Balance of Payment

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Balance of Payments
Balance of Payments
A system of accounts that measures transaction of

goods, services, income, and financial assets between domestic residents, businesses, and governments and the rest of the world during a specific time period.

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Introduction
Balance of payments
Record of the economic transactions between the

residents of one country and the rest of the world

International transaction
Exchange of goods, services, or assets between

residents of one country and those of another

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Double-Entry Accounting
Arrangement of international transactions into

a balance-of-payments account
Credit: Receipt of a payment from foreigners Debit: Payment to foreigners

Balance-of-payments accounts utilize a

double-entry accounting system

Total balance-of-payments account must balance Subaccounts may not balance Surplus occurs when the balance is positive Deficit occurs when the balance is negative

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BOP Statements and Accounting

Cash flow statement dominated by two types of business transactions Real assets Financial assets
Double-Entry accounting is used. Balance of payments may not balance - individual transactions are recorded independently and doubleentry accounting is used in theory only. Will be balanced by the net errors and omissions account.
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Balance-of-Payments Structure: Current Account

Monetary value of international flows

associated with transactions

Merchandise trade Merchandise trade balance: Combining the exports and imports of goods Exports and imports of services Goods and services balance

Add services to the merchandise trade account

Income receipts and payments Unilateral transfers Private transfer payments Governmental transfers

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Capital and Financial Account

All international purchases or sales of assets Includes both private-sector and official transactions Capital transactions
Capital transfers Acquisition and disposal of certain nonfinancial assets

Private-sector financial transactions Direct Investment Securities Bank Claims and Liabilities

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Capital and Financial Account

Financial inflows and outflows
A capital (financial) inflow can be likened to the

export of goods and services A capital (financial) outflow is similar in effect to the import of goods and services.
Official settlements transactions
Movement of financial assets among official holders Official reserve assets Liabilities to foreign official agencies

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Balance-of-Payments Accounts
Current Account
Measures the flow of goods, services, income, and

transfers or gifts between domestic residents, businesses, and governments and the rest of the world.
Goods: imports and exports of tangible goods. Services: imports and exports of services, tourism and

travel, and military transactions. Income: interest and dividend payments to foreign holders of domestic financial assets. Unilateral transfers: international transfers, or gifts, between individuals and governments.
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Balance-of-Payments Accounts (contd)

Capital Account
A tabulation of the flows of financial assets between

domestic private residents and businesses and foreign private residents and businesses. Includes three categories of financial assets:
Financial assets of the domestic government
Private domestic financial assets Foreign financial assets.

Tabulates two types of asset flows Investment flows and changes in banks and brokers cash deposits that arise from foreign transactions.

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Deficits and Surpluses in the Balance of Payments (contd)

Balance-of-Payments Deficit
The sum of the credits and debits in the current

account and the private capital account is negative.

Balance-of-Payments Surplus
A situation where the sum of the debits and credits in

the current and private capital account is positive.

Balance-of-Payments Equilibrium
A situation where the sum of the debits and credits in

the current account and the private capital account is zero.

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What does a Current Account Deficit (Surplus) Mean?

Total debits will always equal total credits
If the current account registers a deficit, the capital

and financial account must register a surplus, or net capital/financial inflow If the current account registers a surplus, the capital and financial account must register a deficit, or net capital/financial outflow

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Net Foreign Investment and the Current Account Balance

Current account balance Synonymous with net foreign investment in national income accounting
Current account surplus - net supplier of funds Current account deficit - net demander of funds

Net borrowing of the nation:

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Impact of Financial Flows on the Current Account

Capital and financial flows may initiate changes in

the current account

Countrys current account deficit can be caused by

a net financial inflow to the Country

Appreciating dollar makes imports cheaper and exports

costly Declining exports and increasing imports results in a rise in the current account deficit, or a decline in the current account surplus

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Is a Current Account Deficit a Problem?

Benefit of a current account deficit
Ability to push current spending beyond current

production Cost of debt service Debt: Good or bad for a nation?

Is the deficit used to finance more consumption or more

investment?5

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Business Cycles, Economic Growth, and the Current Account

Current account and economic performance
Rapid growth of production and employment: Large or growing trade and current account deficits Slow output and employment growth Large or growing surpluses

Holds for both short-term and long-term

Economic growth, employment growth, and trade

balances

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International Economic Crisis Path

Country has Current Account deficit and a Financial Account surplus

Capital acts as financing for growing merchandise/service s deficits

Event questions countrys economic stability- investors withdraw capital rapidly

Capital flight causes loss of financial account surplus - deficit in overall balance of payments results

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Global Effects of Economic Crisis

Recession or depression. Reduction in world demand for products. World markets suffer severe price reductions as demand falls. Declining earnings and growth prospects for other emerging economies.

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