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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-1
INTERNATIONALFINANCIAL
MANAGEMENT
EUN / RESNICK
Fourth Edition
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-2
INTERNATIONALFINANCIAL
MANAGEMENT
EUN / RESNICK
Fourth Edition
Chapter Objective:
This chapter serves to introduce the student to the balance of payments. How it is constructed and how balance of payments data may be interpreted.
3Chapter Three
The Balance of Payments
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-3
Chapter Three Outline
Balance of Payments Accounting Balance of Payments Accounts
The Current Account The Capital Account Statistical Discrepancy Official Reserves Account
The Balance of Payments Identity Balance of Payments Trends in Major
Countries
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-4
Balance of Payments Accounting
The Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping.
N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-5
Balance of Payments Example
Suppose that Maplewood Bicycle in Maplewood, Missouri, USA imports $100,000 worth of bicycle frames from Mercian Bicycles in Darby England.
There will exist a $100,000 credit recorded by Mercian that offsets a $100,000 debit at Maplewood’s bank account.
This will lead to a rise in the supply of dollars and the demand for British pounds.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-6
The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations.
They are composed of the following: The Current Account The Capital Account The Official Reserves Account Statistical Discrepancy
Balance of Payments Accounts
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-7
The Current Account
Includes all imports and exports of goods and services.
Includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is
running a trade deficit. If the credits exceed the debits, then a country is
running a trade surplus.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-8
The Capital Account
The capital account measures the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets.
In 2004, the U.S. enjoyed a $611.2 billion capital account surplus—absent of U.S. borrowing from foreigners, this “finances” our trade deficit.
The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-9
Statistical Discrepancy
There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance.
Exhibit 3.1 shows a discrepancy of $51.9 billion in 2004.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-10
The Official Reserves Account
Official reserves assets include gold, foreign currencies, SDRs, reserve positions in the IMF.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-11
The Balance of Payments Identity
BCA + BKA + BRA = 0where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,
BCA + BKA = 0
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-12
U.S. Balance of Payments Data
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-13
U.S. Balance of Payments Data
In 2004, the U.S. imported more than it exported, thus running a current account deficit of $665.9 billion.
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-14
U.S. Balance of Payments Data
During the same year, the U.S. attracted net investment of $611.2 billion—clearly the rest of the world found the U.S. to be a good place to invest.
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-15
U.S. Balance of Payments Data
Under a pure flexible exchange rate regime, these numbers would balance each other out.
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-16
U.S. Balance of Payments Data
In the real world, there is a statistical discrepancy.
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-17
U.S. Balance of Payments Data
Including that, the balance of payments identity should hold:
BCA + BKA = – BRA
($665.9) + $611.2 + $51.9 = ($2.8)
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-18
Balance of Payments and the Exchange Rate
Q
P
Exchange rate $
S
D
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-19
Balance of Payments and the Exchange Rate
Q
P
As U.S. citizens import, they are supply dollars to the FOREX market.
Exchange rate $
S
D
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-20
Balance of Payments and the Exchange Rate
Q
P
As U.S. citizens export, others demand dollars at the FOREX market.
Exchange rate $
S
D
Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-21
Balance of Payments and the Exchange Rate
Q
P S
D
As the U.S. government sells dollars, the supply of dollars increases.
S1
Exchange rate $ Credits DebitsCurrent Account
1 Exports $1,516.2
2 Imports ($2,109.1)
3 Unilateral Transfers $16.4 ($89.4)
Balance on Current Account ($665.9)Capital Account
4 Direct Investment $115.5 ($248.5)
5 Portfolio Investment $794.4 ($90.8)
6 Other Investments $524.3 ($483.7)
Balance on Capital Account $611.2
7 Statistical Discrepancies
Overall Balance $2.8 Official Reserve Account $2.8
51.9
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-22
Balance of Payments Trends
Since 1982 the U.S. has experienced continuous deficits on the current account and continuous surpluses on the capital account.
During the same period, Japan has experienced the opposite.
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Balances on the Current (BCA) and Capital (BKA) Accounts of the United States
Source: IMF International Financial Statistics Yearbook, various issues
U.S. Balance of Payments Trend: 1982-2004
-800
-600
-400
-200
0
200
400
600
800
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Year
Bal
ance
of
Pay
men
ts (
$B)
U.S. BCA
U.S. BKA
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Balances on the Current (BCA) and Capital (BKA) Accounts of United Kingdom
-50
-40
-30
-20
-10
0
10
20
30
40
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
UK BCA
UK BKA
Source: IMF International Financial Statistics Yearbook, various issues
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-25
Balances on the Current (BCA) and Capital (BKA) Accounts of Japan
Source: IMF International Financial Statistics Yearbook, various issues
-150
-100
-50
0
50
100
150
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Japan BCA
Japan BKA
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-26
Balances on the Current (BCA) and Capital (BKA) Accounts of Germany
Source: IMF International Financial Statistics Yearbook, various issues
-100
-80
-60
-40
-20
0
20
40
60
80
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Germany BCA
Germany BKA
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-27
Balances on the Current (BCA) and Capital (BKA) Accounts of China
Source: IMF International Financial Statistics Yearbook, various issues
-20
-10
0
10
20
30
40
50
60
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
China BCA
China BKA
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 3-28
Balance of Payments Trends
Germany traditionally had current account surpluses. From 1991 to 2001Germany experienced current
account deficits. This was largely due to German reunification and the
resultant need to absorb more output domestically to rebuild the former East Germany.
Since 2001 Germany returned to its earlier pattern. What matters is the nature and causes of the
disequilibrium.
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Balances on the Current (BCA) and Capital (BKA) Accounts of Five Major Countries
Source: IMF International Financial Statistics Yearbook, 2000
-600
-400
-200
0
200
400
600
800
1980 1985 1990 1995 2000 2005
China BCA
China BKA
Japan BCA
Japan BKA
Germany BCA
Germany BKA
UK BCA
UK BKA
U.S. BCA
U.S. BKA
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End Chapter Three