Balance of payment


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Balance of payment

  1. 1. Categories and Definitions  Balance of Payments (BOP) is an accounting of a country's international transactions over a certain time period, typically a calendar quarter or year.  It shows the sum of the transactions (purely financial ones, as well as those involving goods or services) between individuals, businesses, and government agencies in that country and those in the rest of the world.  Every international transaction results in a credit and a debit.  Transactions that cause money to flow into a country are credits, and transactions that cause money to leave a country are debits  We give the payments coming in a plus sign, and the payments going out a minus sign. Balance of Payments:
  2. 2. Major principles of drawing and determination of BoP • account of operations between residents and non-residents • account of operations by the system of double booking • reflection of flows, instead of stocks • cost estimation of operations and transfers of sums denominated in different currencies in one accounting unit • reflection of operations by types and sectors of economy Major items of balance of payments Balance of payments consists of the following components: current account, capital and financial resources account reserve assets. Current account reflects the movement of all goods and services of factor profit and current transfers between residents and non-residents. Capital account includes operations with capital transfers and non-financial assets.
  3. 3. Financial account consists of all operations changing international investment position Here's a synopsis first: Current Account Trade - Exports Imports Private Transfers Official Transfers Factor Services Financial Account (Capital Account) Foreign Direct Investment Portfolio Investment Borrowing and Lending Changes in Reserves Errors and Omissions Balance of Payments
  4. 4. Current Account Trade Exports (X) Exports are goods or services sold to foreigners. They require that foreigners make payments to us. (+) They take a plus sign. Macro Note: since exports are a source of total aggregate demand for nationally-produced goods, changes in exports will produce corresponding changes in national income. If other country’s incomes rise, they will likely import more of our goods, raising out exports. The World Bank figures distinguish between "Merchandise Exports" (Exports of things that you can touch) and exports of services, like shipping, tourism, and communications. Goods. This item includes the trade of goods, including goods for processing with the further re import-re export, repair of capital movable goods such as tonnage, goods acquired by hauling units in ports, non-monetary gold Services cover all categories of services, particularly, freight and passenger traffic, tourism and others, including mainly technical assistance in the form of consulting and training services, geophysical, constructive, communication and governmental services.
  5. 5. Imports (M) Imports are goods or services purchased from foreigners. They require that we make payments to foreigners. (-) They take a minus sign. Macro Note: Generally imports will rise or fall as total national income rises or falls, since they will represent some part of national demand for goods. In that case both demand for imports and demand for locally- made goods will rise. If for some reason people substitute away from domestically-made goods toward imports, that will tend to lower national income. Additionally, some countries may have export industries that require significant amounts of imports. The World Bank figures distinguish between "Merchandise Imports" (Imports of things that you can touch) and imports of services. The sum (X-M) gives you the "trade balance."
  6. 6. Private Transfers into our country mean that foreigners make payments to us. (Suppose your uncle in Japan sends you a check.) (+) They take a plus sign. Private Transfers to other countries are simply payments to people in those countries. Suppose you help to support your children studying abroad. (-) They take a minus sign.  Often private (i.e. made at individual initiative) transfers are made by workers who go abroad and send part of their earnings home, e.g. Indians in the Gulf countries., Turks in Germany, Filipinos in Singapore. So you would expect the Gulf countries to show net negative private transfers, and India to show net positive private transfers. Private Transfers These simply mean payments made between private citizens that are not purchases of anything. Most often they are payments between family members
  7. 7. Official Transfers Like Private Transfers, these are payments that are not purchases of anything that are made by or to governments. Official Transfers into our country mean that foreign governments (or multilateral agencies) make payments to us. (+) They take a plus sign. Official Transfers to other countries are simply payments by our government to other countries. (-) They take a minus sign.  Basically these are government-to-government payments, though some may go through international agencies like the United Nations.  This can be termed "aid" of various kinds; when the United States, for example, got large payments from Japan and other countries to defray costs involved in the Gulf War, those represented large positive official transfers in the U.S. BoP.  For only a few countries, however, are official transfers likely to be a significant part of the overall BoP. Macro note: Large incoming transfers will enable a country to import more — in fact that’s often the intent of foreign aid, and many countries insist that their "aid" be spent on their exports
  8. 8. Factor Services "Factor" here means "factor of production," and in this context factor services are payments for the use of either physical capital, like a factory, or financial capital, like a loan. Payments to us from foreigners that represent interest on loans that we made to them, or profits from physical capital (like factories) owned by our citizens, go into factor services with a plus (+) sign. Payments by us to foreigners that represent interest on loans or profits from physical capital that they own in our country go into factor services with a minus (-) sign.  You may think it is weird that interest payments on a loan go into the current account while principal payments go into the capital account. It is. But this is how accountants see the world. Macro Note: Countries that borrow a lot will show very large amounts of interest payments out, sometimes to the extent that half of their exports are going to pay interest on loans. (One reason why interest payments balloon like this is that when a country has trouble making payments on debt, it may enter into a "rescheduling" agreement that postpones payments of loan principal while continuing interest payments. That lets lenders keep the loans on their books as "performing." The macro effect of this debt burden, however, is that the country consumes a lot less than it makes, and this can tend to reduce gross fixed capital
  9. 9. formation, crippling prospects for future growth. Not to mention lowering overall consumption, which often hits the poor hardest. Capital Account Capital /Financial account Financial Account (asset-related payments) Foreign Direct Investment Payments to purchase fixed capital assets, like factories. • Direct investment- Direct investor is the investor, which has a stockholding or have not less than 10% share in a company, in which he/she invested • Direct investment can have the form of goods, immovable property and financial resources • In the balance of payments direct investments are classified as direct investments abroad, having economic purport of assets (investment of residents in other economies) and direct investment in national economy, having economic character of obligations to non- residents (investment of non-residents in the economy). Payments by foreigners to acquire fixed capital assets in our country take a plus (+) sign Payments to foreigners to acquire fixed capital assets in their countries take
  10. 10. a minus (-) sign Portfolio Investment Payments used to purchase financial assets (securities). Payments by foreigners to acquire securities (like bonds or corporate stock) in our country take a plus (+) sign Payments to foreigners to acquire securities in their countries take a minus (-) sign • Portfolio investment- This category includes investment in corporate securities including shares, sum of which (stockholding) accounts not less than 10% and state debt securities • Debt securities include bonds and bills of exchange with duration not more than 1 year, instruments of money-market and financial derivatives. Borrowing and Lending • It includes Ptrade (commercial loans), governmental and private loans, currency and deposits and other assets and liabilities,
  11. 11. including debit and credit indebtedness on contracts for delivery of goods and services a (interest payments go under factor services). This will include both new loans and repayment of principal associated with old loans. Loans from foreigners to us require them to make a payment to us, so they take a plus (+) sign. You can think of this as a foreign bank buying an I.O.U. from a domestic resident. The I.O.U. is a financial asset. Also, if a foreigner repays the principal on an old loan we made to them, that also requires a payment to us and takes a plus (+) sign. Loans made by us to foreigners require us to make a payment to them, so they take a minus (-) sign. You can think of this as us buying a foreigner’s I.O.U. The I.O.U. is a financial asset. Also, if we repay the principal on an old loan a foreigner made to us, that also requires a payment to a foreigner and takes a minus (-) sign. Changes in Reserves Changes in Reserves  Changes in the quantity of foreign assets held by the Central Bank.  What’s left over after we sum up the Current Account and Capital Account should be the change in the reserves held by the Central Bank.
  12. 12.  If all these activities bring in more foreign exchange than they use, the balance should be accounted for by additional foreign assets held by the central bank.  We call these assets reserves, so total reserves rise.  If all these activities use up more foreign exchange than they bring in, the Central Bank has to fill the gap by selling some of the foreign assets it owns, so total reserves fall. So: Current Account + Capital Account = Change in Reserves  Reserve assets is the component of balance of payments, which is very important in analysing external operations of a country  International reserves consist of external assets of country, operations of which are carried out by the Central Bank  They can be used to finance deficit of balance of payments by interventions on exchange market in order to regulate exchange rate and to maintain stability of the national currency  Reserve assets consist of monetary gold, SDR, reserve positions with IMF, assets in foreign currency (currency, deposits, securities) and other requirements
  13. 13. Balance of Payments Deficit and Surplus In theory, the current account should balance with the capital plus the financial accounts The sum of the balance of payments statements should be zero The Current Account, Capital Account, and Reserve Changes should sum to zero – they should include all of the inflows and outflows of foreign exchange For example, when India buys more goods and services than it sells (a current account deficit), it must finance the difference by borrowing, or by selling more capital assets than it buys (a capital account surplus) A country with a persistent current account deficit is, therefore, effectively exchanging capital assets for goods and services Large trade deficits mean that the country is borrowing from abroad In the balance of payments, this appears as an inflow of foreign capital In reality, the accounts do not exactly offset each other, because of statistical discrepancies, accounting conventions, and exchange rate
  14. 14. movements that change the recorded value of transactions