Balance of payments

1. Balance of payments • What is the price of a country’s currency? • If we know the factors affecting demand & supply, then we shall know the factors influencing exchange rates

2. Hence, the considerable interest in maintaining a record of the factors behind the supply & demand of a country’s currency Can be visualised as an itemisation of the factors behind the demand & supply of a currency

3. Why is the BOP account published? To report the country’s international performance in trading with other nations

4. Factors affecting exports & hence the demand for home currency • Home prices v/s comparable goods abroad • Foreign income • Foreign import duties & quotas

5. Principles of BOP accounting • Double entry bookkeeping • It is a cash flow statement • Designed to always balance; rules for debits and credits • The way it is balanced tells us how a country is doing in its transactions with other countries

6. Components of BOP • Current account • Capital/financial account • Net errors and omissions • Official reserves account

7. Current account • Goods • Services • Investment income • Transfers

8. Current account balance • Fair indicator of a country’s international competitiveness • A current account surplus will strengthen the currency

9. Current account balance Affected by: • Inflation • A comparatively high economic growth- increase in imports while demand for exports lag behind

10. Capital / Financial Account • Capital account Transfers of financial assets and the acquisition and disposal of non-produced/ non-financial assets

11. Financial Account • Direct investment • Portfolio investment • Other investment assets/ liabilities

12. Current & Capital Account Relationship • Inverse relation between the current and capital account • Countries experiencing large current account deficits “ finance” these purchases through equally large surpluses in the capital account

13. Official Reserves Account • Total reserves held by official monetary authorities within the country. • Normally composed of the major currencies used in international trade and financial transactions

14. Net Errors & Omissions • Reasons? • Capital Mobility • Capital Flight

15. Link Between Current & CapitalAccount National Income = Consumption + Savings National spending= Consumption+Investment National Income- National spending = Savings – Investments • Savings – Investments = surplus capital ( that must be invested overseas)

16. i.e Savings = Domestic Inv + Net Foreign Inv Net Foreign Inv= Nation’s net public & private capital flows = capital account deficit

17. Alternatively,A national savings deficit = capital account surplus( net borrowing from abroad)This borrowing finances the excess of national spending over income.

18. If we subtract expenses on domestic goods & services from National Product,the remaining goods & services must be exports

19. Similarly, subtracting spending domestic goods & services from total expenditure, the remaining goods & services must be imports

20. We have now another national income identity:National Income – National spending = Exports – Imports = Net Foreign Investment

21. Thus, in a freely floating exchange rate system,The current account balance & the capital account balance must exactly offset each other

22. Question • A deficit or surplus in the current account is it inherently “good” or “bad”?