Chap003

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Chap003

  1. 1. INTERNATIONAL FINANCIAL MANAGEMENT EUN / RESNICK Third Edition Chapter Objective: This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted. 3 Chapter Three The Balance of Payments
  2. 2. Chapter Three Outline <ul><li>Balance of Payments Accounting </li></ul><ul><li>Balance of Payments Accounts </li></ul><ul><ul><li>The Current Account </li></ul></ul><ul><ul><li>The Capital Account </li></ul></ul><ul><ul><li>Statistical Discrepancy </li></ul></ul><ul><ul><li>Official Reserves Account </li></ul></ul><ul><li>The Balance of Payments Identity </li></ul><ul><li>Balance of Payments Trends in Major Countries </li></ul>
  3. 3. Balance of Payments Accounting <ul><li>The Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping. </li></ul><ul><li>N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government . </li></ul>
  4. 4. Balance of Payments Example <ul><li>Suppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England. </li></ul><ul><li>There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewood’s bank account. </li></ul><ul><li>This will lead to a rise in the supply of dollars and the demand for British pounds. </li></ul>
  5. 5. <ul><li>The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations. </li></ul><ul><li>They are composed of the following: </li></ul><ul><ul><li>The Current Account </li></ul></ul><ul><ul><li>The Capital Account </li></ul></ul><ul><ul><li>The Official Reserves Account </li></ul></ul><ul><ul><li>Statistical Discrepancy </li></ul></ul>Balance of Payments Accounts
  6. 6. The Current Account <ul><li>Includes all imports and exports of goods and services. </li></ul><ul><li>Includes unilateral transfers of foreign aid. </li></ul><ul><li>If the debits exceed the credits, then a country is running a trade deficit . </li></ul><ul><li>If the credits exceed the debits, then a country is running a trade surplus . </li></ul>
  7. 7. The Capital Account <ul><li>The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. </li></ul><ul><li>The U.S. enjoys about a $444,000,000,000 capital account surplus — absent of U.S. borrowing from foreigners, this “finances” our trade deficit. </li></ul><ul><li>The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments. </li></ul>
  8. 8. Statistical Discrepancy <ul><li>There’s going to be some omissions and misrecorded transactions — so we use a “plug” figure to get things to balance. </li></ul><ul><li>Exhibit 3.1 shows a discrepancy of $0.73 billion in 2000. </li></ul>
  9. 9. The Official Reserves Account <ul><li>Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF. </li></ul>
  10. 10. The Balance of Payments Identity <ul><li>BCA + BKA + BRA = 0 </li></ul><ul><ul><li>where </li></ul></ul><ul><ul><li>BCA = balance on current account </li></ul></ul><ul><ul><li>BKA = balance on capital account </li></ul></ul><ul><ul><li>BRA = balance on the reserves account </li></ul></ul><ul><li>Under a pure flexible exchange rate regime, </li></ul><ul><li>BCA + BKA = 0 </li></ul>
  11. 11. U.S. Balance of Payments Data   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  12. 12. U.S. Balance of Payments Data In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion.   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  13. 13. U.S. Balance of Payments Data During the same year, the U.S. attracted net investment of $444.26 billion—clearly the rest of the world found the U.S. to be a good place to invest.   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  14. 14. U.S. Balance of Payments Data Under a pure flexible exchange rate regime, these numbers would balance each other out.   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  15. 15. U.S. Balance of Payments Data In the real world, there is a statistical discrepancy.   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  16. 16. U.S. Balance of Payments Data Including that, the balance of payments identity should hold: BCA + BKA = – BRA ($444.69) + $444.26 + $0.73 = $0.30 = – ($0.30)   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  17. 17. Balance of Payments and the Exchange Rate Q P Exchange rate $ S D   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  18. 18. Balance of Payments and the Exchange Rate Q P As U.S. citizens import, they are supply dollars to the FOREX market. Exchange rate $ S D   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  19. 19. Balance of Payments and the Exchange Rate Q P As U.S. citizens export, others demand dollars at the FOREX market. Exchange rate $ S D   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  20. 20. Balance of Payments and the Exchange Rate Q P S D As the U.S. government sells dollars, the supply of dollars increases. S 1 Exchange rate $   Credits Debits Current Account     1 Exports $1,418.64   2 Imports   ($1,809.18) 3 Unilateral Transfers $10.24 ($64.39)   Balance on Current Account ($444.69) Capital Account     4 Direct Investment $287.68 ($152.44) 5 Portfolio Investment $474.39 ($124.94) 6 Other Investments $262.64 ($303.27)   Balance on Capital Account $444.26   7 Statistical Discrepancies     Overall Balance $0.30   Official Reserve Account ($0.30) 0.73
  21. 21. Balance of Payments Trends <ul><li>Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account. </li></ul><ul><li>During the same period, Japan has experienced the opposite. </li></ul>
  22. 22. Balances on the Current (BCA) and Capital (BKA) Accounts of the United States Source: IMF International Financial Statistics Yearbook, 2000
  23. 23. Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom Source: IMF International Financial Statistics Yearbook, 2000
  24. 24. Balances on the Current (BCA) and Capital (BKA) Accounts of Japan Source: IMF International Financial Statistics Yearbook, 2000
  25. 25. Balances on the Current (BCA) and Capital (BKA) Accounts of Germany Source: IMF International Financial Statistics Yearbook, 2000
  26. 26. Balances on the Current (BCA) and Capital (BKA) Accounts of China Source: IMF International Financial Statistics Yearbook, 2000
  27. 27. Balance of Payments Trends <ul><li>Germany traditionally had current account surpluses. </li></ul><ul><li>Since 1991 Germany has been experiencing current account deficits. </li></ul><ul><li>This is largely due to German reunification and the resultant need to absorb more output domestically to rebuild the former East Germany. </li></ul><ul><li>What matters is the nature and causes of the disequilibrium. </li></ul>
  28. 28. Balances on the Current (BCA) and Capital (BKA) Accounts of Five Major Countries Source: IMF International Financial Statistics Yearbook, 2000
  29. 29. End Chapter Three

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