Balance of Payments and International
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
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
A “credit” transaction leads to receipt of payments
from foreign entities.
A “debit” transaction leads to payment being made to
“sources” and “uses” of funds
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
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
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.
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-
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
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-
Long-term Capital: Maturities ≥ 1 year, e.g., direct
investment, portfolio investments, and loans.
Private flows are usually in the form of FDI and
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 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).
* 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
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
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
• 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
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
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.
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:
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
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
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
– Or current account surplus implies capital account
1. Present a fundamental case for free international trade or
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
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:
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
a. The current account and the capital account.
b. The merchandise trade account and the services
c. The income receipts and payments on assets
account and the unilateral transfers account.
d. The merchandise trade account and the capital
e. The long-term capital and short-term capital
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
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.