Balance of Payments and International Economic Linkages Gross National Product

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					                     GEB 6365-03
       Balance of Payments and International
                Economic Linkages
Definition:
 The BOP is a systematic record of all economic
  transactions between the residents of the reporting
  country and the rest of the world during a given
  period of time, usually one year.
 An  international economic transaction involves
 the transfer of title or rendering of services from
 residents of one country to residents of another
 country.
 BOP   is based on the rule of double-entry book
  keeping in which entries on one side of the ledger are
  called “credits” and entries on the other side are
  called “debits”
A   “credit” transaction leads to receipt of payments
  from foreign entities.
A  “debit” transaction leads to payment being made to
  foreign entities.
               “sources” and “uses” of funds
 Alternatively,
 method of accounting can be used whereby:
   sources = credits = pluses
   uses = debits = minuses
 The   IMF is a primary source of BOP statistics.

 Multinational  corporations use various BOP measures
  to assess the growth and health of specific types of
  trade or financial transactions by country or by region.

 At national levels, monetary and fiscal policies take
  the BOP into consideration.

 Businesses use BOP data to anticipate changes in a
  country’s economic policies driven by BOP factors.

 Question: What are the current issues about US BOP
           position?
    In summary, the BOP account identifies transactions
     along functional lines.
One useful classification is:
a. Current Account: Merchandise, services,
   investment income, and unilateral transfers.
b.   Capital Account: Long-term capital & short-term
     capital.
c.   Official Reserve Account: Official reserve assets
     and foreign official assets.
d.   Net Errors and Omissions: used to account for
     statistical errors, illegal transactions, etc.
   Merchandise Trade:
    Consists of the export of merchandise: goods
    such as trucks, machinery, and computers, and
    the import of French wines, Japanese cameras
    and German automobiles.

   Services and Factor Incomes:
    Include such invisible items as military
    expenditures, travel and transportation, insurance
    premiums, interests and dividends, fees and
    royalties (factor income).
    Also includes wages and salaries paid to non-
    resident workers.
 Unilateral    Transfers: gifts and grants originating
     from both private and government.
1.   Private: Personal gifts, philanthropic activities,
     shipments by relief organizations.
2.   Government: Money, goods, and services to other
     countries.
 Capital  Inflow: Sale or export of domestic assets
  to foreigners = borrowing from ROW.
 Capital Outflow: Purchase or import of foreign
  assets by domestic residents = lending to ROW.
 NationalAccounts Statistics: record all
 expenditures that contribute to a nation’s income
 (GDI or GNI) and output (GDP or GNP)

 GNP:  Total market value of all final production
 with national factors.
 Includes national factors employed abroad and
 net income from work abroad.
 Excludes local production of foreign factors.

 GDP:  Total market value of final production
 within the borders of a nation = GNP less net
 receipts of factor income from ROW
 Capital Account: Loans, investments and transfer of
  fixed assets, such as real estates, and financial assets
  and creation of liabilities. …. FDI, portfolio
  investments and various long and short-term trade
  credits, cross-border loans, currency and bank deposits
  and other accounts receivable/payables related to cross-
  border trade.
 Long-term Capital: Maturities ≥ 1 year, e.g., direct
  investment, portfolio investments, and loans.
 Private flows are usually in the form of FDI and
  portfolio investments.
 Government (official) flows are usually loans, financial
  support in economic development projects overseas,
  subscription to various regional development banks.
 Short-term  capital: claims with maturity of < 1
 year, e.g., demand deposits, short-term loans, and
 short-term securities.

 Short-term capital may be:

 An accommodating adjustment induced by
 merchandise trade, service trade, unilateral
 transfer, or investment incomes.

 An autonomous adjustment attributable to interest
 rate differences among nations and expected
 changes in exchange rates (purely economic reasons).
     Account Balances:
* The Trade Balance:
    Records the balance on merchandise trade.

•   The Balance on Current Account:
    Indicates the balance on current spending.
•




 It   tells whether we are spending more abroad than
    foreigners are spending in our country (ignoring
    investment flows and accommodating flows).
    The most important types of transactions included are
    imports and exports of goods and services, net
    transfer payments and the payment and receipt of
    interests, dividends, and other investment incomes.
  The Basic Balance:
 Isthe sum of the balance on current account and
  the long-term investment account.
 Itindicates the extent to which autonomous long-
  term investments are affecting the balance of
  payments.
 When  a country is a net recipient of long-term
  investment funds, the basic balance should be
  more positive than the current account balance.
 Long-term  investment (net) flows may alleviate or
  aggravate the pressure on the domestic currency.
  The “Performance Balance”
 Provides a summary of all autonomous flows plus
  some accommodating transactions.
 It   is computed by adding short-term capital account to
    the basic balance.
    It therefore provides insights into the extent to which
    short-term investment flows are affecting the pressure
    on domestic currency.
    A negative performance balance means that additional
    accommodating transaction will be needed to meet
    payment requirements.
   A country's ability to execute accommodating transaction
    is limited to the availability of reserves.
    In the absence of reserves, governments may resort to
    restrictive measures on current and capital account
    activities
•   The Net Liquidity Balance:
    Includes the basic balance plus short-term private non-liquid
    capital balance, the allocation of Special Drawing Rights
    (SDR) and errors and omissions.
•   Errors and Omissions
    Theoretically, double entry bookkeeping should cause
    total credits to equal total debts when all accounts are
    taken together.
    However, because of recording errors and omissions this
    equality does not always hold.
    A special entry to make a nation's BOP "balance" is called
    the statistical discrepancy.
•   The Official Settlement Balance:
    Includes net liquidity balance plus the short-term private
    liquid capital balance.
    Exhibit: A typical BOP account for the U.S.
Accommodating transactions have two characteristics:

(a) They are undertaken by a government

(b) Their purpose is to finance a deficit or surplus in
    the BOP.

   However, not all international transactions conducted
    by the government are accommodating.

   Foreign aid is given for political or humanitarian
    purposes, not to finance BOP surplus or deficit,
    hence it is not accommodating.
    Portfolio Investment
   Purchase of Stocks, bonds, and other financial assets.
    The asset owner does not control the foreign firms

    Foreign Direct Investment:

 Takes place when real assets, e.g., land, factories,
 equipment are acquired in a foreign country.
 Also includes acquisition of stocks if control can be
 exercised by buyer.

    Check out current US international transactions at:
          http://www.economicindicators.gov
    External Debt.
   The oil shocks of the 1970s resulted in rapid
    increases in many African and Latin American
    countries' external debt.
 The   resulting debt crisis has greatly impacted the
    global financial system.
     – The Petrodollar Recycling

 Measures     of debt burden for a nation include:
 Debt   service ratio = ratio of interest + principal
    repayment to exports.
   Foreign Debt as a Percentage of GDP
 Whathappens when nation states default? e.g.
 Mexico in August 1982 followed by other nations.

  – Rescheduling (Restructuring) of Loans
  – The role of Money Center Banks
  – The IMF provides economic advice (and structural
    adjustment loans) to help countries solve debt
    problems.
    IMF actions have created controversies.
  – Larger debtor countries include Brazil, Mexico,
    Indonesia, Argentina, Turkey, Egypt, …
Question: Why are managers and investors
          interested in the BOP of countries?
   Helps forecast a country's market potential, especially
    in the short-run.
    A country experiencing a serious BOP deficit is not
    likely to import as much as if it were running a surplus.
   The BOP is an important indicator of pressure on a
    country's foreign exchange rate, unstable currency
    results in exchange gains or losses!
   Continuing deficit in a country's BOP may signal future
    controls on outgoing capital movements, such as
    payment of dividends, fees, interest on foreign
    investment.
 Continuing   surpluses in a country's BOP may indicate
  that country's strong international position, and
  therefore a potentially good location for an operating
  subsidiary, or portfolio investment.
   – Beware of resulting currency appreciation and loss
     of competitive advantage.
   – BOP deficits or surpluses can influence trade
     policies and currency values.
   – Counterpart to a current account deficit is a capital
     account surplus
   – Or current account surplus implies capital account
     deficit
  Discussions:
1. Present a fundamental case for free international trade or
   protectionism.
2. Many contend that “the sky is falling” in that the US has lost
   its competitive edge. US firms are ill-managed, US workers
   are under-trained, and foreigners are buying up the country.
   Policy implications … government worker retraining
   programs, subsidies to improve competitiveness, raise taxes,
   use protectionism, remove old managers …
3   Others insist that everything is wonderful! The US is the
    greatest economy in the world, foreigners love the
    business climate and they invest, US worker productivity
    continues to improve, foreigners sell us things cheaply to
    raise cash to invest in the US!
    Policy implications … let the good times roll! Minimize
    role of government, keep taxes low, encourage FDI …
4. Crisis in the horizon for the U.S. economy as the
   dollar continues to weaken and the budget deficit
   continues to grow.
A     falling currency may be a blessing or a curse.
    U.S. growing trade and budget deficits may lead to a
    crisis in which the dollar falls more sharply driving up
    interest rates and squeezing the economy.
 In a crisis, foreign investors dump stocks and bonds
  for fear that depreciating currency will cause further
  losses.
 Large current account and budget deficits (so called
  twin deficits) with little prospect of resolution, and a
  growing portion of those deficits financed with short-
  term borrowing from foreigners …. increase
  vulnerability to investors lack of confidence!
3.1 Tourism shows up in the:

         a.   Trade balance
        b.    Current account balance
        c.    Capital account balance
        d.    Both a and b
        e.    None of the above
3.2   The Purchase of U.S. Treasury Bond by a
      French Investor Shows upon U.S. BOP as a:

      a.   Credit on the trade account.
      b.   Credit on the long term capital account.
      c.   Debit on the current account.
      d.   Debit on short term capital account.
      e.   Credit on short-term performance balance.
3.3   If the U.S. ran a deficit of $150m on the current
      account in a year when the country was a net
      recipient of $250m in long term capital, then the
      basic balance would be:

           a.     $250m
           b.     $200m
           c.     $l00m
           d.     $400m
           e.     $50m
3.4   A Japanese investment in the U.S. represents a
      foreign factor of production located in the U.S.
      and the rent or income on such investment adds to

           a.    GNP of the U.S.
           b.    GDP of Japan.
           c.    GNP of Japan.
           d.    Current Account Balance of Japan.
           e.    Transfer payments of Japan
3.5   A country's holding of gold, special
       drawing rights, and internationally
      acceptable currencies comprise its:

       a.   Bank reserves.
       b.   Official reserves.
       c.   Secondary reserves.
       d.   Liquid reserves.
       e.   Loan reserves
3.6   A measure of value of production that
      occurs within a country's borders without
      regard to whether the production is done by
      domestic or foreign factors of production is
      commonly referred to as:

           a.   Gross National Product (GNP).
           b.   Net National Product (NNP).
           c.   Net Material Product (NMP).
           d.   Gross Domestic Product (GDP).
           e.   Balance of Payment (BOP)
3.7   The two main categories in the balance of
      payments are:

      a. The current account and the capital account.
      b. The merchandise trade account and the services
         account.
      c. The income receipts and payments on assets
         account and the unilateral transfers account.
      d. The merchandise trade account and the capital
         account.
      e. The long-term capital and short-term capital
         account
3.8. The debt/service ratio is:

    a. The ratio of debt to services income.
    b. The ratio of interest payments plus principal
       amortization to exports.
    c. Relatively low in the western hemisphere.
    d. Inversely related to a country's rate of inflation
    e. The ratio of debt to GDP
3.9   Visible Exports and Imports are:

      a.   The sum total of goods and services traded
      b.   Transactions paid for in money rather
           than barter.
      c.   Merchandise exports and imports.
      d.   Legal exports and imports rather than
           those involving smuggled goods.
      e.   Current account balances
 3.10. The _____ is a record of all international
  economic transactions between a nation and the
  rest of the world within a given period of time .

          a. Foreign Direct Investment
          b. Balance of Payments
          c. Official Reserves
          d. Gross National Product
          e. Gross Domestic product
   3.11 Analyze each of the following transactions
         indicating whether it generates a credit/debit
         and the US BOP account balance it affects.
1. The Chinese bought $45m worth of US beef.
2. An American bought a hotel in Japan for $55m
3. British investors bought $20m of US bonds.
4. Americans bought $40m worth of Iraqi oil.
5. Microsoft sold $32m worth of software to Mexico
6. Japanese visitors spent $5m at Orlando Theme Parks
7. The French invested $45m in US Certificates of Deposit
8. US residents gave $50m to their relatives in Mexico
9. SunTrust paid $5m in interest to Italian investors
10. US doctors received $10m in fees from Brazil.
    3.12 Discuss the effects of the following
          transactions on the US BOP.

1.   US Exports and Imports.
2.   The costs of transporting US exports and imports.
3.   The amount spent by Americans holidaying abroad.
     and amount spent by foreign visitors in the US.
4.   The amount spent servicing US overseas debt.
5.   US investments abroad/foreign investment in US.
6.   Income from US investment abroad.
7.   Interest paid on foreign investment in the US.
8.   US government’s international transactions.
Key:

3.1    b
3.2    b
3.3    c
3.4    c
3.5    b
3.6    d
3.7    a
3.8    b
3.9    c
3.10   b