THE BALANCE OF PAYMENTS AND THE EXCHANGE RATE

Transcription

1 AND THE EXCHANGE RATE Original written by professor Rafael Pampillón at. Original version, 4 December Last revised, 23 May Published by IE Publishing Department. María de Molina 13, Madrid, Spain IE. Total or partial publication of this document without the express, written consent of IE is prohibited. Along with the growth of the countries of the world there has been a rapid increase of economic exchanges among the various national economies. In consequence, the degree of integration among economies has grown to such an extent that they have gone from relatively autonomous and closed systems to become parts of a whole, and in turn to being extremely sensitive to what is going on outside their frontiers. Nowadays it is not unusual to find countries where imports and exports reach very high proportions, in some case 60% of their Gross National Product, and frequently one can see cases of thousands of millions of dollars being loaned to countries from other countries where the domestic saving is higher than the domestic investment. The global economy is becoming more and more dominated by movements of capital; every day, thousands of millions of dollars change hands by satellite and are distributed throughout the world, with tremendous effects on the national economies. Paradoxically, economic discussions tend to focus on world trade and it is often forgotten that the movements of goods and services are, almost always, complementary to the financial movements (of capital). Any attempt at an economic analysis of a country would be pointless without ample information about its economic transactions with other countries. It is the Balance of Payments Sheet which records/shows the economic transactions between the residents of one country and those of the rest of the world. That is why it is an essential document for the study and analysis of a country s economy and for the adoption of its economic policy. The concept of residence is based on the place where the person or the institution that intervenes in the transaction is located. The economic relations of a country, within the framework of the Balance of Payments, highlight the role of the transactions of the capital and financial accounts and their interdependence with the commercial transactions of goods and services, and the levels of production and income. Particularly important within a country s economic transactions with the rest of the world, both because of their volume and because of the great influence they have on the other parameters of the economy (prices, production, yield, employment, etc) are the operations of exports and imports. This fact makes it necessary, before dealing with the balance of payments sheet in itself, to discuss the explanations that Economic Theory has tried to provide for these commercial interchanges between countries, even if in a brief and thus superficial way. INTERNATIONAL TRADE The theory of International Trade attempts to isolate the causes that lead individuals resident in a country to sell to other countries some of the goods they produce and on the other hand provide themselves with other goods from abroad, even if in many cases they can produce them themselves. The second purpose of this theory is to identify the factors involved in deciding the nature of the exchange; that is to say, the prices which influence these exchanges with other countries. 1

2 Generally speaking, the many different theories have focused on the differences between the countries to explain the commercial flows produced between them. At first, it was considered that the basic difference was the technological capacity of each country to produce different products; thus, Portugal was able to produce more wine than Great Britain, applying the same means for its production, while Great Britain had better technology to produce textiles. Great Britain, therefore, could specialise in the production of textiles and buy its wine in Portugal, while the latter country did the opposite. Later it was seen that while one country used a less developed technology than another to produce specific goods, it continued being beneficial for each to continue with the trade. Ultimately, then, it is the differences in the production prices of goods in different countries, whether due to different technologies or other distinguishing factors, that explain why countries specialise in the production of specific goods and export them while they tend to import those goods that are produced more cheaply abroad. Although the price is the basic guiding element, we cannot ignore other factors, such as the quality of the goods, better or worse terms of payment, or the period of time in which large quantities of the goods can be obtained, which, given the great diversity involved, is also of great importance to the supplier. Although the motivations and aims of international trade are the same as those of domestic trade, there are important factors in the former that are not present in the latter, such as the different legislations, quality controls, tastes, and especially the existence of tariff barriers and different national currencies, which gives crucial importance to the exchange rate, given that an exporter or importer is interested in the number of units of his national currency that he will either obtain for his exports or pay for what he imports, and not in what the amount is in the foreign currency. As we can see, this exchange rate is affected not only by the commercial flows of imports and exports, but also by what happens in the other epigraphs of the Balance of Payments. International trade has gone from a situation in which the countries could count on comparative advantages that were stable in the long term, to a more dynamic situation with constant variations. Since the 70 s businessmen have dedicated a large part of their time to remedying the consequences of the external fluctuations arising from the variations in energy prices, interest rates, exchange rates and the rate of inflation. Despite its name, a country s Balance of Payments is anything but balanced. It is simply a list of the transactions between the institutional sectors of a country (the credit system, the Public Administration and other resident sectors) and the rest of the world. The drawing up of the balance of payments of a nation consists of a double entry system, similar to the national accounts, with its own rules, conventions and chart of accounts. The balance of payments can be set out in different ways, but it always reflects the behaviour of the countries in the realm of international economics. Its methodology is adapted to the real external operations of the developed countries and especially to their financial markets. The Balance of Payments is an accounting document which systematically records all the economic transactions which have taken place between the residents of a country and those of the rest of the world, during a certain period of time. The period of time is normally a year; however, several countries draw up a balance of payment every semester or trimester. With regard to the definition of residence, in the case of individual people the criteria used is of habitual residence. Thus all those people who reside permanently in a country, whether they are nationals or foreigners, as well as those who live temporarily in a foreign country on diplomatic or military missions, are considered residents. Tourists or seasonal emigrants are considered residents of the country they come from, whereas the emigrants who settle in a receiving country are considered residents in that country. In the case of corporate entities, all companies with a physical address in the country, and subsidiaries and branches of foreign societies which have a large part of their goods or services there, maintain independent accounting records, pay taxes in that country, have an evident physical presence there, etc, are considered resident. 2

3 The recorded transactions may be of several types: Exchange of goods, services and income for goods, services and income Exchange of goods, services and income for instruments of credit (loans, banker s drafts, foreign currency, etc) Exchange of instruments of credit for instruments of credit Concession or procurement of goods, services and income without offsetting factors Concession or procurement of instruments of credit or foreign currency without offsetting factors These last two types of operations, which do not involve offsetting factors, are called either current or capital transfers, although the distinction between them is not simple, either to carry out or to define conceptually. All these operations are recorded in the Balance of Payments, and are organised on the basis of three basic accounts: current, capital and financial. The Current Account lists the entries for income and payments of the current transactions of any one country with the rest of the world. The resulting balance is the total of the balances of merchandise, services, rents and current transfers. Thus all those operations that involve the buying or selling of goods between residents and non-residents, whether or not they cross physical frontiers, are entered in the balance of merchandise, also known as the balance of trade. The Balance of Services includes all those transactions involving earnings or payments for services. It includes, therefore, income and payments for tourism, royalties, technical assistance, rentals, transportation, etc. The Balance of Incomes includes earned income as remuneration to the workers for their part in the production process and investments that occur as remuneration for a financial asset or liability. As a result, the heading investment income includes the income and the payments generated by the financial instruments held by residents abroad and by non-residents in the country. The balance is determined by the total of assets and liabilities of an economy when compared with other countries at a given moment, and therefore depends on the evolution of the different types of interest. The Balance of Transfers includes all those current operations with other countries that do not involve offsetting factors. The balances of services, income and transfers are sometimes called the balance of invisibles for the non-tangible nature of the operations involved, in contrast with the movement of tangible goods in the commercial or merchandise balances. These four balances together (Trade, Services, Income and Transfers) are known as the current account. It records all those transactions that either represent a remuneration for the national or foreign factors in production that have produced the goods and services exported or imported, or increase the national or foreign disposable income. The main modifications from the previous balance on the current account (Fourth IMF Manual) can be seen in the existence of a balance of income as separate from the balance of services, and in the exclusion of capital transfers from the balance of transfers, since they now form part of the capital account. The Capital Account includes transfers without offsetting capital, and the acquisition and disposition of non-performing, non-financial assets, such as land and subsoil, and transactions of intangible assets, such as patents, copyrights, franchises, etc. Capital transfers are, by far, the most important part of this account. Finally, the Financial Account contains the financial operations previously, in the Fourth Manual, contained in the capital balance. It is divided into four balances, differentiated according to the 3

4 types of financial assets and liabilities in which the corresponding operations materialize: direct investments, portfolio investments, other investments and stock variables. In addition, the different headings within it, except for the stock variables, are subdivided into three institutional sectors: credit system, public administrations and other resident sectors. It includes all those operations which affect the country s position as a creditor or a debtor when compared with other countries. The operations which involve an increase in the country s position abroad as a creditor (concession of credits, increase in foreign currency reserves, etc) or a fall in its position as a debtor, are called capital exports and appear as variation of assets; while the operations which raise its position as a debtor (obtaining loans, foreign investments, etc) or lower its position as a creditor are called capital imports and appear as variation of liabilities. The heading direct investments includes the operations which reflect the investor s aim of obtaining permanent earning capacity from the company he invests in and of attaining a significant level of influence in the decision-making organs. The Fifth Manual defines a direct investor as the owner of 10% or more of the selected company s capital. Portfolio investments include transactions in negotiable values, excluding those which, as shares, fulfil the conditions for them to be considered direct investments. It is subdivided into four main components: shares, bonds and debentures, money market instruments, and derivative instruments. The Fifth Manual does not consider that the separation of portfolio transactions into short term and long term is relevant; thus the concept of a basic balance disappears. The heading Other investments includes operations of commercial and financial loans, separated into short term and long term, and of deposits, including holdings of foreign banknotes. The stock variables section includes all the financial assets freely disposable and controlled by the monetary authority. Its aim is to directly finance any disequilibrium in the Balance of Payments, in order to regulate indirectly the size of such disequilibria, and to act on the exchange rate. Its main components are gold, special drawing rights, reserve positions in the IMF, assets in foreign currency, and other assets. For the recording of transactions between residents and non-residents, the abovementioned balances have one column for income and another for payments. All operations that can mean the inflow of currency for the country appear in the income column, so that while in the current and capital accounts these are exports of goods, income from rents, services and transfers, etc, in the financial account the variation of liabilities appears in the income column (imports of financial capital). All the operations that could mean outflow of currency from the country appear in the column of payments, with the result that while these are imports of goods and payments for rents, services and transfers, etc. in the current and capital accounts, the variation of assets appears in the payments column of the financial account. Under variation of liabilities can be found operations of the financial account that make up the acquisition by non-residents of non-performing financial assets issued by residents, and the payments derived from their sale or amortisation. Any increase of liabilities implies a net financial flow of acquisitions by non-residents. Reductions in liabilities imply a net financial outflow, since the income from acquisitions by foreigners is lower than payments as a result of the sale or amortisation of assets. From a national point of view, a plus sign in the variation of liabilities column means an increase in liabilities for non-residents, and a minus sign a decrease. The variation of assets contains purchases by residents of productive and financial assets issued by non-residents, except for their sale or amortisation. Increases in assets imply that there has been a net financial outflow, since payments derived from acquisitions by residents of assets issued by non-residents are higher than the income as a result of their sale or amortisation. Decreases in assets imply that there has been a net financial inflow, since the payments for acquisitions by residents of assets issued by non-residents are lower than the income as a result of their sale or amortisation. From the national point of view, a plus sign in the variation of assets column means an increase of assets for non-residents, and a minus sign a decrease. 4

5 The reserves are, by definition, an asset for the country against the rest of the world. Consequently, if they increase they have to be recorded with a plus sign, under variation of assets, and if they decrease they will also appear under variations of assets, but with a minus sign. DIAGRAM OF A BALANCE OF PAYMENTS Income Exports of merchandise (1) Exports of services (3) Payments Imports of merchandise (2) Earned income and investments (5) Imports of services (4) Current transfers (7) Earned income and investments (6) Capital transfers (9) Current transfers (8) Capital transfers (10) Variation of assets (12) Variation of liabilities (11) Stock variables (13) Errors and omissions (14) Let s look at an example with data referring to the Balance of Payments of a country, for a specific year, in thousands of millions (billions) of pesos: Income Payments A. Current Account (1) 9,889.1 (2) 1,855.8 (3) 4,546.2 (4) 2,595.1 (5) 1,162.3 (6) 2,257.0 (7) 1,259.2 (8) 1,061.5 Total 16,856.8 Total 17,769.4 B. Capital Account (9) (10) 69.6 C. Financial Account (11) (12) (13) -7.1 Total D. Errors and Omissions (14) Total 17,451.2 Total 17,451.2 The sum of the balances of A+B is exactly the same, but with a different sign, as the sum of (C+D). A+B=-(C+D). From the table, the following comments can be made about the year: There is a deficit in the balance of trade (thick continuous line) since the imports (2) at 11,855.8 thousand million pesos, come to more than the exports (1) at 9,889.1 thousand million pesos. The Invisible Balance (Services, Rents and Transfers) has produced a surplus of 1,054.1 thousand million pesos, since the income (3+5+7) is higher than the payments (4+6+8) The Balance on the Current Account (discontinuous line) records a deficit of thousand million pesos, since the income ( ) does not cover the current payments ( ). 5

6 During the year, there was a considerable net inflow of foreign resources to the economy, due to a significant reduction of the capital outflow (12) at the same time as capital inflows from investments (11), all within the framework of a noticeable reduction of the requirements of foreign financing, which was reflected in a minimum reduction of the central reserves (13). In addition to the table, some examples might help to illustrate these entries. Suppose that an exporter makes a sale to another country to the value of 10 million pesos, to be paid two years later. The export, since it generates income, goes into the income column (box 1), while the concession of the two-year credit leads to an entry in the variation of assets column (box 12), since the increase of the country s position as creditor against other countries represents an exportation of capital. If the sale had been paid in cash, this second entry would have been substituted by an increase in the foreign currency reserves, which would have been recorded in box 13. The importation of a commodity to be paid in six months would be entered in box 2, and another for the same amount in box 11. Alternatively, it could be recorded as a short-term commercial credit, under the heading errors and omissions. In another case, the transfer of 1,000 euros by an emigrant from the country who is in Germany to his family back home would be entered in box 7, and would lead to an increase of 1,000 Euros in the foreign currency reserves, which would be recorded in box 13. Finally, if the government of the country availed themselves of a long-term credit for 100 million dollars from an international organisation, it would be entered under variation of liabilities as a long term capital import (variation of liabilities in the financial account), since it increases the country s position as a debtor against other countries, in box 11, and those 100 million dollars would swell the country s foreign currency reserves (box 13). As each transaction always produces two entries of identical value, one in income and the other in payments, the sum of one column should be exactly the same as that of the other. However, the information about many of these transactions is often incomplete and only one part of the transaction is detected (for example, merchandise that is exported through Customs, without the income in foreign currency corresponding to the exportation charge being recorded). This leads to the sum of the two columns not being equal, and as a result a net errors and omissions account has to be added in the column that shows the lower value, with the aim of equalising the total value recorded in both columns. Thus, in the table presented above, the errors and omissions appear in the payments column. Normally, in fact, the errors in one column are fairly similar to those in the other, so the net errors are relatively few; in years when the exchange rate or the speculative pressure is unstable it is common for the net errors and omissions to be around 2 or 3% of the total sum of a column. These are the so-called leads and lags of foreign trade; in other words the to s and fro s between the physical movements of merchandise across the frontiers and their corresponding receipt or payment. But the errors and omissions will also appear, as a result of the capital flight. INTERPRETATION The addition of the heading errors and omissions means that the balance of payments is always in equilibrium in terms of accounts, in the same way as the balance of a company is always in equilibrium, as the income and payments columns always add up to the same value. What value, then, does the balance of payments have as an instrument for economic analysis? Put simply, it provides us with a detailed account of the relations between one country and the rest of the world during one year. It is interesting to know where, how, and when a positive or negative balance was produced. The analysts need to be able to point to where the deficits or surpluses are produced. The fact that the accounting equilibrium must necessarily be complied with does not mean that the balance of payments must record equilibrium in an economic sense. The problem is to find out which accounts in the balance of payments should be studied in order to see if a deficit or a surplus is recorded. To be able to establish whether there is equilibrium or disequilibrium, in an economic sense, a specific group of transactions have to be isolated and the 6

7 balance shown needs to be checked. So, for example, if we want to know if there is equilibrium in the commercial transactions, we compare the income for exportation of goods with the payments for importation of goods. In the case of the table above, there is a deficit in the balance of trade, since the imports (2) are superior to the exports (1). It is obvious that if the global balance is in equilibrium, this balance of accounts is exactly equal to, but with the opposite sign, that in the combination of the other entries (boxes 3 to 14), which we normally say are below the line. The problem, therefore, is where to draw the line between the transactions we have selected and the others, so that all those transactions whose balance is the most useful when it comes to measuring the economic equilibrium of the balance of payments, are above the line. It could then be said that the balance of payments shows a deficit. Since the objective is to try to decide which group of transactions shows the most economically significant balance, opinions vary enormously on where to draw the line, even more so according to the country and the moment of time. For this reason, we will try to describe the criteria most commonly used to measure the results of the balance of payments, outlining the economic ideas that lead to the adoption of each of the criteria and the problems involved in each one. THE CURRENT ACCOUNT CRITERION 1 Without any doubt, the criterion of the current account is the most widely used; as we have seen, it includes all the transactions of trade, rents and services, as well as transfers. All these transactions are, under this criterion, above the line and their balance is considered the most suitable yardstick for the deficit or surplus on the balance of payments. Two basic reasons are employed to justify adopting this criterion. Firstly, the current account is made up of entries that can be considered irreversible, in the sense that normally neither the merchandise, nor the services, nor the rents, whether imported or exported, nor the transfers, whether received or sent, are returned, in contrast to the financial account, where the majority of the transactions are perfectly reversible (for example, the repayment of a foreign loan). For this reason, is it easier to measure and predict the effects of a specific economic policy on the current account than on movements of capital (financial account). There is a second fundamental reason in favour of this criterion: The balance of the current account (together with the balance of the capital account) indicates the difference between the national savings and investment at the time, and is equal to the net variation of the country s position as debtor or creditor against other countries (balance of the financial account). Thus, a deficit in the current account implies a rise in the country s position as debtor against other countries, which means that during the year the country has received a net foreign loan for the value of the current deficit, which will have to be financed either with autonomous movements of capital that is independent of the situation of the current and capital balances (for example, direct foreign investment), or compensatory or adaptable movements of capital (found in the financial account) which are induced by the economic authorities in order to complement the financing of the said deficit (for example, the sale of the national debt to non-residents). In contrast, a surplus in the current account implies the concession of a net loan from the country to another, since its position as creditor rises by the same amount as the current surplus. In this instance, the country s savings have been enough to finance the internal investment and in addition to grant a net loan to another country (increase of the position of creditor). In the first instance, on the other hand, the national savings were not enough to deal with the internal investment, which had to be complemented by a net foreign loan. The balance of the current account, as it is the equivalent of the net loan to or from another country, is therefore a concept of the National Accounting, and is therefore easily integrated into the nucleus of the economic statistics of a country. The main objection to this criterion is that, rather than indicating that the balance of payments is in a worrying situation of disequilibrium, a deficit in the current account may well be perfectly normal, and even desirable. 1 When we talk about the current account criterion it is to be understood that we are referring to the sum of the balance of the current account and the balance of capital. 7

8 So, for example, a country that needs to obtain abundant real resources from abroad in order to promote its development, looks for the procurement of a net foreign loan with which to finance an internal investment of more than the country s savings, and as we know, a net foreign loan implies a deficit in the current account. In the same way, a surplus on the current account may not be desirable for a country that is a net capital exporter. The short term and long term net capital inflows from abroad, while they maybe enough to finance the current deficit, may also raise the exchange rate of the national currency. If so, it may produce an even greater deterioration in the balance of trade, and consequently in the current account. On the other hand, it may counter the appreciation through official interventions in the exchange markets. The control of inflation needed to maintain the economy s competitiveness means that the financing of the current deficit should be done with stable capitals and not speculative ones. In any case, we must not forget that the foreign deficit has an important cyclical element. In other words, in terms of imports there is general agreement that in periods of expansion imports rise even to above the GDP. In periods of recession, imports rise to below the GDP. In terms of exports there is no clear cyclical component. The combination of these two factors means that the foreign balance worsens in periods of expansion and improves during recessions; that means that the foreign balance is countercyclical. Isolating this component may help us to interpret the figures in the foreign sector more accurately, particularly with reference to its sustainability, since a specific figure of the foreign deficit may not be so worrying in periods of boom as it is in recessions, and vice versa. THE RESERVES CRITERION According to this criterion, all the movements of the current and capital balances as well as all the movements of capitals (which, as we have explained, are to be found in the financial account) remain above the line. This balance therefore coincides with the variation in the country s official reserves, which is the only thing below the line. It must not be forgotten that a country s gold and foreign currency reserves are assets against other countries, and therefore an increase in reserves is an increase in assets. That is why the movements of foreign currency appear in the financial account. tc = Peso $ S 1 S A B MAX C D MIN D 2 D 1 $ The reason why this criterion has been recommended by the International Monetary Fund in the past is that what really matters when it comes to maintaining a fixed exchange rate is the reserves available in order to act on the exchanger market. In fact, the exchange rate is simply the price, in terms of national currency, of a foreign currency; and in order to regulate that price one must have a stock of merchandise (in this case an amount of foreign currency reserves). Let us suppose, for example, that the said country had undertaken to maintain the exchange rate of the peso between 120 and 130 pesos to the dollar. If the supply of dollars on behalf of those who receive them and wish to exchange them for pesos (for example, exporters of goods and services or importers of 8

9 capital) is represented by Sı, and the demand for dollars in exchange for pesos (for example from importers of goods and services and exporters of pesos) is Dı; if the demand for dollars moves to position D² (due, for example, to an increase in the value of the imports) the market forces themselves would mean that the peso devalued to over 130 pesos to the dollar, since in this type of exchange the number of dollars demanded (OB) exceeds the number supplied (OA).To maintain the exchange rate within the permitted margin, the authorities would need to turn to their foreign currency reserves so that by offering an amount of dollars (AB) they could complement the autonomous supply of dollars (OA) and thus satisfy the demand. If, on the contrary, the supply of dollars had risen from Sı to S², Dı being the demand curve, the market would have determined an appreciation of the peso to below 120 pesos to the dollar. To maintain the exchange rate in/at? this minimum level, the authorities would have to purchase a number (CD) of dollars, since the rest of the amount supplied at this exchange rate would be purchased by the autonomous demand (Oı C). In this case the authorities would see their foreign currency reserves rise to the value of the dollars they had had to buy. The reserves criterion, which may be useful in a context of fixed exchange rates, has lost a great deal of its interest since the majority of currencies have adopted a floating exchange rate and abandoned the undertaking to maintain a fixed par value. Under this new floating exchange rate system, the disequilibria are not expressed in losses or increases of reserves, but in depreciation or appreciation of the relevant currency, even if in practice most countries use their reserves to cancel out speculative movements or to soften the variations in the listed price of their currency. THE BASIC BALANCE CRITERION Traditionally, the basic balance has included, as well as the transactions included in the current and capital balances, the long-term movements of capital, and under this criterion it was the result of this basic balance which was taken as a measure of the economy s foreign balance. The theory underlying this criterion is that movements of long-term capital are fairly stable, in contrast with movements of short-term capital. As a result, it can be said that long-term capitals are irreversible in a short period of time and can be placed above the line, together with the typically irreversible transactions of the current and capital balances. It is therefore considered that a deficit in the current and capital balances is not significant if it can be financed by long-term capitals, and that, in contrast, a deficit in the basic balance is worrying, since it can only be financed by shortterm capitals, whose naturally volatile and easily reversible nature makes them not very reliable as a stable source of financing. Although the logical reasoning which supports this criterion is perfectly coherent, various objections can be presented. Firstly, a great number of transactions of long-term capital can easily be reversible, making it meaningless to place them above the line. Yet more important is a second objection: many of the movements of long-term capital are of an accommodating nature; in other words they would not take place by themselves but precisely because, having a deficit in the current balance 2, the authorities obtain and encourage the procurement of long-term credits. In these circumstances, the basic balance can have equilibrium. This situation cannot be continued indefinitely, as a time will come when the financial burden as a result of interests, and the actual repayment of those credits will become impossible for the country to bear. Frequently a third criterion has been suggested, which is midway between the current balance and the basic balance and that could be particularly useful for developing countries. It could be baptized the development balance. Under this criterion the measure of foreign imbalance would be the result of the current balance plus foreign investments. With regards to the basic balance criterion, it excludes the CONTRACTUAL movements of long-term capital (loans and credits), which would be put below the line. Equilibrium in this development balance implies that although there is a current deficit, it is offset by foreign investments, and this situation can be sustained indefinitely, since 2 Remember note 1 9

10 foreign investments, in contrast to credits and loans, do not necessarily involve either an undertaking of repayment for a fixed period or an interest charge. This criterion is very useful for countries that receive a fairly stable inflow of foreign investments, in those in which a current deficit is not worrying if it is covered by means of foreign investments that do not raise their contractual borrowing. However, a criticism of this criterion is that with a persistent equilibrium in this development balance, the country could be gradually putting itself under the control of foreign capital because of the foreign investments, although this is to be expected in any country which, in pursuit of more rapid development, resorts to foreign capital. The problem that has faced us since the Fifth Manual came into force is the impossibility of working out a basic balance in the face of the growing loss of meaning in a dividing line between long- and short-term assets, particularly in negotiable values. As not all the movements of long-term capital can be broken down, this criterion has become virtually irrelevant. PROBLEMS One could say that a country has problems with its balance of payments when the basic balance has a deficit or a surplus (in many cases, a surplus in the balance of payments also creates serious problems for the country) for a long period of time in conditions of free trade and full employment. The period of time is important, since the deficit might be temporary (due to a specific fact, such as a bad harvest), in which case it does not cause serious problems, or it might have more persistent characteristics, which could be more dangerous. The condition of free trade is also vital, since it is always possible to rectify a deficit by applying tariffs or quotas, or other administrative measures. Full employment is important too, since a deficit can always be reduced by policies that restrict the growth of economic activity and of the level of employment. When protection or deflationary policies are used to correct a deficit in the balance of payments it produces a conflict between the objectives of economic growth and full employment on the one hand, and equilibrium in the balance of payments on the other. It is precisely the task of economic policy to resolve these conflicts, as much as possible. In theory, it is easy to know whether a country has problems in its balance of payments or not. However, in practice it is a good deal more complicated. In the first place, one has top judge whether the problems are transitory or permanent; secondly, there are a number of different opinions on the definitions of free trade and full employment, and thirdly, thee are statistical difficulties and conceptual problems in the definition of the basic balance. We are going to focus on this third problem for a while, in view of the number of countries that are facing problems with their external debt. In the process of analysing a balance of payments there are a number of different methods of judging the external debt. A rise in the external debt may, for example, be interpreted as a consequence of investment, due to the fact that the said debt was incurred in order to buy foreign capital assets. In other words, the deficit in the balance e of payments was caused by the decision to ask for a foreign loan, with the aim of financing investment programmes. A different point of view would be that the government had to incur foreign debts to protect its reserves of foreign currency because they had shrunk, as a result of a series of factors. With the first interpretation, the foreign debt has an autonomous nature; with the second, an adaptable one. In the first case, the basic balance criterion as an instrument in the analysis of the balance of payments would be appropriate, while in the second it would be preferable to use the criterion of the current account balance. Thus, although by definition the balance of payments is always in equilibrium, it really depends on the criterion we use to find out if there are problems or not. The difficulty lies in knowing in which part of the balance of payments to draw the dividing line to separate the autonomous transactions from the adaptable ones. In any case, the connection 10

11 between current account operations and financial account ones is of vital importance. Let s look at an example: let s suppose that a national airline company has decided to buy a plane for 200 million dollars. The imports of merchandise will therefore increase by 200 million dollars. Now, according to the manner in which the plane is paid for, we will know under which heading the offsetting entry should be placed. Suppose it is paid for by a long-term credit. In this case, we will put 200 million in the financial account, in variation of liabilities, and it would be mistaken to imagine the deficit in the current account has forced us to borrow 200 million dollars from abroad. The two entries are clearly interdependent. The main problem is therefore in classifying the transactions as autonomous or adaptable. Apart from the conceptual problems, there are also statistical limitations in the analysis of the balance of payments. One example is in the figures that refer to the dividends earned by multinational companies which are sent back by the subsidiaries to the head offices: these dividends are usually miscalculated, so it is more than likely that there will be errors in the balance of the current account. As the balance of payments is always in equilibrium, the errors in the balance of the current account have to correspond to the errors in the balance of capitals and/or in the entry of errors and omissions. The entry of errors and omissions contains the economic movements with other countries that are not recorded. When these unknown movements are small, they are not very worrying; however, when they are important numbers there are logical pressures to improve the statistical procedures. These black holes call for a substantial revision of the collection of statistical data regarding the balance of payments and a closer identification of outflows like, for example, the payments for services and for profits that the subsidiary companies send to their head offices. 11

12 B. MERCHANDISE B SERVICES Tourism and trips Insurance, Transport and Freight Communications and transport Financial and computer services Services lent to companies Personal, cultural and recreational services Royalties and intangible incomes B. EARNINGS Earned Income Capital Earnings -Earnings from Direct Investments -Earnings from Portfolio Investments -Earnings from Investments Excluding Negotiable Values -Earnings from investments in Negotiable Values -Interest from Loans and Credits B TRANSFERS Current Account Capital Transfers (subsoil resources) Net Acquisition of Intangible Assets Capital Account NATIONAL INVESTMENTS ABROAD Direct Investments (unlisted shares, real estate, etc.) Portfolio Investments (shares, investment funds, bonds, debentures, monetary market, etc.) FOREIGN INVESTMENTS IN THE COUNTRY Investments Excluding Negotiable Values Investments in Negotiable Values OTHER INVESTMENTS (Credits, Deposits, etc) STOCK VARIABLES FINANCIAL ACCOUNT ERRORS AND OMISSIONS INCOME PAYMENTS BALANCE V. Liabilities V. Assets VL-VA 12