The Balance Of Payments

1. The Balance Of Payments

2. Contents Measure Nation’s levels of international economic activity, and how it is measured by the balance of payments; Examine the economic relationships underlying the two basic sub-components of the balance of payments – the Current and Capital Accounts; Identify the financial dimensions of international economic activity, and how they differ between merchandise & services trade; Identify balance of payment activities by nations in pursuit of domestic and global economic and political policies; Evaluate the history of capital mobility, and conditions that lead to capital flight in times of crisis

3. The Balance of Payments • The Balance of payments is the summary statement of all international transactions between one country and all other countries ---- Eiteman • The measurement of all international economic transactions between the residents of a country and foreign residents is called theBalance of Payments (BOP) The IMF is the primary source of similar statistics worldwide Multinational businesses use various BOP measures to test the growth and health of specific types of trade or financial transactions by country and regions of the world against the home country

4. Importance of The Balance of Payments • Monetary and fiscal policy must take the BOP into account at the national level • Businesses need BOP data to anticipate changes in host country’s economic policies driven by BOP events • Above of these, BOP data may be important for the following reasons • BOP is important indicator of pressure on a country’s exchange rate, thus potential to either gain or lose if firm is trading with that country or currency • Changes in a country’s BOP may signal imposition (or removal) of controls over payments, dividends, interest, etc • BOP helps to forecast a country’s market potential, especially in the short run

5. Typical BOP Transactions • Examples of BOP transactions from US perspective • Honda US is the distributor of cars manufactured in Japan by its parent, Honda of Japan • US based firm, Fluor Corp., manages the construction of a major water treatment facility in Bangkok, Thailand • US subsidiary of French firm, Saint Gobain, pays profits (dividends) back to parent firm in Paris • An American tourist purchases a small Lapponia necklace in Finland • A Mexican lawyer purchases a US corporate bond through an investment broker in New York. Give some Examples of BOP transactions from Bangladesh perspective

6. Structure of The Balance of Payments • A. Current Account • Net exports/imports of goods and services (Balance of Trade) • Net Income (investment income from direct portfolio investment plus employee compensation • Net transfers (sums sent home by migrant and permanent workers abroad) B . Capital Account Capital transfers related to purchase and sale of fixed assets such as real estate Σ (A:E) = Overall Balance • C. Financial Account • Net foreign direct investment • Net portfolio investment • Other financial items D. Net Errors and Omissions Missing data such as illegal transfers E. Reserves and Related Items Changes in official monetary reserves including gold and foreign exchange reserves

7. Fundamentals of BOP Accounting • The BOP must balance (!?) • Three main elements of actual process of measuring international economic activity • Identifying what is/is not an international economic transaction • Understanding how the flow of goods, services, assets, money create debits and credits • Understanding the bookkeeping procedures for BOP accounting

8. Defining International Economic Transactions • Current Account Transactions • The export of merchandise, goods such as trucks, machinery, computers is an international transaction • Imports such as French perfume and cosmetics, Japanese cameras and German automobiles are international transactions • The purchase of a Benaroshi Shari in Dhaka by an Indian tourist • Financial Account Transactions • The purchase of a Bangladesh Bank’s Treasury bill by a foreign resident

9. BOP as a Flow Statement • Exchange of Real Assets – exchange of goods and services for other goods and services or for monetary payment • Exchange of Financial Assets – Exchange of financial claims for other financial claims

10. The Current Account • Goods Trade – export/import of goods. • Services Trade – export/import of services; common services are financial services provided by banks to foreign investors, construction services and tourism services • Income – predominately current income associated with investments which were made in previous periods. Additionally the wages & salaries paid to non-resident workers • Current Transfers – financial settlements associated with change in ownership of real resources or financial items. Any transfer between countries which is one-way, a gift or a grant,is termed a current transfer • Typically dominated by the export/import of goods, for this reason the Balance of Trade (BOT) is widely quoted

11. Examples of BOP’s Current Account US Current Account, 1997-1999 (billions of US dollars)

12. Practice: BOP Current account

13. The Capital/Financial Account • Capital account is made up of transfers of fixed assets such as real estate and acquisitions/disposal of non-produced/non-financial assets • Financial account consists of three components and is classified either by maturity of asset or nature of ownership. The three components are • Direct Investment – Net balance of capital which is dispersed from and into a country for the purpose of exerting control over assets. This category includes foreign direct investment • Portfolio Investment – Net balance of capital which flows in and out of the country but does not reach the 10% ownership threshold of direct investment. The purchase and sale of debt or equity securities is included in this category This capital is purely return motivated • Other Investment Assets/Liabilities – Consists of various short and long-term trade credits, cross-border loans, currency and bank deposits and other accounts receivable and payable related to cross-border trade

14. Example: The Capital/Financial Account Direct investment abroad (105) (146) (151) Direct investment in the US 106 186 276 Net direct investment 1 40 125 Portfolio Investment Assets purchased by US residents, net (119) (136) (129) Assets purchased by foreign residents, net 386 269 342 Net portfolio investment 267 133 213 Other Investment Other investment assets (264) (47) (159) Other investment liabilities 265 27 136 Net other investment 1 (20) (23) Capital Account Balance 269 153 315

15. The Other Accounts • Net Errors and Omissions – Account is used to account for statistical errors and/or untraceable monies within a country • Official Reserves – total reserves held by official monetary authorities within a country. • These reserves are typically comprised of major currencies that are used in international trade and financial transactions and reserve accounts (SDRs) held at the IMF

16. The Balance of Payments in Total 1997 1998 1999 A. Current Account (140.55) (217.13) (331.48) Goods exports FOB 681.65 672.29 686.66 Goods imports FOB (876.37) (917.19) (1029.92) Goods (Balance Of Trade) (194.72) (244.90) (343.26) Services exports 255.29 260.69 269.58 Services imports (166.51) (182.68) (191.30) Servicestradebalance88.78 78.01 78.28 Income credit 257.35 258.45 276.17 Income debit (251.16) (264.66) (294.65) Balance on Goods, Services & Income . . .6.19 (6.21) (18.48) Current transfers, credits 8.47 9.33 9.41 Current transfers, debits (49.27) (53.36) (57.43) _____________________________________________________________ Source: MSE3, Exhibit 3.7, page 55.

17. 1997 1998 1999 C. Financial Account 269.04 153.59 314.64 Direct investment . . . 1.02 40.27 124.64 Direct investment abroad (105.02) (146.05) (150.90) Direct investment in the US 106.04 186.32 275.54 Portfolio investment assets . . . (118.98) (136.00) (128.59) Equity securities (57.58) (101.24) (114.40) Debt securities (61.40) (34.76) (14.19) Portfolio investment liabilities . . . 385.60 269.33 342.19 Equity securities 67.85 41.95 98.07 Debt securities 317.75 227.38 244.12 ___________________________________________________________ Source: MSE3, Exhibit 3.7, page 55

18. Capital Mobility • The degree to which capital moves freely cross-border is critically important to a country’s balance of payments • Historical patterns of capital mobility • 1860-1914 – period characterized by continuously increasing capital openness as more countries adopted the gold standard and expanded international trade relations • 1914-1945 – period of global economic destruction due to two world wars and a global depression • 1945-1971 – Bretton Woods era, saw great expansion of international trade in goods and services • 1971-2002 – period characterized by floating exchange rates, economic volatility, but rapidly expanding cross-border capital flows

19. Capital Flight “International flows of direct and portfolio investments under ordinary circumstances are rarely associated with the capital flight phenomenon. Rather, it is when capital transfers by residents conflict with political objectives that the term “flight” comes into general usage.” • Five primary mechanisms exist by which capital may be moved from one country to another: • Transfers via the usual international payments mechanisms, regular bank transfers are easiest, cheapest and legal • Transfer of physical currency by bearer (smuggling) is more costly, and for many countries illegal • Transfer of cash into collectibles or precious metals, which are then transferred across borders • Money laundering, the cross-border purchase of assets which are then managed in a way that hide the movement of money and its owners • False invoicing on international trade transactions

20. Balance of Payment of Bangladesh During 1999-2005

24. Home Practice and Preparation • Try to answer the chapter end questions • Try to solve the chapter end problems • Solve the chapter end case from the prescribed text and readings.