BOP

1. Balance of payments
“The balance of payment is a statistical statement for a
given period showing
a) Transaction in goods and services and income
between an economy and the rest of the world
b) Changes of ownership and other changes in that
country’s monetary gold, SDRs and claims and
liabilities to the rest of the world ,and
c) Unrequited transfers and counterpart entries that
are needed to balance, in the accounting sense,
any entries for the foregoing transactions and
changes which are not mutually offsetting.”
- The IMF publication, “Balance of
Payments Manual.”

2. Balance of Payments
 A record of international
transactions between residents of
one country and the rest of the
world
 International transactions include
exchanges of goods, services or
assets
 “Residents” means businesses,
individuals and government
agencies, including citizens
temporarily living abroad but
excluding local subsidiaries of

3. Double-entry Accounting in the
BOP
 All transactions are either debit or
credit transactions
 Credit transactions result in receipt of
payment from foreigners
◦ Merchandise exports (valued f.o.b.)
◦ Transportation and travel receipts
◦ Income received from investments abroad
◦ Gifts received from foreign residents
◦ Aid received from foreign governments

4. Double-entry Accounting (Cont’d)
 Debit transactions involve to payments to
foreigners
◦ Merchandise imports
◦ Transportation and travel expenditures
◦ Income paid on investments of foreigners
◦ Gifts to foreign residents
◦ Aid given by home government
◦ Overseas investments by home country
residents
 Each credit transaction has a balancing
debit transaction, and vice versa, so the
overall balance of payments is always in
balance.

5. Components of BoP
Current account: - Merchandise exports and imports
- Invisible exports and Imports
Capital account: - Short-term
- Long term
Unilateral Transfer Account: - Gifts
- Remittances
Official reserves account:- Gold
-convertible foreign exchange
Balance of payment disequilibrium
 either a surplus
 or a deficit

6. Accounts Overview (Level 1)
 Current Account (all real transfers)
◦ Merchandise trade
◦ Service trade
◦ Transfers
 Capital and Financial Account (transfers of
ownership and financial assets and liabilities)
◦ Changes in private assets
◦ Changes in holdings of official international
reserves
◦ Statistical Discrepancy

7. Current Account
 The current account is that balance of
payments account in which all short-
term flows of payments are listed:
◦ Goods and services balance (exports –
imports)
 Merchandise trade balance (exports – imports)
 Services balance (exports – imports)
◦ Net Investment income
◦ Unilateral transfers
 Private transfer payments
 Governmental transfers

8. What are Services?
 Travel and tourism
 Trade transportation
 Insurance
 Education
 Financial, technical, and marketing
services
 Telecommunication
 Use of property rights (royalties)
 Other professional and consulting
services

9. What is Investment Income?
 Payment to holders of foreign financial
assets, including:
◦ Interest on bonds and loans
◦ Dividends and other claims on profits by
owners of foreign businesses
◦ Payments made to temporary (nonresident)
workers

10. Unilateral Transfers
 Official government grants in aid to
foreign governments
 Charitable giving (e.g., famine relief)
 Migrant workers transfers to families in
their home countries

11. Capital Account
 The capital and financial account is that
balance of payments account in which all
cross-border transactions involving financial
assets are listed. This includes transactions
between foreign and domestic residents, and
foreign and domestic governments.
◦ All purchases or sales of assets, including:
 Direct investment
 Securities (debt)
 Bank claims and liabilities
 Official reserves transactions
 When U.S. citizens buy foreign securities or when foreigners
buy U.S. securities, they are listed here as outflows and
inflows, respectively.

12. Foreign Direct Investment
(FDI)
 Any flow of lending to, or purchases of ownership in, a
foreign enterprise that is largely owned by residents of
the investing country.
◦ Securities (stocks and bonds)
◦ Loans
◦ Bank deposits
◦ Minority ownership positions
 FDI is the purchase of assets to establish financial
control of a foreign entity. Generally ownership of 10%
or more of a company’s outstanding stock is considered
FDI.
 Portfolio investment involves little management control
or interest, and is solely for financial gain.

13. Official Reserve Assets
 Early on in this century, this was
primarily gold
 Now primarily financial assets
denominated in a foreign currency that is
widely accepted in international
transactions:
◦ Euro assets (heavily used by U.S.)
◦ Yen assets (heavily used by U.S.)
◦ U.S. dollar assets (key currency worldwide)
◦ Reserve positions in IMF
◦ SDRs (created by IMF)

14. Official Reserves Transactions
 Governments can influence exchange rates by
buying and selling official reserves.
 The buying and selling of official reserves is
recorded in the “official transactions” account.
◦ Also referred to as “changes in holdings of official
international reserves” or “official settlements
balance”.
 It is the part of the balance of payments
accounts that records the amount of its own
currency or foreign currencies that a nation
buys or sells.

15. Statistical Discrepancy?
 It is the net result of errors and
omissions on both the credit and debit
sides.
 Where do these errors come from?
◦ Under-reporting merchandise imports
◦ Under-reporting investment incomes
◦ Under-reporting capital exports
◦ Basically, people succeed in hiding their
imports, foreign investment incomes,
capital flight from their governments for
tax and other purposes.

16. Account Overview (Level 2)
Current Account
Merchandise trade
exports
imports
Trade Balance
Services
military trans. (net)
other services, net
Service Balance
Balance on goods & services
Investment income, net
Unilateral transfers
US government grants
US govt pensions, and
other transfers
Private remittances and
other transfers
All transfers, net
Balance on current account
Capital Account
Changes in US assets abroad, net
other US govt assets
US private assets
All changes, net
Changes in foreign assets in the US,
net foreign private assets
All changes, net
Changes in holdings of official
international reserves, net
Statistical discrepancy
Balance on capital account

17. Meaning of Overall Balance
 The current account and the capital account
measure the private and non-U.S. government
supply of and demand for dollars.
 Official Settlements Balance:
B = CA + KA
 Because the balance of payments must sum to
zero, any imbalance in the official settlements
balance must be financed (paid for) by official
reserves flows:
B + OR = 0

18. BOP Surplus and Deficit
 The Official Settlements Balance (B ) is
sometimes referred to as the net sum of the
items above the line or autonomous
transactions, and
 The Official Reserves Transactions (OR ) are
referred to as the sum of the items below the
line, also called nonautonomous or
accommodating transactions.
◦ When B = 0, there is said to be a BOP equilibrium,
and if B  0, a BOP disequilibrium.
◦ When B > 0, there is said to be a BOP surplus.
◦ When B < 0, there is said to be a BOP deficit.

19. BOP Surplus and Deficit (Continued)
 In terms of the supply and demand
of a nation’s currency, there is:
◦ A balance of payments surplus if quantity
demanded for a currency exceeds quantity
supplied, putting upward pressure on the
value of the nation’s currency.
◦ A balance of payments deficit if quantity
supplied of a currency exceeds quantity
demanded, putting downward pressure on
the value of the nation’s currency.

20. Official Transactions Account
 Because they are an accounting identity,
the current, capital, and official
transactions accounts must sum to
zero—in total, the balance of payments
balances.
 The supply of currency, including
government’s, must equal the demand
for currency, including government’s.

21. Factors causing Disequilibrium
1]. Economic factors
Development disequilibrium
Cyclical disequilibrium Lawrence W. Towle “Depression always
brings about a drastic shrinkage in world trade, while prosperity
stimulates it.”
Secular disequilibrium
Structural disequilibrium
2]. Political factors
political instability
wars
change in world trade routes
3]. Social factors
changes in tastes preferences, fashion, etc.

22. Correction of Disequilibrium
Automatic Corrections
Deliberate Measures
Monetary
measures
1) Monetary
contraction /
expansions
2) Devaluation/
Revaluation
3) Exchange control
Trade measures Miscellaneous
measures
1. Foreign loans
2. Incentives for
foreign investments
3. Tourism
development
4. Incentives for
inward remittances
5. Import substitutions
Export Promotion
1. Abolition of export
duties
2. Export subsidies
3. Incentives
Import control
1. Import duties
2. Import quota
3. Import
prohibition