INTERNATIONAL FINANCE LESSON 2

Balance of Payments Antu Panini Murshid Today’s Agenda   Balance of payments Review sustainability of current accounts Balance of Payments Accounts   The balance of payments is a comprehensive statement of a country’s economic transactions with the rest of the world for a given period of time—normally a quarter or a year It is composed of the current account and the capital account Current Account  The current account measures transactions associated with trade in goods and services, income from abroad and also transfers and gifts  Remember the current account is more than simply the balance of trade, which is a narrower concept Capital Account  The capital account measures financial transactions, such as purchases of bonds and equities or direct investment activities The Balance of Payments Must Balance    The current account and capital account should balance each other out Each international transaction gives rise to two offsetting entries one appearing in the current account and the other appearing in the capital account Thus a current account surplus is matched by a capital account deficit and a current account deficit is matched by a current account surplus The Change in Foreign Reserves  The change in foreign reserves refers to the sale and purchase of official reserve assets by central banks  Official reserves are foreign assets held by the central bank (usually as cushion against economic troubles) The Change in Foreign Reserves   The change in foreign reserves appears in the capital account, although sometimes people will separate this item from the capital account and refer to a “balance of payments deficit” (or surplus) Change foreign reserves = CA + KA Balance of payments Here “KA” refers to the non-reserve capital account Example Current Account Capital account Trade balance = -$90 billion Net private inflows = $80 billion Net factor income from abroad = -$10 billion Change in foreign reserves = -$20 billion Current account balance Capital account balance = -$100 billion = +$100 billion US Balance of Payments Accounts, 1999 Current Account Capital Account Merchandise Trade Balance -344.82 Capital Inflows (e.g foreign borrowing, receive + sign) 751.32 Trade Balance on Services 77.27 Capital Outflows (e.g US lending, receive a – sign) -421.13 Overall Trade Balance Net Foreign Income From Abroad Balance on Goods and Services and Income Net Unilateral Transfers (e.g foreign aid donations) Current Account Balance -267.55 Statistical discrepancy -24.78 Change in Official Reserves -292.33 Capital Account Balance -46.59 -338.92 17.45 -8.72 338.92 Sustainability of the Current Account  What factors affect the sustainability of a current account deficit?         Growth rate Composition of the current account Openness CA/GDP and debt burden Composition of capital flows Foreign exchange reserves Financial system Political stability ... donations) Current Account Balance -26 7.55 Statistical discrepancy -24 .78 Change in Official Reserves -29 2.33 Capital Account Balance -46.59 -338. 92 17.45 -8. 72 338. 92 Sustainability of the Current... Trade Balance -344. 82 Capital Inflows (e.g foreign borrowing, receive + sign) 751. 32 Trade Balance on Services 77 .27 Capital Outflows (e.g US lending, receive a – sign) - 421 .13 Overall Trade... Payments Must Balance    The current account and capital account should balance each other out Each international transaction gives rise to two offsetting entries one appearing in the current account