BALANCE OF PAYMENTS
A RECORD OF ALL IN AND AOUTFLOWS IN A COUNTRY ARISING FROM
ECONOMIC ACTIVITY IN THE DOMESTIC AND FOREIGN SECTORS DURING A
VIGEN TIME PERIOD. The Balance of Payments (BOP) consists of the CURRENT
ACCOUNT and the CAPITAL ACCOUNT.
Current Account:
Shows all the money flows to and from a country arising from exports and imports or
Goods and Services, plus transfers of income and other net transfers.
If X > M, SURPLUS in Current Account
If X < M, DEFICIT in Current Account
Capital Account:
Records international borrow, lending, investment, and other transactions. Shows how
capital transfers flow to and from other countries.
A current account deficit means that there must be a net inflow in capital account.
CURRENT ACCOUNT CAPITAL ACCOUNT
EXPORTS: produce INFLOWS = CREDIT. Investment Abroad
IMPORTS: produce OUTFLOWS = DEBIT. Investment from Abroad
Change in Official Reserves
NET VISIBLE TRADE: Services Sold abroad
NET TRANSFERS: Foreign Aid Payments.
CURRENT ACCOUNT
Trade Balance:
Show the sum of visible export revenue minus the sum of visible Import expenditure.
A negative value is a Trade Deficit. (+ M) Imports are more than Exports
A positive value is a Trade Surplus (+X) Exports are more than Imports
INVISIBLE BALANCE: (Intangible goods)
Net flows in Services: (TOURISM, PROFESSIONAL SERVICES, TRANSPORT, etc.)
Net Flows in Income: (Wages, Returns of Investment, Profits of Firms, Interest payment)
Net transfers: (Subsidies from other Governments to locals, Transfers from donations
and remittances (presents, gifts to families, prizes, etc.), and Government transfers
(received and sent)...
CURRENT ACCOUNT BALANCE:
Is the sum of visible and invisible trade balances. If credit is more than debit, then there
is surplus in current account. If debits are more than credits, there is a deficit in current
account.
CAPITAL ACCOUNT (K)
If Capital Account is positive (+), assets of the country decrease.
If Capital Account is negative (-), assets of the country increase.
Direct Investment: A foreign firm building a plant or buying an existing factory in local
economy is FDI (Foreign Direct Investment). Credit in K account.
E.g.: if a foreigner buys land for raising cattle in local country, the capital account of the
local economy increases, due to the decrease of the asset: land.
Portfolio Investment: Buying stocks, shares, bills or bonds abroad or foreigners buying
local bonds, stocks, shares, bills, bonds, etc…
E.g. if a person buys bonds from a foreign country: The capital account of the local
economy decreases, but the assets increase (due to the bonds now in property of the
local citizen.)
Other financial flows: Savings Abroad. (Outflow of foreign currency $). Loans to
foreigners mean that K account is decreasing but there is an asset that is going to be
recovered in the future.
Foreign Reserves: are the foreign currency deposits held by Central Banks and
monetary authorities. These are assets of the central banks which are held in
different reserve currencies, such as the dollar, euro and yen, and which are
used to back its liabilities. E.g. the local currency issued.
Balancing item (or statistical error)
Parallel Markets
Illegal trade (not reported flow of capital, illegal trade, smuggling, etc.)
CAPITAL ACCOUNT BALANCE:
The sum of all investment and financial flows to and from a country during a time period.
A + Value shows a K account Surplus
A – Value shows a K account Deficit.
NOTE THAT BALANCE OF PAYMENTS SHUOULD BE ALWAYS IN EQUILIBRIUM:
BOP = 0
A deficit in Current Account has to be covered by a Surplus in the K account.
Example: The table shows the balance of payments for Julia, a college student. Julia is
very fortunate in several respects. First, because her parents are able to provide some
of the funds needed to finances her education. Second, she has a summer job with pays
well. Third, she was given some savings bonds when she was born that provide her with
some interest income every year. The left side of the table shows Julia’s income and
expenditures for a single year. This is her current account. The right part shows the
change in Julia’s assets over the same year. This is her capital account. (Note that the
capital account does not show the overall stock of assets. Only shows the changes in
the stock of assets during the year.) Julia makes 10,000 in her summer job. This
represents Julia’s exports to the rest of the world. (Earns this income by selling her
labour services to a restaurant outside the campus). Over the year, however, she
spends 17,000 on books, clothes, food, photocopying, tuition, haircuts, and other goods
and services. These are Julia’s “imports” from the rest of the world. She has a clear
trade ____DEFICIT_________ equal to 7000. She “imports” more than she “exports”.
There are also two other sources of income shown in Julia’s current account. First, she
earns 500 in interest income. Second, her parents give her 10,000 to help pay for her
education (a transfer) in the terminology of a balance of payments accounting. Julia’s
overall current account shows a surplus of ____3500__. This means that she receives
that amount more in total income than she spends on goods and services. But, where
does this surplus go?
Julia’s BALANCE OF PAYMENT
Current Account (Income and Capital Account (Changes in assets)
expenditure)
Labour Income (“exports”) + 10,000 Financial Assets:
Purchase of goods and - 17,000 Purchase of -1,500
services (“imports”) Canadian Savings
Bonds
Trade Balance (-7,000) Change in - 2,000
Savings Account
Deposits
Interest Income + 500 Capital Account - 3,500
Balance
Transfers (from her + 10,000
parents)
Current Account Balance: + 3,500
BALANCE OF PAYMENTS: 0
Consider Julia’s capital account. The 3500 surplus on current account must end up as
increase in Julia’s assets. She increases her holdings of Canada Savings Bonds by
1,500 and increases her saving account deposits by 2000. Note that since Julia must
make a “payment” to purchase these assets, they appear as a debit item in her capital
account. Julia’s capital account balance is a deficit of 3500.
Finally, note that Julia’s current account and capital account must sum to zero. There is
no way around this fact. Any surplus of income over expenditures (on current account)
must show up as an increase in her assets (or a decrease in her debts) on capital
account. Conversely, any excess of expenditures over income must be financed by
reducing her assets (or by increasing her debts). Julia’s balance of payments must
balance. What is true for Julia is true for any individual and also true for any accounting
unit you choose to consider. Any country’s balance of payment with the rest of the world
must balance.
EXERCISE:
BOP Schedule for the year: 2006
Local Economy: Canada / Foreign Economy: Europe
1. Mohammed who lives in Canada buys $2500 worth of cd of Andrea Boccelli latest
album produced in Italy.
2. Yeshey, Sharon and Winda went for vacations to Spain and spent $.500 in
restaurants, $250 in renting a car and $1250 in hotels in total. They flew in Canadian
Airlines, which is a local owned airline. Spend $ 3000 in total airline tickets.
3. In January, (your name :) ___________________ receives $9,500 from a partner
from Germany to start a medical clinic service in Canada.
4. Maalina and Kohei are studying at P.C. Canada, and receive $2500 each from the
European Youth Movement to support good students in Canada.
5. Quoc buys shares in the Swiss Steel company for $9000.
6. Tessa is in Canada and sends $1000 as a Christmas gift to Awa who is living in
Holland.
7. You send in July, $ 1000 to your partner in Germany as part of the profits made in the
medical clinic during the first term of the year.
8. Lawa sells $1000 worth of Canada’s black tea to the French tea shops.
Post the inflows and outflows of the balance of payment of Canada and Europe
describing if it is an export, import, Investment, transfer, payment of factor of production,
etc. I.E. transaction No. 1, current account = imports 2500 outflow Canada, inflow for
Europe as an export of goods and services.
CANADA / EUROPEAN UNION
Current Account Capital Account Current Account Capital Account
1. Merchandise 1. Merchandise
Import. (-2500) outflow Export. (2500) inflow
Balance of Payments in Canada: Balance of payments in E.U.:
SOLUCION
CANADA / EU
Current Account Capital Account Current Account Capital Account
1. Merchandise 1. Merchandise
Import. (-2500) Export. (2500)
outflow inflow
2. Service Import: 3. Foreign Direct 2. Service Export: 3. Foreign Direct
Tourism Services Investment (9,500) Tourism Services Investment (-9,500)
(-2000) inflow (2000)
4. Transfer Inflow 5. Investment 4. Transfer Outflow 5. Investment
(5000) abroad (-9000) (-5000) (9000) inflow
outflow
6. Transfer outflow: 6. Transfer inflow
remittances (-1000) (1000)
7. Profits paid 7. Repatriation of
abroad (-1000) profits (1000)
8. Merchandise 8. Merchandise
Exports (1000) Imports (-1000)
Balance of Payments in Canada: Balance of payments in E.U.:
$ - 500 +$ 500 $ 500 $ - 500