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Bop done

  2. 2. The Balance of Payments:Learning ObjectivesLearn how nations measure their own levels ofinternational economic activity, and how that ismeasured by the balance of paymentsExamine the economic relationships underlying thetwo basic sub-components of the balance of payments– the Current and Capital AccountsConsider the financial dimensions of internationaleconomic activity, and how they differ betweenmerchandise & services trade2
  3. 3. The Balance of PaymentsIdentify balance of payment activities by nations inpursuit of macroeconomic policiesExamine how exchange rate changes and volatilityinfluence trade balances over timeEvaluate the history of capital mobility, and conditionsthat lead to capital flight in times of crisis3
  4. 4. The Balance of PaymentsThe measurement of all international economictransactions between the residents of a country andforeign residents is called the Balance of Payments(BOP)The IMF is the primary source of similar statisticsworldwideMultinational businesses use various BOP measures togauge (estimate) the growth and health of specific types oftrade or financial transactions by country and regions of theworld against the home country4
  5. 5. The Balance of PaymentsMonetary and fiscal policy must take into account the“BOP” at the national level.Businesses need BOP data to anticipate changes in hostcountry’s economic policies driven by BOP events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 countryor currency Changes in a country’s BOP may signal imposition [(the act ofimposing something (as a tax )] of controls over payments, dividends,interest, etc BOP helps to forecast a country’s market potential, especially in theshort run5
  6. 6. Typical BOP TransactionsExamples of BOP transactions from US perspectiveHonda US is the distributor of cars manufactured in Japan by its parent,Honda of JapanUS based firm, Fluor Corp., manages the construction of a major watertreatment facility in Bangkok, ThailandUS subsidiary of French firm, Saint Gobain, pays profits (dividends)back to parent firm in ParisAn American tourist purchases a small Lapponia necklace in FinlandA Mexican lawyer purchases a US corporate bond through aninvestment broker in ClevelandA rule of thumb that aids in understanding the BOP is to“follow the cash flow”6
  7. 7. Exhibit 4.1 Generic Balance ofPayments7
  8. 8. Fundamentals of BOP AccountingThe BOP must balanceThree main elements of actual process of measuringinternational economic activityIdentifying what is/is not an international economictransactionUnderstanding how the flow of goods, services, assets,money create debits and creditsUnderstanding the bookkeeping procedures for BOPaccounting8
  9. 9. Defining International EconomicTransactionsCurrent Account TransactionsThe export of merchandise, goods such as trucks,machinery, computers is an international transactionImports such as French wine, Japanese cameras and Germanautomobiles are international transactionsThe purchase of a glass figure in Venice by an Americantourist is a US merchandise importFinancial Account TransactionsThe purchase of a US Treasury bill by a foreign resident9
  10. 10. BOP as a Flow StatementExchange of Real Assets – exchange of goods andservices for other goods and services or for monetarypaymentExchange of Financial Assets – Exchange of financialclaims for other financial claims10
  11. 11. The Current AccountGoods Trade – export/import of goods.Services Trade – export/import of services; commonservices are financial services provided by banks toforeign investors, construction services and tourismservicesIncome – predominately current income associated withinvestments which were made in previous periods.Additionally the wages & salaries paid to non-residentworkersCurrent Transfers – financial settlements associatedwith change in ownership of real resources or financialitems. Any transfer between countries which is one-way,a gift or a grant,is termed a current transferTypically dominated by the export/import of goods, forthis reason the Balance of Trade (BOT) is widely quoted 11
  12. 12. The Capital and Financial AccountsCapital account is made up of transfers of fixed assetssuch as real estate and acquisitions/disposal of non-produced/non-financial assetsFinancial account consists of three components and isclassified either by maturity of asset or nature ofownership. The three components areDirect Investment – Net balance of capital which isdispersed from and into a country for the purpose ofexerting control over assets. This category includes foreigndirect investment12
  13. 13. The Capital and Financial AccountsPortfolio Investment – Net balance of capital which flowsin and out of the country but does not reach the 10%ownership threshold of direct investment. The purchase andsale of debt or equity securities is included in this category This capital is purely return motivatedOther Investment Assets/Liabilities – Consists of variousshort and long-term trade credits, cross-border loans,currency and bank deposits and other accounts receivableand payable related to cross-border trade13
  14. 14. The Other AccountsNet Errors and Omissions – Account is used to account forstatistical errors and/or untraceable money within a countryOfficial Reserves – total reserves held by official monetaryauthorities within a country.These reserves are typically comprised of major currencies thatare used in international trade and financial transactions andreserve accounts (SDRs) held at the IMFUnder a fixed rate regime official reserves are more importantas the government assumes the responsibility to maintainparity among currencies by buying or selling its currency onthe open marketUnder a floating rate regime the government does not assumesuch a responsibility and the importance of official reserves isreduced 14
  15. 15. Balance of Payments Interactionwith Key MacroeconomicVariablesA nation’s balance of payments interacts with nearly allof its key macroeconomic variables:Gross domestic product (GDP)The exchange rateInterest ratesInflation rates15
  16. 16. 16In a static (accounting) sense, a nation’s GDP can berepresented by the following equation:GDP = C + I + G + X – MC = consumption spendingI = capital investment spendingG = government spendingX = exports of goods and servicesM = imports of goods and servicesX – M =Current accountbalance
  17. 17. The Balance of Payments andExchange RatesA country’s BOP can have a significant impact on thelevel of its exchange rate and vice versa depending onthat country’s exchange rate regimeThe effect of an imbalance in the BOP of a countryworks somewhat differently depending on whetherthat country has fixed exchange rates, floatingexchange rates, or a managed exchange rate systemUnder a fixed exchange rate system the government bearsthe responsibility to assure a BOP near zeroUnder a floating exchange rate system, the government of acountry has no responsibility to peg its foreign exchangerate.17
  18. 18. 18The relationship between BOP and exchange ratescan be illustrated by use of a simplified equation:CI = capital inflowsCO = capital outflowsFI = financial inflowsFO = financial outflowsFXB = official monetary reservesCurrentAccountBalance(X-M)CapitalAccountBalance(CI - CO)FinancialAccountBalance(FI - FO)ReserveBalance(FXB)BalanceofPaymentsBOP++ + =
  19. 19. The Balance of Payments andInterest RatesApart from the use of interest rates to intervene in theforeign exchange market, the overall level of acountry’s interest rates compared to other countriesdoes have an impact on the financial account of thebalance of paymentsRelatively low interest rates should normallystimulate an outflow of capital seeking higher interestrates in other country-currenciesIn the U.S. however, the opposite has occurred as aresult of attractive growth rate prospects, high levelsof productive innovation, and perceived politicalstability19
  20. 20. The Balance of Payments andInflation RatesImports have the potential to lower a country’s inflationrateIn particular, imports of lower priced goods and servicesplaces a limit on what domestic competitors charge forcomparable goods and services20
  21. 21. Trade Balances and ExchangeRatesA simple concept in principle: Changes in exchangerates changes the relative prices of imports and exportswhich in turn result in changes in quantities demandedIn reality the process is less straight-forward21
  22. 22. Capital MobilityThe degree to which capital moves freely cross-border iscritically important to a country’s balance of paymentsHistorical patterns of capital mobility1860-1914 – period characterized by continuously increasing capitalopenness as more countries adopted the gold standard and expandedinternational trade relations1914-1945 – period of global economic destruction due to two worldwars and a global depression1945-1971 – Bretton Woods era, saw great expansion of internationaltrade in goods and services1971-2002 – period characterized by floating exchange rates,economic volatility, but rapidly expanding cross-border capital flows22