The Financial Account (FA), the Current Account (CA), the Balance of Payments (BOP) and the Net International Investm

1. The Financial Account (FA), the Current Account (CA), the Balance of Payments (BOP) and the Net International Investment Position (NIIP)

2. The Bank of Thailand (BOT) definition of the financial account • The BOT uses a definition that was once the standard international definition, but is not any longer. It differs from the definition of the financial account in Krugman and Obstfeld. In this couse, we’ll use the BOT definition. • On the BOT definition, the financial account surplus is the net addition to the BOT’s foreign exchange reserves due to international transactions in financial assets.

3. The current account surplus • The current account surplus is the net sale of goods and services (including factor services—interest and remittances) by Thai nationals to foreigners. • CA = Exports – Imports + NFI, where NFI is net factor income from abroad. • The current account surplus must either finance the net purchases by Thai nationals of foreign assets or be added to the FX reserves of the BOT.

4. The financial account surplus • The financial account surplus is the defined by the BOT as the sale of the financial liabilities of Thai nationals to foreigners minus the purchases by Thai nationals (other than the BOT itself) of the financial liabilities of foreigners: • FA(BOT) = Exports of fin. assets – Imports of financial assets. • The proceeds must either be used to finance a current account deficit or be added to the FX reserves of the BOT.

5. The Balance of Payments Surplus • The Balance of Payments Surplus is the net addition to the foreign exchange reserves of the central bank. • The BOP surplus is the sum of the additions to the central bank’s FX reserves that result from its financing of transactions on both current and financial account: • BOP = CA + FA(BOT)

6. FA, CA and BOP • To relate the FA(BOT), CA and BOP surplus, it is helpful to use the balance sheet that determines the net international investment position of a country.

7. All assets 79 Thai holdings of the liabilities of foreigners (ex BOT FX) 27 BOT FX reserves 52 All liabilities 79 Foreign holdings of the liabilities of Thai nationals 137 Net international investment position of Thailand -58 Net international investment position (NIIP), Thailand at end of 2005 ($billions)

8. Purchase of liabilities of foreigners 15 Thai purchases of the liabilities of foreigners (ex. BOT FX) 2 Purchases of FX (liability of US Fed) by BOT 13 Sales of Thai liabilities 12 Foreign purchases of the liabilities of Thai nationals 12 Financial account transactions, Thailand 2006 ($billions)

9. FA(BOT), Thailand 2006 • If Thai nationals did not alter their holdings of FX, the sales of Thai liabilities (eg, foreign purchase of equity in Thai companies, foreign deposits in onshore bank accounts etc) to foreigners would have been matched by $12 billion of FX purchases by the BOT. • And, to finance the purchases of foreign assets by Thai nationals, the BOT would have had to sell $2 billion of FX. • The surplus on financial account (BOT definition) was therefore $10 billion.

10. Balance of payments, Thailand 2006 ($billion) • In the previous slide, we showed that in 2006, the FA(BOT) was $10 billion. But an earlier slide gave the increase in FX reserves as $13 billion. • The difference is the current account surplus of $3 billion. In billions of dollars we have: • BOP = 13 = FA(BOT) + CA = 10 + 3

11. The financial account, the current account and the BOP • The slide giving the financial account for 2006 showed that Thai nationals and the BOT purchased $15 billion of foreign liabilities, but only sold $12 billion of their own assets to foreigners. How come? • The difference must have come from net gifts to Thai nationals, or net exports by Thailand of goods, non-factor services and factor services. That is, the ‘missing’ $3 billion must have come from the current account surplus.

12. Adding a balancing item to the financial accounts: • The assets and liabilities in the financial accounts are not equal to each other. For Thailand in 2006, the increase in financial assets was $15 billion and the increase in financial liabilities was $12 billion. • As noted in the previous slide, the ‘missing’ balancing item is the $3 billion current account surplus, which is included with the financial flows in the next slide:

13. Purchase of liabilities of foreigners 15 Thai purchases of the liabilities of foreigners (ex. BOT FX) 2 Purchases of FX (liability of US Fed) by BOT 13 Current account plus sales of Thai liabilities 15 Foreign purchase of the liabilities of Thai nationals 12 Current account surplus 3 Financial account transactions, Thailand 2006 ($billions)

14. The current account and the NIIP • Compare the previous slide, which shows transactions in 2006, with the balance sheet that determined the NIIP of Thailand at the end of 2005. For convenience, the NIIP slide is repeated after this slide. • There is obviously a very close relationship between the two sets of definitions. • The financial flows measure changes in the stocks of international assets and liabilities due to transactions with foreigners. • The current account is the improvement in the NIIP resulting from these transactions.

15. All assets 79 Thai holdings of the liabilities of foreigners (ex BOT FX) 27 BOT FX reserves 52 All liabilities 79 Foreign holdings of the liabilities of Thai nationals 137 Net international investment position of Thailand -58 Net international investment position (NIIP), Thailand at end of 2005 ($billions)

16. Valuation effects • Suppose we tried to estimate Thailand’s NIIP at the end of 2006 as: NIIP at the end of 2005: -$58 billion + CA surplus in 2006: +3 billion = NIIP at the end of 2006: - $55 billion. • This estimate would only be correct if there were no changes in the dollar values of the stocks of assets and liabilities that were not bought or sold during 2006. The BOP flows only record transactions, not unrealized gains and losses.

17. Two minor complications • We have ignored the capital account of the BOP and “Errors and omissions”. • They are briefly explained in the next slide, but will then again be ignored for the remainder of this course.

18. Errors and omissions • Errors and omissions result from BOP data being collected from difference sources—commercial banks, the BOT and the Customs Department and all can make mistakes. • In the data presented in earlier slides, errors and omissions were added to the financial account.

19. The capital account • What is now called the financial account used to be called the capital account. • The name ‘capital flows’ is still very often applied to the components of the financial account. • What is now called the capital account is of trivial importance and is always given as zero in the accounts presented by the BOT. It is mentioned in the text book, but don’t worry about it!

20. Purchase of liabilities of foreigners 15 Thai purchases of the liabilities of foreigners (ex. BOT FX) 2 Purchases of FX (liability of US Fed) by BOT 13 Current account plus sales of Thai liabilities 15 Foreign purchases of the liabilities of Thai nationals 12 Current account surplus 3 Financial account transactions, Thailand 2006 ($billions)

21. FA(BOT) for Thailand, 2006 ($ billion) • FA(BOT) = Increase in foreign ownership of liabilities of Thai nationals ($12 billion) – Increase in Thai (excluding BOT) ownership of the liabilities of foreigners ($2 billion) = + $10 billion.

22. Onshore trading in FX • Suppose that an onshore commercial bank sells $1 million of FX to the BOT and that there is no underlying transaction on current account, and no other financial account transaction. That is, the bank reduces its own holdings of FX, rather than selling FX on behalf of one of its clients. • In exchange for its FX, the commercial bank gets Bht 33 million added to its clearing balance at the BOT.

23. Onshore trading in FX using BOT definitions: • No transactions on current account: CA = 0. • Onshore bank’s holdings of foreign liabilities (FX is a liability of foreign central banks, eg US Fed) fall by $1million: FA(BOT) = $1 million. • BOP = increase in BOT holdings of FX reserves = CA + FA(BOT) = $1 million.

24. Illustrative example • Consider a hypothetical country, Ruritania, whose transactions with the rest of the world are described in cases (a) and (b) below. Set out the components of the GDP, GNP and balance of payments identities in each case. Give the values in each case of the balance of trade, the current account surplus, FA(BOT) and the overall balance of payments surplus (BOP). Assume that all transactions, except those explicitly described, are zero. • In every case: • Exports = $100; • Consumption of imported goods = $110 • Remittances paid abroad by foreign workers in Ruritania = $20.

25. Case (a) In addition to the base case transactions, Ruritanian firms make interest payments to the foreign banks from which they have borrowed of $10. All foreign exchange transactions involving Ruritanian firms and households are made by buying foreign exchange from the BOR, or selling foreign exchange to it.

26. Case (b) An American brewery, Budweiser, sets up a Ruritanian subsidiary that it directly controls. This subsidiary borrows $50 in local currency from a Ruritanian bank. In addition, it imports machinery worth $100 from the USA. The machinery is purchased using US dollars that the parent company, Budweiser (USA), was holding at an American bank. In exchange for the machinery, Budweiser (Ruritania) issues $100 worth of equity to Budweiser (USA).

27. Format for answers: • In each case, set out your answers as follows: • Consumption = • Exports = • Imports = • GDP = • Net factor income from abroad = • GNP = • Current account =

28. Format for answers (cont): • Purchases of Ruritanian liabilities by foreigners = • Minus Purchase of foreign liabilities by Ruritanians, other than BOR = • Financial account (BOT) = • Current account = • BOP = Purchases of FX by BOR =