The Balance of Payments Eiteman et al., Chapter 3 Winter 2004 Outline of the Chapter Typical Balance of Payments Transactions Fundamentals of Balance of Payments Accounting The Accounts of the Balance of Payments Balance of Payments Accounting Capital Mobility 2
The Balance of Payments The balance of payments (BOP) measures all international economic transactions between residents of a country and foreign residents. BOP data influences and are influenced by key macroeconomic variables such as employment, price levels, exchange rates, interest rates, etc. 3 The Balance of Payments Residents are: Individuals who normally stay in the economic territory of the economy; Institutional units whose centre of economic interest is the economic territory of the economy. 4
Typical BOP Transactions Honda U.S. is the U.S. distributor of automobiles manufactured in Japan by its parent company, Honda of Japan. A U.S.-based firm, Fluor Corporation, manages the construction of a major water treatment facility in Bangkok, Thailand. The U.S. subsidiary of a French firm, Saint Gobain, pays profits (dividends) back to its parent firm in Paris. 5 Typical BOP Transactions The BOP has two major subaccounts: The Current Account and the Capital/Financial Account. The Capital Account and the Financial Account are two different accounts but the combination of the two is often referred to as the Capital Account. 6
Fundamentals of BOP Accounting Defining International Economic Transactions The Balance of Payments as a Flow Statement Exchange of Real Assets Exchange of Financial Assets Balance of Payments Accounting 7 The Accounts of the BOP A. Current Account 1. Net exports/imports of goods (trade balance) 2. Net exports/imports of services 3. Net income (investment income from direct and portfolio investment plus employee compensation) 4. Net transfers (sums sent home by migrants, gifts, etc.) 8
The Accounts of the BOP B. Capital Account Capital transfers related to the purchase and sale of fixed assets such as real estate C. Financial Account 1. Net foreign direct investment 2. Net portfolio investment 3. Other financial items 9 The Accounts of the BOP D. Net Errors and Omissions Account Missing data such as illegal transfers E. Official Reserve Account Changes in official monetary reserves including gold, foreign exchange, and IMF position 10
The Accounts of the BOP A = Current Account Balance A + B + C = Basic Balance A + B + C + D = Overall Balance 11 BOP Accounting The balance of payments equation for a country is given by X g M g + X s M s + IN i IN o + UT i UT o + CA i CA o + FDI i FDI o + PI i PI o + OI i OI o + Net Errors and Omissions + FXR = 0 12
BOP Accounting In BOP accounting (accounts A,B,C and D), A credit is recorded whenever the domestic currency is purchased by a foreign resident (exports, foreign borrowing, sale of stocks of a domestic company to a foreigner, etc.); A debit is recorded whenever a foreign currency is purchased by a domestic resident (imports, purchase of stocks abroad, etc.). 13 BOP Accounting The Current Account balance is given by X g M g + X s M s + IN i IN o + UT i UT o. Note on UT: If goods are donated by residents to non-residents, X g and UT o. If cash is donated, the capital account will be credited (inflow of goodwill). Immigrants donate their wealth to residents (i.e. to themselves when they migrate). 14
BOP Accounting The Capital Account balance is given by CA i CA o. Transactions involving copyrights, patents, land or real estate are recorded in this account. This account is sometimes used to offset unilateral transfers. 15 BOP Accounting The Financial Account balance is given by FDI i FDI o + PI i PI o + OI i OI o. OI include bank loans, bank deposits, etc., (can be described as intermediated investments). A loan to a foreigner by a domestic bank: OI o A resident pays a foreigner with a check drawn on a domestic bank: OI i. 16
BOP Accounting The Official Reserve Account balance is given by FXR = Official Reserves Out Official Reserves In = OR o OR i 17 BOP Accounting Foreign currency holdings are either private or official. Private currency transactions appear in the Financial Account. Official currency transactions appear in the Official Reserve account. 18
BOP Accounting, An Example A Chinese citizen sells a patent of interactive dress-up doll for $100,000 to a Canadian citizen who pays by drawing a check on its Canadian bank account. A debit will be recorded in the capital account as a non-financial asset has been purchased and a credit will be recorded in the financial account, in the category other investments, as a liability has been exported abroad. Credit Debit Purchase of a non-financial asset (CA o ) $100,000 Increase in liabilities to foreigners (OI i ) $100,000 19 BOP Accounting, Another Example A Canadian company exports machine tools to Switzerland at the price of SFr2,000,000. At the exchange rate 1 SFr = C$1.1214 (Friday, January 17, 2003), this means C$2,242,800. The Swiss importer pays with a check drawn on its Swiss bank account. A credit is then recorded as an export of goods, X g, and a debit is recorded in the financial account in other investments as private foreign assets have increased. Credit Export of goods (X g ) $2,242,800 Debit Increase in foreign currency holdings (OI o ) $2,242,800 20
BOP Accounting, Another Example An Italian migrates to Canada, bringing $500,000 worth of goods with him. This is an import of goods, so X g. At the same time, this is a unilateral transfer from an Italian to a Canadian (note that the goods keep the same owner but the latter s residency status changes, thus making this transaction similar to a donation from a non-resident to a resident), i.e. UT i. 21 Describe how the following transactions are recorded in the balance of payments. 1. A Canadian business exports $80 million of soybeans to China and receives payment in the form of a check drawn on a Canadian bank. 2. The Canadian government provides refugee assistance to Somalia in the form of corn valued at $1 million. 3. A Canadian company invests $500 million in a chemical plant in Germany financed by issuing bonds in London. 22
4. A Canadian corporation pays $500,000 in dividends to foreign residents, who choose to hold the dividends in the form of bank deposits in New York. 5. A Mexican company sells $2 million worth of cement to a Canadian company and deposits the check in a bank in Toronto. 23