BALANCE OF PAYMENTS ( )

Prof. Chung, Ji-Woong

Korea University Business School

Learning Goals

What is balance of payments and how to read them?

What is the relationship between balance of payments

and exchange rate?

What is the relationship between balance of payments

and national income?

2

So what??

3

WHAT IS BOP?

Why Study BOP?

Exchange rates are determined by demand and supply of

currencies.

The demands and supplies for currencies arise from

international trade flows and international capital flows.

And the balance of payments record and summarize

these transactions.

5

Balance of Payments

The balance of payments is the statistical record of a

period of time.

BOP data can be used to evaluate the performance of the

country in international economic competition.

BOP provides detailed information about the demand and

IMF balance of payment manual http://www.imf.org/external/pubs/ft/bop/2007/bopman6.htm

http://www.imf.org/external/pubs/ft/bop/2007/bop6comp.htm

6

http://www.imf.org/external/pubs/ft/bop/2007/bopman6.htmhttp://www.imf.org/external/pubs/ft/bop/2007/bop6comp.htmhttp://www.imf.org/external/pubs/ft/bop/2007/bop6comp.htmhttp://www.imf.org/external/pubs/ft/bop/2007/bop6comp.htm

BoP from 2006 to 2012 (BPM6)

7

2006 2007 2008 2009 2010 2011 2012

14,083.2 21,769.7 3,197.5 32,790.5 29,393.5 26,068.2 48,082.3

31,433.4 37,129.1 5,170.1 37,866.0 40,082.5 31,660.0 39,816.7

336,494.4 389,568.5 434,651.5 358,189.7 461,444.9 551,765.4 554,174.7

305,061.0 352,439.4 429,481.4 320,323.7 421,362.4 520,105.4 514,358.0

-13,331.8 -11,967.3 -5,734.1 -6,640.5 -8,626.0 -5,849.5 5,733.7

56,842.3 72,994.8 90,634.8 73,580.4 87,282.4 95,257.2 111,558.5

70,174.1 84,962.1 96,368.9 80,220.9 95,908.4 101,106.7 105,824.8

74.5 135.0 4,435.4 2,276.7 1,015.9 2,890.9 5,717.9

-4,092.9 -3,527.1 -673.9 -711.7 -3,078.9 -2,633.2 -3,186.0

-11,025.3 -21,489.1 -862.8 -34,940.7 -27,260.6 -26,753.3 -51,373.5

-7,588.2 -17,935.2 -16,940.6 -14,948.0 -22,184.3 -16,410.0 -18,923.9

-23,230.0 -26,057.8 -2,405.6 49,727.7 42,479.8 13,109.3 6,863.2

484.4 5,444.8 -14,369.4 -3,093.0 828.9 -1,031.3 2,627.8

41,421.4 32,187.5 -23,593.2 2,038.9 -21,414.4 -8,468.6 -28,756.0

-22,112.9 -15,128.4 56,446.0 -68,666.4 -26,970.6 -13,952.8 -13,184.5

-3,126.1 -2,387.5 109.3 289.6 -217.9 -24.7 543.4

68.2 2,106.9 -2,444.0 1,860.7 -1,915.0 709.8 2,747.8

Reserve assets

Capital account

Net errors and omissions

Portfolio investment

Financial derivatives

Other investment

Secondary income

Financial account

Direct investment

Imports

Services

Credit

Debit

Primary income

Current account

Goods

Exports

The Current Account ( )

Includes all imports and exports of goods and services.

Income receipts and payments primary income

Financial returns (interest, dividends etc.)

Compensation (wages and salaries)

Unilateral transfers of foreign aid secondary income

8

The Capital and Financial Account ( / )

Recorded all financial transactions (i.e. changes in assets and

liabilities)

Beginning in 1993, the IMF substituted the term

It assigned a new and narrower definition to the term

9

The Capital Account ( )

Only includes unilateral transfer of capital, such as the

another country.

In most cases, the newly defined capital account is a very

small item on balance of payments.

10

The Financial Account ( )

Includes all other financial transactions, such as cross-

border trades of stocks and bonds.

Foreign Direct Investment (FDI): acquisition of large equity

stake (>=10%) for control purpose ( )

Portfolio investments: not in sufficient concentrations to allow

managerial influence ( ).

Other investments trade credits, bank deposits etc. ( ).

.

11

Reserve Assets ( )

The net change in foreign exchange reserves and

official government borrowing.

Official reserve assets include gold, foreign currencies, SDRs,

reserve positions in the IMF.

Identical to the other financial account items except that

the transactions involve an official government entity.

12

Errors and Omissions (Statistical Discrepancy)

misrecorded

transactions

balance.

Recording of payments and receipts arising from

international trade are done at different times and

places, possibly using different methods.

Hard to keep track of transactions

13

Balance of Payments Algebra

Double entry book-keeping ( )

Most economic transactions have two sides: something of

economic value is provided and something of equal value

is received, and both flows are recorded.

funds (capital outflow)

Increase in assets / decrease in liabilities

Credit (+): Source of funds (capital inflow)

Decrease in assets / increase in liabilities

14

The Balance of Payments Identity

CA + FA (+ RA) = 0

+ (+ )=0

where

CA = balance on current account

FA = balance on financial account

RA = balance on the reserves account

-

make the identify hold.

15

The Relationship Between Current Account and Financial

Account

Current account deficit: Expenditures exceed revenues.

Needs to finance the additional expenditures by

borrowing from abroad (KA credit),

selling assets to someone abroad (KA credit) or

reducing holdings of foreign currency (KA credit or RA credit)

Current account surplus: Net inflow of income.

Should be spent on

buying foreign assets (KA debit),

making new loans (KA debit),

paying off old loans (KA debit), or

accumulating foreign currency (KA debit or RA debit)

16

Example 1

A Korean company buys a thousand cell phones from a

Chinese company and pays for them with a check

drawn from a Korean bank.

Debit (-) on Korean current account.

Credit (+) on Korean financial account.

Once the check arrives in China, it represents a claim

on Korea and thus an increase in a domestic liability to

foreigners.

Until the Chinese exercise that claim to purchase some sort of

Korean output, their willingness to hold that check constitutes a

loan from China to Korea.

17

Example 2

Boeing, a U.S. aerospace company, sells $3 billion of its

747 airplanes to China, which pays with proceeds from a

loan from a consortium of international banks.

balance of payments, which is a credit.

The fact that China borrows from international banks means that

foreign ownership of U.S. assets is going down (U.S. assets

increase). This is a debit on the U.S. balance of payments.

18

BOP AND EXCHANGE RATE

BOP and Exchange Rate

The effect of any item in the balance-of-payments

account on the exchange rate can be determined by

identifying how it shifts the currency supply or currency

demand curve.

More fund inflows Currency appreciation

More fund outflows Currency depreciation

For example (everything else equal):

Current Account surplus Demand for domestic currency

Debit in Reserve Assets Supply for domestic currency

20

J-curve effect

, Imports

However, there is a time lag due to inelasticity of consumption to price.

consume foreign products.

foreign products.

21

/ ( 2010 )

22

Implications For Companies

For example, firms should recognize that persistent

current account deficits in developing countries can signal

that currency devaluations are likely to occur there.

In developed countries, persistent current account deficits

can lead legislators to unleash protectionist policies, such

as tariffs and embargoes on imported goods and services.

Every company in the world doing business with China

keenly follows the effect that the U.S. trade deficit with

China is having on the .

Bekeart and Hodrick

23

Central Bank Intervention

In the Official Reserve Account:

Credit (+) means the central bank has sold reserves or has

acquired more debt.

Debit (-) means the other way.

If

currency (Credit).

The more actively governments intervene in the foreign exchange

markets, the greater the official reserve entry (and its volatility).

24

25