The Balance of Payments The Balance of Payments

The Balance of Payments

The Balance of Payments �Balance of Payments (BOP): a nation’s balance of payments measures all the economic transactions of its economy with the rest of the world o The balance of payments are the accounts in which a nation records its international trading, borrowing and lending �These transactions include, o Exports and imports of goods and services. o Interest and dividends received or paid abroad. o Remittances made by immigrants to their relatives back home.

�D � Every unit of a country’s currency spent on foreign goods and services, ultimately ends up being spent again on something from the country

Current Account �A nations balance of payments measures the exchanges that take place in three separate accounts, o Current account o Capital account o Financial account �Current Account (Balance of trade): measures the flow of funds between a nation and the rest of the world for the purchase of goods and services and income transfers. o The current account includes the visible (goods) and invisible (services) balance

�The balance of trade can be positive or negative, o Trade surplus (positive) o Trade deficit (negative) �The account includes four types of transactions: � 1) Balance of trade in goods: measure the spending by consumers and firms in one nations on another nation’s goods, as well as spending by consumers in the rest of the world on the recording nation’s goods o Exports (+): count as credit in the current account because they require that foreigners make payments to the exporting nation o Imports (-): spending by domestic consumers on goods produced in foreign nations count as a debit in the current account, since it requires payment to

� 2) Balance of trade in services: services refer to non- tangible purchases such as tourism, banking and consulting. Services can be imported and exported, although there is no movement of the product o Service credits (+): services bought by foreigners, either within the nation or from abroad, require a foreign consumer to make payment to a domestic producer and are a credit. • Example; Earnings from the tourist industry in Shanghai are credit in China’s current account because foreigners are spending on transport, accommodation and leisure services within China o Service debits (-): services purchased from foreigners and consumed by domestic households are a debit in the current account because they require a payment to a foreign producer � 3) Income balance: when citizens of one country earn income from activities within another country, the transfer of

o Net transfers payments: refers to the money sent by individuals working abroad, known as remittances, to their families back home. o Income credits (+): includes wages earned by a country’s workers employed abroad which are sent home, interest on a country’s resident’s savings and investments in foreign banks o Income debits (-): wages that are paid by firms in one country to foreign workers in that country and which are then sent abroad. � 4) Current transfer balance: transfers can come from governments or private citizens as a form of aid or payments such as a gift or grants o Transfer credits (+): official and private transfers from foreign governments or households to the government or individuals in a country

Canada’s Current Account

Capital Account �Capital account: records the transactions involving ownership of capital, forgiveness of debt, or the acquisition and disposal of intangible assets between a nation and all other nations o The capital account does not measure the purchase or sale of capital goods between nations, rather the actual transfer of fixed assets from one nation to another �The account includes three types of transactions, � 1) Capital transfers: when a nation’s government or private sector gives money to another nation for the purchase of fixed assets or directly donates capital goods to the residents of another country o Capital transfer credit (+): for the recipient country o Capital transfer debits (-): for the donor country

� 2) Debt forgiveness: the capital account measures the forgiveness of debt from lenders in one country to debtors in another o Debt forgiveness credit (+): debt forgiven by a lender in another nation o Debt forgiveness debit (-): lender’s in a nation forgiveness of debt in another country � 3) Exchange of intangible assets: flow of non-produced, non-financial assets such as patents, copyrights, franchises and the acquisition or disposable of land by government or international organizations

Financial Account �Financial account: measures the exchanges between a nation and the rest of the world involving ownership of financial and real assets o According to the International Monetary Fund (IMF) the financial account is the net change in foreign ownership of investment assets o The most important transaction on the financial account are associated with the buying and selling of stocks and bonds o The financial investments can be divided into two types of investment, portfolio investment and direct investment �Direct Investment: financial investment that gives the

�Foreign direct investment (FDI): refers to the buying and selling of a minimum 10% of a company’s shares by a foreign investor in the domestic economy or by a domestic investor in another nation’s economy �Direct investment is subdivided into two categories, � 1) Direct investment abroad: investors from one country may buy or sell ownership stakes in foreign firms o Credits (+): when domestic investors sell shares in foreign firms there is an inflow of financial capital o Debits (-): when domestic investors acquire an ownership stake in foreign companies there is an outflow of financial capital � 2) Direct investment at home: foreign investors may buy or sell ownership stakes in domestic firms

o Credits (+): when foreign investment in shares of domestic firms increases, there is a net inflow of financial capital o Debits (-): when foreigners sell their ownership stake in domestic firms to domestic investors, there is an outflow of financial capital �Portfolio Investment: financial investment (purchases of stocks and bonds) that does not give the buyer a controlling interest in the institution issuing the assets �There are two subcategories of portfolio investment, �Portfolio investment abroad: domestic investment in foreign firms or government is considered an asset to the home country and a liability to the foreign firm or government

o Debits (-): when domestic investors buy foreign assets, it requires a payment to the foreign stakeholder �Portfolio investment at home: the money spent by foreigners on domestic stocks, shares and bonds counts as a liability for the home country o Credits (+): a foreign investor buying domestic securities makes a payment to the home country o Debits (-): when a foreign investor sells his domestic securities, domestic firms or government must make a payment to the foreign investor �Loans from domestic banks to foreign borrowers and savings by domestic households in foreign banks count as an asset for the home country since foreign interest owe money to domestic interests and vice versa

Foreign Exchange Reserves �Foreign exchange reserves: refer to the assets of other nations held by a country’s central bank o Reserves consist primarily of foreign financial assets such as government bonds and foreign currency o If the flow of money into a country due to its exchanges in the current and financial accounts exceeds the flow of money out of the country, the difference is added to the official reserves o If there is a net outflow of money in a year, the difference is made up by a withdrawal from the central bank’s reserves of foreign exchange

Canada’s Capital and Financial Account

Balance of Payments Sum to Zero

Study Questions � 1. Prepare the balance of payments for the country whose international exchanges are shown in the table below Category Balance (Billions of $) Imports of goods & services 950 Import of goods & services 930 Income -130 Current transfers 70 Direct investment 40 Portfolio investment -80 Capital transfers 90 Transaction in intangible assets -25

� 1 b. Calculate the following balances • • • Current account Financial account Capital account Reserve assets Balance of payments � 1 c. Does the country have a trade deficit or surplus? Interpret the meaning of the current account balance for the nation’s households and firms. � 1 d. Describe how you determined the change in reserve assets and explain why this number is either negative or positive