    • The capital & financial account tracks the payments for those goods & services (KFA)
    • CA + KFA = 0
  • 4. The Current Account
    • Any transaction that represents a flow of funds out of India is represented by debit (-). Transactions that represent a flow of money into India are represented by a credit(+)
      • Net Exports of Goods and Services
        • Exports (+)
        • Imports (-)
      • Net Income From Abroad (NFP)
        • Income Earned by Indian nationals abroad (+)
        • Income earned by foreign nationals in India (-)
      • Net Unilateral Transfers
        • Payments from foreign countries (+)
        • Payments to foreign Countries (-)
  • 5. The Indian Current Account: 2006 (in Millions of Rs.)
    • Exports of Goods, Services, and Income
      • Goods: Rs. 713,122
      • Services: Rs. 307,381
      • Income Receipts:
      • Investment Receipts: Rs. 291,354
      • Employee Compensation: Rs. 3,031
    • Imports of Goods, Services and Income
    • Goods: - Rs. 1,260,274
      • Services: - Rs. 256,337
      • Income Receipts:
      • Investment Receipts: - Rs. 252,573
      • Employee Compensation: - Rs. 8,533
    • Net Unilateral Transfers: - Rs. 67,439
    • Current Account : - Rs. 530,668
  • 6. The Capital & Financial Account
    • Again, any transaction that represents funds flowing into (out of) India are credits (debits) in the KFA
      • Financial assets
        • Foreign acquisition of Indian assets (+)
        • Indian acquisition of foreign assets (-)
      • Official Reserve Assets
        • Foreign acquisition of Indian reserve assets (+)
        • Indian acquisition of foreign reserve assets (-)
  • 7. The Indian Capital & Financial Account: 2006 (in Millions of Rs)
    • Capital Account: - Rs. 3,079
    • Indian Owned Assets Abroad (Increase/Financial Outflow (-))
    • Indian Official Reserve Assets: Rs. 1,523
    • Indian Government Assets: Rs. 537
    • Indian Private Assets: - Rs. 85,574
    • Foreign Owned Assets in India (Increase/Financial inflow (+))
    • Foreign Official Assets in India : Rs.248,573
    • Foreign Private Assets in the India : Rs. 580,600
    • Capital And Financial Account: Rs.542,680
    • CA + KFA = -Rs.530,668 + Rs.542,680 = -Rs.12,012
  • 8. Balance of Payments Accounting
    • Consider three transactions:
        • Wal-Mart buys $100M worth of clothing from a Chinese Manufacturer. Wal-Mart pays for the clothing by writing a check drawn off its account at Bank of America.
        • Warren Buffet collects $50M in interest payments from his financial investments overseas. The Payment is made by crediting Warren’s bank account in London.
        • Microsoft sells $20M worth of software to the French government. They pay in cash.
  • 9. Balance of Payments Accounts
    • Current Account
    • Exports
    • Goods:
    • Services:
    • Imports
    • Goods:
    • Services:
    • Net Factor Income:
    • Net Unilateral Transfers:
    • CA Balance:
    • Capital & Financial Account
    • Foreign acquisition of US assets:
    • US Treasuries:
    • Private Securities:
    • FDI:
    • Currency:
    • US acquisition of foreign assets:
    • FDI:
    • Foreign Securities:
    • Official Reserve Assets
    • Foreign acquisition of US ORA:
    • US acquisition of foreign ORA:
    • KFA Balance:
    -$100M (1) $100M (1) $50 (2) -$50 (2) $20M (3) -$20M (3) -$30M $30M
  • 10. Tsunami Relief Aid
    • President Bush recently authorized $350M in aid for the Asian countries affected by the Tsunami.
      • This will appear in the BOP accounts under unilateral transfers.
      • Assume we pay this transfer in cash (most likely we would pay by check)
  • 11. Balance of Payments Accounts
    • Current Account
    • Exports
    • Goods:
    • Services:
    • Imports
    • Goods:
    • Services:
    • Net Factor Income:
    • Net Unilateral Transfers: -$350M
    • CA Balance: -$350M
    • Capital & Financial Account
    • Foreign acquisition of US assets:
    • US Treasuries:
    • Private Securities:
    • FDI:
    • Currency: $350M
    • US acquisition of foreign assets:
    • FDI:
    • Portfolio Investment:
    • Official Reserve Assets
    • Foreign acquisition of US ORA:
    • US acquisition of foreign ORA:
    • KFA Balance: $350
  • 12. Balance of Payments and Exchange Rates
    • Should the Balance of Payments Accounts influence exchange rates?
      • A BOP deficit (surplus) indicates that financial assets flowing out of (into a) country. Shouldn’t that indicate a currency depreciation?
      • No really….the balance of payments is an accounting statement. Given the pattern of exchange rates, the BOP indicates the transactions that took place (Remember, by definition, BOP=0)
  • 13. The US BOP
    • The US is running record trade deficits due to over consumption (US domestic savings is low and the government deficit is large)
    • Unlike past years, this trade deficit is NOT being financed by foreign private investment in the US, but rather by central banks purchasing US government debt…..this is potentially troubling!