Balance of Balance of Payments Payments AccountingAccounting

By Dr. Neelam Tandon By Dr. Neelam Tandon

The Balance of PaymentsThe Balance of Payments

• Recall the open economy accounting Recall the open economy accounting identity: Income = Expendituresidentity: Income = Expenditures

Y = C + I + G + NXY = C + I + G + NX• Trade Deficits imply NX< 0 Trade Deficits imply NX< 0 Therefore, Y- (C + I + G) = NX < 0Therefore, Y- (C + I + G) = NX < 0

Trade deficit countries are spending Trade deficit countries are spending more than they earn (borrowing from more than they earn (borrowing from the rest of the world)the rest of the world)

Balance of Payments Balance of Payments AccountingAccounting

• Anything that we buy or sell to the rest Anything that we buy or sell to the rest of the world must be paid for. of the world must be paid for.

• The current account (CA) tracks the flow The current account (CA) tracks the flow of goods and services between India of goods and services between India and the rest of the worldand the rest of the world

• The capital & financial account tracks The capital & financial account tracks the payments for those goods & the payments for those goods & services (KFA)services (KFA)

CA + KFA = 0CA + KFA = 0

The Current AccountThe Current Account• Any transaction that represents a flow of funds out of Any transaction that represents a flow of funds out of

India is represented by debit (-). Transactions that India is represented by debit (-). Transactions that represent a flow of money into India are represented by represent a flow of money into India are represented by a credit(+)a credit(+)• Net Exports of Goods and ServicesNet Exports of Goods and Services

Exports (+)Exports (+)Imports (-)Imports (-)

• Net Income From Abroad (NFP)Net Income From Abroad (NFP)Income Earned by Indian nationals abroad (+)Income Earned by Indian nationals abroad (+)Income earned by foreign nationals in India (-)Income earned by foreign nationals in India (-)

• Net Unilateral TransfersNet Unilateral TransfersPayments from foreign countries (+)Payments from foreign countries (+)Payments to foreign Countries (-)Payments to foreign Countries (-)

The Indian Current The Indian Current Account: 2006 (in Millions Account: 2006 (in Millions of Rs.)of Rs.)

Exports of Goods, Services, and IncomeExports of Goods, Services, and IncomeGoods:Goods: Rs. 713,122 Rs. 713,122Services: Services: Rs. 307,381 Rs. 307,381Income Receipts:Income Receipts:

Investment Receipts: Investment Receipts: Rs. 291,354 Rs. 291,354Employee Compensation:Employee Compensation: Rs. 3,031 Rs. 3,031

Imports of Goods, Services and IncomeImports of Goods, Services and Income Goods:Goods: - Rs. 1,260,274- Rs. 1,260,274Services: Services: - Rs. 256,337- Rs. 256,337Income Receipts:Income Receipts:

Investment Receipts: Investment Receipts: - Rs. - Rs. 252,573252,573

Employee Compensation:Employee Compensation: - Rs. 8,533- Rs. 8,533Net Unilateral Transfers:Net Unilateral Transfers: -- Rs. Rs. 67,43967,439Current AccountCurrent Account :: -- Rs.Rs. 530,668530,668

The Capital & Financial The Capital & Financial AccountAccount

• Again, any transaction that represents Again, any transaction that represents funds flowing into (out of) India are funds flowing into (out of) India are credits (debits) in the KFAcredits (debits) in the KFA• Financial assetsFinancial assets

Foreign acquisition of Indian assets (+)Foreign acquisition of Indian assets (+)

Indian acquisition of foreign assets (-)Indian acquisition of foreign assets (-)

• Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of Indian reserve assets (+)Foreign acquisition of Indian reserve assets (+)

Indian acquisition of foreign reserve assets (-)Indian acquisition of foreign reserve assets (-)

The Indian Capital & The Indian Capital & Financial Account: 2006 (in Financial Account: 2006 (in Millions of Rs)Millions of Rs)

Capital Account:Capital Account: - Rs. 3,079 - Rs. 3,079

Indian Owned Assets Abroad (Increase/Financial Outflow (-))Indian Owned Assets Abroad (Increase/Financial Outflow (-))

Indian Official Reserve Assets:Indian Official Reserve Assets: Rs. 1,523 Rs. 1,523 Indian Government Assets:Indian Government Assets: Rs. 537 Rs. 537 Indian Private Assets:Indian Private Assets: - Rs. 85,574 - Rs. 85,574

Foreign Owned Assets in India (Increase/Financial inflow (+))Foreign Owned Assets in India (Increase/Financial inflow (+))

Foreign Official Assets in India : Foreign Official Assets in India : Rs.248,573 Rs.248,573Foreign Private Assets in the India :Foreign Private Assets in the India : Rs.Rs.580,600580,600

Capital And Financial Account:Capital And Financial Account: Rs.542,680 Rs.542,680

CA + KFA = -Rs.530,668 + Rs.542,680 = -Rs.12,012CA + KFA = -Rs.530,668 + Rs.542,680 = -Rs.12,012

Balance of Payments Balance of Payments AccountingAccounting

• Consider three transactions:Consider three transactions:1)1) Wal-Mart buys $100M worth of clothing from a Wal-Mart buys $100M worth of clothing from a

Chinese Manufacturer. Wal-Mart pays for the Chinese Manufacturer. Wal-Mart pays for the clothing by writing a check drawn off its account clothing by writing a check drawn off its account at Bank of America.at Bank of America.

2)2) Warren Buffet collects $50M in interest Warren Buffet collects $50M in interest payments from his financial investments payments from his financial investments overseas. The Payment is made by crediting overseas. The Payment is made by crediting Warren’s bank account in London.Warren’s bank account in London.

3)3) Microsoft sells $20M worth of software to the Microsoft sells $20M worth of software to the French government. They pay in cash. French government. They pay in cash.

Balance of Payments Balance of Payments AccountsAccounts

Current AccountCurrent AccountExports Exports

Goods: Goods: Services:Services:

ImportsImportsGoods:Goods:Services:Services:

Net Factor Income: Net Factor Income:

Net Unilateral Transfers:Net Unilateral Transfers: CA Balance:CA Balance:

Capital & Financial AccountCapital & Financial AccountForeign acquisition of US assets:Foreign acquisition of US assets:

US Treasuries:US Treasuries:Private Securities: Private Securities: FDI: FDI: Currency: Currency:

US acquisition of foreign assets:US acquisition of foreign assets: FDI:FDI:Foreign Securities: Foreign Securities:

Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of US ORA:Foreign acquisition of US ORA:

US acquisition of foreign ORA:US acquisition of foreign ORA: KFA Balance:KFA Balance:

-$100M (1)-$100M (1)

$100M (1)$100M (1)

$50 (2)$50 (2)-$50 (2)-$50 (2)

$20M (3)$20M (3)

-$20M (3)-$20M (3)

-$30M-$30M

$30M$30M

Tsunami Relief AidTsunami Relief Aid

• President Bush recently authorized President Bush recently authorized $350M in aid for the Asian countries $350M in aid for the Asian countries affected by the Tsunami.affected by the Tsunami. • This will appear in the BOP accounts under This will appear in the BOP accounts under

unilateral transfers.unilateral transfers.• Assume we pay this transfer in cash (most Assume we pay this transfer in cash (most

likely we would pay by check)likely we would pay by check)

Balance of Payments Balance of Payments AccountsAccountsCurrent AccountCurrent AccountExports Exports

Goods: Goods: Services:Services:

ImportsImportsGoods:Goods:Services:Services:

Net Factor Income:Net Factor Income:Net Unilateral Transfers: Net Unilateral Transfers: --

$350M$350M

CA Balance:CA Balance: -$350M-$350M

Capital & Financial AccountCapital & Financial AccountForeign acquisition of US assets:Foreign acquisition of US assets:

US Treasuries:US Treasuries:Private Securities:Private Securities:FDI: FDI: Currency: Currency: $350M$350M

US acquisition of foreign assets:US acquisition of foreign assets: FDI:FDI:Portfolio Investment:Portfolio Investment:

Official Reserve AssetsOfficial Reserve AssetsForeign acquisition of US ORA:Foreign acquisition of US ORA:

US acquisition of foreign ORA:US acquisition of foreign ORA: KFA Balance: KFA Balance: $350$350

Balance of Payments and Balance of Payments and Exchange RatesExchange Rates

Should the Balance of Payments Accounts Should the Balance of Payments Accounts influence exchange rates?influence exchange rates? A BOP deficit (surplus) indicates that financial A BOP deficit (surplus) indicates that financial

assets flowing out of (into a) country. assets flowing out of (into a) country. Shouldn’t that indicate a currency Shouldn’t that indicate a currency depreciation?depreciation?

No really….the balance of payments is an No really….the balance of payments is an accounting statement. Given the pattern of accounting statement. Given the pattern of exchange rates, the BOP indicates the exchange rates, the BOP indicates the transactions that took place (Remember, by transactions that took place (Remember, by definition, BOP=0)definition, BOP=0)

The US BOPThe US BOP

The US is running record trade deficits The US is running record trade deficits due to over consumption (US domestic due to over consumption (US domestic savings is low and the government deficit savings is low and the government deficit is large)is large)

Unlike past years, this trade deficit is NOT Unlike past years, this trade deficit is NOT being financed by foreign private being financed by foreign private investment in the US, but rather by investment in the US, but rather by central banks purchasing US government central banks purchasing US government debt…..this is potentially troubling!debt…..this is potentially troubling!