BALANCE OF PAYMENT

Module 1.3

Meaning of BOP

According to the Balance of Payments Manual, the balance of payments is

“a statistical statement that systematically summarizes, for a specific time period, the economic

transactions of an economy with the rest of the world”In other words

It is a measurement of all International economic transactions between the residents of a country and

foreign residents

For the purposes of the Balance of Payments, Residency relates to the economic territory of a country,

not nationality.

Purpose of BOP

To inform government authorities of the overall international economic position of the country in order to assist them in arriving at decisions on monetary and fiscal policy, on the one hand, and trade and payments policy on the other.

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Why BOP Account?

To monitor all international monetary transactions at a specific period of time. (Quarter, year end)

To know how money is coming in and how much money is going out of a country.

To evaluate the general competitiveness of the domestic industry

To set exchange rate or interest rate policies

To forecast a country’s market potential in the short run.

Fundamentals of BOP Accounting

The basic convention applied in constructing the balance of payments is the double-entry accounting system.

Every transaction is represented by two entries with equal values but opposite signs, a debit (−) and a credit (+).

All trades conducted by both the private and public sectors are accounted for in the BOP.

If a transaction involves receipt of money it is credit & if it involves payment it is debit.

Theoretically, the BOP should be Zero, but in practice there will be difference. This is the result of errors or omissions in the compilation of statements accounting for surplus or deficit.

BOP as a Flow Statement

Misconception of BOP as Balance Sheet BOP is a Cash flow statement It depicts the flow of purchases and

payments between the country and all other countries over a period of time.

It does not adds up the value of all assets and liabilities of a country on a specific date like a balance sheet does for an individual firm.

Business Transactions dominating the BOP

Two types of transactions dominate the BOP Exchange of Real Assets:

Exchange of goods (automobile. Computers, textiles etc) and services (banking services, consulting services, travel services) for other goods & services or for money.

Exchange of Financial Assets: Exchange of financial claims ( stocks, bonds,

loans, purchase or sale of companies) for other financial claims or money.

Classification of BOP Accounts The balance of payment accounts are

separated into 3 broad accounts:♦ Current account ♦ Capital account♦ Financial account

Classification of BOP Account

The current account includes all transactions between resident and non-resident entities that involve economic value.a. Goods and Servicesb. Income encompasses the compensation of employeesc. Current transfers cover transactions such as taxes on income, workers' remittances, and premiums and claims on non-life insurance.

Current Account

The Capital Account covers (i) capital transfers and (ii) the acquisition/disposal of non-produced, non-financial assets.

Capital Account

FinancialAccount

The Financial Account covers (i) direct investment, (ii)portfolio investment, (iii) other investments (trade credits, loans, currencies and deposits) and (iv) changes in reserves.12

BALANCE OF PAYMENTS CREDIT AND DEBIT TABLE

Credit Debit •Exports of goods and services•Income receivable from abroad•Transfers from abroad•Increases in external liabilities•Decreases in external assets

•Imports of goods and services•Income payable abroad•Transfers to abroad•Decreases in external liabilities•Increases in external assets

Balance of Payments credits denote a reduction in assets or an increase in liabilities; debits denote an increase in assets or a reduction of liabilities.

Problem No. 1 :Classify the following transactions into current, capital and financial a/c, net errors and omissions

(a) A German based pension fund buys U.S. government 30 year bonds for its investment portfolio.

Answer: Financial account: portfolio investment liabilities.

(b) Scandinavian Airlines System (SAS) buys jet fuel at Newark Airport for its flight to Copenhagen.

Answer: Current account: Goods: Exports FOB.(c) Hong Kong students pay tuition to the University of

California, Berkeley.Answer: Current account: Services: credit.(d) The U.S. Air Force buys food in South Korea to supply

its air crews.Answer: Current account: Goods: Imports FOB.

Problem No. 1 :Classify the following transactions into current, capital and financial a/c, net errors and omissions

(e) A Japanese auto company pays the salaries of its executives working for its U.S. subsidiaries.

Answer: Current account: Services: credit.(f) A U.S. tourist pays for a restaurant meal in Bangkok.Answer: Current account: Services: debit.(g) A Colombian citizen smuggles cocaine into the

United States, receives cash, and smuggles the dollars back into Colombia.

Answer: Net errors and omissions.(h) A U.K. corporation purchases a euro-denominated

bond from an Italian MNE.Answer: Does not enter the U.S. balance of payments.

Problem No. 2: Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved:

(a) A U.S. food chain imports wine from Chile.Answer: Debit to U.S. goods part of current account, credit to

Chilean goods part of current account.(b) A U.S. resident purchases a euro-denominated bond from a

German company.Answer: Debit to U.S. portfolio part of financial account; credit to

German portfolio of financial account.(c) Singaporean parents pay for their daughter to study at a U.S.

university.Answer: Credit to U.S. current transfers in current account; debit to

Singapore current transfers in current account.(d) A U.S. university gives a tuition grant to a foreign student from

Singapore.Answer: If the student is already in the United States, no entry will

appear in the balance of payments because payment is between U.S. residents. (A student already in the U.S. becomes a resident for balance of payments purposes.)

Problem No. 2: Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved:

(e) A British Company imports Spanish oranges, paying with Eurodollars on deposit in London.

Answer: A debit to the goods part of Britain’s current account; a credit to the goods part of Spain’s current account.

(f) The Spanish orchard deposits half the proceeds of its sale in a New York bank.

Answer: A debit to the income receipts/payments part of Spain’s current account; a credit to the income receipts/payments part of the U.S. current account.

(g) A London-based insurance company buys U.S. corporate bonds for its investment portfolio.

Answer: A debit to the portfolio investment section of the British financial accounts; a credit to the portfolio investment section of the U.S. balance of payments.

(h)An American multinational enterprise buys insurance from a London insurance broker.

Answer: A debit to the services part of the U.S. current account; a credit to the services part of the British current account.

(i) A London insurance firm pays for losses incurred in the United States because of an international terrorist attack.

Answer: A debit to the services part of the British current account; a credit to the services part of the U.S. current account.

(j) A California-based mutual fund buys shares of stock on the Tokyo and London stock exchanges.

Answer: A debit to the portfolio investment section of the U.S. financial account; a credit to the portfolio investment section of the Japanese and British financial accounts.

Problem No. 2: Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved:

(k) The U.S. army buys food for its troops in South Asia from venders in Thailand.

Answer: A debit to the goods part of the U.S. current account; a credit to the goods part of the Thai current account.

(l)A German automobile firm pays the salary of its business executive working for a subsidiary in Detroit. U.S.

Answer: Germany would record a debit in the income payments/receipts in its current account; the U.S. would record a credit in the income payments/receipts in its current account.

(m) An American tourist pays for a hotel in Paris with his American Express card.

Answer: A debit would be recorded in the services part of the U.S. current account; a credit would be recorded in the services part of the French current account.

Problem No. 2: Classify the following as a transaction reported in a sub-component of the current account or the capital and financial accounts of the two countries involved:

Thank you